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It’s never good news to find out you owe taxes to Uncle Sam. It’s even worse to find out you can’t afford to make the payment.
Tax experts say that the most important thing to do if you owe the IRS is to file your return on time, even if you can't pay. The federal tax deadline is midnight, April 15 except for Maine and Massachusetts residents, who have until April 17, thanks to state holidays.
“If you don’t file your return, the IRS can hit you with failure-to-file penalties and even a tax lien, on top of any interest you might owe,” says Tim Steffen, a certified public accountant and director of advanced planning at Baird Private Wealth Management in Milwaukee. “Extending your return doesn’t extend your time for paying your tax. Your taxes are still due on the tax deadline."
The IRS charges a penalty that amounts to 5 percent of the balance. Each month that you don’t pay, it will add another 5 percent, up to 25 percent. That balance will also be subject to interest, which the IRS will adjust each quarter. The rate is currently 6 percent.
To deal with the problem you can try to find the money now, ask for help or leniency from the IRS, or do a combination of both. You can also ask the IRS to forgive all or a portion the debt, though that's very hard to do.
Option 1: Find the Money
To pay your tax bill, you can use a variety of tactics, each with benefits and drawbacks:
• Take the funds from savings. Try to avoid taking a distribution from a retirement account, such as your IRA, Steffen advises. That will only compound your problems next tax season, when you’ll owe income tax on the amount withdrawn plus a 10 percent penalty if you’re younger than 59½.
• Use a credit card with a 0 percent interest intro offer. If it’s available to you, this option could work much better than using a high-interest credit card that’s already in your wallet. Just be sure to pay off your debt before the rate expires.
Keep in mind, too, that if you file electronically, using a credit card could cost you a bit more than paying out of pocket. The IRS authorizes just a few companies to process electronic credit and debit card payments, and they’ll charge you credit card processing fees that this year are as high as 1.99 percent of your balance, with a minimum fee of $2.50. On a $2,000 tax bill, you’ll have to pay an extra $39 if you pay by credit card.
• Use a credit card you already have. You can delay the actual payment by a month or so and maybe earn rewards points, but keep in mind how that gambit could backfire.
If you can’t pay your credit card bill on time and in full, you’ll be subject to the card’s annual interest rates. According to CreditCards.com, the current average credit card rate is 17.67 percent.
And if you’re paying taxes using a rewards card, keep in mind that the typical credit card reward is 1 percent; on a $2,000 tax payment, that’s worth $20. If you’re late on a payment, you’re likely to wipe out that reward with penalties and late fees.
• Borrow against your home or from a bank. A home equity line of credit, at an interest rate far lower than that of a credit card, could be an option. But keep in mind that you can no longer deduct the interest from borrowing that isn't related to building, buying, or improving your home. You may also be able to get a personal loan from your bank or credit union, Steffen says.
• Make a partial payment. Even if you can’t pay the whole tax bill, pay as much as you can. That will cut down the size of the penalty and interest you’ll have to pay the IRS.
Such an approach could backfire, though, if the partial amount you owe is large and you pay it using a credit card, says Mike Velazquez, a CPA at The Accountancy in Glendale, Calif. “It would make no sense for you to put that on a credit card to carry a compound interest rate of 29 percent and potentially have your credit rating take a hit.”
He says you’re better off arranging to pay off the entire amount using an IRS-sponsored installment plan, because it has a lower interest rate (see below). Unlike credit card companies, the agency doesn’t report on its debtors to credit bureaus.
Option 2: Request More Time to Pay
The IRS also offers a number of payment options, which for the most part are far less costly than than paying interest on a credit card.
• Ask for a payment extension. If you haven’t applied for a payment extension before, this could be an option. After you file your tax forms on time without payment, the IRS will contact you to ask whether you will be able to pay within 120 days. If you choose this option, the agency will charge you a monthly fee of 0.5 percent of the amount owed.
• Consider an installment plan. This is a good option if you need more time. When you file your tax return, fill out IRS Form 9465, “Installment Agreement Request.” The IRS will then set up a payment plan for you, which can last as long as six years. There are several options, depending on how much you owe and how long you think it will take to pay the tax. You may incur a setup fee, which ranges from about $30 to $225. The fee can drop significantly if you arrange for direct payments from your bank account.
