Can't pay your taxes? Here's what to do

It is tax season, and you owe thousands to the Internal Revenue Service. But you cannot pay.

Now what?

"The key element is proactivity," says Lance D. Christensen, a certified public accountant in Garden City, N.Y.

"Be proactive in filing for an extension. Be proactive in communicating your inability to pay. If the collections unit of the IRS reaches out to you first, things can get ugly."

No matter how much you owe, throwing in a portion of your payment immediately "as a peace offering" is your best option, said Bill Farmer, a tax expert in Lexington, Ky.

Farmer calls this an unofficial payment plan. "If you owe a big balance on the due date, send the IRS about 40 percent of what you owe," he said.

In about six weeks, you will get a letter explaining the full balance of what you owed and that you only paid part of your bill. If you do not have the balance, send as much as you can, he advised.

If you owe more than that, you will need to do whatever possible to reduce your outstanding balance to that sum, then go on a payment plan that will give you up to 60 months to repay, using Form 9465.

Setting up a payment plan requires an origination fee of $120. If what you owe can be paid off within the next four months, Farmer said, call the IRS and request that time to pay in full.

Keep in mind that everyone who pays taxes late will be assessed penalties and interest.

For those who fail to file and fail to pay anything at all, the penalty can be as much as 25 percent of what you owe.

Farmer sees this problem fairly often when clients sell a home, have not paid capital gains tax and suddenly owe $10,000 to $15,000 as a result.

"Borrow the money from the bank or credit cards, or even family or friends," said Daniel Henn, a CPA based in Florida. "You generally don't want the federal government as a creditor."

Henn's advice? Sell something such as stocks, bonds and mutual funds. Cash in a certificate of deposit or hold a garage sale.

As a last resort, you can withdraw funds from an IRA or 401(k), which has its own set of tax implications. Another option — although it is far from ideal — is to borrow against your 401(k). Most plans allow for a loan of up to 50 percent of your balance.

Generally, taxpayers with assets are best off with an installment agreement.

"If the tax can be paid off within a 60-month period, it's a rather simple process to get this approved," said Crystal Stranger, who helps clients deal with the IRS in Hawaii. "Lack of income and having assets can be a dangerous IRS situation, though, as when collections gets wind of this they are likely to escalate the process of attaching liens."

It can cost 30 points on your credit score and will make obtaining credit more difficult. A levy is the next step after a lien and can be imposed through your employer — clawing back a portion of every paycheck or contractual payment — or your bank. Once the IRS has served notice, you have 21 days to negotiate terms with them.