The Challenging Waters of Managing an Unpaid Tax Liability
By: Michael Deblis
Tags: Taxes

As the adage goes, there are only three absolutes in life: birth, death, and taxes. Unless, of course, you cannot afford to pay or for some reason are otherwise resistant to paying the money owed to the IRS — and even this state of being will only ever be temporary.

In general, the Internal Revenue Service is not particularly open to a lack of payment. To this extent, the IRS expects to be paid what it has deemed to be a tax liability, inclusive of any fees or penalties, and that’s the end of that. However, for those who don’t pay and cannot pay, there may be other courses of action available.

Collection Alternatives: What to Do When Paying Taxes Isn’t Possible

For those taxpayers unable to pay some or all of the amount owed to the federal government, it may be appropriate to consider a collection alternative, or a secondary form of settlement that can allow a taxpayer to make amends with the IRS in spite of incomplete or delayed payment. These options include:

An extension of time

Currently Not Collectible status

Full or partial payment per the terms of an installment agreement

An Offer in Compromise

While it would be nice if collection alternatives were available to anyone who didn’t want to pay, financial situation is generally taken into account for those applying for assistance. Prior to considering a plea for a collection alternative, the IRS evaluates what they consider to be reasonable collection potential (RCP). IRM sections 5.15 and 5.8.5 detail how this financial analysis is performed, which begins with the submission of a Form 433-series Collection Information Statement.

Application for Extension of Time to Pay

For those unable to pay a large liability and are subsequently panicked about it, ignoring the problem and hoping it goes away can be a preferred method of management. However, this isn’t wise for many reasons, least of all the chance for an extension of time due to financial hardship. While not a common form of handling financial struggles that leave tax liabilities out of reach, numerous code sections allow for time extensions ranging from six to 18 months.

As soon as taxpayers are aware of an inability to pay what is due, Form 1127, Application for Extension of Time for Payment of Tax Due to Undue Hardship, should be filed promptly. The information submitted with Form 1127 must demonstrate undue hardship if a payment is made — and that hardship must go above and beyond inconvenience.

The IRS will make a decision to grant, deny, or tentatively grant an extension within 30 days. If an extension is denied, taxpayers have 10 days to file a written appeal.

Currently Not Collectible Status

If an extension isn’t granted but the taxpayer is still able to demonstrate that there is no way to pay tax debts without significant hardship, the IRS may place an account on Currently Not Collectible (CNC) status. This effectively means that the IRS will not pursue traditional collection activities until the taxpayer’s financial situation improves. However, late penalties will continue to accrue on these accounts, and the IRS has the option to file a Notice of Federal Tax Lien and withhold refunds in future years.

If a request for CNC status is denied, taxpayers may have the ability to argue their case with the Appeals Office or the Tax Court. Unlike other collection alternatives, the Tax Court has declared that the IRS may place taxpayers into CNC status even if current filing obligations are not met.

While in CNC, the 10-year statute of limitations on collection continues to run. An account can be taken out of CNC status should a taxpayer’s financial challenges resolve.

Installment Arrangements or Agreements

For those unable to pay the entirety of a tax liability without undue hardships, an installment agreement (IA) can be granted to taxpayers who apply in exchange for a small fee, provided all required filings are current. Low-income taxpayers may be able to pay a reduced fee by filing Form 13844, Application For Reduced User Fee For Installment Agreements. IAs exist in many forms, including:

Guaranteed Installment Agreement: An IA plan for those with under $10,000 of tax debt excluding penalties and interest that does not require a CIS. The IRS will not place a lien, provided all tax payments are made via direct debit within 36 months. Guaranteed Installment Agreements are not available for those who have entered into installment plans in any of the five preceding tax years.

An IA plan for those with under $10,000 of tax debt excluding penalties and interest that does not require a CIS. The IRS will not place a lien, provided all tax payments are made via direct debit within 36 months. Guaranteed Installment Agreements are not available for those who have entered into installment plans in any of the five preceding tax years. Streamlined Installment Agreement: An IA plan for those with under $50,000 of tax debt including penalties and interest and who are current on all tax filings. Under this agreement, debts must be paid within 72-months before the Collection Statute Expiration Date. This plan requires an online payment agreement with approval granted within 30 to 60 days. For those with over $25,000 in debt, a Direct Debit Installment Agreement request should be made via Form 9465-FS.

