October 15th is upon us again, and some of you may be facing a daunting tax bill and unable to pay. Even some of the most careful and successful people have faced unforeseen financial situations due to covid. However, there are NO MORE extensions this year. It’s time to pay….
Now, before your stress goes off the chart, there are a few things you can AND need to do that will lessen the pain, and frankly minimize any collateral damage.
File Your Taxes even if You Can’t Pay
First, always file your Federal 1040 personal tax return by October 15th (including any State tax returns). Even if you can’t pay…If you don’t file your tax return it only makes things worse!
Some people wonder why the IRS is so upset when they don’t file, and presume that they are OR should be more upset that they aren’t paying their tax bill. Actually, the IRS is more concerned when they don’t even get a tax return. See, they have to assume the worst when they don’t hear from you. Otherwise stated, if you aren’t filing your tax return, the IRS may think you are hiding from them or owe them a lot more than you really do.
The Penalties for ‘Not Filing’ are far worse than for ‘Not paying’.
Now, it’s also really helpful to understand what the ‘costs’ are and how the IRS is going hit you. It’s not just a simple ‘penalty’ or ‘interest’; it’s a combination of factors and the passage of time only makes it worse. Here are the 3 costs that really start to add up:
- Interest due – The interest on any unpaid taxes accrues at the annual rate of six percent (6%). That may not seem too bad at first, but when you include it with the penalties it can really catch up to you.
- “Failure to Pay” penalty – This penalty accrues at the rate of one-half a percent (1/2%) per month or part of a month (to a maximum of 25%) on the amount actually shown as due on the return.
- “Failure to file” penalty – This penalty remember is easily avoided if you simply file and not even send a dime with your tax return. But if you don’t reach out and let the IRS know what is going on (by filing a tax return), they slap a hefty penalty on you that accrues at the rate of 5% per month or part of a month (to a maximum of 25%) on the amount of tax your return should show you owe. (If both the Failure to File and Failure to Pay penalties apply, the Failure to File penalty drops to 4.5% per month (or part thereof) so the total combined penalty remains at 5%.)
- Then it starts to Snowball… The maximum combined penalty for the first five months is 25%. Thereafter the failure to pay penalty can continue at 1/2% per month for 45 more months (an additional 22.5%). Thus, the combined penalties can reach a total of 47.5% over time. Both of these penalties are in addition to interest you will be charged for late payment.
Here is an Example. Let’s say you owe the IRS $20,000 on October 15th and simply throw up your arms in exasperation and not file!! What are the rough numbers on what you may owe when you get around to paying the bill…let’s say next May 31st before June 1. The interest will be approximately $900 (8.5 months). The failure to pay and the failure to file penalty are a combined 5% for the first 5 months, or part thereof, for a total of $5,000. Then, the failure to file penalty continues for another 1/2 per month for 4 months (making sure you don’t pay on June 1st or you get charged the penalty for the entire month of June), for a hit of another $800. The grand total could end up being $26,700, or more. If you would have at least filed your tax return on October 15th, without even a payment, the total grand total would have been close to $21,800. ($900 in interest over 9 months and 4 1/2% on the balance in penalties). In this example, simply filing your tax return would have saved you over $5,800!!
Include any Payments You can with Your tax return
Next, do your best to include as much of a partial payment as possible when you file your tax return. Consider borrowing the funds from anyone or any institution that will charge you less than 10% in interest. Remember, when you add the penalties to the interest payment, it starts to put you in a double digit cost.
Most importantly, don’t ignore the IRS. Start communicating with them immediately and call any phone numbers on paper work you receive directly from the IRS. Ask for 60-90 days to pay the bill. Oftentimes, the IRS will hold off on any collection procedures for up to 3 months and give you some breathing room during the holidays and hopefully come up with payment in January.
BEWARE…and this is important- Watch out for two critical scams!!
- The IRS will never, and I repeat never, call YOU. If anybody calls up and claims to be an IRS agent, collecting for the IRS, or trying to cut you a deal with the IRS. Politely tell them you will contact them in writing and hang up. Many experts encourage potential targets of a scam NOT to antagonize the perpetrator. Don’t yell at them or call them names. Just hang up the phone. You never know what retaliation they could take out on you in the form of identity theft or worse.
