Preparing clients for tax surprises: How to handle tax bills that clients cannot pay

"I owe how much?" and "How am I supposed to pay that?" are two questions many CPAs have heard. CPAs also encounter new clients who have not filed a tax return in several years and want to file now.

In both situations clients have unpaid tax liabilities that they are not able to pay immediately, and they need a solution. The good news is that the IRS offers several solutions to assist taxpayers to pay their taxes and become compliant. In late 2008 and early 2009, the IRS introduced the Fresh Start Initiative to help taxpayers with tax debts come into compliance. In 2012, a major expansion of the program provided more help for struggling taxpayers. This discussion provides information for advising clients who cannot pay in full and resources for clients.

Payment plans for full balance due

Taxpayers who are unable to pay the amount they owe by the original filing due date will be subject to interest and late-payment penalties for each month they are late. While taxpayers can file an extension of time to file their returns, no extension of time exists to pay the tax due. However, the taxpayer may be able to establish a payment plan with the IRS. Failure to pay taxes on time can result in the IRS's filing a Notice of Federal Tax Lien or a tax levy, both of which may affect a taxpayer's ability to apply for credit. As a general rule, the balance due on a payment plan incurs interest, and the IRS diverts future tax refunds to offset the balance due.

Eligible taxpayers can apply online for a payment plan at www.irs.gov. Individuals seeking a long-term payment plan who owe $50,000 or less in combined tax, penalties, and interest, and have filed all required returns, and individuals seeking a short-term payment plan who owe less than $100,000 in combined tax, penalties, and interest are generally eligible. Businesses seeking a long-term payment plan that owe $25,000 or less in combined tax, penalties, and interest, and have filed all required returns are generally eligible. Generally, user fees apply; however, if the taxpayer qualifies for a short-term payment plan (120 days or less) no user fees apply. Individual balances over $25,000 or business balances over $10,000 must be paid by direct debit.

A taxpayer who does not qualify for an online application must complete and mail Form 9465, Installment Agreement Request, and Form 433-F, Collection Information Statement. Taxpayers may also qualify for the offer-in-compromise program, which can reduce the amount of the balance due to the government.

Offers in compromise

Offers in compromise allow taxpayers to settle their tax debt for less than the full amount and should be considered in cases where taxpayers are unable to pay the full amount of their taxes or if payment would create a financial hardship. To be eligible to request an offer in compromise, a taxpayer must meet the following initial requirements:

• File all tax returns that are legally required;
• Receive a bill for at least one debt included in the offer;
• Make all required estimated tax payments for the current year;
• Make all required federal tax deposits for the current year (applicable to business owners with employees);
• Not be involved in an open bankruptcy proceeding;
• Not have any open audit or outstanding innocent spouse claims; and
• Not have the ability to pay in full or through an installment plan and/or equity in assets.

The IRS recommends using the Offer in Compromise Pre-Qualifier tool found at irs.treasury.gov/oic_pre_­qualifier; however, this is not required for submission of an offer.

An offer in compromise is submitted using the following forms:

• Form 433-A (OIC), Collection Information Statement for Wage Earners and Self-Employed Individuals, or 433-B (OIC), Collection Information Statement for Businesses, and all required documentation as specified on the forms; and
• Form 656, Offer in Compromise — individual and business tax debt (corporation/LLC/partnership) must be submitted on separate Forms 656.

There is an application fee of $186 and an initial payment that is nonrefundable, both of which must be submitted with the offer. Detailed instructions can be found in Form 656-B, Offer in Compromise Booklet.

While it is important to be aware of the various options available to taxpayers who owe money to the IRS, the most important thing a CPA and trusted adviser can do is to help taxpayers avoid surprises. Remind clients about the importance of consulting their tax adviser whenever their financial condition changes. Advance planning enables taxpayers to prepare for additional taxes that may be due. Advisers may suggest increasing estimated taxes or withheld taxes, or they may advise setting aside a certain amount of money to be prepared to pay taxes when the taxpayer files a return.

Some surprises are wonderful, but tax surprises rarely are.