What to do if you can’t pay your taxes: consequences and potential options

While every American living abroad or stateside has to file an Individual Tax Return and pay the taxes they owe, millions don’t. In 2022, for example, 40% of all US households paid no income tax whatsoever.

Of course, you have to get down to brass tacks before making sweeping generalizations about the reasons behind it. Very few Americans willingly plan to avoid paying taxes. Some might find it hard to file a return themselves so don’t pay on top of not filing. Others have cash flow issues, i.e. no money to send to the IRS (Internal Revenue Service) on April 15th.

However, it’s never a good idea to avoid paying your taxes, even if you didn’t file your tax return on time. The IRS is the worst creditor to have, and they possess a number of tools in their arsenal to collect what they are owed. 

In this article we’ll go over what happens if you can’t pay your taxes: the options you’ve got and the penalties you might face.

What should you do if you can’t pay your taxes?

You should still file your return on time, even if you can’t pay. It’s the most important thing you ought to do. You can also file Form 4868 instead of the usual 1040. The former allows you more time — until October 15th — to file your return.

However, filing and paying what you owe are two separate things. Form 4868 doesn’t give you an additional 6 months to pay, only more time to file. Filing on time is important to avoid being hit with a failure-to-file penalty. It stands at 5% of the tax you owe — monthly — and can reach a maximum of 25%.

On top of filing on time, you should pay whatever you can to the IRS, as a further sign of goodwill.

 Additionally, there are several options available to you if you can’t pay right now: 

• Request a payment extension.
• Apply for a payment plan.
• Take out a personal loan.
• Arrive at an offer in compromise.
• Prove a “currently not collectible” status.

The IRS payment options

A payment extension

As we said, this is quite separate from an extension to file. You can delay your tax payment by up to 6 months using Form 1127 — but you’ll have to prove undue hardship.

Along with the form you’ll need to submit a list of all your current assets and liabilities, as well as an itemized statement of all the money you’ve spent and received in the previous three months.

A payment plan

There are two options: a short-term plan and a long-term one. 

A short-term payment plan covers up to 120 days during which you have to pay the taxes you owe. You also have to owe less than $100,000 in taxes, with interest and penalties factored in.

A long-term payment plan is also known as an installment agreement. This plan can give you an additional 72 months to pay, but you have to owe less than $50,000 in taxes, interest, and penalties.

Finally, if you owe more than $50,000 to the IRS you apply for a non-streamlined installment agreement. You’ll also have to prove that the usual installment agreement doesn’t work for you: For example, because it doesn’t run long enough for you to pay everything back.

A personal loan

A popular option is to pay back the IRS. You can take out a loan from a bank or a credit union, and the upsides are clear: fixed interest rates, fixed monthly payments, and a set repayment plan. Many personal loans are also unsecured, meaning you don’t have to put up any collateral. Do keep in mind you’ll need a high enough credit score to qualify for a personal loan.

An offer in compromise

In essence, you tell the IRS you can pay a certain amount of taxes in a lump sum — but the number is lower than the one indicated on your tax return. It’s a settlement of sorts, where you promise to pay your taxes going forward to incentivize the IRS to write off some of the taxes you owe right now. Offers in compromise can take a long time to reach, however — and not everyone is granted one.

A “currently not collectible” status

This is where you prove to the IRS that you cannot pay right now due to your financial circumstances. However, it doesn’t mean you’ll never have to pay: The IRS will review your status on an annual basis and if they decide that your situation has improved, they’ll expect you to start paying.
A few other things to keep in mind if you apply for the “currently not collectible” status:

• The IRS might ask you to provide proof of your financial status (assets, income, and expenses).
• The IRS might place a lien on your assets (more on what it means below).
• The interest and penalties will continue to add up while you are in a CNC status.

