How to settle your own tax debts

Tax form

(MoneyWatch) A few days ago I wrote about the IRS expanded payment options for folks who owe tax and can't afford to pay in one lump sum. Here's a look at IRS payment and settlement options that can provide relief.

Installment Payments

Even if you owe more than $50,000 you may still request and qualify for an installment payment plan, but the process requires filing several additional forms. You'll need to attach a completed Collection Information Statement, Form 433F and include a payment proposal on a Request for Installment Agreement, Form 9465, with your tax return. The IRS will reply with a written notification letter explaining the proposed payment terms have been accepted or need to be changed.

The IRS charges a user fee of up to $105 for setting up an installment agreement. You have up to five years to pay under the installment agreement and you'll have to pay all future taxes in full and on time.

You'll pay penalties and interest on the taxes you owe until the agreement is paid off. However, depending on your individual circumstances, the IRS could offer a payment plan at a reduced interest rate. Also, as a condition of the installment agreement, any future tax refunds will be automatically applied against the amount you owe until the balance is paid off.

If the IRS determines that you cannot pay your tax debt, they may temporarily delay collection until your financial condition improves. During the payment delay, your tax debt will continue to increase due to the penalties and accrual of interest until your balance is paid in full. The IRS may also file a Notice of Federal Tax Lien to protect the government's interest in your assets until your tax is paid in full.

Offer in Compromise

The option of last resort is the Offer in Compromise, or OIC. This is an agreement where the IRS and the taxpayer settle the tax liability for less than the full amount owed. In connection with an OIC, the reduced amount allowed to be paid must equal what the IRS believes they can reasonably collect from the sale of your assets such as real property, automobiles, bank accounts, etc.

The IRS may grant an OIC on the grounds that there is legitimate doubt that the taxpayer could ever pay the full amount of tax owed (doubt as to collectability), or there is doubt that the amount owed is correct (doubt as to liability). Also, if collection of the tax owed would create an economic hardship, the IRS may consider an OIC.

To request an OIC, you must send a completed Form 656, Offer in Compromise and include a $150 application fee.

And be skeptical about tax firms who claim their services will settle your tax debts for "pennies on the dollar!" Most of them simply help you to apply for an OIC, which is something you can do yourself or with the help of your tax preparer.

The bottom line is that the IRS offers options for folks who need to pay their tax debts over time. Making a partial payment of what you owe and filing an Online Payment Agreement Application is better than not filing and not paying at all.

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.