By submitting Internal Revenue Service (IRS) Form 4868 by the April 15 deadline, a taxpayer is granted an automatic six month extension for filing their taxes until October 15.
However, while this certainly helps in that it means one can avoid six months worth of late filing penalties, it’s important to note that late filing penalties and late payment penalties (and interest) are two different things. Form 4868 will not help you with the latter. If you are struggling to pay your taxes by April 15, by all means you are better off submitting a Form 4868 for a filing extension (or just filing on time even if you can’t pay in full yet) than delaying filing and wracking up both kinds of penalties, but if you want an extension on the deadline to pay, that’s a different form.
For that you’ll need to submit Form 1127, which is a request for an extension of up to six months to pay your taxes. But unfortunately whereas Form 4868 to avoid the late filing penalties automatically gets you an extension, Form 1127 is scrutinized much more closely and is more difficult to get approved. You’ll need to provide the IRS with thorough documentation of your assets and income, and convince them that you simply have no disposable income available to use for paying the taxes you owe, and no realistic way to even borrow the money.
But let’s say either your Form 1127 is disapproved, or the additional six months runs out and you still can’t pay some or all of your taxes owed, and so you find yourself with a debt to the IRS.
At this point you may seek what’s known as an “offer in compromise” (OIC), which requires submission of Form 656. An OIC is a proposed payment plan where the IRS would agree to settle for something less than the full balance plus interest plus fees to which they would otherwise be entitled.
A taxpayer applies for an OIC in one of two ways. In order to propose a lump sum settlement, the taxpayer must include a $150 application fee plus 20% of the proposed lump sum. In order to propose payment over time in monthly installments, the taxpayer must include the $150 fee plus the first month’s installment, and then continue to submit at least the amount of a monthly installment every month while the settlement offer is being considered. (A taxpayer who can show extreme hardship may in some circumstances be partly or wholly exempt from these fees and down payments. Also, the $150 application fee is not required if relief is being sought solely on the basis of doubt that the assessed tax liability is correct.)
Just like with Form 1127, it is far from a slam dunk that you will have an OIC approved. The IRS will only consider an OIC if at least one of the following three conditions are met:
1. There is some doubt as to whether the assessed tax liability is correct.
This is not a requirement that the assessed tax liability be proven to be incorrect. Instead it allows the IRS to show some flexibility in gray area cases.
2. There is some doubt as to whether the full amount of the tax debt would be collectible by the IRS anyway if they did not offer relief.
In deciding if a tax debt is collectible, the IRS looks at a formula of 48 times the monthly disposable income, plus total assets. The IRS expects to be able to collect this much, so it will normally only consider an OIC offer at least this high.
3. There is reason to believe collection of the full tax debt, even if possible, would result in unacceptable economic hardship or would be unfair and inequitable.
This allows the IRS to go easier on taxpayers who are disabled, elderly, or have extenuating circumstances making payment especially difficult.
If the OIC is accepted by the IRS, then the rest of the lump sum or the remainder of the monthly installments must be paid as proposed, or the agreement can be voided. If the proposed settlement is rejected by the IRS, then the tax debt remains in place, though it is reduced by the amount the taxpayer paid off in submitting the proposed settlement. If the IRS fails to accept or reject the proposed settlement for two years, then by default it is treated as accepted.