An IA plan for those with under $50,000 of tax debt including penalties and interest and who are current on all tax filings. Under this agreement, debts must be paid within 72-months before the Collection Statute Expiration Date. This plan requires an online payment agreement with approval granted within 30 to 60 days. For those with over $25,000 in debt, a Direct Debit Installment Agreement request should be made via Form 9465-FS. Partial Payment Installment Agreement: An IA plan that does not account for the entirety of a taxpayer’s balance, allowing for a payment agreement for those who can only make a partial lump-sum payment. Requested via Form 433-A, PPIAs are granted to those who have no assets or equity in assets, are unable to secure a loan, or who are in a situation in which the liquidation of assets would cause undue hardship, and last through the statute of limitations on a collections period. Those who have defaulted on an IA in the last 24 months must make payments via direct debit or payroll deduction.

The Six-Year Rule for Repayment of Tax Liability

For balances that exceed $50,000 in which a taxpayer cannot afford to pay the whole amount and the streamlined installment agreement option does not apply, the six-year rule for repayment may be an option. This rule allows for the payment of living expenses in excess of Collection Financial Standards as well as payments like student loan or car loan minimum payments, provided it is demonstrated that the unpaid tax liability can be paid in full within six years. The IRS requires proof of financial situation for this agreement, and may require an attempt to seek personal loans or liquidate assets for the purpose of paying tax debts prior to agreeing to payments in installments.

National and Local Standards, and the One-Year Rule

In some cases, a taxpayer may not be eligible for any of the formal installment arrangements. In this case, it is expected that the taxpayer will continue to make payments based on ability to pay. This amount is calculated by the IRS and is based on the National and Local Expense Standards, often referred to colloquially as National Standards, to determine average estimated expenses.

As is only to be expected, tension frequently arises in cases in which National Standards are used to determine ability to pay, in large part because National Standards are often incongruous with reality. When this occurs, the IRS may consider using a taxpayer’s actual expenses should there be demonstrative proof that abiding by national or local standards would leave taxpayers unable to meet obligations. Further, the one-year rule may also be taken into effect in these situations; in essence, if a taxpayer can’t meet obligations or pay tax debt within the six-year time frame, they may be provided an extension of one year to minimize other essential spending. When the one-year role and the six-year rule are used in conjunction, a taxpayer can effectively extend tax payments for up to 84 months.

Fast Track Mediation for Collection Cases

In some cases, the stock collection avenues may not be the right fit, or at least not as they currently stand. When this occurs, requesting a fast track mediation process may be a better option. When mediation is requested, the IRS can appoint a mediator who will work as a go-between for the taxpayer and the Collections Division to determine how much and under what circumstances a taxpayer should pay. Mediation can be requested using Form 13369, Agreement to Mediate and must encompass a taxpayer’s full financial position.

If IRS Appeals believes there is a legitimate need for a mediator — they can, of course, determine that this is not needed — a meeting will be scheduled between the taxpayer and the Collection Group Manager to outline the process. If this request is denied, the case will be returned to the Collection Division. Unlike most first-time IRS decisions, there’s no appeal here; if the IRS says no, the answer is no.

Appealing the Rejection of an Installment Agreement

If an installment agreement is rejected, taxpayers do have the option to file an appeal within 30 calendar days of the rejection notice using Form 9423, Collection Appeal Request. If this doesn’t gain traction, taxpayers may also be able to appeal to the Tax Court.

Offers in Compromise

There are a number of options less extreme than an OIC, or offer in compromise, but for those who are sure they are unable to pay amounts due by the Collection Statute Expiration Date, an OIC, or an alternative offer in an amount different than that of the determined liability, may be the best possible option. While filing Form 433-A and Form 565, Offer in Compromise, gets the ball rolling, the IRS also suggests that taxpayers use their handy online tool to determine the feasibility of an OIC.

Currently, there are three types of OIC arrangements:

Doubt as to Collectibility

In a doubt as to collectibility case, the IRS agrees to accept a lesser amount to settle all debts owed, essentially admitting that it is unlikely that the full amount will be collected before the end of the CSED. To make this kind of offer, taxpayers must file both forms related to OICs as well as pay a $186 application fee in order to propose a lump sum offer — which is somewhat of a misnomer; the amount is actually due in up to five installments beginning the month after the OIC is accepted — or a partial payment offer. A lump sum offer comes with a sizable catch: 20% of the amount of the OIC is due with the application, and this amount is non-refundable. A partial payment offer, on the other hand, requires six to 24 monthly installments upon which payment must begin before the OIC is officially accepted. These pre-acceptance payments are, of course, non-refundable. The amount to be collected is one equal to the Net Realizable Equity (NRE), or the quick sale amount, of assets plus the amount of income remaining after National Standards are applied.

Doubt as to Liability

Doubt as to liability OICs are primarily filed when there is true doubt as to the legitimacy of a tax liability. There is no application fee here, and the review process is similar to an audit reconsideration examination.

