What If You Can't Pay Your Taxes?

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So you owe taxes--you owe big time--and you can't possibly pay the balance. You aren't alone: The number of Americans who are behind on their taxes is estimated to be anywhere from 8 to 20 million.

So what do you do if you can't pay your tax bill? You have a mix of options, depending on your situation, and the IRS would certainly recommend that you reevaluate whether you can pay or not.

"The IRS will encourage an individual to borrow on their credit cards or take out a home equity line of credit. The IRS wants to be paid, and paid first," says Mary Lou Gervie, director of forensic accounting and dispute services at Watkins Meegan, a CPA firm based in Bethesda, Md.

But if you absolutely can't pay, there are two main approaches the IRS suggests. Since everyone's situation is different and there's no one-size-fits-all strategy, it's best to consult a tax preparer or professional for advice before proceeding. Here are your options:

[Read: Are You Taking Enough Tax Deductions?]

The monthly installment. If you're behind on your taxes but feel you can pay eventually, this is probably your most appealing option.

The national media office at the Internal Revenue Service was unable to produce anyone for an interview, but the IRS did send information recommending that taxpayers who are behind either attach a letter with their tax return or fill out Form 9465--or better yet, simply go to www.irs.gov and fill out an online payment agreement application (www.irs.gov/Individuals/Online-Payment-Agreement-Application).

If you fill out the form online, you'll find out right away if you're eligible; going the snail-mail route generally takes 30 days or longer. If you owe $50,000 or less and can pay what you owe within six years, you can get a payment agreement, according to the IRS.

Why you might want to do this: Pretty obvious. You can pay the IRS monthly and no longer worry about what you owe the government.

What may be problematic: You still have plenty to worry about.

"Interest continues to accrue on the tax debt until paid in full," says Scott Estill, a former IRS senior trial attorney who is now in private practice in Littleton, Co., and specializes in helping taxpayers resolve issues with the IRS. He is also the author of "Tax This! An Insider's Guide to Standing up to the IRS" and several other tax publications.

Other than accruing interest, what's so bad about it continuing to add up? It may not end up being so dire, but it depends on the size of your debt, says Estill. "Depending upon the amount of the debt and the amount of the monthly payment, there may be situations in which negative amortization occurs, which is when the balance increases every month because the payment does not cover all of the interest on the debt," says Estill.

There are other negatives, he adds, explaining that the IRS can still file a federal tax lien against you and your property even with a payment plan in place, which can make it challenging to get a decent loan.

Estill also notes: "The IRS may require full financial disclosure of assets and liabilities, thus providing them with a road map to your assets if the installment agreement falls through by default." That is, due to missing payments.

Another concern, especially if you're self-employed and not seeing taxes removed from each paycheck: While you're paying your back taxes in a monthly installment plan, you still need to make payments on the current year so you don't fall behind. "It can be very stressful for people to come up with a fairly large amount every month," says Gervie. "It squeezes them."

In fact, if you make your monthly payment too high and fail to budget for taxes on the current year you need to pay, you might start a vicious cycle of owing the IRS indefinitely.

[Read: Lesser-Known (But Common) Tax Mistakes to Avoid.]

An offer in compromise. This is the second approach the IRS recommends if a taxpayer simply cannot pay what they owe.

In the words of the IRS, and the following is wordy but worth reading for anyone who might need to do this: "An offer in compromise allows you to settle your tax debt for less than the full amount you owe, if you meet strict requirements. This may be a legitimate option if you can't pay your full tax liability, or doing so creates a financial hardship. We consider your unique set of facts and circumstances: ability to pay; income; expenses; and asset equity. Generally, an offer will not be accepted if the IRS believes the liability can be paid in full as a lump sum or through a payment agreement. Before we can consider your offer, you must be current with all filing and payment requirements. Use the Offer in Compromise Pre-Qualifier to confirm your eligibility and prepare a preliminary proposal: http://irs.treasury.gov/oic_pre_qualifier/"

Why you might want to do this: Again, pretty obvious. You don't want to have this problem hanging over your head forever.

What may be problematic: You're spilling your financial guts to the IRS, says Estill. "Thus, the IRS will have an excellent road map to assets if the offer does not succeed," he says.

But there is also a statute of limitations the IRS has to collect a debt, and an offer in compromise extends that for an extra year, plus the time the offer was being reviewed, says Estill.

As Estill puts it, if you have a tax return for 2005 that was filed on April 15, 2006, your statute of limitations currently ends on April 15, 2016. But if your offer in compromise is rejected and it took the IRS six months to review the offer and reject it, it now has until Oct. 15, 2017, to collect the debt. So that's something to think about.

And yet another concern: "There is a five-year period of compliance required after the offer is accepted, and if the taxpayer has problems with paying a tax debt in the five years following the acceptance of the offer, it can cause the offer to be revoked and the taxpayer ends up back in the same position as pre-offer," says Estill.

Whatever you decide to do, file. It can be scary dealing with the IRS because, well, it's all-powerful. Nevertheless, file--even if you can't pay.

"It doesn't get better by hiding your head in the sand just because you don't have the money," says Benson Goldstein, senior technical manager of taxation for the American Institute of CPAs, which is headquartered in New York.

[See Avoid These 10 Common Tax Mistakes.]

Goldstein adds that if for no other reason, you should file to get that decade-long statute of limitations started.

Not that you want to drag out the experience of owing the IRS for 10 years, but if you don't file, it will take longer to resolve your tax issues. What you likely won't do is go to jail or lose your house from owing the IRS, says Estill. That is, as long as you're on the up and up when working with the agency.

"There has to be some intention to deceive or defraud the IRS before criminal elements come into play," says Estill.

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