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A day may come when you can't pay your taxes in full. Learn how to avoid paying costly penalties.
More than 259,000 businesses paid civil penalties to the Internal Revenue Service (IRS) in 2011 for failing to pay their tax bills. In fact, the IRS doled out civil penalties to businesses, individuals and employers totalling more than $5.7 billion for the same time period.
What’s the point? The IRS wants its money immediately and has many tools at its disposal for collecting any and all tax debts. What is not as clearly understood are the legitimate options that can help you avoid the trouble, interest, and penalties that accompany unpaid tax bills. Here’s a look at the procedures for requesting payment extensions as well as installment payment arrangements that will keep the IRS from instituting its collection process (including liens and property seizures) against you or your practice.
AVOIDING PENALTIES AND INTEREST
If you are entitled to a refund, the IRS may pay interest, but no penalty exists for either filing or paying late because no amount of money is due. The IRS will calculate penalties and interest on the amount of money you owe for unpaid taxes, however. Payments are calculated on the amounts due.
In general, taxpayers are subject to three separate penalties, which are for:
The failure-to-file penalty generally is more than the failure-to-pay penalty. Thus, if you are unable to pay all of the taxes you owe, you still should file all tax returns on time and explore other payment options.
The failure-to-file penalty accrues at the rate of 5% per month or part of a month (to a maximum of 25% reached after 5 months) on the amount of tax your tax return shows as owed.
The failure-to-pay penalty is gentler, accruing at the rate of only 0.5% per month or part of a month (to a maximum of 25% reached after 50 months) on the amount shown as due on your tax return.
If both penalties apply, the failure-to-file penalty drops to 4.5% per month, so the total combined penalty remains at 5%. Therefore, your maximum combined penalty for the first 5 months is 25%. Thereafter, the failure-to-pay penalty can continue at 0.5% per month for 45 more months, yielding an additional 22.5%. In total, these combined penalties can reach 47.5% of your unpaid liability in less than 5 years.
Both of these penalties are in addition to interest charged on all late payments. If you also failed to pay your estimated taxes, an additional penalty is tacked on for those missed payments. This penalty is computed at 3% above the federal short-term interest rate for the period.
Fortunately, when it comes to actually paying your tax bill and avoiding penalties and interest, you have several viable options, including borrowing, using credit cards, and even making the IRS an offer. (See “Take steps now to avoid problems later.”)
TAKING OUT A LOAN
Given the rate at which the afore-mentioned penalties and interest grow, consider borrowing the money you need to pay your taxes. In many situations, the rate of interest you pay to a family member or bank would be less overall than the amount you would have to pay the IRS.
Loans from relatives, friends, or your practice’s principals and/or shareholders are often the simplest method to pay your tax bill. When loans such as these are not available, a loan from a bank or other commercial lender might be the answer, however, such loans are unlikely to be made on favorable terms to any hard-pressed taxpayer. Moreover, unless business related, interest on a loan to pay taxes is usually nondeductible.
The Taxpayer Relief Act of 1997 authorized the U.S. Treasury to accept credit or debit card payments for federal taxes but prohibits the IRS from paying a fee or consideration to service providers for processing these transactions. To provide taxpayers this payment option, the IRS entered into non-monetary contracts and agreements with service providers.
Although credit card loans are likely to carry high interest rates-interest that, in most cases, is not tax deductible-paying taxes by credit card has several advantages, including convenience. You can file early and make payment by credit or debit card later, thereby delaying out-of-pocket expenses. Best of all, paying via credit or debit card is safe and secure.
When you pay with a credit card, a standard commercial credit card processing company handles your payment; the IRS does not receive or store credit card numbers. The service providers that offer electronic tax payment options accept American Express, Discover, MasterCard, and Visa credit cards and usually charge fees based on the amount of your payment. The IRS also offers special options if you owe a large amount ($100,000 or more). To make payments this way, you must contact a service provider directly.
Although the IRS will not receive or charge a fee if you use a credit card to make your payments, service providers charge so-called convenience fees. The IRS cannot pay or reimburse you for this convenience fee; however, it is a deductible business and individual expense.
For a description of the IRS’ electronic payment options, visit www.irs.gov/uac/Electronic-Payment-Options-Home-Page. Keep in mind that you cannot use any of these options to make federal tax deposits. Further, funds not properly deposited may be subject to a 10% penalty for failure to deposit funds through an authorized financial institution or the IRS’s Electronic Federal Tax Payment System.