- Watch out for companies offering to settle your debt with the IRS for pennies on the dollar (wether contacting you by phone, email, mail or you hear their Ad on the Radio or T.V.). It is VERY VERY uncommon, and in fact rare, that you would ever be able to cut a deal with the IRS allowing you to pay a little something or nothing. I KNOW the commercials sound really enticing and they offer a free consult. DO NOT call them or proceed forward with them. They will ultimately ask you for money up front and make outlandish promises. I have met so many clients and students in my classes taken advantage by companies such as these. Retain a licensed CPA that YOU find and interview, then pay for their services by the hour and closely monitor their progress.
What are My Other Options to Pay
Now, once you file your tax return and you still owe taxes, it’s time to take proactive action. Do not put your head in the sand hope the problem goes away. Here are several things you need to do that I discuss more fully below:
- Consider claiming undue hardship and an Extension to Pay
- Borrow money from anyone possible
- Apply for an Installment Agreement
- Consider an Offer in Compromise
Undue hardship “Extension to Pay”. It’s important to remember that an extension of time to file your return does not mean you have an extension of time to pay your tax bill. An extension of time for payment may be available, however, if you can show payment would cause “undue hardship,” as discussed below. You will avoid the failure to pay penalty if an extension in granted, 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 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 12 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, and it comes with at least 3 important requirements to consider:
- To establish undue hardship it is not enough to show that it would just be inconvenient to pay your tax when due. For example, if you would have to sell property at a “sacrifice” price you may qualify. But if a market exists, having to sell property at the current market price is not viewed as resulting in undue hardship.
- You would 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.
- To qualify for an extension, you have to provide security for the tax debt. The determination of the kind of security—such as bond, filing a notice of lien, mortgage, pledge, deed of trust, personal surety, or other form of security—will depend on the particular circumstances involved. When your application for an extension is granted you must deposit any collateral agreed upon with the IRS. No collateral will be required if you have no assets.
Form 1127 is used to apply for an Extension to Pay. A statement of assets and liabilities must be attached as well as an itemized list of receipts and disbursements for the 3 months preceding the tax due date.
Borrowing money to pay taxes. If you don’t think you can get an extension of time to pay your taxes, borrowing money from anyone you can. It will certainly be cheaper than paying the IRS interest and penalties over the long haul. Loans from relatives or friends are often the simplest method to pay the bill. One advantage of such loans is that the interest rate will probably be low, but you must also consider that loans over $10,000 at below market interest rates may trigger tax consequences. Where loans from individuals are not available, a loan from a bank or other commercial source could be sought, but such loans are not likely to be made on favorable terms to a hard pressed taxpayer. Moreover, interest on a loan to pay taxes is nondeductible personal interest. In contrast, if you can take out a home equity loan and use the proceeds to pay off your tax debts, you will probably be paying at a lower rate than with other types of loans, and the interest payments will be deductible even if the loan proceeds aren’t used in connection with the house.
Home equity loans are, of course, not an option for everyone and they may be too time-consuming in some situations. However, it is relatively quick and easy to use credit cards or debit cards to pay the income tax bill whether you file your income tax return by mailing a paper copy or by computer. Several companies are authorized service providers for purposes of accepting credit card or debit card payments. Only those cards approved by IRS may be used. However, as with other loans from businesses, credit card loans are likely to be at relatively high interest rates and the interest is not deductible. Moreover, the service providers also charge a fee based on the amount you are paying.
Installment agreement request. Another way to defer your tax payments is to request IRS to enter into an installment payment agreement with you. This request is made on Form 9465 or by applying for a payment agreement online. IRS charges a fee for installment agreements, which will be deducted from your first payment after your request is approved. Form 9465 requires less information than the hardship extension application. If the liability is under $50,000, you will not be required to submit financial statements. Even if your request to pay in installments is granted, you will be charged interest on any tax not paid by its due date. But the late payment penalty will be half the usual rate (1/4% instead of 1/2%), if you file your return by the due date (including extensions).
