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Scottsdale, AZ 85254
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April, 2011 Tax Tips and News

The April 15th (this year 18th) Dilemma:   “I Owe, but I Can’t Pay”

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.  If so, you have a lot of company.

The worst thing you can do is to do nothing!  A significant portion of my practice is resolving tax debts.  Some of my clients, when faced with this dilemma, unfortunately did exactly the wrong thing.  They did nothing – no filing, no extension.  This is why they later became my clients. 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”.  There are separate penalties for filing late and paying late (see below), but the failure to file penalty is much worse than the failure to pay penalty,

The IRS has the authority to 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 all of your reported income, but only the barest bone deductions possible.  This means you can end up in a hole from which it is very difficult to get out.

Therefore, as the 11th hour now looms, you really have only two rational choices:  get your return filed by April 18th 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.   Two reasons for doing this are 1) if you are due a refund, you won’t get it without filing a return; and 2) if you don’t file, the three year statute for the IRS commencing an audit or assessing a tax 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.  As mentioned, 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 one-half of one percent (.005) 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 file 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.  Both penalties can be abated upon a showing of reasonable cause, but you are at the mercy of the now very aggressive IRS and state taxing authorities.  There is no late payment penalty during the six-month period covered by an extension provided 90% of your tax has been paid by the due date. 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 your total 2010 income tax liability (including the amount still owing) must be estimated with reasonable accuracy on extension form 4868.

As to paying the tax there are alternatives available.  If you will have a near term influx of cash, 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.  There will likely be service charges associated with this as well as an IRS convenience fee which is nominal. 

Finally, if none of the above will 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 bank account on the requested date for the amount due each month.  This will also lower the installment agreement user fee from $105 to $52.



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