Wednesday, October 3, 2007


Q. Oi vey! I filed an automatic extension back in April, giving me until October 15th to file my 2006 income tax returns, because I did not have the money to pay the tax I owed. The deadline is fast approaching, but I still do not have the money to pay the tax due! What can I do?

A. The most important thing is to make sure you get your 2006 Form 1040 (or 1040A) – and any applicable state income tax return - in the mail by (preferably before) October 15th, even if you cannot pay all, or any, of the income tax due!

The reason for this is the difference between the penalty for paying late (.5% - or ½ of 1% - of the balance due per month, or part thereof) and the penalty for filing late (5% of the balance due per month, or part thereof). The penalty for filing late is 10 times as much as that for paying late!

The automatic extension granted by filing Form 4868 back in April extends the time to file the return, not the time to pay the tax. The tax was due on April 17th, with or without an extension, and the clock for penalty and interest assessments began to run on April 18.

Your options for dealing with the balance due on your return are as follows:

(1) You can mail the return, with a payment of as much of the amount due as you can afford to send, before October 15. Once the return has been processed, “Sam” will send you a notice for the remainder of the tax due, plus penalty and interest. You can then pay all, or part, of the balance due. “Sam” will continue to send you notices, with penalty and interest accruing, until you are paid in full. I would only suggest using this method if you are able to pay the full balance in two or three payments.

(2) You can request an “Installment Agreement” by submitting Form 9465 (Installment Agreement Request) with your return. You can also request an Installment Agreement by completing an Online Payment Agreement Application at the IRS website. With such an arrangement you agree to pay a certain amount per month. Your application indicates how much you wish to pay (for example, if you owe $1,000 you may want to send $100-$200 per month) and on which day of the month you want to make the payment. You can arrange to have the monthly payment automatically deducted from your bank account. There will be a “user fee” for setting up an Installment Agreement, which depends on your method of payment and level of income. Of course penalty and interest will continue to accrue until the entire amount is paid in full. The greater the amount of your monthly payment the less the amount of penalty and interest you will pay.

(3) You can charge the amount you owe on your 2006 Form 1040 or 1040A to a credit card via the Official Payments Corporation website. I am torn about recommending this method. For one, you will be charged a convenience fee of 2.49% of the payment up front. Plus, you will be paying interest on the declining balance at the rate charged by your credit card company, which in many cases will be substantially higher than the combined fees, interest and penalties charged by the IRS in an Installment Agreement. You should do a comparison calculation before choosing this option. On the somewhat plus side - if you are forced to default on your credit card payments at least you won't have the IRS after you with its arsenal of liens and levys. Plus, you have a better chance of reducing your credit card payments via working with a credit counseling agency or negotiating with the credit card company upon default than getting an equally favorable Offer In Compromise accepted, and credit card debt is much easier to discharge in bankruptcy than income tax obligations (see below).

The above options are for those who owe a manageable balance to “Sam” and will be able to pay it off within a period of 2 years or less. However, if you owe your “uncle” a ton of money that you will never be able to pay off without winning the lottery there are two other options available to you. You can submit an “Offer In Compromise” or request a “Partial Payment Installment Agreement”. You should consult a tax professional if you are interesting in these options.

As a last resort there is always bankruptcy. Income tax debts may be eligible for discharge under Chapter 7 or Chapter 13 of the Bankruptcy Code. Of course you will need a lawyer – who you will have to pay in full up front before you can even start the bankruptcy process.

But before you do anything else make sure to get that 2006 Form 1040 or 1040A prepared and signed and in the mail ASAP. If you are using a tax professional to prepare your return and you haven’t given him/her your 2006 “stuff” yet get it to him/her today! Even so, speaking as a tax pro myself, at this late date there is no guarantee that your return will be done in time for an October 15th filing – and whose fault is that!


No comments: