If you aren’t one of those lucky Americans who get a tax refund from the IRS, you might be wondering about your options for paying off your tax liability by the April due date.
Generally, tax due occurs when a wage earner is under-withheld on their payroll or a self-employed individual fails to make sufficient estimated tax payments. Situations like these can be a problem.
The IRS encourages taxpayers to pay the full amount of their tax liability on time, and it imposes significant penalties and interest on late payments. Thus, if you are unable to pay the taxes that you owe, it is generally in your best interest to make other arrangements to obtain the full funds to pay your taxes so that you are not subjected to the government’s penalties and interest. Here are a few options to consider.
Family Loan – Obtaining a loan from a relative or friend may be the best bet because this type of loan is generally the least costly in terms of interest.
Home Equity Loans and HELOCs - Use the equity in your home—the difference between your home’s value and your mortgage balance—as collateral. As the loans are secured against the equity value of your home, home equity loans offer extremely competitive interest rates—usually close to those of first mortgages. Compared with unsecured borrowing sources, such as credit cards, you’ll be paying less in financing fees for the same loan amount. Unfortunately, obtaining these loans takes time, so if you anticipate that you’ll need funds from such a loan to pay your taxes that are due in April, you should get the application process started right away.
Credit Card – Another option is to pay by credit card by using one of the service providers that work with the IRS. However, as the IRS will not pay the credit card discount fee, you will have to pay that fee. You will also have to pay the credit card interest on the payment.
Short-Term Payment Plan – If you can fully pay the tax owed within 180 days and owe less than $100,000, including tax, penalties, and interest, you can apply for a short-term payment plan online at the IRS website. You won’t be charged a set-up fee but will still have to pay penalties and interest until the balance owed is fully paid. Setup fees will be charged if you apply for a payment plan by phone, mail, or in-person instead of online.
Installment Agreement – If you owe the IRS $50,000 or less, you may qualify for a streamlined installment agreement that allows you to make monthly payments for up to six years. You will still be subject to the late payment penalty, but it will be reduced by half. In addition, interest will also be charged at the current rate, and you will have to pay a user fee to set up the payment plan. By signing this agreement, you agree to keep all future years’ tax obligations current. If you do not make payments on time or if you have an outstanding past-due amount in a future year, you will be in default of the agreement, and the IRS will then have the option of taking enforcement actions to collect the entire amount that you owe. If you seek installment agreements exceeding $50,000, the IRS will need to validate your financial condition and your need for an installment agreement through the information you provide in the Collection Information Statement (in which you list your financial statements). You may also pay down your balance to $50,000 or less so as to take advantage of the streamlined option.
Tap a Retirement Account – This is possibly the worst option for obtaining funds to pay your taxes because it jeopardizes your retirement and because the distributions are generally taxable at the highest bracket, which adds more taxes to the existing problem. In addition, if you are under age 59½, such a withdrawal is also subject to a 10% early-withdrawal penalty that compounds the problem even further.
Filing Extensions – Don’t mistake the ability to apply for an extension of time to file your tax return as also being an extension to pay any tax liability. It is not and does not grant you an extension of time to pay. The penalties and interest on the amount due will continue to apply as of the original due date of the return.
Enforced Collections - If the taxes cannot be paid timely, and the IRS is not notified why the taxes cannot be paid, the law requires that enforcement action be taken, which could include the following:
Issuing a Notice of Levy on salary and other income, bank accounts, or property (IRS can legally seize property to satisfy the tax debt)
Assessing a Trust Fund Recovery Penalty for certain unpaid employment taxes.
Issuing a Summons to the taxpayer or third parties to secure information to prepare unfiled tax returns or determine the taxpayer’s ability to pay.
Note: To collect delinquent tax debts, certain federal payments (vendor, OPM, SSA, federal salary, and federal employee travel) disbursed by the Department of the Treasury, Bureau of Fiscal Service (BFS)) maybe subject to a levy through the Federal Payment Levy Program (FPLP).
Fresh Start Initiative - The IRS also has what is called the “Fresh Start” initiative to offer more flexible terms in its existing Offer-in-Compromise program, which, under certain circumstances, allows taxpayers to settle their tax debt for reduced amounts. This enables financially distressed taxpayers to clear up their tax problems faster than in the past. While resolving tax problems might previously have taken four or five years, taxpayers may now be able to resolve their problems in as little as two years.
If you have questions about the payment options or an offer-in-compromise, please give us a call. Whatever you decide, don’t just ignore your tax liability, as that is the worst thing you can do.