Consequences of ignoring tax debt

Even if you get an extension to file, you still need to pay the taxes you owe by April 15th. If you don’t, you’ll be hit with a failure-to-pay penalty + interest on it.
The failure-to-pay penalty stands at 0.5% of the sum you owe — monthly. It can add up to an additional 25%. The current interest rate is 8%. The federal short-term rate is used to calculate it.

If you also fail to file on time, you are hit with a respective fine of 5% per month. When both penalties are applied, the smaller (failure-to-pay) is subtracted from the latter (failure-to-file), so the total percentage doesn’t go above 5% monthly.

At some point, you’ll get a government letter demanding you pay your taxes. If you ignore that too, the IRS will likely soon issue a federal tax lien. In short, it is a legal claim on any assets — business and personal — that you have. A lien is a matter of public record, so you might have problems getting credit at a bank or selling your home for a good price.

Finally, the IRS can issue a levy. A lien is simply a claim on your property but a levy is the actual seizure thereof. It’s a powerful tool: it allows the IRS to withdraw money from your bank account, withhold money from your paycheck, and collect and sell your property, such as your house and car.
However, these four requirements should be met before a levy kicks into gear:

• The IRS sends you a Notice and Demand for Payment.
• You ignore it.
• The IRS sends you an Advanced Notice of Intent to Levy (30 days before it comes into force).
• The IRS sends you advanced notification of Third Party Contact: that they contacted a third party about collecting your property.

One final step the IRS might take is pressing criminal charges for tax evasion. However, it is extremely rare: This measure is only resorted to in extreme cases where people owe exorbitant amounts of money.

Penalty relief opportunities

If you are hit with a penalty for failure-to-pay, don’t panic yet. You might qualify for relief on one of three possible grounds: first time abate, reasonable cause, and statutory exception.

First time abate

In short, you should have a good history of tax compliance to qualify for the first time abate relief. According to the IRS, that constitutes:

• You filed your taxes on time for the last three years.
• You didn’t receive any penalties for the last three years — or they were later removed for a reasonable cause.

You can request penalty relief even if you haven’t yet paid your tax in full. In that case, the penalties will be removed up to the point where you alerted the IRS to this. However, they will continue to accrue, along with interest, until you pay taxes in full. Once you do that, contact the IRS again to remove them.

Reasonable cause

You might qualify for reasonable cause relief if you demonstrate that you showed all the reasonable care and prudence, yet were unable to file or pay on time — largely due to causes beyond your control. These might include:

• fires, natural disasters or civil disturbances
• inability to get records
• death, serious illness, or unavoidable absence of yourself or your close family
• issue with e-filing

Do keep in mind that causes that appear reasonable to you might not appear this way to the IRS. These include:

• reliance on a tax professional
• lack of knowledge
• mistakes and oversight
• lack of funds

Statutory exception

You probably can name at least one reason off the top of your head: natural disaster. The IRS grants relief to taxpayers living in federal disaster areas almost every year — check their website to see if you might qualify. Other reasons include:

• receiving — and relying — on incorrect written advice from the IRS
• mailing a return on time
• being a member of the military in a combat zone

Conclusion

Owing money to the IRS is never fun — but it’s not the end of the world if you don’t ignore the problem. If for some reason you can’t pay your taxes by April 15th, the least you can do is file your return on time — or get an extension to file. You should also aim to pay what you can, even if it’s not the entire sum.

After that, you have options on how to pay. These include requesting an extension, applying for a payment plan, taking out a loan, arriving at an offer in compromise, or proving a “currently not collectible” status.

Whatever you choose, don’t ignore the IRS and your obligation to pay taxes. Otherwise, you might be hit with financial penalties, face a federal lien or levy on your assets, and even risk jail time. 
Keep in mind you might also qualify for penalty relief opportunities if you have a good history of tax compliance, can demonstrate reasonable cause for not paying, or fall under one of the possible statutory exceptions.

If you think you might find yourself unable to pay taxes come April — and the tax landscape is too complicated to navigate on your own — drop us a line. We’ll review your case, recommend possible solutions, and even talk to the IRS on your behalf.