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Navigating Tax Debt – What to Do When You Can't Pay the IRS

Michael Reynolds | January 26, 2024

[Prefer to listen? You can find a podcast version of this article here: E209: Navigating Tax Debt – What to Do When You Can't Pay the IRS]

While taxes are always on our minds throughout the year, it’s especially prominent during tax season.

While you never want to have tax issues, sometimes it’s unavoidable. Maybe you had some unexpected events that led to large tax bills, or maybe you neglected to pay quarterly estimated taxes.

Whatever the reason, it can be stressful when you find yourself unable to pay the IRS. It's a situation no one wants to be in, but it's important to know that there are steps you can take to address the issue and find a solution.

First and foremost, it's important to remember that ignoring tax debt will only make matters worse. The IRS has various collection methods at its disposal, including wage garnishments and levies. You don’t want to ignore debts to the IRS.

By taking proactive steps, you can mitigate the potential financial consequences and work towards resolving your tax debt.

If you're feeling overwhelmed and unsure of what to do next, don't worry – you're not alone. It happens to many of us and there are options for resolving tax debt.

Understanding tax debt and its consequences

Tax debt is an uncomfortable reality that many individuals face. It happens when you owe the IRS more money than you can afford to pay.

As mentioned before, you always want to prioritize tax debt.

When the IRS realizes that you have outstanding tax debt, they will send you a notice demanding payment. This notice will outline the amount you owe, including any penalties and interest that have accrued.

It's essential to take this notice seriously and not ignore it. Ignoring the notice will only worsen the situation and make it more difficult to resolve your tax debt.

I’ve seen way too many people ignore IRS notices and let tax debt pile up and then things are much harder later on.

Ignoring debt owed to the IRS can have several significant consequences:

  • Penalties and Interest: The IRS charges penalties and interest on unpaid taxes. These can add up quickly, increasing the total amount you owe.
  • Tax Liens: The IRS may place a lien on your property. A federal tax lien is a legal claim to your property, including property that you acquire after the lien arises. This can affect your credit score, making it difficult to get loans or credit.
  • Tax Levies: The IRS may levy, or legally seize, any type of real or personal property that you own or have an interest in. For instance, the IRS could seize and sell property like vehicles, boats, or real estate. They could also levy property that is yours but is held by someone else (like your wages, retirement accounts, bank accounts, rental income, accounts receivables, the cash loan value of your life insurance, or commissions).
  • Refund Offset: If you are due a refund from the IRS, they may use it to offset your unpaid taxes.
  • Passport Revocation: For significant tax debt, the IRS can certify your debt to the State Department, which can then deny your passport application or renewals. In some cases, they may even revoke your current passport.
  • Criminal Charges: While rare, in cases of tax evasion or fraudulent filing, criminal charges can be filed, which could lead to fines and imprisonment.
  • Impact on Social Security Benefits: Unpaid taxes can lead to a portion of your Social Security benefits being levied.
  • Impact on Business: If you're a business owner, unpaid taxes can lead to seizure of business assets, and your ability to operate your business could be impacted.
  • Professional Consequences: Certain professions may have clauses in their contracts or codes of conduct regarding the fulfillment of legal obligations, including tax payments. Non-compliance could affect your professional status or licensure.
  • Personal Stress and Financial Strain: Constant worry about unresolved tax debt can lead to personal stress. Financial planning and credit are also adversely affected.

Ignoring the problem usually leads to more severe consequences over time.

Common reasons for tax debt

There are several common reasons why folks find themselves unable to pay their tax debt. Some of these reasons include:

  • Financial Hardship: Unexpected financial difficulties, such as a job loss, medical expenses, or a business downturn, can make it challenging to meet your tax obligations.
  • Underestimating Tax Liability: Failing to accurately estimate your tax liability or not setting aside enough money for taxes can leave you with a hefty tax bill that you can't afford to pay.
  • Tax Return Errors: Mistakes on your tax return can result in an audit or additional taxes owed, leading to tax debt.
  • Self-Employment Taxes: Self-employed individuals often face difficulties with paying their quarterly estimated taxes due to the complexity of self-employment tax calculations and the absence of an employer withholding the taxes on their behalf.

Understanding the reasons behind your tax debt can help you address the root causes and make better financial decisions moving forward.

Steps to take when you can't pay the IRS

When you find yourself unable to pay the IRS, taking immediate action is crucial. Here are some steps you should consider:

  • Review Your Finances: Take a comprehensive look at your financial situation, including your income, expenses, and assets. This analysis will help you determine how much you can realistically pay towards your tax debt.
  • Communicate with the IRS: Contact the IRS as soon as possible to let them know about your situation. Ignoring their notices will only make matters worse. Explain your financial hardship and explore the options available to you.
  • File Your Tax Returns: Even if you can't pay the full amount owed, it's essential to file your tax returns on time to avoid additional penalties. Filing your returns will also help you gain a clearer understanding of your overall tax debt.
  • Consider Professional Help: If you find the process overwhelming or don't know where to start, it may be beneficial to seek professional help from a tax attorney, enrolled agent, or certified public accountant (CPA). These professionals specialize in tax matters and can guide you through the process.

Taking these initial steps will set the foundation for resolving your tax debt and finding a solution that works for you.

Communicating with the IRS

When communicating with the IRS, it's important to be honest, transparent, and prompt. Here are some key points to consider:

  • Keep Records: Maintain detailed records of all your communication with the IRS, including dates, names of representatives, and any agreements or resolutions reached.
  • Respond Promptly: If the IRS requests additional information or documentation, respond promptly. Delaying or ignoring their requests can lead to further complications.
  • Be Honest About Your Financial Situation: Provide the IRS with accurate information about your income, assets, and expenses. This will help them assess your ability to pay and determine the best course of action.
  • Ask for Clarification: If you don't understand something or need clarification, don't hesitate to ask. The IRS representatives are there to assist you and provide guidance.

