How to Handle a Tax Bill You Can't Afford

10/06/2025

It’s a moment that can make any business owner’s stomach drop: you’ve filed your taxes, and the number staring back at you—whether from the IRS, your state tax agency, or both—is far larger than you can comfortably pay. The immediate reaction might be a mix of panic and frustration, but I’m here to tell you that this is a manageable situation. The worst thing you can do is ignore the problem. Trust me, both federal and state governments have long memories and powerful collection arms.

 

The key is to be proactive and communicate with both the IRS and your state tax authority. A resolution with one agency does not automatically resolve your debt with the other.

 

The Cost of Doing Nothing: Federal and State Penalties

Before we dive into the solutions, it’s crucial to understand the consequences of inaction. The IRS imposes penalties and interest, and you can be sure your state does, too.

 

  • Federal Failure-to-Pay Penalty: This is typically 0.5% of the unpaid taxes for each month or part of a month that the taxes remain unpaid, capped at 25% of your unpaid tax liability.
  • State Penalties: Every state has its own structure for penalties and interest, which can sometimes be even harsher than the IRS's.
  • Interest: Both the IRS and state agencies charge interest on underpayments and penalties. This interest is typically compounded, causing the total amount you owe to grow surprisingly fast.

These charges can significantly inflate your original tax debt on two fronts, making it critical to address the issue head-on with each agency.

 

Your Options When You Can’t Pay Your Tax Bill in Full

The good news is that both the IRS and most state tax authorities have programs in place to help taxpayers. You will need to negotiate with each one separately.

 

1. Short-Term Payment Plan

If you think you can pay your tax debt in full within a few months, this might be your best option.

  • Best For: Taxpayers who need a bit of extra time to get their finances in order.
  • The Details: The IRS offers a payment extension of up to 180 days. Many states offer similar short-term extensions. While setup fees are rare for this option, penalties and interest will continue to accrue on your outstanding federal and state balances until they are paid in full.

2. Installment Agreement

An Installment Agreement allows you to make predictable monthly payments over a longer period.

  • Best For: Taxpayers who can’t pay in full right away but can afford to make regular monthly payments.
  • The Details: The IRS allows monthly payments for up to 72 months, and most states have similar installment plans. You will need to set up two separate payment plans—one with the IRS and one with the state. Setup fees may apply for both, and interest will continue to accrue, but getting into a formal agreement can reduce the monthly failure-to-pay penalty rate.

3. Offer in Compromise (OIC)

An OIC allows certain taxpayers to resolve their tax liability for a lower amount than what they originally owed.

  • Best For: Taxpayers experiencing significant financial difficulty, for whom paying the full amount would create a genuine economic hardship.
  • The Details: Both the IRS and many states have an OIC program. Each will conduct its own independent and thorough financial review, considering your income, expenses, and asset equity. An accepted federal offer does not guarantee an accepted state offer, or vice-versa. You will have to apply and qualify separately.  And the requirements in both cases tend to be stringent.

4. Currently Not Collectible (CNC)

In some cases, a tax agency may determine that a taxpayer is unable to pay their tax debt at all.

  • Best For:  Taxpayers who can demonstrate that paying their tax debt would leave them unable to meet their basic living expenses.
  • The Details: Both the IRS and some states may agree to place your account in a temporary hardship or "Currently Not Collectible" status. This does not mean the debt is forgiven; it's a temporary pause on collection actions like levies. Penalties and interest continue to grow, and the agencies will periodically review your financial situation to see if you are able to resume payments.

How to Take the First Step

Facing a large tax bill from two different government bodies can feel doubly daunting, but your strategy remains the same: act now. File all your returns on time, even if you can’t pay, to avoid the steep failure-to-file penalties.

Next, you must address both liabilities. This brings up a critical strategic point: which tax debt should you pay first? While every situation is unique, many tax professionals recommend prioritizing your state tax liability. In our experience, state tax agencies are often more aggressive, less flexible, and can move much faster than the IRS to issue levies or garnish wages. They are smaller organizations with more concentrated power. Resolving your state debt first can often prevent more immediate and disruptive collection actions.

 

Navigating the parallel, but separate, collection processes of the IRS and a state tax agency is complex. This is where professional guidance is not just helpful, but essential. An experienced tax professional can represent you before both agencies to negotiate resolutions that work in tandem.

 

Don’t let federal and state tax debts spiral out of control. Take action today to get back on the right track.

 

Sign up today for a FREE discovery call.

 

 

Greg Tobias, Enrolled Agent

Admitted to practice before the Internal Revenue Service

 

Source

  • Internal Revenue Manual (IRM) Part 5, Collection Process
  • IRS Publication 594, The IRS Collection Process
  • Internal Revenue Code § 6159, Agreements for payment of tax liability in installments
  • Internal Revenue Code § 7122, Compromises
  • IRS.gov, Payment Plans, Installment Agreements
  • IRS.gov, Offer in Compromise
  • Official publications and websites of various state tax agencies.

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