United Airlines will lose hundreds of millions in revenue for the public relations disaster dragging a customer off their airplane widely seen in a video gone viral; while the IRS will gain hundreds of millions in revenue for their public relations fortune dragging Wesley Snipes to jail and confiscating Tori Spelling’s bank account widely seen in headlines across America. Over a hundred million Americans lawfully and properly pay their taxes each year, but what happens to those who don’t, and what options does a taxpayer have who cannot pay!
Consider the three most common penalties taxpayers are subject to: First, the “Failure to file” penalty. This 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. Even a taxpayer who can’t make payments, should file their return, or an extension, to avoid this penalty. Second, the “Failure to pay” penalty is gentler, accruing at the rate of only 1/2 % per month or part of a month (to a maximum of 25%) on the amount actually shown as due on the return. Note, If both apply, the failure to file penalty drops to 4.5% per month (or part) so the total combined penalty remains at 5%. 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, computed at 3% plus the quarterly published federal short term rate (4% in March 2017). Third, the “Missed Estimated Tax Payments“. If you also missed estimated tax payments, an additional penalty is tacked on for the period running from each payment’s due date until the tax return due date, normally April 15th (or earlier, if the payment is made before the due date). This penalty is also computed at 3% above the fluctuating federal short term interest rate for the period.
The IRS collections officers do not distinguish between the celebrity elite of Hollywood and a randomly selected United Airlines Passenger in getting their money. The first, most effective way to avoid the above penalties is to evaluate if you qualify for first time abatement from penalties for failing to file a tax return, pay on time, and/or to deposit taxes when due. To qualify for what the IRS calls “administrative relief”, the following must be true: 1) You didn’t previously have to file a return or you have no penalties for the 3 tax years prior to the tax year in which you received a penalty. 2) You filed all currently required returns or filed an extension of time to file. 3) You have paid, or arranged to pay, any tax due. Keep in mind, the failure-to-pay penalty will continue to accrue, until the tax is paid in full. It may be to your advantage to wait until you fully pay the tax due prior to requesting penalty relief under the Internal Revenue Service’s first time penalty abatement policy.
Taxpayers who file for extensions can escape the failure to file penalty for six months, but will not escape failure to pay penalty unless they can show extenuating circumstances created an undue hardship. Also, just by getting an extension of time to pay, taxpayer will still be required to pay the interest on the amount due: 3% plus the federal short term interest rate for the period.
An undue hardship grants extension of time to pay will not be granted if the deficiency was the result of negligence, intentional disregard of the tax rules, or fraud. Also, 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 where a market exists and the taxpayer is not happy with the market price, the exception would not qualify. 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.
Form 1127 is used to apply for an undue hardship extension. 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. Additionally, to qualify for an undue hardship 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.
Whether hardship extension period has been applied for or even expired, another way to defer your tax payments is to request IRS to enter into an installment payment agreement with you. The IRS installment agreement may call for less than full payment of the tax liability over the term of the agreement, if it determines such an agreement will facilitate partial collection of the liability. This request is made on Form 9465 or by applying for a payment agreement online. IRS charges a fee of $120 for installment agreements ($52 when the taxpayer pays by way of a direct debit or $43 if the taxpayer is a low-income taxpayer), 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).
IRS may 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, or the IRS determines that your financial condition has significantly changed. The 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.
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
If you don’t think you can get administrative relief, undue hardship extension of time to pay your taxes, or a favorable installment agreement, borrowing money to pay the taxes should be considered as a last resort. 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. 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 may 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. PayUSAtax.com, Pay1040.com, and OfficialPayments.com are authorized service providers for purposes of accepting credit card or debit card payments. 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.
At Isler CPA, we have seen taxpayers come to us after they hid heads in the sand and ignore both tax payment and filing when they run into financial difficulties. But tax liabilities do not go away if left unaddressed. We work with taxpayers working to eliminate these problems. The alternative will include escalating penalties, plus the risk of having liens assessed against your assets and income, and eventually seizure and sale of your property. With the IRS, you are not being randomly selected like a United Airlines passenger, and your chances of getting a free ride are about as good. These tax nightmares can be avoided by working with us to take advantage of arrangements offered by the IRS.