What if you owe more than you can pay?
It can be a paralyzing feeling. You have filled out your return, and now you realize you cannot afford to pay all of the amount you owe.
This could be from a variety of reasons, from not withholding enough, to job changes, or just not saving enough back to cover your taxes. Whatever the reason you know that the IRS will want their money.
Here are some ways to handle the problem.
* Above all, avoid penalties
* How to pay the taxes you owe
* Avoid underpayments in the future
Above All, Avoid Penalties
The IRS assesses penalties if you don’t file your return and don’t request an extension on time. These penalties are steep: 5 percent of your tax liability per month up to a maximum of 25 percent.
To avoid this, make sure to file your return on time, or file for an extension of time to file, even if you cannot pay the taxes you owe.
Caution: If you file for an extension of time to file on April 17 with Form 4868 do not understate your tax liability on purpose. When you later file your return and it shows a much larger amount of taxes due, the IRS can come back at you and invalidate your extension. If this happens, you will have to pay not only late payment penalties and interest, but also late filing penalties.
How to Pay the Taxes You Owe
You have more options than you think. You can:
- Obtain a bank loan or other financing to allow you to pay the IRS in full. This is often the best approach. Here is why: The IRS will charge you interest at the current federal underpayment rate (around 5 percent at the time of this writing), plus a late payment penalty of .5 percent per month on the unpaid balance. These interest rates may be higher than anything your local bank will charge.
- Use your credit card to pay the balance due on time. The IRS charges a convenience fee as a percentage of your tax, and you will have to pay finance charges to your credit card company.
There are always credit card companies offering special low introductory rates for a period of time: if you know that you can pay off the balance on the card within the low interest rate period, consider this option rather than letting the IRS charge you at their going rate (not to mention the penalties for late payment).
- Pay the IRS late. To keep the penalties down, start out by paying as much as you can when you file your return.
The IRS keeps good records of what you owe. When the IRS mails you a notice showing how much you still owe for the year, mail the balance as soon as you receive that notice. The IRS charges interest at the current federal underpayment rate (around 5 percent at the time of this writing), plus a late payment penalty of 1/2 percent per month on the unpaid balance. So the sooner you settle up, the less you'll pay in penalties.
- Request an installment agreement with the IRS. You do this by completing Form 9465, Installment Agreement Request, and attaching it to your return when you file it.
You will be asked to enter the amount you can pay each month. Try to pay as much as possible, but not more than you can handle.
A good rule-of-thumb for the payment amount is to divide the balance due by the number of months until your next tax return is due (which is usually April 15 of the next year). For example, if you owe $1,000 as of April 15, 2005 and you request an installment agreement for your 2004 tax return, make a payment of $100 with the return, and request $100 monthly payments on the balance of $900 plus penalties and interest. By the time your 2005 tax return is due on April 17, 2006, you will have paid off your 2004 liability. If the IRS accepts the installment agreement, they charge a reduced late payment penalty of 1/4 percent per month and interest at the IRS's going rate, plus a $43 user fee.
You must keep all future tax liabilities current. That means that if you owe money on your next tax return, you must pay the entire balance due by the due date of the return in addition to the payments you are making on this agreement. If you do not pay the entire balance on future returns, the IRS can nullify your installment agreement.
- Ask the IRS for an extension of time to pay. An extension of time to pay will be considered by the IRS only if paying the tax will cause you undue hardship. To make this request, file Form 1127 by the time the taxes are due. This eliminates those late payment penalties we mentioned earlier, but the IRS will still charge interest on the unpaid balance.
To get an extension of time to pay, you have to show the IRS that you cannot sell assets or borrow any money to pay the taxes without causing yourself and your family severe loss and undue hardship. In addition, you need to provide a statement showing your assets and your debts, and another statement showing your cash receipts and your cash disbursements for the three months up to the due date of the taxes.
Avoid Underpayments in the Future
If you are a wage earner, it is a good idea to reevaluate your tax withholding at the beginning of each year to make sure you have enough taxes withheld.
If you receive income from sources that do not withhold taxes, you may need to make quarterly estimated tax payments by filing IRS Form 1040-ES. If you have another job which DOES withholding taxes, you may be able to adjust your allowances on Form W-4 to pay enough taxes for both jobs.
Go Back to FAQ topics -- |
