What Happens If I Owe More Taxes Than I Can Pay?

Facing a tax bill larger than what can be immediately paid can cause stress. Many individuals find themselves in this position, but established procedures and resources are available. This guide clarifies what occurs when you owe more taxes than you can afford and outlines steps to address the situation.

Immediate Implications of Unpaid Taxes

Failing to pay taxes by the due date results in financial consequences from the tax authority. A failure-to-pay penalty is typically assessed, calculated at 0.5% of the unpaid taxes for each month or part of a month the balance remains outstanding. This penalty has a maximum limit of 25% of your unpaid taxes. If an approved payment plan is in place, this monthly penalty rate may be reduced to 0.25%.

Interest accrues on unpaid taxes and penalties from the original due date until paid in full. This interest compounds daily. The interest rate on underpayments can change quarterly.

The tax authority sends notices when taxes remain unpaid. The first notice, often a CP14, informs you of the balance due and payment deadline. Subsequent notices, like CP501 and CP503, serve as reminders. Ignoring these can lead to more serious notices, such as a CP504 or LT11/CP90, which may indicate an intent to levy assets.

File your tax return on time, even if you cannot make the full payment. This avoids the failure-to-file penalty, which is generally much higher than the failure-to-pay penalty. The failure-to-file penalty is typically 5% of the unpaid taxes for each month or part of a month the return is late, also capped at 25%. If both penalties apply in the same month, the failure-to-file penalty is reduced by the failure-to-pay penalty amount, maintaining a combined monthly penalty of no more than 5%.

Understanding Your Payment Options

When unable to pay your tax liability in full, the tax authority offers several options to manage your debt. Understanding these options and preparing necessary information is a first step. Each option has specific eligibility criteria and requires a detailed financial picture.

Installment Agreement (IA)

An Installment Agreement (IA) allows monthly payments over an extended period, typically up to 72 months. Individuals may qualify if they owe $50,000 or less in combined tax, penalties, and interest, and have filed all required tax returns. To apply, confirm your identity and gather basic personal information, including the exact amount owed. Online applications may require bank routing and account numbers for direct debit. Form 9465, Installment Agreement Request, is the primary document, but an online application may be available for those owing $50,000 or less, potentially reducing the setup fee.

Offer in Compromise (OIC)

An Offer in Compromise (OIC) allows taxpayers to settle tax debt for a lower amount than owed. This option is considered when there is doubt as to collectibility, meaning the tax authority believes you cannot pay the full amount due to your financial circumstances. To apply, submit a comprehensive financial picture, including income, expenses, assets, and liabilities. Key forms include Form 656, Offer in Compromise, and either Form 433-A or Form 433-B, Collection Information Statement. Prepare by gathering documentation like pay stubs, bank statements, bills, and asset records to support your claim of inability to pay.

Currently Not Collectible (CNC)

Currently Not Collectible (CNC) status is a temporary designation for taxpayers with severe financial hardship, making them unable to pay their tax debt. While in CNC status, collection efforts are suspended, though interest and penalties may continue to accrue. Eligibility requires proving that paying your tax debt would prevent you from meeting basic living expenses like housing, utilities, food, and transportation. To request CNC status, provide a detailed financial statement, often using a form similar to the Collection Information Statement (Form 433-A or 433-F). This involves documenting income, monthly expenses, and assets and liabilities to demonstrate inability to pay without significant hardship.

Applying for a Payment Arrangement

After assessing your financial situation and preparing documentation, the next step is the formal application process. Submission methods and review stages vary by arrangement type.

Installment Agreement

For an Installment Agreement, individuals owing $50,000 or less can apply online through the tax authority’s online payment agreement tool. This requires creating an online account, often with photo identification for verification. If your debt exceeds online limits, mail Form 9465 with your tax return or to the designated address. The tax authority generally notifies approval within 30 days. If approved, you receive a confirmation detailing terms, including payment amount and due dates. Ongoing compliance requires timely payments and filing all future tax returns on time.

Offer in Compromise

An Offer in Compromise requires mailing a completed Form 656, along with the appropriate Collection Information Statement (Form 433-A or Form 433-B) and supporting financial documentation. A non-refundable application fee, typically around $205, and an initial payment based on your proposed offer are generally required, unless you meet low-income certification guidelines. The tax authority reviews your application, which can be lengthy, and may request additional information or an interview. If denied, you typically have the right to appeal.

Appealing a Decision

If a payment arrangement application is denied, or if you disagree with a collection action like a lien or levy, you may appeal through the Collection Appeals Program (CAP). Use Form 9423, Collection Appeal Request, to initiate this process. For certain collection actions, discuss the issue with the tax authority employee and their manager first. If unresolved, inform the tax authority of your intent to file Form 9423 within a few days, then mail the form within a specific timeframe, such as three business days. The appeals process is often informal, conducted by phone, and aims for resolution within a few days; however, a CAP appeal decision is usually final and cannot be appealed further in tax court.

Seeking Professional Assistance

Navigating tax debt can be complex. Various professionals and organizations offer support and guidance, providing expertise in understanding options and communicating with the tax authority.

Tax Professionals

Tax professionals, such as Enrolled Agents (EAs), Certified Public Accountants (CPAs), and tax attorneys, have specialized knowledge in tax law. EAs are federally authorized to represent taxpayers, while CPAs offer accounting and tax services. Tax attorneys provide legal advice and represent taxpayers in complex cases, including litigation. These professionals can assist with preparing financial statements, negotiating with the tax authority, and ensuring accurate submission of forms and documentation, potentially improving your payment arrangement outcome.

Low Income Taxpayer Clinics (LITCs)

Low Income Taxpayer Clinics (LITCs) offer free or low-cost assistance to individuals with tax disputes who meet income thresholds. LITCs are independent from the tax authority and provide services including representation in audits, appeals, and collection matters. They help taxpayers respond to notices and correct account problems, ensuring fairness for low-income taxpayers. LITCs also provide educational outreach, especially for those for whom English is a second language.

Taxpayer Advocate Service (TAS)

The Taxpayer Advocate Service (TAS) is an independent organization within the tax authority that helps taxpayers resolve problems they could not address through normal channels. TAS assists taxpayers with financial difficulties due to tax issues, those facing immediate threats like levies, or those who have repeatedly tried to contact the tax authority without success. TAS acts as a voice for taxpayers, protecting their rights and working to resolve systemic problems within tax administration.