What to Do When You Owe Back Taxes

File your tax return

It's important to file your tax return even if you know you can’t pay the taxes owed. Not filing will generate additional fees. The failure-to-file penalty is 5% of the amount owed per month, up to 25%, which you can avoid if you file on time even without paying your taxes.

Failure-to-pay penalty

The failure-to-pay penalty is 0.5% of your unpaid taxes per month, up to 25% of the unpaid taxes. However, if you don’t file your return on time, you’ll owe an additional 5% of the amount owed per month, up to 25%.

But note that, if you’re charged both the failure-to-pay and the failure-to-file penalties in the same month, the failure-to-file penalty is reduced by the amount of the failure to pay.

For example, if you owe $5,000, you’ll be charged a failure-to-pay penalty of $25 per month, up to $1,250. If you didn’t file either, you’ll be charged an additional $250. However, if both fees are charged in the same month, the failure-to-file penalty would be reduced by $25.

Arranging a payment plan will reduce your failure-to-pay penalty to 0.25% per month. If you don’t arrange a payment plan and don’t pay the taxes owed, you will eventually get an IRS letter with the intent to seize your assets. If you receive this letter and still don’t pay, the failure-to-pay penalty increases to 1%.

Keep in mind that you're charged interest on the balance owed, including any penalties. The amount charged is the federal short-term rate plus 3%. If you refuse to file your return, the IRS will complete a return on your behalf called a Substitute for Return (SFR) and use that to determine what you owe.

Explore payment options

If you owe taxes you can’t pay, you have two options. You can either set up payment plans, called “installment agreements,” or attempt to settle the debt, called an “offer in compromise.”

Installment agreements

The best option for paying back taxes is to set up a payment plan with the IRS, also called an installment agreement. Payment plans are easy to set up if you owe less than $50,000 and can pay the total owed within six years. You will have to file all past due tax returns to qualify.

When applying, you’ll be asked for a monthly payment amount. If you don’t complete this section, the IRS will choose a payment that will pay off your debt in 72 months. Consider paying it off as quickly as possible because interest continues to accrue until it is paid in full.

If you owe less than $10,000 and submit a payment plan that will pay the debt off within three years, your plan may be automatically accepted.

You can set up a payment online, by mail or over the phone. The online option is the easiest and cheapest if you owe less than $50,000. If you owe more than $50,000, you must use the mail-in option.

Installment agreements: Setup options

How much you pay for setting up an installment agreement depends on how you create the payment plan and your payment method.

1. Online: You can request a payment plan on the IRS website. You won’t have setup fees if you are setting up a plan to pay the debt within 180 days. If you need more than 180 days, the setup fee is $22 if you pay by direct debit and $69 if you pay via other means. There’s also a $10 fee to revise an existing payment plan.

   If you are low-income, you can request to waive these fees.

2. By mail: If you want to apply for a payment plan through the mail, fill out Form 9465. The setup fee for this option is $107 if you make payments via direct debit, and $178 if you pay by other methods.

   You must fill out this form if you owe more than $50,000.

3. Over the phone: You can call 800-829-1040 to arrange a payment plan. The fees for this option are the same as applying by mail, $107 if you make your payments via direct debit and $178 if you pay using a different method.

Offer in compromise

An offer in compromise is a settlement offer to pay less than you owe. To qualify, you must have:

• Filed all your tax returns
• Received a bill for at least one tax debt included in the offer
• Made all required estimated tax payments for the current year
• Paid all required tax deposits for the current quarter and the two preceding quarters if you’re a business owner with employees

You must make an offer to the IRS on the amount you would like to settle for. Form 656 walks you through the calculations to come up with the figure. Steps include:

• Entering your income and basic living expenses to get your “remaining monthly income”
• Listing all your assets
• Using your remaining monthly income for up to 24 months plus the market value of your assets to determine your offer to the IRS

You’ll be required to sell all your assets and use all your income above basic living expenses for up to two years, effectively starting over financially.

A $205 fee applies. You must send in the first payment along with your application and continue to make the payment while your application is under review.

» DISCOVER: What Is an Offer in Compromise?

