April, 2009 Tax Tip
The April 15th Dilemma: I Owe, But Don’t Have the Dough
Does this describe you? Your tax returns have been completed, signed, and ready to be mailed or E-filed, but you don’t have the money to pay all or part of the amount due.
A significant portion of my practice is resolving tax debts. Many of my clients, when faced with this dilemma, unfortunately did exactly the wrong thing. They did nothing – no filing, no extension. The first year perpetuated into a second year, a third year, and the next thing they knew they hadn’t filed for several years and had accumulated a serious tax debt with attendant interest and penalties. You see, the IRS can file returns for you based upon information it has received from third parties and can make an assessment on that “substitute for return”. This is the last thing you want to have happen as the return will include only the barest bone deductions possible. This means you will end up in a hole from which it is very difficult to extricate yourself.
Therefore, as the 11th hour now looms, you really have only two rational choices: get your return filed by April 15th or file for an extension. I have worked with clients who believed they did not owe any tax and, therefore, for whatever reason didn’t file or extend. While it is true there is no interest or penalties unless there is an unpaid liability, you still should file or extend in a timely manner. Just to name a couple reasons, if you are due a refund, you won’t get it without filing a return. Also, if you don’t file, the three year statute for the IRS commencing an audit will not begin. In other words, the statute will never expire on an unfiled return. The IRS can come in way down the road and hit you with a tax liability plus several years of interest and penalties.
If you have a balance due on a late tax return the IRS will calculate interest and penalties. There are two types of penalties, failure to file on time and failure to pay on time. The failure to file penalty is 5% of the balance due each month or part of month that the filing is late. The failure to pay penalty is .5% of the balance due each month or part of month that the tax remains unpaid. This penalty is reduced by the amount of failure to pay penalty for any month. Therefore, if you file late and also owe, the combined penalty is 5% for each month the return is late up to a maximum of 5 months, or 25%. If the tax remains unpaid after 5 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%. Both penalties can be abated upon a showing of reasonable cause but you are at the mercy of the (now very aggressive) IRS (and very likely state taxing authorities). You can see it is of the utmost importance to file your return or obtain an extension even if you cannot pay the tax. This will save you the late filing penalty.
The extension is automatic and it is for six months. The only requirement is that the total 2008 income tax liability (including the amount still owing) must be estimated with reasonable accuracy with extension form 4868.
As to paying the tax there are alternatives available. If you will have a short term influx of cash (if you do, I want to see you), try to borrow the money from a relative or friend. If this is not possible, perhaps you may be able to get a quick draw on a home equity line of credit. You can also use a bank credit card by contacting a service provider approved by the IRS. The may be service charges associated with this as well as an IRS convenience fee which is nominal.
Finally, if none of the above work for you, you can request an installment agreement by completing form 9465 and attaching it to or E-filing it with your return. The form asks you to enter the amount you are paying with the return, 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. IMPORTANT: Be sure you are current on all payments, or the IRS can nullify the agreement. I strongly recommend that you have the IRS debit your account on the requested date for the amount due each month. This also lowers the installment agreement user fee from $105 to $52.
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