Dealing With Overdue Federal Income Tax

It is not uncommon for individuals to find themselves with an unpaid federal tax balance. Common reasons for inadequate withholding include self-employment income, dual salaries, and bonus income. Tax filers who are unable to pay their federal balance in full have options available to reduce and eliminate the balance over time.

Tax returns should always be filed by their due date, even if it leaves a tax balance unpaid. The specific penalty for filing late can usually be avoided by submitting the return itself in a timely manner. If you cannot include the balance due in full with your tax return, the most appropriate payment option depends on how soon you can pay and how much is owed.

Payment in full within 120 days

The most straightforward arrangement is to simply agree to pay the entire balance within 120 days. The 120-day agreement can be requested by calling the IRS or visiting their online payment agreement (OPA) page. A major advantage of paying the balance within 120 days is that there is no fee to set up an agreement. There are, however, interest charges and a penalty for paying late.

Installment agreement

The OPA page at the IRS website is also used to set up payment agreements longer than 120 days. If you owe $50,000 or less in individual income taxes, you may be able to use the OPA page to set up an agreement. A fee is charged to set up payment plans longer than 120 days. The fee amount is dependent on how the plan is initiated and whether or not you pay with a direct debit from your bank account.

The failure-to-pay penalty is normally one-half of 1 percent of the balance, but it may be reduced to one-quarter of 1 percent while an installment agreement is in place. There is also a charge for interest on the unpaid balance. However, the relatively low interest rates of recent years are reflected in the interest rate charged on federal tax debts.

Interest charges

The interest rate that an individual pays on unpaid federal income tax is based on a financial benchmark referred to as the federal short-term rate. The actual rate charged is the federal short-term rate plus an additional 3 percent. Even though the interest is compounded daily, the rate compares favorably to some other sources of funds. The IRS publishes a rate notice each quarter of the year.

Other options might be available in dealing with a large amount of tax debt, such as an offer in compromise. Tax penalties can sometimes be abated. Contact a tax service for more assistance in problem resolution.