What to do if you are facing serious tax debt

By Andrew Housser
The U.S. federal income tax filing deadline of April 17, 2012, is just days away. Taxpayers who find that they cannot pay their income tax debt due need to know what they should do to manage their situation.
In 2009 (the most recent data available), U.S. residents filed more than 140 million federal income tax returns. In 2010, more than 10 million accounts were delinquent -- 7 percent of all accounts. These taxpayers owed more than $114 billion in taxes, penalties and interest. Also in 2010, the IRS served notices of levies (a key enforcement tool in which the IRS takes possession of assets to collect on unpaid tax) on 3.6 million cases. On another 1 million accounts, they filed liens, which can mar credit scores.
If you owe taxes, it is extremely important to communicate with the IRS and take action to resolve the tax debt. Otherwise, serious legal and financial problems can result. Depending on how much they owe, and individual circumstances, taxpayers have several different options for tax bills they cannot pay:
1. File a return.
If you do not file a return at all, you are likely to add significantly to your tax debt. The IRS can ask you to take steps to pay your debt, including selling or mortgaging property or getting a loan. The IRS also can levy bank accounts, wages or other income. As well, the IRS can file a substitute return for you. This return is unlikely to include all exemptions or deductions, so it is important to file your own return.2. Double check your math -- and get a second opinion.
If you complete your return, and owe a panic-inducing amount, first double-check all your numbers. Review financial information to identify deductions you might have missed. Consider steps to reduce taxes, such as contributing to a tax-advantaged account. If you have not consulted an accountant, consider doing so to see if he or she can identify any other ways to help lower the bill.3. Be aware of penalties.
Filing late incurs penalties of 5 percent of the tax due on a return per month, to a maximum of 25 percent. In addition, late payments accrue monthly interest at 0.5 percent of the unpaid amount each month, plus interest on the balance owed. Filing one year late could add up to 38 percent to the original amount owed. You can file an extension, but taxes owed are still due April 17. If paying would create "undue hardship," it is possible to request a six-month payment extension, but be aware that the IRS only offers extensions in very selected cases.4. Find alternative payment methods.
If you can pay by using a credit card or a loan, borrowing from friends or family, or liquidating some savings or investments, it often can be less costly to do so than to pay IRS penalties.5. Contact the IRS directly.
Taxpayers who absolutely cannot pay taxes should contact the IRS. Agency policies may reduce penalties for taxpayers who do so, or who pay a late bill voluntarily. After being contacted by a taxpayer, the IRS also may waive penalties because of extenuating circumstances such as a death in the family, serious illness, financial records lost in a natural disaster, or reason the IRS deems "reasonable cause."6. Apply for an installment agreement.
Taxpayers who owe up to $25,000 can pay the amount due in monthly installments. Along with the tax return, attach Form 9465 (Installment Agreement Request), or complete the Online Payment Agreement application. Setting up the agreement costs $105, or $52 if the taxpayer signs up for direct withdrawal from a bank account. At the time of application, state the amount of the proposed monthly payment and a proposed monthly payment date. The agreement will accrue interest plus a late payment penalty on the unpaid taxes for each month, or part of a month, after the due date that the tax is not paid.
7. Consult a specialist.
Taxpayers who owe more than $10,000 will benefit from professional help. Tax relief specialists can negotiate directly with the IRS on the consumer's behalf to help them obtain a settlement. These advisors can help obtain one of two types of IRS settlement, depending on the severity of an individual's situation: An offer in com­promise reduces the principal amount owed to the IRS. An installment agreement is a payment plan for the amount due, and often includes a reduction in penal­ties. In 2010, the IRS accepted just over one-fourth of the offers in compromise that were submitted, so it is important to submit the best offer possible and work with a tax relief specialist with a proven, excellent success rate.
8. Be cautious about planning on bankruptcy.
Historically, consumers in severe tax debt might file for Chapter 7 bankruptcy protection or try to wait for the 10-year statute of limitations on tax liability to expire. However, the 2005 bankruptcy reform law significantly limited the ability to obtain Chapter 7 filings. The bill's "means test" requires many consumers to file Chapter 13 bankruptcy, which establishes a repayment plan rather than wiping out all debt. If tax debt is the primary problem, taxpayers are better off consulting a tax relief specialist. This step also will avoid a bankruptcy judgment on the credit record.
You cannot hide from the IRS. No matter how much tax debt you have, the best route is to face your responsibilities and resolve your issues to achieve peace of mind in tax season and throughout the year.