Tax Bill too Big? IRS Offers Payment Options

If this year's tax filing deadline will be a "pay" day for you and you don't have the cash, the Internal Revenue Service gives you several payment options.

First, even if you can't pay your tax bill, go ahead and file your return on time. This way, you'll avoid the IRS' failure-to-file penalty of 5% per month (up to a maximum of 25%) of your balance due. You'll still face that penalty each month your bill is outstanding, but it's only 0.5% of the amount you owe.

Paying With Plastic

Now take a look at what you owe.

Some taxpayers find the easiest way to pay, either part of what they owe or their full tax bill, is with a credit card. The IRS has awarded contracts to three companies to accept payments by plastic: Official Payments, Link2Gov and WorldPay. They take American Express, Discover, MasterCard, Visa or debit cards.

Remember, while this may get you off the hook with Uncle Sam, it will cost you in other ways. Each company has its own fee schedule, with credit card fees ranging from 1.89% to 2.35% of your tax bill and debit card fees of nearly $4 per transaction.

If you pay a fee, make a note of it for next year's filing. The IRS has ruled that this amount will now be deductible as a miscellaneous itemized expense.

Keep in mind that if you don't pay off your credit card in full, you'll start racking up interest charges on your account. In some cases, though, your credit card interest charges might fall below IRS penalties and interest you'd owe if you don't pay on time.

So before you decide to pay with plastic, run the numbers so you don't pay anyone -- neither Uncle Sam nor your credit card company -- more than necessary.

Installment Plans

If your tax bill is too large for a credit card, the IRS will take monthly payments. You even get to pick your monthly payment amount and the day it will be due.

In fact, if you've previously filed -- and paid -- taxes on time, your tax bill is less than $10,000 ($25,000 for businesses) and you convince the IRS that you can't come up with that much all at once, the agency can't turn down your request. Your installment plan, however, must pay off the due tax in at least three years; businesses have just two years to pay. To get the program going, attach Form 9465, Installment Agreement Request, to the front of your tax return.

Financially strapped taxpayers also can use an installment plan to make partial payments of tax liability. The IRS previously had allowed partial installment payments but stopped the practice in 1998 when an IRS attorney raised questions about the IRS' authority to accept such payments without statutory authority. Congress officially granted the IRS the power to resume partial payment installment agreements as part of the American Jobs Creation Act of 2004.

While the IRS argued for legislative reinstatement of the partial-payment option, approval is not automatic. Taxpayers who request a partial-payment installment agreement must provide detailed financial information, including data on equity assets, that the IRS will verify. Plus, the IRS will review the arrangement every two years to determine whether the taxpayer's financial status has changed, and if it has improved, the amount of installment payments could increase or the agreement could be terminated.

Regardless of whether you pay your tax bill in full or partially via an installment agreement, keep in mind that paying over time, even to Uncle Sam, will cost you more. The IRS charges a one-time fee of $105 unless you arrange to have your installment payments made via direct debit from your bank account.

The fee drops to $52 for direct-debit agreements. Some lower-income taxpayers could pay a reduced fee of $43, which was the previous user fee for all installment agreement applicants.

You'll be billed for any fee when the agency sends you a notice detailing your payment terms. Plus, penalties and interest continue to accrue to your unpaid tax bill. The IRS may also file a federal tax lien against you, which will be released when you pay off your installment loan.

If you want to apply for an installment arrangement, the IRS now accepts online applications.

Let's Make a Deal

What if you can't pay off your tax bill, in whole or part, in three years or five years or even longer? Then it might be time to negotiate.

Changes issued in February make this option available to more taxpayers. Now, if your income is as much as $100,000 (up from $50,000) and your tax debt is less than $50,000 (previously, the tax bill limit was $25,000), you can request an offer in compromise, or OIC, from the IRS.

The IRS might be willing to accept your lump-sum payment offer of less than your total tax bill if it is realistic. In these cases, the agency hopes to get some taxpayer money sooner than it would after years of costly collection efforts.

The key here is that the amount must reasonably reflect your ability to pay. It's not merely haggling to get your tax bill reduced. In fact, the IRS is stepping up its efforts to weed out taxpayers who use the OIC route merely to delay paying their bills. Since Nov. 1, 2003, any taxpayer making a reduced payment offer has needed to include a $150 application fee with the request. The agency hopes this means that it will hear only from folks who truly need the negotiated bill.

The IRS will review your financial situation and future income potential to determine whether your offer is appropriate. Be warned, however. Uncle Sam says this program was designed only for extreme cases, and few filers will qualify for the program under the terms the IRS would like. If you believe your situation does indeed meet the requirements, you need to file two forms: Form 656, Offer in Compromise, and Form 433-A, Collection Information Statement.

You must also submit the $150 application fee along with Form 656-A, Income Certification for Offer in Compromise Application Fee and Payment. (The fee is waived for filers who have little or no income. They can claim a poverty exception when they file Form 656-A.) If you don't send this form along with your fee, the IRS will return your offer application "without further consideration."

If you submit everything as required, and the IRS determines you do not meet the qualifications and rejects your offer, you are out $150. But if the agency accepts your offer, your fee will go toward your new payment amount.

Then the IRS wants even more upfront. Your offer must include a 20% payment for lump-sum cash payment offers or your first installment payment if you're seeking a periodic payment plan.

The IRS also says it's willing to work with taxpayers who are having a hard time in this economy making their payments, tax or otherwise. The agency has created a special website with "what if" scenarios regarding tax and payment issues. The key is to call the IRS and let the agency know you need help meeting your tax obligations. If you just ignore your bill, the agency will continue to assess penalties and interest charges.

Regardless of which payment method you choose, make your decision now. Delay will only compound your financial and tax problems. And try to pay something. By sending in any amount when you file your return, at least you'll ultimately reduce your interest and penalty charges.