If you have a tax debt and can’t afford to pay in full, then you can set up an IRS installment agreement. The IRS installment agreement allows you to pay your taxes over a number of months or years and will keep the IRS from attacking your bank accounts and other assets.
To qualify for an IRS installment agreement, you must file all required returns and forms, must be current with your estimated tax payments, and if you are an employer, you must be current with your federal tax deposits.
So, if you have a tax debt, you need to get into compliance before the government will allow you to pay prior years taxes over time. Once your returns are filed, then you must make estimated quarterly payments for the current year or increase your withholding to ensure you won’t owe this year. If you do owe and can’t pay, the installment agreement will be voided and all of your hard work will have been wasted.
The primary purpose of the IRS installment agreement is to allow you to pay your tax debt in full over time. However, because the IRS has only 10 years to collect from you after the tax is assessed/return(s) filed, you might not need to pay the full amount. If the 10-year collection statute expires while you are in an installment agreement, the remaining balance is eliminated and you get a fresh start.
What You Need To Know
If you’re granted an IRS installment agreement that does not pay the balance in full before the statute expires, the IRS will review your account every two years to look for additional income sources. They will also compare future tax returns to the financial statement you submitted to determine if you can afford to pay more each month. Basically, you’ll be under constant review while in a partial pay installment agreement.
An IRS installment agreement costs $43 to set up and, if it’s voided, a $24 user fee will be assessed to reinstate. Of course, these fees are minimal compared to the time and effort (and legal fees if you hire a professional) an installment agreement on a large balance due will require.
Note that, if your IRS installment agreement request is approved, interest and penalties will continue to accrue and a tax lien will likely be filed to protect the government’s interests should you default. The lien will be required unless you can prove that it will cause you significant harm.
* In my experience, the only time the government doesn’t file a lien is when the debt will be paid in 12 months or the client had a clause in his employment contract that he will be terminated if he became subject to an IRS tax lien… usually someone in the financial or investment business.
Interest will accrue at around 7% to 8% per year and is at a variable rate. For the current interest rates, see www.IRS.gove. Late payment penalties will apply at 0.5% of the unpaid tax for each month or partial month you are late, up to 25%. If the IRS was forced to track you down, this penalty can be increased to 1% per month for a total of 50%.
If you recently filed your returns on April 15 with a balance due, you may be able to avoid the late payment penalty by paying in full, including interest, by October 15. In any event, if you are proactive with the IRS, you should be able to avoid the extra 25% late payment penalty… pay 25% in late penalties rather than 50%.
Most IRS installment agreements require you to complete a detailed financial statement, and provide supporting documents, using IRS Form 433-A. There are two exceptions to this requirement:
Guaranteed Installment Agreement
If you owe $10,000 or less of income tax (not including interest and penalties), you qualify for a Guaranteed IRS Installment Agreement without the need for a financial analysis or manager approval. You may request a Guaranteed Installment Agreement through www.IRS.gov if all of the following conditions are met:
- You owe income tax of $10,000 or less,
- You have filed and paid all tax returns that are due for the 5 years prior to the liability… which is to say, you only owe for the current year,
- You can’t immediately pay the liability,
- You can fully pay the liability over the next 3 years (including interest and penalties),
- You file and pay all tax returns during the term of the agreement, and
- You have not had an IRS installment agreement in the last 5 years.
This means that, if you can afford to pay off the debt in 3 years, you don’t need to hire a professional. You should simply go on to the website and get it done.
If you can’t afford to make significant payments, then you will be required to provide detailed financial information and might want to hire someone to at least review your 433-A before it goes in. In this case, you should consider being listed as uncollectible or placed on a partial pay installment agreement. I don’t often recommend an Offer in Compromise on such a relatively small balance due because of the effort and costs involved and that you would need to be (basically) destitute to qualify.
Streamlined Installment Agreement
If you owe $25,000 or less (including interest and penalties), you may qualify for a Streamlined IRS Installment Agreement. Again, this doesn’t require a financial statement or other supporting documentation. It does require you to be up to date on your filings and estimated payments or W-2 withholdings.
