If you’ve fallen behind on your income tax payments, it’s time to take charge of the situation to catch up.
One of the most effective ways to do so involves setting up an Internal Revenue Service (IRS) installment plan that breaks up your tax debt into smaller monthly payments. The IRS charges a monthly penalty interest rate of 0.5-5%, depending on whether you filed or not, so it’s best to start as soon as possible.
You’ll be happy you did — the 0.25% interest rate on a repayment plan will be lower than ignoring the back taxes due. Here’s what you need to know if you’ve fallen behind on your taxes, how payment plans work, and how to set up an IRS payment plan.
IRS payment plan interest rate and penalties
Installment agreements require that you pay the balance, penalties and interest imposed by the IRS on a certain due date every month. The IRS typically charges a late payment penalty of 0.5% in interest of the total debt amount each month. If you never filed, the IRS late filing penalty jumps up to 5% of the unpaid taxes due for each month. Penalties max out at 25% for unpaid and unfiled taxes.
The IRS payment plan interest rate is lower than the penalty interest rate charged for not paying your tax bill. You’ll be charged a reduced 0.25% interest during the installment agreement.
Not filing your taxes will cost you much more than the amount you owe. Even if you can’t afford your tax bill, it’s best to file and work out a payment plan. The penalties are much lower if you follow that approach.
How to set up an IRS payment plan
If you’ve received notice from the IRS that you owe money and can’t afford to make a lump sum payment, don’t get overwhelmed. You can opt to set up an IRS installment agreement. Depending on the size of the debt, the agreement breaks down what you owe into monthly installments that work with your budget.
The IRS payment plan interest rate accrues daily on your debt until it’s paid off. Prioritize repaying your back taxes, even if it means cutting back on some budget items, such as groceries, eating out and entertainment. The sooner you can clear up your debt to the IRS, the more money you’ll save in interest charges. Here are your options.
Short-term payment plan, also called a guaranteed installment agreement
If you can repay your income tax debt within three years, you’re eligible for a short-term payment plan. And if you can repay the debt in 120 days, you won’t be charged a setup fee. When examining your budget to ensure you can stick to the agreement, don’t forget to account for the penalties and interest due — you’ll also need to pay those back in your monthly installments.
The short-term or guaranteed installment agreement is easy to set up. Apply online, call the IRS at (800) 829-1040 or complete the Form 9465, Installment Agreement Request. You can submit the form at an IRS walk-in office or mail it in. When applying, you’ll need to choose from the following monthly payment options:
- Check or money order
- Credit or debit card, although additional fees will apply on credit card payments
- Direct Pay that debits your checking account
- Electronic Federal Tax Payment System (EFTPS) for online or telephone payments
If your tax debt balance is over $25,000, the only payment option available is the Direct Pay method that debits automatically from your designated checking account each month.
Long-term payment plan, also known as an installment agreement
Long-term IRS payment plans are for larger tax debts that may require more time to repay. The IRS recommends an online payment agreement for reduced setup fees. You can also mail a completed Form 9465, Installment Agreement Request or submit it at an IRS walk-in office. Here are the setup fees when you apply for an IRS repayment plan:
- Apply online and agree to Direct Pay payments: $31
- Apply by phone, in-person or mail and select Direct Pay: $107
- Apply online and choose other payment methods such as check, money order or credit card payments: $149
- Apply by phone, in-person or mail and choose alternative payment methods such as check, money order or credit card payments: $225
Depending on your specific financial situation and needs, the IRS may waive the setup fee if you meet the low-income requirements.
Once you know the installment length you’ll need, you can apply for a payment plan online, by phone, by mail or in-person. To apply for an IRS installment agreement, you’ll need to round up the following information:
- A valid email address
- Your name as it appears on your most recent tax return
- Your Social Security number or Individual Tax ID Number (ITIN)
- Your address as shown on the most recent tax return
- Date of birth
- Filing status (single, married, etc.)
- The amount of back taxes due
Once you follow the process, the IRS will need one of the following to verify your identity. You will need one of the following:
- A cell phone number registered in your name
- Your bank account number
- The activation code the IRS mailed you, which takes 5-10 business days to receive
Before you choose an IRS payment agreement
After reviewing the requirements for the short-term and long-term repayment plan options, make sure you’ll be able to make the monthly payments and fulfill the requirements. Not doing so could cause significant issues.
If you miss payments or can no longer afford the plan you signed up for, the IRS may fine you for defaulting on the agreement. At worst, they may cancel the current agreement and file a federal tax lien as well as levy your wages and bank accounts.
If you reapply for a payment agreement after being canceled, the IRS will ask for an explanation of why you defaulted on your original agreement. They may also require you to submit all your financial information for a full review before they approve you for another payment plan.
It may be better to set up a payment plan with the minimum monthly payment you can afford. Track your expenses carefully. In the months where you can afford to pay more, you can make extra payments. That way, you don’t default on your agreement but manage to pay it down faster on the months you have spare cash.
How to make extra payments on your installment plan
Paying off your tax debt as quickly as possible will save you on the monthly interest you’re responsible for. If you have extra cash, the extra payment gets you one step closer to being free and clear.
You can pay off the full amount (or a portion) of your balance by following these steps:
- Visit www.irs.gov/payments.
- Choose a payment method of Direct Pay, debit card or credit card.
- Click on “Make a Payment.”
- When asked for the “Reason of Payment,” choose “Tax Return or Notice.”
- When prompted in the “Apply Payment To” section, choose “1040, 1040A, 1040EZ.”
- Choose the tax year you owe in the “Tax Period for Payment” and continue.
- Once the payment processes, you’ll receive a confirmation to keep for your records.
If you prefer to mail a check or money order for the extra payment amount, make the check payable to the Department of Treasury. Include your Social Security number, 1040 and the filing year you are paying taxes for, and mail to the following address:
Ogden, UT 84201-0010
How to avoid a Notice of Federal Tax Lien
In the past, taxpayers following an installment agreement to repay their taxes would have a Federal Tax Lien placed on their property until the balance was repaid. The IRS Fresh Start Initiative revised this rule.
If you owe less than $25,000, the IRS will not place a lien on your property. For debts greater than $25,000, you can avoid the Notice of Federal Tax Lien if you sign up for an installment agreement plan using direct debit.
Paying off your back taxes
Receiving a tax due notice from the IRS that you owe taxes can be stressful. Fortunately, you have the option to resolve the debt by taking action to pay off your taxes by arranging a repayment plan.
Apply for an installment plan that works for your budget, and make sure you can afford the payments. Consider making quarterly tax prepayments in the future, so when April 15 comes, you’re not hit with a huge tax liability. Consulting with a tax professional could help. With a little planning and some budget adjustments, you can keep the IRS happy and save yourself the worry of receiving tax notices in the mail.