WHAT IF YOU CAN’T AFFORD TO PAY IRS?

You finish your tax return and find you don’t have enough cash to pay Uncle Sam. You’re not alone, and you won’t go to jail. The IRS has some options as well as some more forms for you.

You finished your return and you’re still in shock. You made a lot of money and paid a lot of bills. But now you’re looking at a tax bill that you just can’t afford to pay.

Relax. You’re not alone, and your plight is not unusual. Moreover, you’re not going to jail. There are criminal penalties if the Internal Revenue Service can prove (the burden of proof is on them) that you intentionally didn’t pay your taxes, but we’ll assume that’s not the case here. You just ran low on cash, and nobody goes to jail just because they owe money — even to the IRS.

Your return is done — that’s how you know the magnitude of your debt. Send it in. Don’t hold it just because you owe money that you can’t pay. But don’t mail it until it’s due, on April 15. You can’t go to jail because you don’t have the money to pay your tax bill, but you can go to jail for not filing. It’s a criminal act, and you’re not a criminal, so get that return in the mail.

If you file and don’t pay in full, the IRS computers will automatically send you a letter asking for the tax due and any interest from the due date.

There is a penalty for late filing of 5% of the tax not paid by the due date for each month, or part of a month, that your return is late. Generally, the maximum penalty is 25%. But if your return is more than 60 days late, the minimum penalty is $100 or the balance of the tax due on your return, whichever is smaller.

Begging and Borrowing

But avoiding the late-filing penalty doesn’t get the tax paid. Consider all of the possible sources of money. Can you borrow from friends or relatives? Do you have any equity in your house? If so, a home-equity loan might help eliminate or minimize your tax liability. Moreover, the interest on the loan likely would be deductible on next year’s return.

Do you have potential cash in your credit cards? The interest wouldn’t be deductible, and probably would be much higher than the rate the IRS would charge. Still, you might prefer to eliminate the specter of the IRS, and the post-midnight nightmares that go with it.

If You Can’t Come Up With the Money

All that having been said, one of the IRS’s best-kept secrets is the fact that the law provides for an extension of time to pay your taxes. While the IRS denies this, the agency has nevertheless gone to the trouble of creating a form on which to make the application. It is Form 1127, Application for Extension of Time for Payment of Tax. I have always found it peculiar that IRS has a form to engage a procedure the agency says does not exist.

Unlike Form 4868 (discussed more extensively in my article Stretched for time? Get and extension!), the payment extension is not automatic. Most payment extension requests are denied because the few people who file them do not know how to prove they are entitled to an extension.

To win the extension, you must demonstrate that you exercised reasonable business care and prudence in providing for your taxes, but through no fault of your own and due to circumstances beyond your control, you are unable to pay on time. You must also show that paying on time will cause an economic hardship. Hardship exists when, because of enforcement action, it is impossible to pay necessary living expenses. Finally, you must agree to give the IRS security for the unpaid tax. The IRS achieves this by filing a tax lien — which most taxpayers find distasteful. Although that might not sound like a good idea, the fact is that when you do not pay in full, the IRS almost always files a lien anyway.

If the extension is granted, you may receive up to six additional months to pay your taxes — without penalties. Interest accrues during the extension period. However, by avoiding penalties, you cut in half the amount of additions the IRS imposes. More important, while on the payment extension, the IRS cannot execute enforcement actions. This means no levies on your wages and other cash resources as long as you pay the tax by the extended due date.

If IRS denies your Form 1127, you can still avoid enforcement action by filing Form 9465, Installment Agreement Request. You will find more coverage of this form below.

Moreover, just submitting Form 1127 puts you in a better position to seek abatement of the failure-to-pay penalties later. This is because filing the extension is the quintessential act of good faith. You put the IRS on notice of the problem and take affirmative steps to resolve it rather than waiting for the IRS to chase you down for payment.

Get an Installment Agreement

What if you can’t find the cash and IRS turns down your Form 1127 payment extension request? Remember, you’re not alone.

Ask for an installment plan. In fact, the IRS Web site has an interactive calculator that helps you figure the monthly payment amount and actually prints out an installment agreement (Form 9465) for you to file.

If you qualify for a “streamlined” agreement — generally, if you don't owe more than $25,000 and will be able to pay it off within five years — you can find out about how long the payments will last. The true length of your payments is a function of both how much you owe and the interest rate charged; since that rate changes every three months, these figures are estimates, not guaranteed maximum payments. If the interest rate goes down, you may actually pay over a shorter period of time.

