How Do IRS Back Taxes Cause Financial Hardship?
Back taxes owed to the IRS can cause financial hardship in many ways, from penalties and liens to wage garnishment, bank levies, and more.
Failure-to-Pay Penalty
If taxes are not paid by the due date in April, the IRS will automatically impose penalties and charge interest on the balance due.
The failure-to-pay penalty amount is based on how long the tax due remains unpaid. Note that it cannot be more than 25% of back taxes.
Keep in mind that if you request an extension to file in October you still must pay what you owe in April. There is no extension to pay taxes.
Failure-to-File Penalty
A failure-to-file penalty is assessed when you do not file a return by the April due date or October extension deadline.
You will be charged 5% of your back taxes each month until you file. For example, if you owe $1,000 and do not file taxes, the IRS will add $50 every month that your return is late.
Just like with failure-to-pay, failure-to-file penalties cap at 25% of your tax liability.
For both penalties, interest begins accruing on unpaid taxes from the return’s due date and does not stop until the IRS receives full payment.
Interest rates are adjusted quarterly and may go up or down or stay the same.
Tax Liens
When a taxpayer fails to pay back taxes or does not contact the IRS about entering into a payment plan, the IRS may put a federal tax lien on their property.
Liens prevent homeowners from selling or using their homes as collateral to take out loans.
The consequences of tax liens can include damage to credit scores and an inability to refinance the property.
Bank Levies
A levy occurs when the IRS seizes a person’s bank account or other property because they owe back taxes.
Levies are used to collect the money needed to offset unpaid taxes. In addition to checking and savings accounts, the IRS can levy paychecks, freelance/self-employment income, tax refunds, 401ks and other retirement and pension accounts, Social Security and disability payments, cars and home, and more.
The IRS in most cases does not have to go to court to levy property. However, levying a person’s principal home requires court approval.
Wage Garnishment
Levying a person’s paycheck is called wage garnishment. How much money the IRS takes from wages depends on an individual’s disposable income and what they need for basic living expenses.
No matter what, the IRS cannot garnish the entirety of a person’s weekly, biweekly, or monthly income.
What are the Standard Payment Plan Options for Back Taxes?
Popular IRS payment plans include:
Short-Term Payment Plan
Owe less than $100,000. Paid within six months (180 days).
Long-Term Payment Plan
Individuals owe less than $50,000 or businesses owe less than $25,000. Paid within 6 years (72 months).
Partial Payment Installment Agreement
If proposed monthly payments will not cover the full tax debt by the Collection Statute Expiration Date (CSED), a taxpayer can submit a financial statement and documentation to qualify for a PPIA.
This partial payment option is then regularly reviewed for changes in the taxpayer’s financial situation.
What are Debt Reduction Options for Back Taxes and Financial Hardship?
“Offer in Compromise
When a taxpayer “offers” to pay a fraction of their tax debt by making a partial lump-sum payment or periodic payments, and the IRS approves the offer amount, this is an Offer in Compromise (OIC) agreement.
Once a taxpayer makes the agreed-upon payments for the reduced settlement amount, the IRS eliminates the full debt from their account.
Penalty Abatement
Penalty abatement involves requesting that the IRS reduce or remove penalties for a reasonable cause. Fires, serious illnesses, natural disasters, or special circumstances that prevented a taxpayer from filing or paying on time are examples of reasonable causes.
The IRS generally approves penalty abatement for people with good tax compliance histories and who have never incurred penalties.
What are the Relief Options If You Have a Hardship But Don’t Qualify for Debt Reduction?
Currently Not Collectible (CNC) Status
Taxpayers may be eligible for CNC status if they can prove they face severe financial hardship from sudden unemployment, illness, or catastrophic personal events.
Individuals placed in CNC status will not have to make immediate payments and collections will be paused. However, this relief option for hardship is only temporary.
How Does the IRS Evaluate Financial Hardship?
The IRS assesses financial hardship on a case-by-case basis by considering income, assets, liabilities, employment status, and outstanding medical expenses.
Forms and documentation for applying for financial hardship include Form 433-A for individuals and Form 433-B for businesses.
Documents like paystubs, bank statements, bills, and expense records must be provided to support hardship claims.
What If You Already Have an Installment Agreement or OIC and That Payment Causes Hardship?
If you can no longer make payments for an existing OIC or installment agreement due to a new hardship, you will need to contact the IRS as soon as possible so you do not default.
You may be able to modify your agreement or request CNC status. The IRS will require additional documentation supporting your new claim of financial hardship, such as bills, medical records, unemployment, and bank statements.
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