By maintaining open and transparent communication with the IRS, you can work towards finding a resolution that suits your financial circumstances.

I want to stress that the IRS is easier to work with than most people think. As I’ve worked with clients in these situations, the overwhelming majority of them have shared that the IRS has demonstrated a strong desire and willingness to be flexible and create a payment plan that works for them.

Options for resolving tax debt

The IRS offers several options for individuals and businesses struggling with tax debt. Here are some of the most common options:

Setting up an Installment Agreement

One option available to those unable to pay their tax debt in full is to set up an installment agreement with the IRS. An installment agreement allows you to pay off your tax debt over time in smaller, more manageable monthly payments. This can provide relief by spreading out the financial burden and giving you the opportunity to catch up on your tax obligations.

To set up an installment agreement, you will need to submit Form 9465, Installment Agreement Request, to the IRS. This form requires you to provide details about your financial situation, including your income, expenses, and assets. The IRS will review your application and determine whether you qualify for an installment agreement. If approved, they will outline the terms of the agreement, including the amount you need to pay each month and the length of the agreement.

It's important to note that while an installment agreement can provide temporary relief, you will still be responsible for paying any interest and penalties that accrue during the repayment period. Additionally, if you default on the agreement, the IRS can take further collection actions against you.

Offer in Compromise: Negotiating a Settlement

Another option to consider when you can't pay the IRS is applying for an offer in compromise (OIC). An offer in compromise is a settlement agreement that allows you to pay a reduced amount to settle your tax debt. It's a potential solution for those who are unable to pay their tax debt in full or would face financial hardship by doing so.

To apply for an offer in compromise, you will need to submit Form 656, Offer in Compromise, along with detailed financial information to the IRS. This form requires you to disclose your income, expenses, assets, and liabilities. The IRS will review your application and consider factors such as your ability to pay, income, expenses, and asset equity. If approved, they will accept your offer and you will be required to pay the agreed-upon amount.

It's important to understand that applying for an offer in compromise does not guarantee acceptance. The IRS carefully evaluates each application and will only accept an offer if they believe it represents the maximum amount they can expect to collect from you. Additionally, there is a non-refundable application fee and you may need to make an initial payment towards your offer.

Applying for a Temporary Delay or Hardship Status

If you're facing financial hardship and are unable to pay your tax debt, you may be eligible for a temporary delay or hardship status. This option allows you to temporarily suspend collection activities while you work towards improving your financial situation.

To apply for a temporary delay or hardship status, you will need to contact the IRS and explain your financial hardship in detail. This could include evidence of unemployment, medical expenses, or other extenuating circumstances that prevent you from paying your tax debt. The IRS will review your situation and determine whether you qualify for a temporary delay or hardship status.

It's important to note that a temporary delay or hardship status is not a long-term solution and does not eliminate your tax debt. It simply provides temporary relief from collection activities, giving you time to improve your financial situation. During this period, it's crucial to explore other options, such as setting up an installment agreement or applying for an offer in compromise, to address your tax debt in the long term.

Seeking professional help for tax debt

Navigating tax debt can be complex and overwhelming, especially when you're unsure of the best course of action. That's why it's important to seek professional help when dealing with tax debt issues. Enlisting the services of a qualified tax professional, such as a tax attorney or certified public accountant (CPA), can provide valuable guidance and expertise.

A tax professional can help you understand your options, navigate the IRS processes, and negotiate on your behalf. They will review your financial situation, assess the best strategy for addressing your tax debt, and ensure that you're taking advantage of any available tax credits or deductions. Additionally, they can help you avoid common pitfalls and ensure that you're in compliance with tax laws.

When selecting a tax professional, it's important to choose someone with experience in dealing with tax debt issues. Look for professionals who specialize in tax resolution and have a track record of successfully helping clients navigate through tax debt problems. Be sure to ask for references and thoroughly research their credentials before making a decision.

Conclusion and proactive measures to avoid future tax debt

Navigating tax debt when you can't pay the IRS can be challenging, but it's important to remember that there are options available to help you address the issue. Whether it's setting up an installment agreement, applying for an offer in compromise, or seeking a temporary delay or hardship status, taking proactive steps can mitigate the potential financial consequences and help you work towards resolving your tax debt.

However, it's equally important to take proactive measures to avoid future tax debt. Here are some steps you can take to stay on top of your tax obligations and minimize the likelihood of finding yourself in a similar situation in the future:

  • Keep accurate records: Maintaining organized and accurate records of your income, expenses, deductions, and credits can help ensure that you're properly reporting your taxes and minimizing the risk of errors or omissions.
  • File your taxes on time: Make it a priority to file your taxes on time each year. Failing to do so can result in penalties and interest, which can add to your tax debt burden.
  • Pay estimated taxes: If you're self-employed or have income that is not subject to withholding, consider making estimated tax payments throughout the year. This will help you avoid owing a large sum at tax time and potentially facing a tax debt.
  • Seek professional advice: Consulting with a tax professional can provide valuable insights and guidance on tax planning strategies that can help you minimize your tax liability and avoid future tax debt.

By taking these proactive measures, you can avoid the stress and financial burden of tax debt and maintain your financial stability.

When you find yourself unable to pay the IRS, it's crucial to take proactive steps and explore the options available to you. Setting up an installment agreement, applying for an offer in compromise, or seeking a temporary delay or hardship status can provide relief and help you work towards resolving your tax debt. Additionally, seeking professional help and taking proactive measures to avoid future tax debt are key to maintaining your financial stability.

Don't ignore the problem! This always makes it worse.

Remember, you're not alone – there are resources available to guide you through the process and help you navigate tax debt responsibly.