Effective Tax Administration

When there’s no doubt as to collectibility or to liability, the only option left is an OIC due to effective tax administration, in which the taxpayer essentially argues that the tax cannot be paid due to undue hardship or other outstanding circumstances. To qualify, taxpayers must be compliant and show no history of potential tax evasion.

While this option technically exists, it’s unlikely that it will ever come to fruition for a taxpayer struggling to pay. An OIC for effective tax administration is a rarely-granted pathway.

Rejection of an OIC

If an OIC is rejected, there is an appeals process taxpayers can follow if desired, which includes:

Filing Form 13711, Request for Appeal of Offer in Compromise, which allows taxpayers to appeal a rejection while also providing the opportunity to dispute assets and expenses as outlined in the rejection letter

Post-appeals mediation, a process that allows for a non-binding mediation through which taxpayers can argue disputes of fact or law

Withdrawal of the Notice of Federal Tax Liens

Liens are rarely a good thing, and this is especially true in regards to the IRS. An IRS lien can negatively affect credit score, making it harder to do things like rent a home or buy a car. As such, many taxpayers actively pursue the termination of a lien.

If a Notice of Federal Tax Lien, or NFTL, is filed prematurely, a taxpayer is granted an IA, or the lien is somehow preventing the collection of tax, a taxpayer can request a withdrawal by filing Form 12277, Application for Withdrawal of Filed Notice of Federal Tax Lien. A taxpayer can also request the withdrawal of a lien if it can be demonstrated that doing so would be in the best interest of the taxpayer.

If a lien withdrawal request is denied, a taxpayer has the right to appeal. If the lien is successfully withdrawn, the taxpayer will then have to dispute the lien with Equifax, Experian, and TransUnion in order to remove the lien from a credit report.

New Jersey Collection Alternatives

Federal tax isn’t the only form of tax the average citizen may find himself unable to pay; state and local taxes don’t go away just because federal tax provides an undue burden. As such, most states also have regulations in place to handle those who cannot afford to pay their taxes on time. Take, for example, New Jersey.

The process starts in New Jersey with a billing notice requesting payment. If this is not met, the amount due is forwarded to Pioneer Credit Recovery, a private firm contracted by the state. Should PCR take over, all amounts then come with a 10.7% service fee. Similar to the IRS, the New Jersey Division of Taxation doesn’t take kindly to the potential loss of its money, and thus provides several possible pathways to make sure payments are eventually made. These include:

Extension of Time to Pay Due to Undue Hardship: For those unable to pay due to undue hardship, as the name implies, New Jersey does offer a penalty-free extension. As nice as this sounds, this option is rarely offered or accepted.

For those unable to pay due to undue hardship, as the name implies, New Jersey does offer a penalty-free extension. As nice as this sounds, this option is rarely offered or accepted. The Deferred (Installment) Payment Plan: For those unable to pay their entire tax liability, New Jersey makes requesting a payment plan easy via the use of a Deferred Payment Request Form. An option for taxpayers who have not been on a payment plan in the last three years, this opportunity provides 24 months to pay off tax debt in installments. Other forms of tax debt can result in payment plans of three to 36 months as determined by PCR. If the debt amount is larger than $2,500 and a payment plan of over 12 months is employed, the state will file a Certificate of Debt against the taxpayer and add a 10% fee.

For those unable to pay their entire tax liability, New Jersey makes requesting a payment plan easy via the use of a Deferred Payment Request Form. An option for taxpayers who have not been on a payment plan in the last three years, this opportunity provides 24 months to pay off tax debt in installments. Other forms of tax debt can result in payment plans of three to 36 months as determined by PCR. If the debt amount is larger than $2,500 and a payment plan of over 12 months is employed, the state will file a Certificate of Debt against the taxpayer and add a 10% fee. Closing Agreement Request (Form 906): Should there be an indication that debt cannot be collected or the liability itself is in question, an offer in compromise is an option — sort of. The state does not make the forms to do this available, and will not accept any proposal made on nonconforming forms, creating quite a conundrum. Instead, New Jersey will accept a Closing Agreement, or an agreement that the taxpayer will pay and the state will accept an amount other than the determined liability. Unlike the IRS’ 10-year statute of limitations, New Jersey’s is 20. Further, New Jersey does not publish the criteria it uses to consider Closing Agreements; each potential Agreement is evaluated on a case by case basis.

While there are certainly avenues available for those who can’t afford to pay their taxes, the IRS still expects payment, even if that means small payments over the next six or more years. No matter the reason, from job loss to financial irresponsibility, it’s not going to be easy to convince the IRS that they don’t need the full amount of an unpaid liability. Sooner or later, and in one way or another, the IRS will expect every cent (or almost every cent) they are owed.