If you're worried you won't be able to pay your income taxes by this year's April 17 filing date, don't panic; but don't ignore the deadline and certainly don't wait for the IRS to reach out to you first. Acting quickly not only gives you more repayment options, it can also significantly lower any penalties you might owe the government.
I'll get to the repayment options in a moment, but first, a bit of good news: Earlier this week the IRS announced that it will provide two new forms of tax relief for certain 2011 taxpayers:
- The IRS is offering a six-month grace period for failure-to-pay penalties for certain wage earners who have experienced long periods of unemployment; or, if self-employed, experienced a 25 percent or greater reduction in business income in 2011 due to the economy.
- The IRS has also doubled the threshold for filing a streamlined installment repayment agreement (where you don't have to supply a detailed financial statement) from $25,000 in taxes owed to $50,000.
If your 2011 federal tax return or extension request isn't postmarked or electronically filed by midnight on April 17, 2012, the penalty on any taxes you owe increases dramatically. You'll usually have to pay an additional 5 percent of taxes owed for each full or partial month you're late, plus interest (the federal short-term rate plus 3 percent -- currently 3.19 percent), up to a maximum penalty of 25 percent of the amount owed. But file your return or extension request on time and the penalty drops tenfold to 0.5 percent per month, plus interest.
Here's how it can add up: Say you owe $2,000 in federal income tax. If you haven't requested an extension, you would be charged an additional $100 (5 percent) for each month you're late. Had you filed for an extension, the penalty would drop to only $10 a month (0.5 percent).
The new penalty-relief policy for certain taxpayers works like this:
- You must have been unemployed for 30 consecutive days or longer in 2011 (or in 2012 up through April 17).
- Your adjusted gross income cannot exceed $200,000 if married and filing jointly ($100,000 if single or head of household).
- You cannot owe more than $50,000 in 2011 taxes.
- To get the six-month penalty-free payment extension, you must pay all taxes, interest and other penalties by October 15, 2012.
- The failure-to-pay penalty amounts being waived are the same as described above (5 percent per month if you miss the filing deadline or 0.5 percent if you file by April 17 -- both up to a maximum 25 percent penalty). However, the IRS is still legally required to charge interest on unpaid back taxes, as outline above.
- If you meet the penalty-waiver eligibility criteria, you must complete and submit IRS Form 1127-A by April 17. (Note: Don't submit with your tax return; separate mailing instructions are found on the form.)
Be sure to contact the IRS early if you won't be able to pay on time. They may even waive the penalty, depending on your circumstances -- for example, if your underpayment was due to a casualty, natural disaster, death or serious illness of an immediate family member or other unusual event. Call 800-829-1040 or read Filing Late and/or Paying Late for more information.
IRS tax repayment alternatives that may be appropriate and available to you include:
Pay by credit card. You will likely be charged a small fee that is tax-deductible if you itemize expenses. Just be sure you can pay off your credit card balance within a few months, or the interest accrued might exceed the penalty. To learn more, visit this site.
Short-term extension. If you think you'll be able to pay the full amount owed within 120 days, speak to an IRS representative (800-829-1040) or apply online HERE to see if you qualify for a short-term extension. If granted, you'll still owe interest on your debt, but will avoid the application fee for an installment agreement.
Installment agreement. If you need longer than 120 days, an installment agreement will let you pay off your bill in monthly installments for up to six years, depending on your particular case. Penalties are reduced to 0.25 percent a month, although interest continues to accrue on outstanding balances. If your combined bill for tax, penalties and interest is $10,000 or less, you qualify for a guaranteed installment agreement provided you have filed and paid all taxes for the previous five years and haven't had an installment agreement within that time.
What's new is that the IRS has doubled the threshold to qualify for a streamlined installment agreement, which means you don't have to supply a detailed financial statement with your application. If you owe $50,000 or less and are in good standing, you're likely to qualify -- that's double the previous $25,000 threshold. Also, the maximum term for streamlined installment agreements has been raised from 60 to 72 months.
If you owe more than $50,000, you still may qualify, but may be required to file a detailed Collection Information Statement.
There is a $105 fee to enter an installment agreement. The fee is reduced to $52 if you set up a direct debit installment plan (or $43 for low-income filers -- check IRS Form 13844 to see if you qualify). To apply for an installment agreement, fill out an Online Payment Agreement Application or submit IRS Form 9465.
Offer in Compromise. Under certain dire financial-hardship circumstances, the IRS may allow taxpayers with annual incomes of up to $100,000 (raised from the previous cut-off of $50,000) to negotiate a reduction in the amount they owe through an Offer in Compromise.
To qualify, you must be current with all filing and payment requirements and not in an open bankruptcy proceeding. There is a $150 non-refundable application fee, which may be waived for low-income applicants. You'll also be required to submit an initial payment with your application.
Please note: Only a small number of offers in compromise are accepted and you should only pursue one after having exhausted all other payment options. For step-by-step instructions, read the IRS Form 656 Booklet. If you opt to hire a tax professional to help, read this IRS Tip Sheet.
If you find yourself unable to make payments on your installment agreement or offer in compromise, call the IRS immediately for alternative payment options, which could include reducing the monthly payment to reflect your current financial condition. You'll likely be asked to provide proof of such changes so have that information available when you call.
IRS tax lien rules relaxed. One of the biggest downsides to owing the government money is that it can place a tax lien on your assets and future earnings. This is doubly painful because having a tax lien on your credit report can seriously damage your credit score and make it more difficult to buy or sell a car or home, among other disadvantages.
Last year the IRS significantly reduced the number of liens it issues by doubling the amount at which tax liability would trigger a lien to $10,000. The agency also made it easier for many people to remove liens from their credit report. For example:
- Once you've paid off your debt, you can request the IRS to update its public records to reflect that the lien has been withdrawn, which will remove it from your credit report. Before, the lien would remain on your report as "released" for seven years.
- You now can usually have your tax lien withdrawn by entering into a direct debit installment agreement for debt under $25,000. Just be sure you don't default or a new lien could be imposed.
- To request a lien withdrawal in either of these cases, submit IRS Form 12277.
The IRS has a handy guide called The What Ifs for Struggling Taxpayers that reviews the tax impacts of different scenarios such as job loss, debt forgiveness or tapping a retirement fund.
Also, see my previous blog, Tax Strategies in a Tough Economy.
Nothing beats staying current on your taxes, but if you fear you may fall behind, explore these options before the penalties start snowballing.
This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.
To participate in a free, online Financial Literacy and Education Summit on April 23, 2012, go to Practical Money Skills.