What to do if you can’t pay your tax liability.

Filing your taxes can be such a headache, but what about a tax bill higher than you can afford? We understand the IRS’s collection process can be very intimidating, so let’s discuss some options that can help keep the IRS from instituting its collection process which include liens, property seizures etcetera.

Most importantly, don’t let your inability to pay your tax liability in full keep you from filing your tax return properly and on time. You’ll want to include as large a partial payment as you can, but just filing without full payment can save you substantial amounts in filing penalties. There are also procedures that exist for payment extension and installment payment which we will survey later on.

The most common penalties include, “failure to file” and “failure to pay”. The “failure to file” penalty accrues at a rate of 5% per month or partial month to a maximum of 25% on the amount of tax your return should show you owe. The “failure to pay” penalty is less harsh, accruing at a rate of ½% per month or partial month to a maximum of 25% on the amount actually shown due on the return. The maximum combined penalty if you do not file or pay is 5% for the first five months is 25%.   After this the failure to pay penalty can continue at ½% per month for 45 more months. Thus the combined penalties can reach a total of 47.5% over time in addition to interest you will be charged for late payment. If you also missed estimated tax payments an additional penalty is tacked on beginning on the payment’s due date until the tax return due date or whenever payment is made. This penalty is computed at 3% above the fluctuating federal short term interest rate for the period.

One of the payment extensions available is “undue hardship”. If you can show that payment would cause undue hardship, i.e. needing to sell property at a “sacrifice” price in order to pay, you may qualify. You would also have to show that you do not have enough cash and assets convertible into cash in excess of current working capital to meet your tax obligations. You would also have to show you cannot borrow the amount needed except on terms that would inflict serious loss and hardship.  In that case you will avoid the failure to pay penalty but you will still be charged interest. If you qualify you will be given an extra six months to pay the tax shown as due on your tax return. If the IRS determines a “deficiency”, i.e., that you owe taxes in excess of the amount shown on your return, the undue hardship extension can be as long as 18 months and in exceptional cases another 1 months can be tacked on. However, no extension will be granted if the deficiency was the result of negligence, intentional disregard of the tax rules, or fraud. Form 1127 is used to apply for an extension. Attached to this form should be a statement of assets and liabilities and an itemized list of receipts and disbursements for the 3 months preceding the tax due date. Additionally, as a condition to granting an extension of time for payment of tax, the IRS may require a bond not exceeding twice the tax.

You can also borrow money to pay taxes. If you don’t think you can get an extension of time to pay, you should consider borrowing money to pay your liability. Loans from relatives or friends are often the simplest method to pay the bill. Where loans from individuals are not available, a loan from a bank could be sought, but these are not likely to be made with terms favorable to you as a distressed taxpayer. Another option can be a home equity loan, as you will probably be paying at a lower rate than with other types of loans. These may be too time consuming as well.

You may also be able to request an installment agreement on Form 9465 or by applying online. The IRS charges a fee for installment agreements, which will be deducted from your first payment after your request is approved. This request requires less information than the hardship extension application. If the liability is $50,000 or less you are not required to submit financial statements. Though you may have this request granted will still be charged interest on any tax not paid by its due date. However, the late payment penalty for the installment agreement is half the usual rate (1/4% instead of ½%) if you file your return by the due date including extensions.

Overall, too many taxpayers tend to fail to file their tax returns when they know they cannot pay their tax liability. But these tax liabilities do not go away if left unaddressed. It is very important that you file a properly prepared return even if full payment cannot be made. Include as large a payment as you can with the return and begin working with the IRS for a hardship extension or installment agreement as soon as possible. This will avoid escalating penalties, and the risk of having liens assessed against your assets and income. In many cases, these tax nightmares can be avoided by taking advantage of arrangements offered by the IRS. Of course, Innovative Solutions CPA’s are always willing to discuss all of these matters on a strictly confidential basis and offer advice and assistance. Please don’t hesitate to call!