Here in the United States of America, the collection of taxes is based on your ability to pay. Due to unfortunate circumstances, for example, Coronavirus or poor financial management, you may find yourself unable to pay your tax bill. It has been estimated that in the 2020 extended tax season, as many as a third of American taxpayers may be unable to fully pay their taxes on time. It is a bad idea to not file income taxes, so consider filing even if you cannot pay!!!
Tax authorities have a file on nearly everyone’s wages and income. Without a filed tax return, tax authorities will create their own substitute for return often lacking deductions and credits a taxpayer would get if they filed. Filing starts clocks on the time you can be audited, the time for collection, and starts aging the tax debt for potential discharge in bankruptcy or offers in compromise. Without filing compliance, it is not possible to get or keep an installment payment agreement, nor to request other types of forbearance. Ignoring tax filing requirements will eventually cause a levy whereby money is unexpectedly seized from your bank account.
So even if you cannot pay, it is still recommended to file!
One good outcome for a taxpayer is when taxes were incorrectly calculated, to begin with. Because of the complexity of the US tax code, a surprising number of tax returns, especially self-prepared tax returns, are incorrect, with substantial errors that can often go in either direction.
A tax return with errors may be corrected, amended to produce a refund within the later of two years from the date of payment or three years from the date of filing based on internal revenue code (IRC) section 6511. After the IRS’s loss in Weisbart v. U.S. revised Treasury Regulations indicate the IRS will reconsider all claims for refunds previously disallowed on similar grounds, no matter how old.
If the corrected tax return reduces an unpaid debt rather than producing a refund, the return may be corrected at any time (although once in collections the administrative procedure may be more complex than filing an amendment).
Again, the collection is based on the ability to pay. If you cannot afford to pay your tax debt in full, you can obtain an installment agreement allowing affordable monthly payments. If you can not afford any payments whatsoever, you can be placed in non-collectible status and have collection activity paused until your situation improves, with a reconsideration of your situation in two years.
The ability to pay is based on complex formulas using regional standard costs. Allowable expenses are based on the greater or lesser of actual or standard costs depending on the nature of the expense and the collection timeframe. The IRS form used to determine the ability to pay is called Form 433. It comes in several flavors, 433-A and 433-F are most commonly used. If you want this kind of relief you must provide bank statements or receipts for a 3 month period, and all assets that might be used to pay the tax debt must be disclosed. 433 requests and strategies are complex to the point that it is desirable to have most 433 filings prepared by a tax professional.
(At the time of this writing) an “automatic”, “streamlined” or “campus non-streamlined” installment agreement for up to $250,000 that will be full paid within the collection statute of limitations can be set up somewhat automatically and does not require disclosing 3 months of financial information nor completing form 433.
Offers in compromise, doubt as to collectability (settling tax debt for pennies on the dollar, as widely advertised on TV) may be a good option for certain taxpayers without the potential for significant future income. IRC 6502 usually gives the government 10 years after assessment to collect a tax debt. If the 10 years is likely to run out without collection in full then the government will consider such offers in compromise. The offer in compromise is NOT just a negotiation! It is based on the calculation of reasonable collection potential from the same information used to request an installment agreement.
Bankruptcy will often release income tax debt over 3 years old that is on file for over 2 years if any addition to the debt is over 240 days old. It will not release tax debt from a substitute for return (if the taxpayer never filed), and it will not release liens attached to real estate.
Please note that this is an evolving complex regulatory practice area, and not all details can be communicated in a brief article such as this one.