Avoid common mistakes

One of the most significant mistakes you can make is ignoring you owe back taxes. The IRS isn’t going to forget, and it won’t go away on its own. While it’s stressful to owe back taxes, the best thing you can do is stay in communication with the IRS.

According to Cristina Wiebelt-Smith, a senior wealth advisor at Gertsema Wealth in St. Joseph, Missouri, another common error is not filing your tax returns altogether because you don’t have the money to pay. It actually makes things “much worse.” She said, “Penalties and interest keep adding up and not filing can disqualify you from the IRS payment plans.”

Common mistakes to avoid include:

1. Not filing your return: You might think that your taxes will fly under the radar if you don’t file. Instead, you’ll pay additional penalties for not filing and the government will file a Substitute for Return (SFR) on your behalf. It’s better to file and set up a payment plan for what you owe. “The biggest mistake people make when they owe taxes is procrastinating. They avoid the problem instead of taking action, especially failing to set up a payment plan,” Wiebelt-Smith said.
2. Ignoring letters from the IRS: Getting a letter can ruin your day, but ignoring it can ruin your year. Don’t let notices from the IRS go unopened.
3. Not seeking a payment plan: While there are pros and cons to IRS payment plans, generally the IRS is generous with its installment agreements. If you can pay the debt within six years, you’ll likely get your payment plan approved.

Seek professional help

If you don’t owe very much and you’re able to set up a payment plan that works for you, then you may not need professional help. But there are a lot of situations that do require an expert from a tax relief company.

When to seek help

“You should consider hiring a tax professional anytime you owe back taxes, don’t understand an IRS notice that you’ve received or are unsure about what to do next,” Wiebelt-Smith said.

• Significant debt: If you owe over $50,000, you may want to seek professional help. Applying for a payment plan for amounts over $50,000 must be done through the mail, and the IRS may request extra documentation about your personal situation.
• Notice to levy: If you’ve received a letter that the IRS is going to start seizing your assets, you may want to talk to an expert. The IRS is aggressively collecting the debt, so you’ll want to see how you can protect yourself.
• Offer in compromise: You may want to seek assistance if you’re applying for an offer in compromise. Since they are not usually accepted, you’ll want to present a strong case.
• You’re overwhelmed: You don’t have to wait until the tax situation is serious before hiring an expert. What is simple today can become complicated if you ignore it. If the thought of dealing with the IRS gives you a panic attack, ask for help.

“If you’re stressed, confused or worried about penalties or what your options are, that’s a good sign that you need some professional help,” Wiebelt-Smith said.

Who can help

Here’s a list of tax professionals who can help with back taxes and guide you through your options.

A tax professional can help you navigate your options, offer alternatives, and, in some cases, represent you to the IRS.

1. Certified Public Accountant (CPA): CPAs can handle complex tax situations and represent you to the IRS if needed.
2. Enrolled agent: An enrolled agent is similar to a CPA but specializes in taxes. They can also represent you when dealing with the IRS.
3. Tax attorney: Tax attorneys understand tax laws and can represent you in court and with the IRS.
4. Taxpayer Advocate Service: The Taxpayer Advocate Service is an organization that assists people with tax issues free of charge. They can help you understand notices you’ve received and explain your rights and options, but they can’t represent you to the IRS.
5. Low-income taxpayer clinics: These clinics assist low-income taxpayers. They can represent you, both with the IRS and in court. If you qualify, their services are free.

» EXPLORE: How Much Does Tax Relief Cost?

Understanding the IRS collection process

If you owe back taxes, the IRS will try to collect. Typically, you’ll have about four months after you receive a bill before the IRS starts seizing your assets.

Step 1: IRS sends a bill: The bill states the amount owed, including any penalties or interest, and requests payment in full. You will receive three of these notices. During this time, set up a payment plan if possible.

Step 2: Notice of intent to levy: After three months, you will receive a notice that the IRS intends to start seizing your assets. You’ll have 30 days to set up a payment plan. You will also have the opportunity to request a court hearing.

Request a court hearing if you don’t feel you owe the taxes or if you’ve tried to make payment arrangements but were rejected.

Step 3: Notice of federal tax lien: Thirty days after the intent to levy notice, the IRS will begin to seize your assets. They can garnish your wages or Social Security payments, seize your bank accounts and seize your property.