You do your best to make sure your clients do not get any unpleasant surprises when you hand them their completed tax returns. You remind them of the requirement to prepay their taxes through withholding or estimated tax installments – and to adjust those prepayments if circumstances change during the year. Nevertheless, there will always be clients who owe tax when they file their returns. And, with the economy still less than robust, you may have clients who have skimped on tax prepayments to meet other obligations. Moreover, many of these clients may not have the funds available to pay up when the tax bill comes due.
What not to do. Impress upon your clients that they should not hold off on filing their returns until they can come up with the money to pay the tax due in full. If a return is not filed on time, the client will be hit with failure-to file-penalties, in addition to penalties and interest on the unpaid tax bill.
What to do. Advise clients to pay as much as they can, as soon as they can, to minimize late payment penalties and interest, even if that means liquidating investments or borrowing money. While a client may balk at cashing out savings or borrowing to pay a tax bill, the interest charged on borrowings may be lower than the combined penalties and interest owed to the IRS on late payments. Bear in mind that some types of borrowing may have tax or other advantages. For example, interest on a home equity loan may be deductible for tax purposes. In addition, clients may want to consider borrowing from a 401(k) plan or life insurance policy, if available. While the interest payments are not tax deductible, the client is essentially borrowing from himself or herself since the payments on the loan replenish the account or life insurance value.
A client who needs time to cash in assets, or arrange for a loan, can apply for a short-term extension of 60 to 120 days. The IRS does not charge a fee for a short-term extension, but penalties and interest continue to accrue on the unpaid tax.
Installment payment agreements. If other options are not available, a client can request an installment payment agreement from the IRS. Here again, interest and penalties continue to accrue until the tax is paid in full. In addition, the IRS charges a one-time user fee for setting up an installment agreement. Generally, the fee is $120, but the fee is reduced to $52 for direct debit agreements, under which the agreed upon payments are automatically deducted from the client’s bank account. The fee may be reduced to $43 for low-income individuals.
If the tax due, plus penalties and interest, is $50,000 or less, an individual client can arrange for a streamlined installment payment agreement. The maximum term for streamlined installment agreements is 72 months, and the minimum monthly payment is $25. If the total amount due is greater than $25,000, but not more than $50,000, the client must agree to a direct debit agreement to qualify, without submitting a financial statement. If the client does not agree to make the payments by direct debit, the client must complete Form 433-F, Collection Information Statement.
Streamlined agreements are available to small businesses with $25,000 or less in unpaid liabilities. These agreements give a business 24 months to pay by direct debit.
The IRS generally will not take enforced collection actions, such as levying a client’s wages or bank accounts, when an installment agreement is being considered, while an agreement is in effect for 30 days after a request is rejected, or during the period the IRS evaluates appeal of a rejected or terminated agreement.
Offers in compromise. A client who is struggling to make ends meet may qualify for an offer in compromise (OIC). An OIC is an agreement between a taxpayer and the IRS that settles the taxpayer’s tax liabilities for less than the full amount owed. Absent special circumstances, an offer will not be accepted if the IRS believes that the liability can be paid in full as a lump sum, or through a payment agreement.
In most cases, the IRS will not accept an OIC, unless the amount offered by the taxpayer is equal to, or greater than, the reasonable collection potential (RCP). The RCP is how the IRS measures the taxpayer’s ability to pay, and includes the value that can be realized from the taxpayer’s assets, such as real property, automobiles, bank accounts and other property. The RCP also includes anticipated future income and less certain amounts allowed for basic living expenses. A streamlined OIC program, involving fewer requests for financial information and greater flexibility in determining ability to pay, may be available for taxpayers with annual incomes up to $100,000 and tax liabilities of less than $50,000.