Let’s Talk About Tax

A taxpayer with substantial back taxes has a few options to deal with IRS pressure to get them paid. One of those is the payment plan, which the IRS calls an “installment agreement.” While an installment agreement can be a good outcome in some cases, there are many pitfalls to avoid when entering into one.

In an installment agreement, the amount of tax, penalty and interest owed is not reduced. Rather, payments are simply spread out over time. In fact, interest and penalty continues to be added to the total amount owed so that the total liability continues to increase.

The best candidates for payments plans are taxpayers with relatively modest debts but who are unable to pay the amounts when due to the IRS. Generally, if the total amount of tax, interest and penalty owed is $50,000 or less, then a taxpayer can enter into an installment agreement without a great deal of difficulty. The forms can be filled out and submitted online, and payments can automatically be extended over the course of 72 months.

In addition, the IRS will generally stop enforced collection action while a taxpayer is abiding by an installment agreement. That means that, absent unusual circumstances, there will not be any levies issued to bank accounts or employers, or other aggressive, affirmative actions to collect tax. However, the IRS may still file a notice of a federal tax lien in order to make sure that a taxpayer is not in a position to dispose of any property while the tax liabilities are still being paid.

For a taxpayer who owes a modest amount, and is able to cashflow payments over six years, therefore, an installment agreement can be a good resolution. If a taxpayer is very close to the $50,000 threshold, then making a payment upfront to get under that amount can make a lot of sense. As a practical matter, someone who owes $51,000 has a lot of paperwork to do, while someone who owes $49,000 has an easy time. Therefore, making a $2,000 payment before trying to get an installment agreement in place is a good option.

For taxpayers who owe more than $50,000, the process is more complicated. A taxpayer in that situation needs to submit the appropriate financial information to convince the IRS to allow the payments to be made over time. That financial information, generally provided on an IRS Form 433, can be quite extensive and lead to disagreements with the IRS about how to account for various assets and income. The IRS may also require that a taxpayer liquidate any substantial assets it has to pay down the tax immediately rather than allowing the taxpayer to spread the payments over time.

But perhaps the biggest problem for a taxpayer who ends up in an installment agreement is simply the fact that she or he now has an ongoing payment obligation relationship with the IRS. This creates a number of complications that can become problematic over time. For example, the IRS can periodically request that the taxpayer update financial information to see if the payment amount is right. In addition, creating new, additional tax liabilities in later tax periods, or failing to file any required tax returns, can invalidate the installment agreement. Finally, missing a payment to the IRS can result in serious difficulties because the IRS can revoke the installment agreement, and there is not an easy mechanism for talking to someone about correcting the matter.

As a result of all of this, we rarely recommend to our clients that taxpayers who owe large amounts pursue an installment agreement. Rather, we would recommend that such taxpayers either seek an offer in compromise, which would cap the amount owed and have it paid in a relatively short amount of time or seek financing from a bank or other third party. When a taxpayer has a choice between owing the IRS money and owing money to lender, it is almost always better off choosing the liability to the lender. As a result, while there are instances when an installment agreement makes sense, it is rarely the best outcome for a taxpayer who owes the IRS a significant amount of back taxes.