ASKING FOR AN EXTENSION
The IRS is quite clear: it wants all taxes paid when due or sooner, even demanding immediate payment when granting extensions of time in which to file a tax return. Under some circumstances, however, you may arrange a short-term extension. A short-term extension will give you up to 120 days to pay. No fee is charged, but the late-payment penalty plus interest will apply.
An extension of time to pay also is available if you can show that making the payment when due would cause “undue hardship.” Qualifying for an undue hardship extension gives you an extra 6 months in which to pay the tax shown as due on your tax return. You will avoid the failure-to-pay penalty, although you still will be charged interest. Naturally, it is not enough to show that it would just be inconvenient to pay your taxes when they are due; you must demonstrate that it will be a real hardship to make the payment.
Should the IRS determine a “deficiency,” that is, taxes owed in excess of the amount shown on the return, the undue hardship extension can be as long as 18 months and, in exceptional cases, another 12 months can be tacked on. No extension will be granted if the deficiency was the result of negligence, intentional disregard of the tax rules, or fraud, however.
CONSIDERING INSTALLMENT PLANS
The IRS often is willing to accept installment payments for some tax debts. Generally, the IRS will allow you to make installment payments on the taxes you owe if the amount is $25,000 or less. In fact, the IRS is required to enter into a “guaranteed installment agreement,” whereby the tax liability is $10,000 or less, not counting interest and penalties.
If you owe more than $25,000, payment plan options also exist, but the IRS must first determine whether you are eligible.
Although partial-pay installment agreements are relatively easy to obtain, the IRS can re-evaluate the terms every 2 years. For example, if the IRS thinks you can afford to make bigger payments, then you might have to re-negotiate your partial-pay installment agreement. Of course, you also can request a re-evaluation at any time your circumstances change to such a degree that you can no longer make your agreed on payments.
MAKING AN OFFER
Negotiating is an acceptable practice when it comes to tax bills. An offer-in-compromise is an option the IRS provides so you can settle your tax debts at a fraction of their face value. You cannot, however, request this method until you examine and exhaust all other payment options.
Before the IRS will consider an offer-in-compromise, you must be in compliance and have the ability to pay and to borrow. For example, you must be current on your estimated tax payments or federal income tax withholding, you must be making your payroll tax deposits on time, and you must have filed all tax returns at the time you make an offer-in-compromise.
Like any creditor, the IRS prefers a partial payment to no payment at all. Thus, the IRS might be willing to settle your tax bill for less than the full amount if:
DEMONSTRATING A REASON
If you can demonstrate that a reasonable cause exists to abate or remove the tax penalties levied against you, you may be surprised to find those penalties forgiven by the IRS. Of course the IRS will determine whether reasonable cause exists by considering all the facts and circumstances.
Generally, ignorance of the law is not an excuse to avoid meeting your tax obligations. Your penalties may diminish, however, when certain factors apply. These factors include your level of education, whether you were subject to the tax previously, whether you were previously penalized by the IRS, recent changes in the tax law or tax forms you could not have reasonably had knowledge of, or whether the complexity of the issue involved was substantial.
AVOIDING SERIOUS CONSEQUENCES
Do not allow the inability to pay your tax liabilities in full keep you from filing all tax returns properly and on time. Also, remember that an extension of time to file your tax return does not extend the time you have to pay your tax bill.
You have several alternatives for resolving unpaid taxes: installment agreements, partial-pay installment agreements, or an offer-in-compromise. Your two other options-filing for bankruptcy or being declared “not currently collectible” by the IRS-are far less desirable.
The complexity of the current tax rules and the many options available to every physician who is unable to pay his or her tax bills require professional guidance.
Take steps now to avoid problems later
The realization that you cannot pay your taxes can be overwhelming. If you do not pay your taxes or fail to contact the Internal Revenue Service (IRS) regarding payment arrangements, the collection process will begin. To collect your tax debt, the IRS may seize your salary, any other income you receive, your bank accounts, and the property you own. It also may issue a summons to force you or a third party to provide additional information it can use to determine your ability to pay. Fortunately, the IRS offers detailed information about how you can pay up eventually and avoid or reduce penalties and interest on what you owe.