There actually are human beings just like you, me and your Aunt Mildred who work at the Internal Revenue Service. Honest. And they’re aware of the tough economy, the high unemployment rate and rising gas prices. That’s why, without even an act of Congress (literally), for the past three years the agency has eased up on the penalties for folks who have a tough time paying their income taxes.
Continue Reading Below
However, just like you, me and good old Aunt Mildred, the IRS doesn’t like to be ignored; that can make the situation get ugly very quickly.
First of all, even if you don’t have some or all of the money to cover your tax bill, “definitely file your tax return,” says Mark Luscombe, attorney, CPA, and principal tax analyst at CCH, a leading provider of tax law information.
Not filing your federal income tax return is a misdemeanor crime: You could end up with a $25,000 fine and prison time if you follow the advice of folks who insist the federal income tax is unconstitutional. The Supreme Court has ruled on this (twice) and decided it is.
You can also get hit with a “failure to pay” penalty of 5% of the amount you owe for every month your return is overdue. The good news (if you can call it that) is that the penalty maxes out at 25% per month; in addition, you’ll also be charged interest. According to Luscombe, when combined with the failure to pay penalty, total charges end up being around 10% per year.
If you ignore those “reminders” from the IRS pointing out that you that you forgot to file your return, the agency can submit one on your behalf. “If you don’t file and the IRS initiates an audit, they will subpoena your bank records” Luscombe warns, and just about any other information it can uncover to come up with an own estimate of your income.
Continue Reading Below
Since the IRS version of your return won’t include any deductions, your tax bill is likely to be significantly higher. Then it’s up to you to prove the agency wrong.
On or about the same time, the IRS will initiate the collection process, which can involve either a tax “levy” or a tax “lien.” A levy gives the government the ability to seize your property: money in bank accounts, your house, your car, etc.
A tax lien can be even more devastating. “It’s an actual filing that… tells the world you owe the IRS 'x' amount of dollars,” says Luscombe. “It’s reflected in your credit report.” As a result, it destroys your credit rating. If you were thinking of borrowing money to pay your tax bill, fahgetaboutit; with a tax lien on your record, no one’s going to loan you money. Moreover, as Luscombe points out, “If you work in the securities industry or the government, it can prevent you from getting a job or get you fired.”
As the Taxpayer Advocate has noted, this just makes it even more difficult for someone to cough up the dough they owe. None the less, Luscombe says in recent years the IRS has been pouring more resources into enforcement and the number of liens and levies filed has been increasing. It’s probably safe to say that by the time the IRS hits this stage, you’ve pretty much exhausted any sympathy folks might have had for your situation, especially since the agency has loosened the rules to give taxpayers more options to comply with the law.
Under the “kinder, gentler” standards it has adopted since the recession, the IRS will not file a lien unless you owe more than $10,000. (That’s up from $5,000.) According to CCH, the new rules also make it easier for a tax lien to be removed from your credit record. However, you need to make a formal request to the IRS to withdraw the lien. In addition, “if the taxpayer enters into a direct debit installment agreement with the IRS they can have the tax lien withdrawn while they are paying off the debt,” according to Luscombe.
Your first option is to try to find some other source for the money to cover your tax bill; Aunt Mildred, for instance, or, perhaps you have some investments you can cash in. “If you have alternate sources of money, these might be cheaper than the IRS,” advises Luscombe. “A home equity line of credit. Even a credit card is worth looking at. Perhaps most importantly, paying in full will keep you off the Internal Revenue Service’s radar screen.
According to CCH, if you don’t have all of the money to cover your tax bill right now, but expect to have it in a few months, you can apply for a “short-term administrative extension.” This gives you an extra 120 days to pay in full, but you will be still be subject to interest on the outstanding balance. “The IRS can be flexible if you can assure them you’ll pay in 120 days,” says Luscombe. “That will likely hold off [on them filing] a lien.” They might also waive the filing fee for Form 9465.
If you need more time, you can apply for an Installment Agreement- essentially a loan from the IRS--by also filing Form 9465. Instructions can be found here
However, in order to qualify, you have to meet certain conditions:
*A good payment record for the past five years
*A good filing record
*You owe less than $10,000
*You can demonstrate that you’ll be able to pay your bill within three years
“If you meet the conditions, you’re pretty much guaranteed the IRS will accept your application,” says Luscombe. However, you might have to agree to give the IRS priority over your other creditors, which could upset your credit card issuers. He adds there is some room to negotiate the exact terms, but cautions that “some say the IRS is reasonable and others say they’re not.”
If there’s simply no way you’ll ever be able to afford to pay the amount you owe, then you can enter into an “offer in compromise.” This involves trying to whittle down what the IRS says you owe. Perhaps there’s a legal question about to what the amount is--rather than each party risking the cost of litigation and possibly losing, they might decide to compromise. The problem is, this is never automatic or guaranteed. “Statistically, the IRS is not generous with offers in compromise,” warns Luscombe. Plus, “you have to provide a lot of financial information” to justify your argument.
The bottom line: 1. File your tax return whether you can pay your bill in full or not. 2. Approach the IRS to arrange how you will come up with the money before they contact you.
Ms. Buckner is a Retirement and Financial Planning Specialist at Franklin Templeton Investments. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content.
If you have a question for Gail Buckner and the Your $ Matters column, send them to: firstname.lastname@example.org, along with your name and phone number.