If You Can’t Pay Your Taxes, What’s Next?

HBS Tax Representation Services

As April 18th fades to memory many Americans find themselves face-to-face with an uncomfortable reality: owing taxes they are unable to pay.  Some did not have enough taxes withheld from their paychecks.  Others didn’t realize how much of their social security would be taxable.  Many are business owners stuck in the cash-poor mire of a reboundless recession.

Regardless of the reason they owe back taxes, all face a common dilemma that includes the prospect of interest, penalties, and the vast collective resources of the federal government.  So many find themselves in this untenable position that I have decided to devote next few columns to discussing IRS collection procedures and the options available to taxpayers facing them.  Today I’ll begin this discussion by focusing on the interest and penalties the IRS imposes on unpaid taxes and some circumstances under which these assessments can be removed.

The IRS adds interest to past-due balances on a daily basis.  The interest rate used is determined every three months and is benchmarked by adding 3% to the federal short-term interest rate.  The IRS interest rate was 4% from the first quarter of 2009 through 2010. It was reduced to 3% for the first three months of 2011.

The IRS also imposes two penalties on past due individual return balances.  The first is the late-payment penalty.  The late-payment penalty is one-half of one percent (0.5%) of the outstanding tax balance and is assessed each month or part of a month taxes remain unpaid up to 25% of the unpaid tax.  The late-payment penalty increases to one percent (1%) if taxes remain unpaid ten days after a Notice of Intent to Levy (a notice that the IRS plans to take property to satisfy a tax obligations) is filed.  The penalty is reduced to one quarter of one percent (0.25%) if the original return was filed by the due date and an installment agreement has been established.

The second penalty is the late-filing penalty.  The late-filing penalty is equal to five percent (5%) of any unpaid tax.  It is assessed each month or part of a month a return is not filed passed the due date up to 25% of the unpaid balance (five months).  If a return is over 60 days late the minimum penalty is $135 or the tax due, whichever is smaller.

There are a number of circumstances under which interest and penalty should not be assessed by the IRS.  Unfortunately, however, these assessments are added automatically making it the responsibility of the taxpayer (or their representative) to petition the IRS for their removal.  Interest is the most difficult assessment to have removed and is generally only abated is the result of: 1) An IRS administrative delay, 2) It was assessed on a balance due caused by an erroneous, IRS generated refund, or 3) It was assessed during a period in which an extension was allowed due to a region being a presidentially declared disaster area.

The IRS may remove late-filing and late-payment penalties if the failure to file or pay was due to “reasonable cause,” not intentional neglect.  What is deemed “reasonable cause,” however is quite limited and can include: 1) Destruction of the taxpayer’s home or business, 2) The taxpayer being absent from their “tax home” for reasons beyond their control, or 3) The death or illness of the taxpayer or an immediate family member.

To qualify for the removal of late-payment penalties a taxpayer must show that paying the penalties would cause severe financial distress.  They must also show that they were financially prudent before the due date of their return and that an unexpected event occurred that rendered them unable to pay their tax obligations.

In this article we have discussed the interest and penalties the IRS will add to unpaid individual taxes and a few reasons the IRS may consider their removal.  In future columns we will discuss the IRS collection process, various options available to pay past due balances and rare instances in which the IRS may accept less than the total tax due.  In the mean time, please feel free to contact our office if you have any questions or need assistance with your taxes.

Brett Hersh's avatar
  • Author: Brett Hersh
  • Bio: Brett Hersh, EA, MBA, is the owner of HBS TAX & Small Business Experts. He is an Enrolled Agent (EA) with the IRS and licensed by the US Treasury Department to prepare all tax returns and represent taxpayers before the IRS for audits, collections and appeals. He is also Dave Ramsey’s ELP for Tax and Accounting, a continuing education instructor for tax professionals through Lorman Education, and a local speaker/presenter on the topics of tax and business growth. He can be reached at (304) 267-2594.