Each year, many Americans file their tax returns and discover that they owe more income tax than they can afford to pay immediately. Additionally, many taxpayers owe back taxes and have no idea how they can pay those extraordinary amounts.
Fortunately, the Internal Revenue Service (IRS) understands that income taxes, including back taxes, can be a severe burden on taxpayers. They have instituted a program that allows taxpayers to pay taxes in monthly installments instead of in a large, one-time, lump-sum amount. Taxpayers must have filed all past tax returns in order to qualify for this agreement.
Read on to find out how to implement and maintain a valid installment agreement.
Filing Form 9465
Form 9465 is the IRS application form for an installment payment plan. Taxpayers who owe $50,000 or less in taxes, penalties and interest may be able to complete an online payment agreement (OPA) application. Taxpayers may access the form from the IRS website or by calling 1-800-829-1040.
Any taxpayer owing no more than $10,000 will have their installment payment plan application automatically approved with the following stipulations:
- The taxpayer has "timely filed all income tax returns"
- Has not entered into an installment payment agreement within the past five years
- Must be able to pay the entire outstanding balance within three years
Those who owe more than $50,000 need to return a completed IRS Form 9465 on paper with original signatures. They may do this, generally, by attaching it to the front of their tax return at the time of filing. However, the form can be submitted by itself at any time.
Also, any taxpayer owing more than $50,000 must also submit Form 433-F along with Form 9465, something that can't be done online.
Generally, repayments are required to be completed within 72 months—or six years. Taxpayers who have defaulted on their installment plans within that time can petition for reinstatement, but they cannot ignore their previous agreement by creating a new one.
Who Should Not Use Form 9465
Individuals who are already making payments under an installment agreement with the IRS are not eligible to use Form 9465 and must contact the IRS at 1-800-829-1040 if they need to make arrangements for payment of additional amounts. Individuals who should also call 1-800-829-1040 instead of filing Form 9465 include those who are in bankruptcy and want to make an offer-in-compromise.
Whether you can use Form 9465 or not, there are actually a variety of solutions you can try If you receive an unexpected bill from the IRS.
Benefits of Installment Plans
The advantage of an installment plan is obvious: It gives taxpayers more time to pay off their federal taxes in an orderly manner. As long as the terms of the agreement are honored and the taxpayer is able to make their payments, any collection efforts by the IRS or private collection agencies will cease. Eligible individuals can get a six-month extension for filing their tax returns and possibly paying their tax bills if they are under certain financial hardships.
Setting Up an Installment Plan
The IRS does not allow taxpayers to establish installment plans for free. A one-time setup fee is also charged. The amount depends on how you pay. Here's how the IRS website describes the options:
- $31, if you set up an online payment agreement and make your payments by direct debit
- $107, if you don’t set up an online payment agreement, but make your payments by direct debit
- $149, if you set up an online payment agreement but don’t make your payments by direct debit
- $225, if you don’t set up an online payment agreement and don’t make your payments by direct debit
It's also $225 if you set up a payroll-deduction system for what you owe. The fee is reduced to $43 for individuals with income below a certain amount; that can be $31 with an online payment agreement and payment by direct debit. Those who don't meet IRS qualifications for the reduced fee can request it using Form 13844, "Application For Reduced User Fee For Installment Agreements," IRS instructions explain. There is an $89 fee to modify or terminate the installment agreement ($43 for low-income taxpayers). Furthermore, interest and penalties are applied to the unpaid balance until it is paid off.
Penalties for Unpaid Taxes
The IRS charges a daily compounding interest rate equal to the short-term federal funds rate plus 3%, calculated on a quarterly basis. In addition to the interest charged, the IRS will also assess a failure-to-pay penalty of .5% on the unpaid balance each month or part of a month up to a maximum of 25%. For taxpayers who file on time and are on an installment plan, the penalty decreases to .25% for each month the installment plan is in effect. The total penalties and interest can easily add up to 9% to 12% per year, and taxpayers must be prepared to pay this amount in addition to their principal balance. For this reason, taxpayers are strongly encouraged to make more than the minimum monthly payment whenever possible.
Example – Deductions Fred files his taxes for 2017 and owes a total of $7,000. He submits Form 9465 with his return and establishes a 36-month payment plan. If the federal funds rate is 3%, the IRS will charge Fred a 6% interest rate on the outstanding balance. If the failure-to-file penalty is 0.5%, then he will also pay another 6% annually in penalties until the balance is paid off; 12% of $7,000 is $840, although this amount will decrease on a monthly basis as the principal is repaid.
Methods of Payment
Taxpayers have several methods of payment available. They can send personal checks, cashier's checks or money orders; they can debit money directly from their bank accounts or pay by credit card. The electronic federal tax payment system may also be used (this requires a separate registration). However, a key factor to remember is that the payment absolutely, positively must be made by the date each month that is specified in the agreement.
Payments may be made between the first and 28th of each month. If the agreement stipulates that the taxpayer must make the payment by the 15th of each month and payment is not made, then the agreement is immediately considered to be in default. Therefore, those who pay by check or money order are advised to mail in their payments at least seven to 10 business days before the due date to ensure timely receipt. However, the IRS has now upgraded its website to allow taxpayers to modify their installment agreements online. Individuals can now revise their payment dates and even the terms of their agreement, including method of payment and other details. Authorized representatives can also access the site and do this on behalf of their clients.
The Bottom Line
Taxpayers with outstanding tax bills don't have to panic about how to pay their taxes. The installment-agreement application process is relatively quick and painless, although penalties and interest can add up over time. Individuals who are unable to pay their federal tax bill and do not make arrangements with the IRS may be subject to the IRS collection process, and may be subject to more penalties and interest than if they had made arrangements up front to make installment payments. For more information, consult IRS Topic 202.