“It’s the easiest way to go as long as you submit a reasonable request to the IRS,” says Larry Pon, a CPA in Redwood Shores, Calif. As a rule of thumb, he says, divide the balance owed by six and agree to pay that amount each year for six years. If you end up needing installment plans for more than one tax year, hire a tax attorney or CPA to negotiate a workable plan with the IRS.
There’s another benefit to signing up for an installment plan: If you’re unable to make payments, the failure-to-pay penalty—which begins to accrue the day after the tax-filing deadline—will grow at just 0.25 percent per month—compared with 0.5 percent if you don’t sign up for the agreement.
You should have no trouble getting the IRS to grant you an installment agreement if you're applying for the first time, Pon says. "However, if you still owe from previous years and have not kept up with your agreements with the IRS, they may not be as easy to work with."
Once your agreement is in place, there's nothing to stop you from paying off the debt sooner. Indeed, that might be a good strategy if your financial situation improves. Paying very small monthly installments means it will take you a long time to make a dent in the balance, Pon notes. In the meantime, the IRS will continue to charge you interest and penalties.
Keep in mind that when you set up an installment plan with the IRS, you agree to be current with your current-year taxes. That means making sure you're having enough withheld from your paycheck, or making estimated payments for the current year. "The IRS will cancel the installment plan if you don't make the payments or owe a balance on your next tax return," Pon says.
• Ask for leniency due to hardship. You’ll need to prove that paying your tax debt will cause you a tremendous burden, perhaps forcing you to sell your home. But this could get you more time to make your payment, and in some cases the IRS will also waive any payment penalties. Read Form 1127, “Application for Extension of Time for Payment of Tax Due to Undue Hardship,” to see whether you meet the requirements.
There’s no rule book on the circumstances that qualify you for leniency, Velazquez says. “The IRS is getting tougher on what it agrees to,” he says. “Ultimately, it is based on facts and circumstances of each case.”
Option 3: Ask for a Reduction in Your Tax Bill
A last-ditch step is to apply for an offer in compromise, a Hail Mary arrangement that reduces your tax debt permanently. The IRS says that an offer in compromise allows you to settle your tax debt for less than the full amount you owe. It may be a legitimate option if you can’t pay your full tax liability or if doing so creates a financial hardship. Typically the debt has to be at least three years old, Pon says.
Before applying for an offer in compromise, the IRS requires applicants to have filed all their tax returns. So if you didn’t file in previous years, you will need to finish those missing returns. It also requires that you pay the current year’s estimated tax payments. Refer to the IRS’ Booklet 656-B, “Offer in Compromise,” for details on the application procedure. To see whether you could be a candidate, the IRS offers a prequalifier online tool. There’s a $186 application fee.
Offers in compromise are rarely granted. “You are asking the IRS to essentially erase what you owe them,” Velazquez says. “Understandably, they do so under the rarest of circumstances. But if there is reason to believe you don’t owe what they say you owe or there is doubt as to whether the IRS will ever collect from you—say, you’re terminally ill—then they will listen to plausible arguments to reduce your debt.”
Anne-Marie Long, a CPA at SKC & Co. in Boonton, N.J., concurs that getting an offer in compromise is a long shot. "If you have assets," she says, "the IRS will most likely determine that you are able to pay."
Don't Forget About State Taxes
With all the delayed payment choices for federal taxpayers, Daniel Morris, senior partner at Morris+D’Angelo, a CPA firm in San Jose, Calif., suggests that clients pay their state tax bills before their federal bills. They can then take advantage of the variety of payment options that the federal government provides.
“States are less flexible than the federal government,” he says. “The federal government’s installment plan is more taxpayer-friendly.”
Plan for the Future
And to avoid the same surprise next year, check the IRS Withholding Calculator or talk to a tax expert about how much to withhold from your paycheck or how much in quarterly payments to make for 2019, advises Eric Bronnenkant, head of tax at Betterment, an online financial adviser.
Seniors can even direct a portion or all of their once-a-year, required minimum distributions from retirement accounts toward their taxes. The IRS treats those payments as if the seniors had been making quarterly payments year-round. That can help seniors avoid penalties they otherwise might pay for not paying every quarter.
Of the pain you may be facing now, Bronnenkant says, “learn for next year.”
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