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Three Options When You Can't Pay Your Taxes

What to do when you can't pay the taxes you owe by April.

You filled out your tax forms and the final number was a surprise--a big balance owed to the Internal Revenue Service. Don't panic, says tax expert Daniel J. Pilla, founder of and author of The IRS Problem Solver. It's very possible that the IRS will work with you, but you need to know your options.

File an extension to pay. A little-known provision allows taxpayers suffering severe hardship additional time to pay their taxes without incurring penalties, although interest continues to accrue at the standard federal rate plus 3 percent per month. Form 1127 Application for Extension of Time for Payment of Tax Due to Undue Hardship isn't automatic, like the filing extension, and you'll have to have extenuating circumstances to be approved. However, Pilla says, today's economic climate gives many people a reasonable chance. "If you've suffered an illness, job loss, death in the family or other extreme circumstances and you can't pay your taxes, it's worth trying," he says.

Work out a payment plan. More likely, the IRS will approve an installment agreement. File Form 9465 Request for Installment Agreement and, if the amount is $25,000 or less inclusive of combined tax, penalties and interest, you may qualify for streamlined acceptance procedures that don't require additional documentation. If the amount you owe exceeds $25,000, Pilla says the IRS will likely require "a financial CT scan," which includes documentation of your income, assets and expenses to determine how much you can afford to pay every month.

Consider a settlement. Settlements from the IRS are a last-resort method to settle up what you owe. If you have a financial hardship, few assets or a limited ability to repay what you owe, the IRS has distinct settlement options based on whether you truly owe the tax, whether you have the ability to repay and other factors. If you qualify, you may be able to satisfy your liability by paying less than your balance, interest and penalties. There are stringent criteria for each case, however, so Pilla warns against trusting anyone who guarantees settling for pennies on the dollar. "It just doesn't happen that way," he says.

Whatever you do, says Pilla, don't fail to file your taxes, and do your best to stay current with ongoing tax obligations. If you fall behind on your current tax obligation, the IRS may cancel any installment agreements you have. Also, Pilla suggests, consider hiring an experienced CPA, tax attorney or enrolled agent to help you negotiate with the IRS. 

Gwen Moran is a freelance writer and co-author of The Complete Idiot's Guide to Business Plans (Alpha, 2010).

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This article was originally published in the April 2011 print edition of Entrepreneur with the headline: An IOU for the IRS.

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