What Happens If I Don’t Pay a Deficiency Balance?

A deficiency balance occurs when the IRS determines a taxpayer has not paid the full amount of tax owed, often due to errors, unreported income, or disallowed deductions. Promptly addressing this balance is important, as ignoring it can lead to escalating financial consequences and serious IRS enforcement.

Understanding Penalties and Interest

Not paying a deficiency balance by the due date triggers penalties and interest. The IRS charges interest on underpayments, which accrues daily and compounds on the total unpaid balance. The interest rate on underpayments is generally the federal short-term rate plus three percentage points, adjusted quarterly.

Taxpayers also face a failure-to-pay penalty. This penalty is 0.5% of the unpaid taxes for each month or part of a month the tax remains unpaid, up to a maximum of 25% of the unpaid taxes. If a taxpayer has an approved payment plan, this penalty rate can be reduced to 0.25% per month. Conversely, if the IRS issues a notice of intent to levy and the tax remains unpaid for 10 days, the failure-to-pay penalty can increase to 1% per month.

A separate penalty, the failure-to-file penalty, applies if a tax return is not submitted by its due date. This penalty is significantly higher, typically 5% of the unpaid taxes for each month or part of a month the return is late, also capped at 25% of the unpaid tax. If both failure-to-file and failure-to-pay penalties apply, the failure-to-file penalty is reduced by the failure-to-pay penalty amount, ensuring the combined monthly penalty does not exceed 5%. For returns filed over 60 days late, a minimum penalty applies, which is the lesser of a set amount or 100% of the tax owed.

IRS Enforcement Measures

When a deficiency balance remains unpaid, the IRS can take enforcement actions to collect the debt. A federal tax lien is a legal claim the government places against a taxpayer’s property, including real estate, personal property, and financial assets, to secure unpaid taxes. A lien arises after the IRS assesses the tax liability, sends a notice and demand for payment, and the taxpayer neglects or refuses to pay. This notice is a public record, alerting creditors to the government’s claim. While a lien secures the government’s interest, it does not directly seize assets.

A tax levy is the legal seizure of a taxpayer’s property to satisfy a tax debt. Before initiating a levy, the IRS sends a series of notices, including a Final Notice of Intent to Levy and Notice of Your Right to a Hearing, which provides a 30-day window to respond. This notice informs the taxpayer that the IRS intends to seize assets if the debt is not resolved.

The IRS can levy various assets, including bank accounts, wages, and other income. For a bank account levy, the IRS notifies the bank, which then freezes the funds up to the amount owed for 21 days. If the debt is not resolved within this period, the bank transfers the funds to the IRS. For a wage levy, the IRS can require an employer to withhold a portion of earnings and send it directly to the IRS until the debt is paid. The IRS also has the power to seize other physical assets, such as vehicles or real estate.

Resolving Your Tax Debt

Resolving an unpaid tax deficiency balance involves several IRS options. An installment agreement allows taxpayers to make monthly payments for up to 72 months. To qualify, taxpayers must have filed all required tax returns. Monthly payments are based on the taxpayer’s ability to pay, considering income, expenses, and assets. An installment agreement can help prevent further enforcement actions like levies and may reduce the failure-to-pay penalty rate.

An Offer in Compromise (OIC) allows taxpayers to resolve their tax liability with the IRS for a lower amount than what is owed. An OIC is approved when there is doubt as to collectibility (the IRS believes it cannot collect the full amount) or when collecting the full amount would cause significant financial hardship. The IRS considers a taxpayer’s ability to pay, income, expenses, equity in assets, and future earning potential when evaluating an OIC. The application process for an OIC requires submitting specific financial information and forms.

For taxpayers experiencing severe financial hardship, the IRS may place their account in Currently Not Collectible (CNC) status. This temporary status pauses IRS collection efforts, including levies and liens, when the IRS determines the taxpayer cannot pay the debt without sacrificing basic living expenses. While in CNC status, interest and penalties may continue to accrue, and the tax debt does not disappear. The IRS periodically reviews a taxpayer’s financial situation while in CNC status and can resume collection efforts if their ability to pay improves. To qualify for CNC status, taxpayers must demonstrate that their income barely covers necessary living expenses and that they have limited assets.

The Collection Statute Expiration Date (CSED) is generally 10 years from the date the tax was assessed. After this date, the IRS can no longer legally collect the tax debt. However, certain events, such as requesting an installment agreement, filing an OIC, or filing for bankruptcy, can extend this 10-year period.

Communicating with the IRS and Seeking Assistance

Responding promptly to IRS notices is important when faced with a deficiency balance. Ignoring these communications can lead to more aggressive collection actions. The IRS typically sends a series of notices, with each successive letter indicating a more serious collection intent. These notices often provide information about the amount owed, penalties, and available appeal rights.

If you receive a notice of intent to levy, you have the right to a Collection Due Process (CDP) hearing. This hearing allows taxpayers to discuss collection alternatives, such as installment agreements or offers in compromise, with an independent IRS appeals officer. Timely requesting a CDP hearing can temporarily halt collection actions, providing an opportunity to negotiate a resolution.

Seeking professional assistance can be beneficial for taxpayers who find navigating the tax system challenging. Tax professionals, such as Certified Public Accountants (CPAs), Enrolled Agents (EAs), or tax attorneys, possess specialized knowledge of tax law and IRS procedures. They can help analyze a taxpayer’s financial situation, identify errors, prepare necessary forms, and represent the taxpayer before the IRS. Engaging a professional can be particularly helpful for complex tax situations, significant tax debt, or when dealing with IRS enforcement actions like liens or levies. While it is possible to resolve tax issues independently, a professional can often secure more favorable terms and ensure compliance with tax regulations.