The fee for entering into an installment agreement is $105, except that the fee is $52 when the taxpayer pays by way of a direct debit from the taxpayer’s bank account, and, notwithstanding the method of payment, the fee is $43 if the taxpayer is a low-income taxpayer. A low-income taxpayer is an individual who falls at or below 250% of the dollar criteria established by the poverty guidelines updated annually in the Federal Register by the U.S. Department of Health and Human Services.
Note that an installment agreement request can be made after your hardship extension period expires. Additionally, IRS has the authority to enter into an installment agreement calling for less than full payment of the tax liability over the term of the agreement. It may do so if it determines such an agreement will facilitate partial collection of the liability. IRS may also terminate an installment agreement if the information you provided to IRS in applying for the agreement proves inaccurate or incomplete or IRS believes collection of the tax involved is in jeopardy. Finally, the IRS can even modify or terminate an installment agreement if any of the following occur:
- you miss an installment.
- you fail to pay another tax liability when it’s due.
- you fail to provide an update of your financial condition where IRS makes a reasonable request for you to do so.
- IRS determines that your financial condition has significantly changed.
IRS must give you 30 days notice before altering, modifying or terminating the installment agreement and it must explain its reasons for the action. This notice requirement does not apply when collection of the tax is in jeopardy. Here is the IRS website on the basics of the Installment Agreement Request: https://www.irs.gov/businesses/small-businesses-self-employed/streamlined-processing-of-installment-agreements
Beware and don’t get ambitious!! A $5,000 penalty applies to any person who submits an application for an installment agreement if any portion of the submission is either based on a position which IRS has identified as frivolous, or reflects a desire to delay or impede the administration of federal tax laws. IRS may also treat that portion of the submission as if it had never been submitted. However, the penalty is clearly aimed at those who abuse the process and should not deter taxpayers with legitimate applications from using the installment agreement process.
Filing an Offer in Compromise (“OIC”). The OIC is essentially the process of ‘cutting a deal’ with the IRS. You’re basically stating to the IRS you can’t afford to pay your taxes and are asking for them to reduce the amount you owe, the interest, penalties, or all three. Now it sounds easy, and you’re in a tough situation right? The IRS will certainly want to negotiate with you. Not so fast my friend.
This process takes a long time and it is essentially based on your ability to pay. They are going to go through everything you own, and I mean everything. They will also look at your income, expenses and determine what they think you can and should pay. It is not a fun, easy or quick process.
To make matters worse, there are a hundreds if not thousands of individuals and companies scamming taxpayers with ‘too good to be true’ promises that they can settle your debt for pennies on the dollar. I love how they typically have a commercial showing a couple sitting by a pool and palm trees in Florida claiming they owed the IRS $200,000 or more and settled for less then $5,000. It’s crazy out there! Be careful. Make sure to ‘pay as you go’, use a reputable law firm or accounting firm, and don’t pay any big fees up front. Moreover, constantly monitor the process and even call the IRS yourself to see how your Offer is moving through the system. I have met so many people taken advantage of in this process and they end up still owing the IRS and losing thousands of dollars to some scam artist.
Here it the IRS website that can give you some basics about the process and what to expect: https://www.irs.gov/payments/offer-in-compromise
Avoiding more serious consequences. Again, too many taxpayers hide their heads in the sand when they run into financial difficulties by failing to file their tax returns. But tax liabilities do not go away if left unaddressed. Remember, it is always important that you file a properly prepared return even if full payment cannot be made. Include as large a partial payment as you can with the return and start working with the IRS for a hardship extension or installment agreement as soon as possible. The alternative will include escalating penalties, plus the risk of having liens assessed against your assets and income. Down the road, the collection process will also include seizure and sale of your property. In many cases, these tax nightmares can be avoided by taking advantage of arrangements offered by the IRS.
I know this is a difficult topic, but if you are in this predicament and need to discuss the situation further, please contact an attorney or CPA in our office that can discuss the situation with you.
* To sign up for Mark’s weekly Free E-Newsletter and receive his Free E-Book “The Top 10 Best Tax Saving Secrets Everyone Should Know” visit www.markjkohler.com.
Mark J. Kohler is a CPA, Attorney, co-host of the Radio Show “Refresh Your Wealth” and author of the new book “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You” and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP.