Owing Uncle Sam: Options for paying federal income taxes

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Find yourself owing federal income tax to the government after agreeing to an audit adjustment or when filing your federal income tax return? Naturally, if you have the money, send the check and get it over with. If you're not liquid right now, here are some ways to pay.

Use your credit card

The first two companies listed below have contracts with the IRS and other government agencies. They have been processing millions of dollars worth of government credit card payments for about a decade. (The EFTPS program is a part of the U.S. Department of Treasury.) There are two advantages to using credit cards. The first is that you will have immediate proof of payment. The second is the bonus or mileage points you earn for those charges.
When using these services, the tax agency doesn't pay the merchant fees — you do. (Merchant fees are the costs the merchants normally pay for accepting your credit card.) These fees will generally cost about 2.5 to 5% of the taxes you pay. (They call it a "convenience" fee — that's for the convenience of the tax agency, not you.) Suppose you'd like to use your credit cards but don't want to pay online. Here are two other ways to use your credit cards.
  • Alternative 1: Use your credit card checks. Read the fine print. See what they are going to charge you. See if you can get a no-transaction-fee check. Remember to ask for reduced interest or 0% interest on the charge. You might still get your mileage points.
  • Alternative 2: Call your credit card company and request a cash advance to be deposited into your account. It will take a week or 10 days, so do it now. If you request it of your credit card company, you might get it without transaction fees — otherwise, expect to pay 2 to 3% of the amount charged. Look for a card that has a maximum fee. Beware. Some don't. Be sure to request low or 0% interest, and ask about the mileage points.

You can't afford to pay now, but will ultimately

If this is the case, there are three ways to go.
  1. File Form 9465, Installment Agreement Request. This is the method the IRS generally suggests if you are not able to pay your balance within 120 days. Think twice before requesting an installment agreement (IA). There are fees for an IA, which you will have to pay again and again if you default on the agreement. You may give the IRS your bank account numbers and to make payments by direct debit. In the past, the IRS has levied the bank account immediately when you were late. These days, the kinder, friendlier IRS gives you a chance to make good.
  2. Don't file the Installment Agreement Request. Send the IRS whatever you can afford with the first balance due letter. Save up and send money every time the IRS sends you a balance due notice. If you expect to have enough money to pay the balance off in about six to nine months, this may be a little cheaper and less invasive than requesting the IA. You'll still be paying interest on the penalties and taxes, but the interest is probably less than many credit cards.
  3. Borrow the money from family or friends. If they love you and trust you — and you're really reliable about paying them back — it's the best option. When you're a few days late, they won't be attaching your bank account. If you're going to flake out on the loan, though, don't borrow the money in the first place. You will destroy valuable relationships and trust. There are still other options.

When the balance is too large to pay off

The balance is so large that you're just never going to have the money. You're elderly and are living on a fixed income. You're insolvent. You can't even afford a bankruptcy attorney. You're not hiding any assets or money. If any of these are the case, call the IRS and tell them the truth. The IRS can put a special collections hold on your balance due and may periodically contact you to review the situation. Interest penalties may continue to accrue during this time. If you can never pay the balance, the debt may be permanently eliminated. There is generally a 10-year limit for the IRS to collect money from you after a tax debt is recorded. (Your state may have different limits, or no limits at all.) Some actions can stop that clock, but it's best if you get a good tax professional to help you determine where you stand when you're in that situation. It's also a good idea to have a tax attorney perform these computations.

Request an offer in compromise (OIC)

Suppose you aren't really insolvent, but the balance is just so unbearable that you feel beaten down by it. Perhaps you have a job or some sort of steady income from your business, but you'll never earn enough to pay all the taxes due. You may have a way out. The Offer in Compromise (OIC) Program might be able to help you. When you file an offer in compromise, you're asking the IRS to accept a fraction of what you owe on your taxes — and to write off the rest of your debt. But don't get carried away. There is no promise that your tax debt of $50,000 will get cut to $3,000.
The OIC myth. Seen or heard the offers of how some agencies can settle your claims for "pennies on the dollar"? The Internal Revenue Service has, and several years ago issued a consumer alert, advising taxpayers to beware of these claims. According to the IRS announcement, "This bad advice costs taxpayers money and time." An Offer in Compromise is an agreement between a taxpayer and the IRS that resolves the taxpayer's tax debt. The IRS has the authority to settle, or "compromise," federal tax liabilities by accepting less than full payment under certain circumstances.

Qualifying for an offer in compromise

Late-night television, radio, and even some daytime television commercials fill your ears with promises of tax miracles. You're probably getting lots of e-mail, too. After the IRS files a tax lien against you, your mailbox likely will be filled with solicitations from certain tax firms promising you quick resolution of your problems.
The truth is they may take far too much of your money — and not help you nearly as much as you'd expect. We suggest only using use firms when you can get a recommendation from someone you know who has used them successfully. Otherwise, go to your own tax professional to have them help you — or to ask them for a recommendation.
The IRS also offers a do-it-yourself kit. It's free. There's a Form 656 booklet that can be downloaded from the IRS's website. The IRS even provides workshops on filling in these forms. Check the IRS website at www.irs.gov or call them at 800-829-1040 to see if they are offering a workshop near you. Before you do all that, be sure you qualify.
What if you don't qualify for an OIC? Don't waste your time applying if you don't meet the IRS standards for applying. Here are some general parameters.
  • Ability to pay
  • Income
  • Expenses
  • Asset equity
Are you expecting a windfall? An inheritance? Or a great job about to start pouring money your way? Don't lie. That may be tax fraud and could lead to civil and/or criminal penalties.
Look at your own earning capability over the next five years. Even though it may be tight, if there's enough left over, by living within your means, the IRS will reject your offer. They won't wait while you pursue your dreams and live as a starving artist. They'll simply reject your offer in compromise.

What to do if you qualify for an OIC

Suppose you do qualify and are ready to prepare an OIC. Be thorough. Attach legible copies of all forms, bank statements, and bills requested by the IRS. Enclose three months' worth. If you're not willing to provide the IRS with this much information, don't even start the process. The IRS now requires a fee to be sent in with the application. So, you're wasting your money if you don't follow through.
The IRS reports that more than 80% of applications for offers in compromise are rejected as incomplete. Another 10% are rejected because people don't respond. If you simply attach everything and enclose anything else they want, you're already in that small minority that might get accepted. It is highly advisable to work with a competent tax professional who has a track record of getting OICs for their clients. It is a long, complicated process and having a pro who has gone through it can help. Since you must provide all the documents anyway, you can save yourself dozens of hours of billable time if you gather them all and organize them yourself.
The OIC process is slow and nerve-wracking. The costs? Even if you hire an ethical tax professional to deal with the IRS on your behalf, expect to pay for at least 10 to 15 hours, if you're organized and cooperative. If you must be chased down and hounded to get documents or if you just dump all your records on them and expect them to do all the work, you're back up to 20 to 40 hours.

This discussion is intended to represent a generic discussion of possible payment options when you owe money to the IRS. Your individual results may vary based on the specific facts and circumstances of your case. It is highly recommended that, as early as possible, you consult a tax advisor experienced in dealing with the IRS to discuss the specific options available to you.

This article is excerpted from Small Business Taxes Made Easy by Eva Rosenberg. Copyright © 2005 by The McGraw-Hill Companies.

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