Amid the current pandemic, and loss in revenue, many taxpayers are asking how they will be able to pay their tax bill. This is a common issue for taxpayers, even among careful and successful clients when unforeseen circumstances such as the Coronavirus arises.

First, remember, the IRS is not trying to make you bankrupt, destitute, homeless, and we do not have debtors prison in our country!  You just need to learn the rules and steps to take to relieve your tax troubles in a measured and agreeable way.  This month, the government has offered to send most taxpayers an Economic Impact Payment or stimulus check.  For more information about status, payment type, or direct deposit amount, the IRS is establishing a portal here.

Next, always, make sure to file your personal and business tax returns by the deadline (after extensions). Even if you can’t pay.  Generally, the penalties for ‘Not Filing’ are far worse than penalties for ‘Not paying’.

Third, pay as much of a partial payment as you can, even if you have to borrow funds.  In fact, just filing and making a partial payment will save you substantial amounts in interest and penalties.  Following the options below using partial payments, extensions and installment arrangements will keep the IRS from using its collections powers: primarily liens and property seizures.

Level 1:
If you are a business owner whose business is struggling while taking a salary, stop taking a salary for the first couple of quarters of 2020.  Take minimal owner draws instead.  This will save on payroll taxes and better reflect your business’ current financial downturn.

Also, use the IRS employer payroll tax deferment options offered by the new CARES ACT if you have employees to pay those taxes next year!

Level 2:
Not able to pay on July 15th (usually April 15th) beyond just payroll taxes.

You need to implement an immediate plan to make sure you can pay your taxes as soon as possible if you are a little short on funds come July 15th (usually April 15th).  In fact, millions of taxpayers ‘file an extension’ without payment and still owe.

However, there is a cost: Penalties and Interest

  • Interest due – The interest on any unpaid taxes accrues at the annual rate of six percent (6%). This might not look too bad actually, but it’s the penalty that will get you.
  • Penalty due – This falls under the “Failure to Pay” penalty accrues at the rate of only 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.

Even if you can’t pay your taxes, file an extension, THEN start saving up your money and file your Tax Return on time (by October 15th) even if you can’t pay.

For example if you file an Extension on July 15th, and take the next three (3) months to quickly pay your tax bill (let’s assume before October 15th), then you file your return and the interest rate was essentially 3% (1.5% in interest for 1/4 of the year and 1.5% in penalties).

Level 3:
Not able to pay on October 15th

Do not think all is lost if can’t pay taxes by October 15th and just decide not to file.  Now, you are still paying interest and penalties under the “Failure to Pay” provision, but NOW you are assessed the dreaded “Failure to File” penalty.

  • “Failure to file” – penalty 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%.]
  • 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.

Now, once you file your tax returns, you still owe taxes.  Be sure to take proactive action: the problem doesn’t go away.  Here are 4 things you should consider I will discuss further below:

  1. Claiming undue hardship and an Extension to Pay
  2. Borrow money from anyone possible
  3. Apply for an Installment Agreement
  4. Offer in Compromise

1: 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.

2: Borrowing money to pay taxes.  It will certainly be cheaper than paying the IRS interest and penalties, it is often the simplest method to pay the bill, and 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.  If friends or family are not available, a loan from a bank or other commercial source should be considered, but they may not give favorable terms to a distressed taxpayer.  Also, interest on a loan to pay taxes is nondeductible personal interest.

Alternatively, 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.  Please contact our offices for a list of options of authorized online providers for tax payments.  Of course, as with other loans from businesses, credit card loans are likely to be at relatively high interest rates and the interest is not deductible.  Additionally, the service providers also charge a fee based on the amount you are paying.

3: 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 and filed with your taxes, or by applying for a payment agreement online.  The 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; however the fee is $43 regardless of whether direct withdrawal is used if the taxpayer is a low-income taxpayer (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 in #1 expires.  The IRS may 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.  Also, 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

4: Filing an Offer in Compromise (“OIC”).  This is the process of ‘cutting a deal’ with the IRS because you admit you can’t afford to pay your taxes and are asking the IRS to reduce the amount you owe, the interest, penalties, or all three.  Beware, the IRS will certainly want to negotiate with you, so this is not automatic.

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, look at your income, expenses and determine what they think you can and should pay.

The IRS website gives some basics about the process and what to expect: https://www.irs.gov/payments/offer-in-compromise

In all of this, the key is to remember: tax liabilities do not go away if left unaddressed, 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.  Taking prompt action will avoid escalating penalties, and avoid the risk of having liens assessed against your assets and income, and possibly even seizure and sale of your property.  By taking advantage of arrangements offered by the IRS, you can remain in good standing with the government and lenders.

If you are in this predicament and need to discuss the situation further, please contact your CPA who can discuss the situation with you.