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It’s never good news to find out you owe taxes to Uncle Sam. It’s even worse to find out you can’t afford to make the payment.
If you’re in that situation, be sure to file the paperwork with the Internal Revenue Service by Tuesday, April 17. If you don’t, the IRS will charge you a penalty that amounts to 5 percent of the balance; each month that you don’t pay, it will add another 5 percent, up to 25 percent. That balance will also be subject to interest, which the IRS will adjust each quarter. The rate is currently 5 percent.
Then consider these options to help you pay:
Request a payment extension. If you haven’t applied for a payment extension before, this could be an option. After you file your tax forms on time without payment, the IRS will contact you to ask whether you would be able to pay within 120 days. If you choose this option, the agency will charge you a monthly fee of 0.5 percent of the amount owed.
Make a partial payment. Even if you can’t pay the whole tax bill, pay as much as you can. This will cut down the size of the penalty and interest you’ll have to pay the IRS.
Such an approach could backfire, though, if the partial amount you owe is large and you pay it using a credit card, notes Mike Velazquez, a CPA at The Accountancy, based in Glendale, Calif. “It would make no sense for you to put that on a credit card to carry a compound interest rate of 29 percent and potentially have your credit rating take a hit,” he notes.
In that instance, you’re better off arranging to pay off the entire amount using an IRS-sponsored installment plan with its lower interest rate, he says. Unlike credit-card companies, the agency doesn’t report on its debtors to credit bureaus—as long those taxpayers aren’t subject to any IRS liens or other serious collection situations, Velazquez says.
Consider an installment plan. This is a good option if you need more than 120 days to pay your tax bill and you owe less than $50,000.
When you file your tax return, fill out IRS Form 9465, Installment Agreement Request (PDF). The IRS will then set up a payment plan for you, which can last as long as six years. You’ll incur a setup fee, which ranges from about $31 to $225, depending on how much income tax you owe. The fee can drop significantly if you arrange for direct payments from your bank account.
“It’s the easiest way to go as long as you submit a reasonable request to the IRS,” says Larry Pon, a CPA based in Redwood Shores, Calif. As a rule of thumb, he says, divide the balance owed by six and agree to pay that amount each year for six years. If you end up needing installment plans for more than one year, hire a tax attorney or CPA to negotiate a workable plan with the IRS.
There’s another benefit to signing up for an installment plan: If you’re unable to make payments, the failure-to-pay penalty, which begins to accrue the day after the tax-filing deadline, will grow at just 0.25 percent per month—compared with 0.5 percent if you don’t sign up for the agreement.
Ask for leniency due to hardship. You’ll need to prove that paying your tax debt would cause you a tremendous burden, perhaps forcing you to sell your home. But this could get you more time to make your payment, and in some cases the IRS will also waive any payment penalties. Read Application for Extension of Time for Payment of Tax Due to Undue Hardship to see whether you meet the requirements.
There’s no rule book on the circumstances that qualify you for leniency, Velazquez says. “The IRS is getting tougher on what it agrees to,” he says. “Ultimately it is based on facts and circumstances of each case.”
Apply for an “offer in compromise.” This is a way to reduce your tax debt permanently. The IRS says that an offer in compromise allows you to settle your tax debt for less than the full amount you owe. It may be a legitimate option if you can’t pay your full tax liability or if doing so creates a financial hardship. Typically the debt has to be at least three years old, Pon notes.
Before applying for an offer in compromise, the IRS requires applicants to have filed all their tax returns. So if you didn’t file in previous years, you will need to finish those missing returns. It also requires that you pay the current year’s estimated tax payments. Refer to the IRS’ Booklet 656-B, “Offer in Compromise” (PDF), for details on the application procedure. To see whether you could be a candidate, the IRS offers a prequalifier online tool. There’s a $186 application fee.
Offers in compromise are rarely granted. “You are asking the IRS to essentially erase what you owe them,” Velazquez says. “Understandably, they do so under the rarest of circumstances. But if there is reason to believe you don’t owe what they say you owe or there is doubt as to whether IRS will ever collect from you—say, you’re terminally ill—then they will listen to plausible arguments to reduce your debt.”
Don't Forget About Your State Taxes
With all the available delayed payment choices for federal taxpayers, Daniel Morris, senior partner at Morris+D’Angelo, a CPA firm based in San Jose, Calif., suggests that clients pay their state tax bills before their federal bills. They can then take advantage of the variety of payment options that the federal government provides.
“States are less flexible than the federal government,” he says. “The federal government’s installment plan is more taxpayer-friendly.”
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