April, 2008 Tax Tip
What To Do If You Can’t Pay Your Taxes
Here is a common scenario this time of the year: Your tax return has been completed, signed, and ready to mail or E-file but you don’t have the money to pay all or part of the amount due. You may be happy to know that you have choices. However, doing nothing should not be one of them!!
There are two penalties that can apply here. The failure to file on time penalty is 5% of the balance due each month or part of month that the filing is late. The failure to pay on time penalty is .5% of the balance due each month or part of month that the tax remains unpaid. The failure to file penalty is reduced by the amount of the failure to pay penalty for any month. Therefore, if you do not file on time and also owe tax, the combined penalty is 5% for each month the return is late, up to a maximum of five months, or 25%. If the tax remains unpaid after five months, the .5% penalty continues to run, up to 25% until the tax is paid. Doing the math, the total penalty for failure to file and pay can be as high as 47.5% (22.5% late filing and 25% late payment). Each penalty can be abated upon a showing of reasonable cause, but know that you are at the mercy of the (now very aggressive) IRS (and very likely state taxing authorities).
Therefore, you can see that it is of the utmost importance to file the return or obtain an extension even if you cannot pay the tax. This will save you the late filing penalty.
CAUTION: If you file for the automatic 6-month extension, do not understate the liability that you reasonably expect your return will show once it is filed. The extension can be viewed as a contract - the IRS will grant you the extension provided you tell them what your liability will be. If you don’t keep your end of the bargain, they have the authority to retroactively invalidate your extension. This means you will owe late filing penalties as well as late payment penalties.
As to paying the tax, you do have alternatives to consider. If you will have a short-term influx of cash, try to borrow the money from a family member or friend. If this is not possible, can you get a quick draw on a home equity line of credit? Also, you can use a bank credit card by contacting a service provider approved by the IRS. There is normally a service charge, which can vary from provider to provider, as well as an IRS convenience fee of $2.95. Interest could, of course, apply to credit card charges not paid on time.
If the above will not work for you, you can request an installment agreement by completing Form 9465 and attaching it to your return. You will be asked to enter the amount you can pay each month and the date you will pay it. Pay as much as you can, but not more than you can handle. If the IRS accepts the agreement, the late payment penalty is reduced to .25% per month. The current installment agreement user fee for a non-direct debit installment agreement is $105, and the fee for a direct debit installment agreement is $52.
Be sure you are current on all payments, or the IRS can nullify the agreement.
An important question to ask yourself if you are in this position is how can I avoid it in the future? Increasing your withholding or making quarterly estimated tax payments are two possible options.
The key message to be taken from this Tax Tip is, even if you can’t pay your taxes by the due date, don’t incur a double whammy by failing to file your return or an extension by the due date. The penalties are too severe.
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