If you annually fail to pay taxes on something specific, it may take several years for the IRS to realize it. For example, if you withdraw money from your 401K, that money becomes taxable, and you are supposed to report it to the IRS. If you fail to do so, the IRS may not realize for many years, and when it finally makes an assessment (a determination that you owe that money), you may find yourself in several years of tax debt. These payments you owe to the IRS are called “liabilities.”
So what can you do if you end up with multiple years of unpaid taxes? The good news is the IRS allows you to set up an installment plan to pay off the outstanding taxes over a number of years rather than all at once. The bad news is that even with a payment plan, those outstanding payments will still accrue penalties and interest each year they go unpaid. Furthermore, when you submit your monthly payments to a payment plan, the money will go first to the oldest penalty, then to any accrued interest, and finally to the principal amount you owe. Imagine, for example, the IRS discovers you haven’t been paying a certain tax for the last six years (2015-2021) and you open an installment plan. Each time you make a payment, that money will go first to the penalties that aren’t paid off (starting with 2015), then to the interest accrued since 2015, and the remainder (if there is any) will go against the total outstanding amount.
If you end up in a situation like this, you may have a desire to request the payments go to the more recent years first so that you can pay those liabilities off before they accrue any interest. But is this possible? The short answer: sort of. Unfortunately, it is not possible to control where the monthly installments for the payment plan go. However, as a quick call to the IRS will reveal, you are also free to make a separate one-time payment towards your outstanding liabilities and choose which year the payment goes against. This payment can be made online or over the phone- however, be aware that there is a service fee for making the payment over the phone. If you know at the time you are setting up an installment plan that you will also be making separate one-time payments, you may want to factor this into the amount you commit to sending in each month. You can also modify your installment plan to make the monthly amounts smaller.
Can You Have Two Installment Agreements with the IRS at the same time?
What happens if you already have a payment plan for outstanding taxes and the IRS assesses in a subsequent year that you have new unpaid liabilities? For example, if you already have a plan for 2013-2017, and you are unable to make a full payment in 2020, can you simply create a second payment plan for the 2020 liability? The solution is actually much simpler – you can just amend your existing installment plan to include the new outstanding payment. The IRS does not allow you to create an additional payment plan. With this system, you will still run into the same problem of not being able to direct your payments to specific years, therefore you may want to consider finding a way to make a one-time separate payment to pay for the most recent year’s liability instead of adding it to the payment plan.
IRS Installment Agreement Coronavirus
In November of 2020, the IRS added a series of measures to make payment plans more user friendly to help those hit hardest by the COVID-19 pandemic. For example, it expanded the duration of short-term payment plans from 120 to 180 days and began allowing taxpayers with less than $250,000 of debt to set up installment agreements without providing a financial statement.