Practical solutions for overcoming tax debt

Taking the first step toward dealing with tax debt is a big deal, and it shows your commitment to a brighter financial future. Nobody likes owing taxes, but the IRS has strategies in place to help you get caught up. Let’s take a look at what happens when you have tax debt and a few options for handling it. 

This article is meant for informational purposes only. Seek advice from a tax professional about your specific situation.

What is tax debt?

Tax debt is money you owe for taxes after the deadline to pay. There are several common causes of tax debt:

• Not filing a tax return

• Underestimating what you owe

• Not having the money to pay your taxes

• Having interest and penalties added to the tax amount

Whatever the cause of your tax debt, there's at least one solution. The IRS may be a tough creditor, but it also has systems in place to help you catch up. 

Consequences of tax debt

We know that there are many compelling reasons for falling behind financially. Even so, you could end up on the IRS’ radar if you fail to pay your federal tax debt. Here are some of the consequences you could face:

• Penalties for not paying are separate from penalties for not filing a return.

• Failure to file penalties are more severe than failure to pay penalties. If you owe taxes and don’t file on time, the penalty is 5% of what you owe for every month (or part of a month) that your return is overdue, up to 25% of what you owe.

• If you file but don’t pay, the penalty is 0.5% of your unpaid balance per month, up to 25% of the unpaid amount. 

• After five months, the failure to file penalty maxes out at 25%. The failure to pay penalty continues to run until it also maxes out. If you are subject to both penalties, the maximum total penalty is 47.5% (22.5% late filing and 25% late payment) of the tax that you owe. If you fail to file and it turns out that you’re due a refund, you won't pay interest or penalties. 

• In addition, the IRS charges interest on unpaid balances. In 2024, the interest rate is 8%. 

If this is your first time getting caught off-guard, you can apply to have both penalties waived. 

What happens if you don’t pay your taxes?

Missing the federal tax deadline will cause certain events to be set in motion. The IRS eventually sends you a notice telling you how much they think you owe and demanding payment. You won’t want to ignore this notice: If you don't respond within 10 days and make arrangements to pay, the agency could take more serious action. 

Here are some of the ways the IRS is allowed to pursue unpaid tax debts:

• Liens and levies. The IRS can take money from your bank accounts. They can also seize real estate, boats, cars, or other vehicles and sell them to cover your tax debt. 

• Garnishment. The IRS can withhold part of your wages, Social Security benefits and retirement income, as well as future state and federal tax refunds, until you’re paid up. 

• Travel restrictions. They can even get your passport revoked if you owe a lot and are seriously delinquent.

• Criminal charges. The IRS may file charges if you refuse to pay or try to hide assets from them.

The IRS has up to 10 years to collect back taxes. But there’s no need to look over your shoulder. The agency offers solutions for those who can’t afford to pay immediately. 

Steps to resolve tax debt

It’s uncomfortable to have tax debt hanging over your head, but you can turn your situation around quickly. If you have a notice from the IRS, respond right away. And if you can pay anything toward your past-due taxes, do it, because you’ll save on penalties and interest. 

1. Catch up on your filing

If you haven’t filed taxes for one or more years, prepare and submit the past-due returns—you have to be current on your filings to qualify for most repayment or relief plans. If you’re completely overwhelmed, contact the IRS Taxpayer Assistance Center. Trained volunteers can help you with your taxes for free. 

While you’re working on getting caught up, file this year’s return on time or get an extension, even if you can’t pay what you owe. Filing could save you money even if you do owe taxes. If you file and you owe but you can’t pay, at least you won’t be hit with the failure to file penalty.

If you’re not ready to file, submit Form 4768, Application for Extension of Time to File by the deadline. Filing an extension gives you up to six more months to file your tax return. You’ll still have to deal with the failure to pay penalty if you don’t pay the full amount of taxes you owe by the tax filing deadline for that year (usually April 15th). But 0.5% per month is a lot less than 5% per month. 

2. Pay as much as you can when you can

Failure to pay and failure to file penalties are based on the amount of taxes you owe. If you owe less, the penalty is smaller. So even if you can’t pay the entire amount, send in as much as you can. 

3. Explore payment options

Next, get familiar with IRS payment alternatives. The right one for you depends on the size of the problem. 

Credit card or digital wallet

The IRS lets you pay your taxes with a credit card or digital wallet. You’ll pay a credit card processing fee of about 2%. This might not be the cheapest option, because most credit cards charge a higher interest rate than the government does. 

Short-term payment plan

The short-term payment plan gives you up to 180 days to repay what you owe. You can apply online if your balance (including interest and penalties) is under $100,000. There are no setup fees, and you can pay directly from your bank account, by check or money order, via electronic transfer, or over the phone. You can also pay with a credit or debit card, but fees apply. 

Long-term payment plan

If you can’t afford to pay your tax debt in 180 days, a long-term repayment, also known as an installment agreement, might work for you. When you apply, you propose a monthly payment that’s affordable for you. The IRS will generally accept what you suggest as long as it will clear your balance, interest, and penalties within 72 months. You can apply online as long as you don’t owe more than $50,000. If you’re not eligible to apply online, contact the IRS. They may still approve your proposal.

CNC status

What if you can't afford to pay taxes at all? If financial hardship leaves you little money after you pay living expenses, you can request “Currently Not Collectible” (CNC) status. You must submit a form with proof of your financial situation. The IRS reviews your finances every year for 10 years, and may forgive any remaining balance after that. If your finances improve, they can ask you to make payments on your tax debt.

Offer in Compromise

The IRS may accept less than your full balance as payment in full. They consider your assets and future income to determine what you can pay. Once you pay that amount, the remaining balance is forgiven. The Offer in Compromise Prequalifier page on IRS.gov can help you determine what you’d need to pay. 

Penalty relief

There are several penalty relief programs that can reduce what you owe the IRS. If this is the first time you’ve been hit with an IRS penalty or you have a compelling reason for failing to file or pay on time, you can ask to have penalties waived or reduced. Do it in writing, and if possible, include whatever evidence you may have to support your claim. You can call the IRS or submit Form 843.

When to seek professional tax help

Note that we aren’t tax pros and can’t advise you on your specific tax situation. All of this information is on the IRS’ website, and we gathered it here as a summary that you can start with. The forms and instructions are available online for anyone to access. For state tax debt, every state has its own process. For specific advice about your options, it’s a good idea to call the IRS at 833-678-7020 or talk to a qualified tax professional about your situation.

Tax professionals like CPAs, Enrolled Agents, and tax attorneys can help you deal with unaffordable tax debt. If the amounts are large, your returns are complicated, or you’re in legal trouble, consider hiring someone to help. 

Pro tip: The IRS uses a standard formula to calculate what they’ll accept in an Offer and Compromise. There’s no haggling involved. 

What’s next

If you can’t pay what you owe the IRS, do these things to prepare for contacting them:

• File past-due returns.

• Review your finances and determine what you can afford to pay. 

• Choose a repayment plan or apply for relief.

• Keep up on your current year’s taxes. The IRS will consider your current tax obligations when they calculate how much money you have available to cover payments on back taxes.