RULES ON PAYING YOUR INCOME TAX BALANCE LATE

 The following information briefly explains what will happen if a taxpayer is unable to PAY his/her entire federal income tax obligation.  Similar penalties and interest are assessed by a state where a taxpayer is unable to pay his/her state income tax liability.

First and most importantly, do not let your inability to pay your tax liability in full keep you from filing your properly prepared income tax on a timely basis.  Include as large a tax payment as you can.  As discussed below, just filing your tax return without full payment can save you substantial amounts in late filing penalties.  More importantly, procedures exist for payment extensions and installment payments arrangements, which will keep the IRS from instating its collection process (liens, property seizures, etc.) as discussed below.

Extensions of time.

Remember, when you request and receive an extension of time to file your income tax return from the IRS or the state, this is ONLY an extension of time to FILE your income tax return.  It does not mean that you have an extension of time to PAY your tax liability.  Taxes are due on the original filing date.

Overview of the most common tax penalties. 

1. The “failure to file” penalty accrues at the rate of 5% per month or of a part of a month, up to a maximum penalty of 25% on the amount of the net unpaid tax liability.  This is the penalty that can be avoided by filing the tax return on time even if you cannot pay the full amount due.

2. The “failure to pay” penalty accrues at ½ % per month or part of a month, up to a maximum of 25% of the amount your unpaid income tax.

3. If BOTH the failure to file AND the failure to pay penalties apply, the failure to file penalty drops to 4.5% per month from the 5% level in item 2 above, so the combined penalty remains at 5% per month.  The maximum combined penalty for the first five months is 25%.  Thereafter, the failure to pay penalty continues at ½ % per month for 45 more months, an additional 22.5%.  Thus, the combined penalties can reach a maximum of 47.5% over time.

4. Both of the above penalties are in addition to the interest you will be charged for your late payment.  The late paying interest rate varies, currently at 8% per annum, compounded daily.

5. If you were required to make estimated tax payments and failed to do so, an additional penalty is tacked on for the period running from each payment’s due date until the tax return due date, normally April 15^th.  This penalty is computed at 3% above the fluctuating short-term interest rate for the period.

6. IMPORTANTLY, NONE of the above interest or penalties are tax deductible. This means that since they are paid with after tax dollars, your effective interest cost is significantly higher than the stated percentages.

Installment agreement request.

The most common way to defer your tax payments is to request that the IRS enter into an “installment agreement” with you.  The IRS currently charges a $45 fee for reviewing an installment agreement, which is then deducted from your first installment payment after your request has been approved.  An installment agreement request requires less information than the hardship extension application.  If your liability is under $25,000, you will not be required to submit financial statements.  Even if your request to pay in installments is granted, you will be charged interest on any tax not paid by its due date, but the late payment penalty will be half the usual rate, ¼ % per month instead of ½ % per month, if you file your tax return by its due date including extensions.

 The IRS is required to grant your installment agreement request if ALL of the following apply:

1. You tax liability is $10,000 or less, AND
2. You have not failed to file your tax returns and pay your taxes due in the prior 5 years, AND
3. You have not entered into an a previous installment agreement in the prior 5 years, AND
4. Your installment agreement provides for full repayment within 3 years, AND
5. You agree to comply with the laws during the agreement period, AND
6. You file a completed Form 9465 with the IRS, AND
7. You timely submit any financial statements as required by the IRS in certain cases.

The installment agreement may be terminated and therefore, all of your unpaid taxes will become immediately due if any of the following occur:

1. You provide inaccurate or incomplete information to the IRS when applying for the agreement, OR
2. You miss any installment payment, OR
3. You fail to pay another tax liability when due, such as your income taxes during any of the 5 years following the date the installment agreement was granted, OR
4. You fail to provide updated information on your financial condition where the IRS makes a reasonable request for you to do so. OR
5. The IRS “believes” that collection of your tax liability is in jeopardy.

Undue hardship extensions.

An extension of time for payment of taxes owed may be available IF you can show that payment of the tax would cause “undue hardship,” as discussed below.  You will avoid the failure to pay penalty if an undue hardship extension is granted by the IRS, 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.  Also, if the IRS determines that you owe taxes in excess of the amount shown on your tax return, called a tax “deficiency,” an “undue hardship” extension can be granted for as long as 18 months, as long as the excess taxes were not the result of negligence, intention disregard for the tax rules, or fraud.

To qualify for undue hardship, you have to show the IRS that you do not have enough cash and assets convertible into cash, in excess of current working capital, to meet you tax obligations.  You also have to show the IRS that you cannot borrow the amount needed to pay your tax obligations except on terms that would inflict serious loss and hardship upon you.  It is not enough to show that it is inconvenient to pay your tax when due.  For example, if you 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 causing undue hardship.

To qualify for the extension, you have to provide security for the tax debt, if you have any.  The determination of the kind of security taken, such as a bond, filing a notice of lien, a deed of trust, personal security, or other form of security, will depend on the particular circumstances involved.  You must file a completed Form 1127 to apply for the extension, along with a detailed statement of your assets and liabilities, and an itemized list of receipts and disbursements for the three months preceding the tax due date.  If your application for an extension is granted, you must deposit any collateral agreed upon with the IRS immediately.