Why You Should Avoid the IRS Installment Agreement

The IRS installment agreement allows taxpayers who cannot pay the taxes they owe in one lump sum to make monthly payments to the government. This may sound like a good option if you do not have the cash readily at hand come the filing deadline. However, for a few reasons, taxpayers are generally better off steering clear of this installment plan and using other another payment option.

Setup Fees

You will have to pay a fee to set up the installment agreement. If you plan on having the payments automatically deducted from your account, you will be able to pay only $52. Otherwise, your fee will be $105 unless your income is below the government's poverty line by 250 percent or more. In that case, you can apply to pay only $43 (figures current in May 2011). In any case, the setup fee amounts to extra money you are paying the government—for the opportunity to pay the government.

Interest Fees

You will also have to pay interest on the taxes you owe. This interest rate will be compounded daily, based on the short-term federal funds rate. The IRS will add 3 percent to this federal funds rate to compute how much to charge you in interest. In most cases, it will add up to between 9 and 12 percent per year.

Late Fees

If you for some reason cannot make your payment one month, the IRS will charge you a "failure to pay fee." This will usually be .5 to 1 percent of the total balance that you still owe. If you forget your payment a few months, this can really add to the balance you owe the government.

Consider Other Options

With these factors in mind, you should consider other, less expensive options for paying your tax debt. For example, you might be able to secure a personal loan from a bank at a lower interest rate. You could also look into getting a home equity loan, which would almost assuredly be less expensive and provide you with a lower payment.

If you will be able to pay off the bill within 1 year, you might even consider putting the balance on a credit card with a zero percent introductory rate. This method can be dangerous if you do not pay the balance off before the rate goes up, but if you can put yourself on a strict payment schedule, you can avoid paying as much as you would through the IRS installment agreement.

What is the smallest payment amount I can make on an installment agreement to the IRS?

The smallest payment you can make on an IRS installment agreement is determined by the negotiations you, your lawyer or a judge carries out with the IRS. The IRS approaches this determination using an "allowable living expenses" measurement for your geographic area and family size. Any amount not qualifying as an allowable living expense will be handed over to the IRS each month. However, you and your attorneys can argue for a lower sum. You will have to prove that the sum the IRS has requested would place undue hardship on you, your family or your financial situation.

Can the IRS change my installment agreement?

If you have missed a payment on your IRS installment agreement, you will be sent a form CP 521. This notice will include a deadline for you to make the late payment, and it may also include details about fees and interest you may be charged. The IRS can change your installment agreement if you fail to make payments, and this CP 521 is the first notice that a change may be pending. To maintain control over your agreement, pay the past due amount by the date noted on this form. Failing to act may lead the IRS to send your debt to collections and alter your agreement.

What happens to an IRS installment agreement for a business if the company folds?

An IRS installment agreement is added to the total debts your company owes when it folds. If you are not declaring bankruptcy, you will have to pay the installment agreement in full prior to closing your business books. If you are declaring bankruptcy, then a judge will determine the order of importance of your debts. IRS debt is the most senior form of debt. Judges are instructed to force the repayment of this debt, typically by liquidating your business assets, prior to allowing you to repay any other loans. If the IRS debt is in your name rather than the business name, you may remain liable even after the bankruptcy has been resolved on the business end.