Do IRS Payment Plans Really Work?

It depends. If the size of the tax debt is small, and the size of the monthly payment on the proposed installment agreement is relatively large, then yes, it can work.

However, the fact is most people who get into tax trouble also have other financial pressures making it difficult to come up with a payment large enough to actually pay down the taxes.

The reason you need a large payment: A tax debt not only accrues interest, it also accrues penalties. When the penalties are added to interest, the effective growth rate can be on the order of about 25%!

Most people do not bother to run the numbers, or ask IRS how long it will take to pay down the tax based on the monthly payment they propose. Often they are misled, and many come to a tax professional a year or two later saying: "I’m in this payment plan with IRS, but it doesn’t seem to be going down!"

This is a real-life example from a recent consultation: Client had a tax debt of $30,000. At 25%, the annual growth would be $7,500/year, which, divided by 12, would be equivalent to $625/month. What was the client paying? $300/month. What do you think was happening to the tax balance he was owing?

There are almost always better alternatives than an installment agreement with the IRS or state tax agency. If you know you owe the tax and there is no dispute as to the amount, among the alternatives are paying off the tax debt in a lump sum using lower-interest credit lines or borrowed money from friends and family, or paying off the tax debt interest-free in a Chapter 13 bankruptcy plan.

Be careful with installment agreements. They can be misleading. Run the numbers and get help if necessary.