With the April 15th deadline approaching you may be wondering what will happen and what you should do in the event you cannot pay your taxes on time.
First and most importantly, don't let your inability to pay your tax liability in full keep you from filing your tax return properly and on time. Include as large a partial payment as you can. As discussed below, just filing without full payment can save you substantial amounts in filing penalties. More importantly, procedures exist for payment extension and installment payment arrangements which will keep IRS from instituting its collection process (liens, property seizures, etc.).
The "failure to file" penalty accrues at the rate of 5% a month (to a maximum of 25%) on the amount of tax your return should show you owe. The "failure to pay" penalty is gentler, accruing at the rate of only 1/2% a month (to a maximum of 25%) on the amount actually shown as due on the return. (If both apply, the failure to file penalty drops to 4.5% a month and the combined maximum is 25%.) Both of these penalties are in addition to interest you will be charged for late payment. 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, April 15th (or earlier, if the payment is made earlier). This penalty is computed at 3% above the fluctuating federal short term interest rate for the period.
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.
To establish undue hardship you must show more than 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. 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.
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. IRS charges a small fee for installment agreements, which can be added to the tax due. Form 9465 requires less information than the hardship extension application. If the liability is under $10,000, you will not be required to submit financial statements. However, penalties and interest accrue on the outstanding portion of your tax liability while the installment agreement is in effect. Thus, you should attempt to make the payments you make as large as reasonably possible to minimize these additional charges.
Note that an installment agreement request can be made after your hardship extension period expires.
The installment agreement may terminate and all your taxes become due immediately if any of the following occur:
Too many taxpayers hide their heads in the sand when they run into financial difficulties, for example, by failing to file their tax returns. But tax liabilities do not go away if left unaddressed. It is very 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 readily offered by the IRS.
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