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. Nonetheless, there will always be clients who owe tax when they file their returns. 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. In addition, clients may want to consider borrowing from a 401(k) plan or life insurance, if available. While the interest payments are not tax deductible, the client is essentially borrowing from him 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. Form 9465, Installment Agreement Request, is generally used to set up an installment agreement. However, clients with a balance due of no more than $50,000 can apply online for a payment agreement instead of filing Form 9465.
Generally, the fee for an installment agreement is $225, but the fee can be as low as $31 if the agreement is set up online and the client agrees to pay by direct debit from a bank account. The fee is $107 if the agreement is not set up online but payments are made by direct debit, or $149 if the agreement is set up online but payments are not made by direct debit. A reduced fee of $43 may apply for lower-income individuals, and the IRS may waive or reimburse the fee if certain conditions are met.
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 on 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.
Extension for undue hardship
Form 1127, Application for Extension of Time for Payment of Tax Due to Undue Hardship, can be filed to extend the time for paying tax. However, the IRS’s concept of hardship may not match your client’s. The form instructions make it clear that undue hardship means more than an inconvenience. The client must show that they will have a substantial financial loss — such as selling property at a sacrifice price — if the tax is paid when due.
If granted, a hardship extension will generally not last for more than six months. Interest on the tax due will run until the tax is paid. Moreover, penalties may be imposed if the tax is not paid within the extension period.
Offers in compromise
A client who is struggling to make ends meet may qualify for an offer in compromise (OIC), 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, 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.