Wondering what will happen if you or someone you know cannot pay their income taxes? Here’s a look at your options.
Common penalties
The “failure to file” penalty accrues at 5% per month or part of a month (to a maximum of 25%) on the amount of income tax your tax return shows that you owe. The “failure to pay” penalty accrues at only 0.5% per month or part of a month (to 25% maximum) on the amount due on the return. (If both apply, the failure to file penalty drops to 4.5% per month (or part) so the combined penalty remains at 5%.) The maximum combined penalty for the first five months is 25%. Thereafter, the failure to pay penalty can continue at 0.5% per month for 45 more months. These combined penalties can reach 47.5% over time in addition to any interest that you will owe on your balance due.
Undue hardship extensions
Keep in mind that an extension of time to file your return doesn’t mean an extension of time to pay your tax bill. A payment extension may be available, however, if you can show payment would cause “undue hardship.” You can avoid the failure to pay penalty if an extension is granted, but you’ll be charged interest. If you qualify, you’ll be given an extra six months to pay the tax due on your return. If the IRS determines a “deficiency,” the undue hardship extension can be up to 18 months and, in exceptional cases, another 12 months can be added.
Borrowing money
If you don’t think you can get an extension of time to pay your taxes, borrowing money to pay them should be considered. You may be able to get a loan from a relative, friend, or commercial lender. You can also use credit or debit cards to pay a tax bill, but you’re likely to pay a relatively high-interest rate and possibly a fee.
Installment agreement
Another way to defer tax payments is to request an installment payment agreement. This is done by filing a form and the IRS charges a fee for installment agreements. Even if a request is granted, you’ll be charged interest on any tax not paid by its due date. But the late payment penalty is half the usual rate (0.25% instead of 0.5%) if you file by the due date (including extensions).
The IRS may terminate an installment agreement if the information provided in applying is inaccurate or incomplete or the IRS believes the tax collection is in jeopardy. The IRS may also modify or terminate an installment agreement in certain cases, such as if you miss a payment or fail to pay another tax liability when it’s due.
Avoid serious consequences
It’s important to file a properly prepared return even if full payment can’t be made to avoid the failure to file penalty. Include as large a partial payment as you can with your income tax return and start working with the IRS to pay your balance due as soon as they contact you. Income tax liabilities don’t go away if left unaddressed.
The alternative may include escalating penalties and having liens assessed against your assets and income. Down the road, the collection process may also include seizure and sale of your property. In many cases, these nightmares can be avoided by taking advantage of options offered by the IRS. Taking certain steps now can keep the IRS from instituting these punitive collection processes.