The rate is calculated on the basis of the short-term federal rate plus 3 percentage points, as of the first month of each quarter. The rate on overpayments was 4% for the October-December 2003, for example. (Corporations get only 3%.) The IRS also charges 4% interest on underpayments (except for large corporate underpayments, which have an 6% rate). The IRS issues a news release in the last month of each quarter announcing its rates for the following quarter.

If you don’t meet the criteria for a “streamlined” agreement, you can compare your monthly expenses to the amounts allowed under the IRS’ Collection Financial Standards to determine an appropriate tax-payment amount.

You can actually print out Form 9465, Installment Agreement Request, from the Web site and mail it to the IRS for review and approval. The Web site doesn’t store or transmit any personal data.

If the IRS approves your request, you will be charged a $43 fee. Don’t submit the fee with the form. The IRS normally will deduct the fee from your first monthly payment.

Even if your Form 9465 request is approved, you still will be charged interest and may be assessed a late-payment penalty on any tax not paid by its due date. To limit interest and penalty charges, file your return on time and pay as much of the tax as you can.

Form 9465 is easy to complete. It asks for your name, address, Social Security number, the name of your bank and your employer. (Relax. Based on your W-2 and the 1099 the bank sends, the IRS already has that information.) It then asks how much you owe and how much you want to pay each month. You don’t need an attorney or an accountant to fill it out. If you can pay the outstanding liability within 12 months and promise to keep current with this year’s taxes, almost all requests are granted.

If you can’t pay what you owe within 12 months, request an installment plan that you can realistically meet. The IRS takes a harder line on longer payment periods, but the government has granted such requests after investigating the individual circumstances.

Offer in Compromise

In the past, there were only two situations where the IRS would consider an Offer in Compromise:

1.

Your liability for the taxes owed was in question, or;

2.

The IRS wasn't sure it could collect the taxes, no matter what it did.

In your case, there’s no doubt as to liability. The real issue is, can they collect?

Unfortunately, when reviewing “collectibility,” the IRS looks at whether you could ever pay, irrespective of how long it takes and regardless of its economic impact on you. In the past, the agency would do whatever it could to deny Offer in Compromise relief if there was any arguable position.

The IRS does accept applications for an Offer in Compromise plan based on “severe or unusual economic hardship.”

The IRS can now approve Offer in Compromise based simply on economic hardship.

You can qualify for this new provision if you have a history of filing and paying your taxes and “collection of the entire tax liability would create economic hardship, or exceptional circumstances exist where collection of the entire tax would be detrimental to voluntary compliance.”

To apply for this program, you must first submit a copy of Form 656, the standard Offer in Compromise application. This form also can be downloaded from the IRS Web site. And you must now pay a $150 application fee. You must also complete Form 433-A, Collection Information Statement for Individuals and the Self-Employed — or Form 433-B if your business is incorporated.

The IRS has cautioned that this program is designed only for taxpayers in very extreme circumstances. It’s not designed for everyone with a financial problem, nor should it be viewed as an invitation to avoid paying taxes.

In making an Offer in Compromise, you can offer to make a lump-sum, cash payment or fixed payments over a short-term period of time. In many cases, people borrow from friends and relatives. However, these people have to know upfront, before they commit any money, that the IRS is going to accept those dollars as payment in full.

The fixed-payment option combines all debts, including interest, owed under the terms of the offer into a single payment. Be warned, however, that the law still requires interest to be accrued. That means that if you default on your agreement, the entire amount of taxes owed, plus penalty and accrued interest, will then be due.

IRS Wants to Make a Deal

The IRS is interested in settling your tax liability. In fiscal 2002, the agency accepted about 29,000 offers out of 124,000 applications. The number of acceptances has been around 25,000 to 30,000 for the last five or six years. Applications have been around 120,000 a year since 1992.

IRS statistics also reflect an enormous drop in liens, levies and seizures in recent years. Levies dropped from nearly 3.5 million in fiscal 1997 to a low of about 200,000 in 2000. In fiscal 2002, the total was 667,000. Liens fell from from 400,000 to under 200,000 in 2000. In 2002, the total was 492,000. Seizures dropped from 10,090 a year up until 1997 to only 364 in 2002.

As former IRS Commissioner Charles Rossotti pointed out, “In the end, this helps all taxpayers. Instead of collecting nothing from people with an unpaid tax bill, we’re able to collect something.”

Don’t Hide From the IRS

The final word on what to do when you can’t pay your taxes is communication. The IRS is a vast bureaucracy filled with people asked to do an impossible job. Talk to them; don’t hide. The sooner you approach them, and the more often you respond with changes in your situation, the more comfortable they will be in working with you.

Always get the names of the people you speak with and keep notes of what was said. The new commissioner of the IRS has asked that his employees stress “customer service.” After all, isn’t “service” part of their name?