What if You Can’t Pay Your Taxes?

Paying Bills

Getting to the end of your 1040 form and finding a balance due isn’t fun, though at least you can pat yourself on the back for not having made a free loan to the U.S. Treasury. But knowing that you don’t have the money to pay that bill can make you really miserable.

Here are seven ways to keep the payments--and the misery--to a minimum.

* Scramble. The deadline for filing income taxes isn’t until April 18 this year. That gives you one extra weekend to hold a yard sale, cash in a bank CD or tap your home equity line. Those are all reasonable places to get money to pay your tax bill.

* Don’t use your credit card. When you use your credit card to pay your income taxes, you’ll have to pay a convenience fee of as much as 2.35%, just for making the transaction. And with the average annual interest rate on credit cards now pushing 17%, according to IndexCreditCards.com, it’s hard to see how this makes sense.

You’re better off borrowing from the Treasury itself; its current interest rate for late payments is 4% a year. (That figure changes quarterly.) Even the so-called “convenience checks” that your credit card company says charge zero interest usually require upfront fees that are higher than the IRS rates.

* File your return on time. Even if you don’t have the money, you’ll save by getting the paperwork done. That’s because the Internal Revenue Service penalties for not filing are far higher than the penalties for not paying.

Consider this example, provided by the Tax & Accounting business of Thomson Reuters:If a couple owes $5,000, files on time, and doesn’t pay the bill for three months, it will pay a late payment penalty of $75. But if they don’t file their return until they have the money in hand three months later, they’ll owe a late filing penalty of $750. If you can’t finish your return on time, at least file an extension, says Robin Christian, senior tax analyst with Thomson Reuters. “Getting an extension will avoid a late filing penalty, but interest and the late payment penalty on the unpaid tax amount will accrue until the tax is paid.”

* Buy time from the IRS. You can send in your return with as much money as you have, and wait for the tax agency to bill you, suggests the California Society of CPAs. That should take about 45 days. You’ll have to pay the penalty and interest on the amount still due. Pay what you can, and wait another for another IRS bill, the group said in a statement. “It takes a while for the IRS to get serious. So… you can buy yourself some time.” But the California group pointed out that with penalties accruing every time you fail to pay off the balance, you’ll end up spending more money with this approach than if you’d come up with the money by the due date.

* Go on the installment plan. If you think your shortfall will take more than three or four months to cover, you can file a form 9465 and ask the IRS to let you pay it off over time. This is called an installment plan. There’s a one-time fee of $105 (cut to $52 if you agree to let the IRS automatically debit your bank account). The IRS has become quite liberal in working out payment plans for folks who don’t have the cash to pay their taxes, says Bob Meighan of TurboTax. “It’s not quite automatic, but it’s generally approved,” he said.

* Protect your credit score. If you owe more than $10,000, things get worse. If your unpaid tax bill is that big, the IRS is “almost certainly” going to enter a tax lien against you, and that will immediately lower your credit score by about 200 points, says Gerri Detweiler, a personal finance expert with Credit.com. “So you really want to get it below $10,000.”

If you absolutely, positively can’t do that, try for an installment agreement with an automatic debit order, she advises. After a few months of payments flowing as they should under that agreement, the IRS will remove the lien from your credit report if you ask it to. And that should enable your credit score to recover.

* Re-calculate your withholding. If your tax situation hasn’t changed, you may want to send in more money in estimated payments or get your employer to withhold more money for your federal taxes for 2011. Because having to do this once is bad enough; it’s even more depressing when the last-minute cash hunt becomes an annual event.