The streamlined agreement allows you to make payments over 60 months rather than 36 months… assuming the collection statute won’t expire in that time.
As with all installment agreements, you must keep up to date on your IRS filings and payments or the agreement will be voided and collection actions will resume.
I also note that the streamlined agreement is only available to individuals and businesses owing income tax or, if the business is closed, any kind of tax. This means that civil penalties don’t generally qualify for the streamlined agreement.
Help, I Owe the IRS Big Time
When you don’t qualify for either of the simplified IRS installment agreement programs, you are in for a battle. You must complete IRS Forms 433-A and/or 433-B (or IRS Form 433-F) and provide all kinds of supporting documentation. This often includes 3 to 6 months of bank statements, pay stubs, W-2s, and proof of most expenses (housing, automobile and utilities). Then, these expenses are compared to the allowed standards. Any expense that the collector deems is excessive or unnecessary will be disallowed.
Once your income and expenses have been reviewed and pared down, the IRS will expect you to hand over the difference (if any) each month. So, if your income after taxes is $5,000 and your allowed expenses are only $2,000, then you can “afford” to pay $3,000 per month to the government.
Note that many expenses will be denied out of hand. For example, the IRS won’t usually allow you to make payments to your credit cards or for any unsecured loans (such as loans from family). Your Uncle wants his cut off the top, no matter how it will damage your credit or business. You may need to deal with these bills before beginning to negotiate an IRS installment agreement.
There Are Two Categories
The Service has two categories for your expenses: Necessary and conditional. Necessary expenses are those which provide for you and your family’s health and welfare or for the production of income. These include (minimal) housing, an automobile to get to and from work, food, clothing, utilities, and current taxes. If you don’t have a job, or you have two cars and only one spouse works, then you may not be allowed an automobile expense.
Conditional expenses are those that are not necessary and are allowed only if the tax liability, including interest and penalties, will be paid in full within 5 years. If you can’t afford to pay off the IRS within 5 years, then you can request up to 1 year to reduce or eliminate your conditional expenses and get your necessary expenses in line with the standards.
If you’re not able to pay the debt in full and are requesting a partial pay IRS installment agreement, no conditional expenses will be allowed. As stated earlier, the government will be very tough on you if you are requesting a partial pay agreement.
One last comment on the IRS installment agreement. When only one spouse owes the great collector, the IRS is usually unable to collect from the innocent spouse. This occurs when you use the married filing separate return or one spouse is hit with a civil penalty.
When the “guilty” spouse goes to negotiate an installment agreement, the IRS will allow only a portion of the household expenses… usually calculated as a percentage of his contribution towards the total family income. For example, if the husband is the one caught in the IRS’s web, and he makes 45% of the total family income, he is allowed 45% of the family expenses. If the government says you’re permitted $3,000 per month in expenses, he will be allowed $1,350 of this and the IRS will want the rest. If he is earning $5,000 after taxes, he can afford an installment payment of $3,650 per month.
What if I Default on an IRS Installment Agreement?
You’ve been successful in negotiating an IRS installment agreement and now find you can’t afford it. This happens all the time… I believe because the collector pushes so hard on the taxpayer’s expenses that he or she has no safety net and no way to deal with changes in circumstances.
An IRS installment agreement will be revoked if:
- You miss or are late with a payment,
- You fall behind on other taxes due (miss an estimated payment or incur a new tax debt while in an installment agreement),
- You fail to give the IRS updated financial information when requested (usually applies to partial pay agreements where the IRS want to see if your finances have improved),
- You gave the IRS inaccurate or incomplete information when negotiating your installment agreement (note that lying on your financial statement can become a crime), or
- You refuse to pay a modified payment amount based on your updated financial information.
I hope this post on the IRS installment agreement has been helpful. I will conclude by noting that an installment agreement longer than 5 years is seldom a good deal. If you owe the IRS more than you can pay in 5 years, you should think about an Offer in Compromise or borrow to pay off the great collector.