15 things you need to know when clients owe taxes to the IRS

There are more than 18 million individual and business taxpayers who owe money to the IRS. 

Each year, about one out of every six individual clients (that’s more than 26 million taxpayers) files a tax return with a balance due. Many of those people can’t pay. They need advice and potentially an alternative to paying the entire balance at once.

If you’re advising these clients, here are 15 things they need to know about IRS collection that come into play before and after filing.

1. File the return before the due date. 

That a return should be filed may seem obvious to practitioners, but for many taxpayers who are going to owe, it’s tempting to ignore the problem and just not file. Remind them that not filing only makes matters worse because it can mean a very expensive failure-to-file penalty that can add up to 25% more to the balance. 

Also, clients who request filing extensions aren’t immune to penalties. Remember to inform your clients that if they don’t pay 90% of the ultimate balance they owe with the extension, they’ll incur a failure-to-pay penalty.

2. Get into an agreement with the IRS.

Clients should also be made aware that, depending on their circumstances, if they owe money to the IRS and don’t pay, the IRS can file a tax lien or issue a levy to collect the taxes. The only way your client can avoid these enforced collection actions is to get into an agreement with the IRS.

3. Starting in 2015, no agreement may mean no passport.

In late 2015, Congress passed a law that allows the U.S. State Department to revoke taxpayers’ passports or deny passports to those who owe more than $50,000 to the IRS and are not in an agreement to pay.

4. There are options. There are several types of IRS collection agreements.

The installment agreement is the most common payment arrangement. There are several kinds of those available, depending on your client’s situation. Your client can also get an extension of up to 120 days to pay the IRS, just by asking for it. 

If your client is in a hardship situation (determined according to IRS standards), there are hardship agreements. These include deferring payment (called “currently not collectible” by the IRS), or the offer in compromise for extreme hardship situations, when the IRS will settle the tax debt for less than the taxpayer owes. For more, see “IRS Offers Collection Alternatives for Your Financially Distressed Clients.”

All of these options are viable agreements with the IRS, and clients will avoid levies and potentially passport problems. Depending on your client’s circumstances and on the type of agreement your client may enter into, the IRS may file a tax lien.

5. Taxpayers can request and receive most agreements on irs.gov.

In the past year, the IRS has made improvements to its online payment arrangement tool on irs.gov. In fact, in 2015, the tool was used four times more than in 2014. That’s largely because setting up the agreement with the tool was much quicker than waiting on IRS phone lines or waiting for a paper response from the IRS.

6. Some agreements come with a federal tax lien.

Extensions to pay and streamlined installment agreements are surefire ways to avoid a tax lien filing if your client acts proactively. However, if your client owes more than $50,000 (which is rare) or owes more than $10,000 and can’t pay within six years, the IRS will usually file a tax lien.

If your client does have a tax lien, once he or she pays off the balance, you can use lien-withdrawal procedures to help remove the tax lien from your client’s credit and public record.

7. The IRS has 10 years to collect.

If your client can’t pay the IRS before the 10-year statute to collect expires, the IRS usually writes off the remaining tax, interest, and penalties. For this reason, any agreement that doesn’t pay off the balance before the statute of limitation expires always requires taxpayers to file detailed financial statements and other documents with the IRS to prove that they can’t pay the IRS with assets and income.

8. Don’t forget to request penalty abatement toward the end of the installment agreement.

As clients finish paying in an installment agreement, many tax professionals forget to request penalty abatement for their clients for failure to pay penalties. These penalties accrue over the term of the installment agreement. If your client has a three-year clean compliance history before the year with the penalty, use first-time abatement to remove the penalties paid for one tax period. See “Know These Penalty Abatement Realities to Better Help Your Clients” for additional guidance on requesting penalty abatement.

9. Your client must file all required returns to get into an IRS agreement.

If your client needs a collection alternative, it’s essential that your client file all required tax returns for the past six years. If your client hasn’t filed any of these returns, your client won’t be able to get into an agreement with the IRS (other than the extension to pay). If you’re not sure whether your client has filed returns for the past six years, research your client’s history using IRS transcripts.

10. An offer in compromise (OIC) may be a possible solution in desperate times.

OICs are over-publicized, but they are a possible solution if your client can’t pay within the statute of limitation—based on IRS financial standards. The OIC pre-qualifier tool is a good resource to determine whether your client qualifies. You should completely evaluate your client’s circumstances to see if an OIC is a good option.

11. Your client should pay by direct debit to avoid default. 

Missed payments result in additional fees to reinstate an installment agreement—and unpleasant letters from the IRS. Taxpayers who pay by check are three times more likely to default on their agreement. 

Keep in mind that with direct debit installment agreements your clients won’t get a monthly letter reminder of how much they owe the IRS. Instead, the IRS will send only an annual statement of account activity, including the balance owed and accrued penalties and interest. Direct debit agreements also have a lower setup fee, $52, versus the $120 fee for payment by check.

12. Use the streamlined installment agreement to get the best terms. 

The streamlined installment agreement usually comes with the best payment terms. Your client can make equal monthly payments for up to 72 months, for balances of up to $50,000.  

If your client owes more than $50,000, advise your client to pay down the debt to below the $50,000 streamlined installment agreement threshold to get payment terms over 72 months. Otherwise, the IRS will determine the payment based on your client’s income and IRS-allowed expenses. That can yield a much higher payment than the streamlined agreement terms.

13. Avoid defaulting on the agreement.

If your client owes again and can’t pay, his or her current agreement will default. Your client will have to reinstate the agreement and pay a $50 reinstatement fee to the IRS. 

Taxpayers often cause their agreements to default because they should have made estimated tax payments or need to increase their income withholding.

Also, if any additional amounts become due from other IRS compliance activity, such as an audit or underreporter inquiry, your client should pay those in full or request that the IRS add them to the existing agreement to avoid default.

14. Your client won’t get any refunds until he or she has paid the entire balance.

Clients often don’t understand this aspect of collection agreements, so be sure to give them a heads-up. Until your client pays the entire balance, the IRS will always take the refund.

15. The annual interest and penalty cost of an installment agreement is about 6%.

The IRS currently charges a 3% interest rate on underpayments. If your client gets into an installment agreement, the failure to pay penalty is 0.25% per month, or 3% per year. In essence, in addition to the initial setup fee, the cost of an installment agreement is 6% of the total balance owed per year.

Now, give your clients peace of mind

It’s common for taxpayers to file and owe. If you have a client who owes the IRS and can’t pay, that client will look to you for reassurance and expertise. These 15 essential IRS collection knowledge points will help you advise your client on what to do next.   

Jim Buttonow, CPA/CITP, directs tax practice and procedure product development for H&R Block, and serves as chairman of the IRS Electronic Tax Administration Advisory Committee (ETAAC). He has more than 28 years of experience in IRS practice and procedure.