A copy of the original article posted on WalletHub: http://wallethub.com/edu/what-if-i-cant-pay-my-taxes/8031/.
Tax season is a stressful time for most people, but it’s especially difficult for those of us with doubts about our ability to pay the IRS. The good news is there are a number of ways anyone can make an unmanageable tax obligation easier to deal with without drastically driving up the costs.
The specific manner in which you ultimately approach your tax tab largely depends on the length of time you’ll need to amass the money that is due. As you’ll see below, the options available to people with short-term cash flow issues are far different than those typically leveraged by folks with more fundamental financial difficulties.
- Don’t try to hide: You’re simply not going to slip through the cracks, and the IRS has proven far more willing to work with people when they’re straightforward about their ability, or lack thereof, to meet tax obligations. So, submit your return by the April 15 deadline even if you don’t have the money to pay and establish an open dialogue with the tax collection agency.
- File a Return No Matter What: The IRS levies separate penalty fees for failing to pay taxes and failing to file a tax return. At a minimum, you want to eliminate the latter since it is entirely within your control.
- Leverage free advice: You’re already on the right track by researching your options online, and continuing to do so is highly recommended. You can also supplement your search with more personalized feedback from a variety of human sources, including third-year law students at the free “tax clinics” that many schools offer and more experienced accountants and lawyers who offer free consultations.
- Watch out for scams: There are plenty of companies out there that will be quick to promise miracle fixes to even the most severe tax problems. View them with intense suspicion. Make sure to thoroughly research any company you even consider working with in order to verify they are reputable. And remember, if an offer sounds too good to be true, it probably is.
- Reevaluate withholdings: While it won’t help you this time around, it’s important to understand that owing money on your taxes means you’re not putting enough aside to cover your obligations. So, in order to prevent your problems from persisting, start saving a bit more from each of your monthly payments. You should fill out a new W-4 form and submit it to your employer in order to get a larger amount withheld from your paycheck.
- Improve your budgeting: The situation of owing money to Uncle Sam underscores the importance of financial planning and a carefully constructed budget. You should therefore take this opportunity to cut your spending on anything that is not a necessity in order to build positive habits for the future and repay the IRS as quickly as possible.
If You Need Up to 30 Days: Just Wait for a Bill
If a temporary cash-flow interruption is at the heart of your inability to pay, you may want to submit your tax return and simply wait to receive a bill from the IRS. The tax collection agency notifies people who have existing tax obligations of what they owe, plus any interest and late fees, a few weeks after the April 15 filing deadline has passed and it’s had the chance to process returns submitted by then. The IRS currently charges 3% interest on underpayments as well as a monthly late fee equal to 0.5% of what you owe, which is a fairly palatable price to pay for buying yourself a bit of extra time.
You should only use this strategy if you literally need 2-3 extra weeks to pay. After all, it will take the IRS 10 days to process requests for an extension or payment plan anyway, but you still want to make sure not to get on the agency’s bad side.
If You Need 31 – 120 Days: Apply for an Extension
The IRS offers 120-day payment extensions. You won’t be charged an application fee for this type of short-term extension, but you will have to pay a late fee and 3% interest on your outstanding balance. Qualifying individuals may be able to get fees and interest waived through the IRS Fresh Start initiative.
If You Need 120+ Days: Weigh Your Options
Those who need more than about four months to assemble the funds required to repay the IRS interestingly have a bevy of strategies from which to choose. Many of these approaches are a bit more extreme than those geared toward people with shorter time frames, but that is to be expected. The key is to weigh all of these options and choose the course of action that is best for your particular situation.
- Set up an installment agreement with the IRS: You can apply for the ability to pay off your tax obligation over time by filling out Form 9465 if you owe less than $50,000 (principal, plus interest and fees) as well as Form 433-F if you owe more than that.
Keep in mind that you will have to pay a fee for setting up a payment plan: $52 if you sign up to have payments automatically debited from a checking account every month, $105 if you want to mail a check or have a portion of your paycheck garnished, or $43 if your income is below a certain level. The IRS doesn’t usually attempt collections while an installment agreement application is being considered, when such an agreement is in effect, or for 30 days after an application has been rejected.
- Use a credit card: In certain situations, it’s financially beneficial to pay off your tax obligation using a credit card and thereby shift your debt away from the IRS to your card’s issuer. Our sister site CardHub offers a good perspective on the pros and cons of paying your taxes with a credit card.
- Submit an offer in compromise: This is a negotiation instrument that allows you to get square with the IRS by paying back less than you actually owe through the use of a lump-sum payment or a payment plan. Uncle Sam will probably accept this type of deal if you offer what he will likely be able to collect from you in the near future, based on your income, assets, debts and liabilities. There is a $150 application fee for an offer in compromise.
- Tap into your 401(k): There are two ways to leverage retirement savings for tax payments: borrowing from your funds or withdrawing them entirely. Borrowing is definitely the preferred option, as it does not trigger the 10% early withdrawal penalty for people who are younger than 59½. You will have to repay your future self with interest, but as long as the rate is decent this could be a good option.
- Use a HELOC: A Home Equity Line of Credit could serve as a relatively inexpensive means of paying off your IRS obligations, depending on the terms of course. This is a very risky route to go, however, because a failure to repay your resulting balance could lead to you losing your home.
- Sell assets: Divesting yourself of certain assets is a straightforward yet potentially very painful way to raise the capital needed to pay the tax man. We recommend only considering this option as a last resort.
Ultimately, it’s important to reiterate that while people often act like you have to go into hiding if you can’t pay your full tax obligation right away, that’s actually the worst thing to do. The IRS is much more likely to work with you if you’re upfront about your situation, and there are indeed a number of ways that you can buy yourself some extra time without doing too much damage to your bank account. The exact route you decide upon will depend on how long you need to come up with the cash.
Ask the Experts
For additional insights regarding the steps consumers can take if they don’t have the funds to pay the IRS, we turned a panel of leading accounting and tax professors. You can check out their responses to the following questions below.
- Do you have any additional tips for people who do not have the funds necessary to pay an upcoming tax obligation?
- Is it ever a good idea to tap into a 401(k) or other retirement account to satisfy tax obligations?
- What tips do you have to help people avoid being short the funds necessary to cover their tax payments in the future?