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First and most importantly, don't let your inability to pay your tax liability
in full keep you from filing your tax return properly and on time. Include
as large a partial payment as you can with the filing of your return. Simply
filing your return without full payment can save you substantial amounts
in filing penalties. Not only that, procedures exist for payment extension
and installment payment arrangements that will keep the IRS wolves at bay,
and will keep the folks from the IRS collection division from instituting
its collection process (which can include liens, property seizures, etc.).
Overview of the Most Common Penalties
The "failure to pay" penalty is kinder and gentler, accruing at the rate
of only 1/2% a month (to a maximum of 25%) on the amount actually shown as
due on the return. (If both penalties apply, the failure to file penalty
drops to 4.5% a month and the combined maximum is 25%.) Both of these penalties
are in addition to interest you will be charged for late payment.
If you also missed estimated tax payments, an additional penalty (called
an "underpayment penalty") is tacked on for the period running from each
payment's due date until the tax return due date, April 15th (or earlier,
if the payment is made earlier). This penalty is computed at 3% above the
fluctuating federal short-term interest rate for the period. For 1997, that
rate was about 9%.
Undue Hardship Extensions
But, to Uncle Sammy, hardship really means hardship. To establish undue hardship
you must show much more than simple inconvenience regarding the payment of
your tax bill. For example, if you would have to sell property at a "sacrifice"
price you may qualify under the hardship rules. But if a market exists, having
to sell property at the current market price is not necessarily viewed as
resulting in undue hardship.
You would have to show that you do not have enough cash and assets that you
could convert into cash to meet your tax obligations. You would also have
to show that you can't borrow the amount needed except on terms that would
inflict serious loss and hardship.
To qualify for such a hardship extension, you also have to provide security
for the tax debt. The determination of the kind of security -- such as bond,
filing a notice of lien, mortgage, pledge, deed of trust, personal surety,
or other form of security -- will depend on the particular circumstances
involved. When your application for an extension is granted, you must deposit
any collateral agreed upon with the IRS. Obviously, no collateral will be
required if you have no assets.
IRS Form 1127 is used to apply for this hardship extension. A statement of
assets and liabilities must be attached as well as an itemized list of receipts
and disbursements for the 3 months preceding the tax due date. But please
don't think that the filing of this form will solve all of your problems.
Most likely it will not. It is not very often that the IRS accepts the
application, so don't get the impression that simply filing Form 1127 will
buy you an extra six months of time to pay your tax. It most likely will
not, unless your circumstances are extremely special.
Installment Agreements
And Uncle Sammy wants to make sure that you keep your installment promise.
The installment agreement may terminate and all your taxes become due immediately
if any of the following occur:
1. The information you provided to the IRS in applying for the agreement
proves inaccurate or incomplete.
2. You miss an installment.
3. You fail to pay another tax liability when it's due.
4. The IRS believes collection of the tax involved is in jeopardy.
5. You fail to provide an update of your financial condition when
the IRS makes a reasonable request for you to do so.
The IRS must give you 30 days' notice before altering, modifying, or terminating
the installment agreement and it must explain its reasons for the action.
But this notice requirement does not apply when collection of the tax is
in jeopardy.
Avoiding More Serious Consequences
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Message Board Q&A
1. Gradea1a asks…
Q: I bought stock on margin and I am not filing schedule A. Can
I take the interest off somewhere? Is it part of cost basis?
A: Nope. If you don't itemized, the deduction is lost. You cannot
add the interest to your cost basis.
2. DPJON wonders…
Q: Hopefully I can make this clear enough and still keep it simple.
If I purchase 1000 shares of XYZ @ $10.00 per share, it drops to $5.00 and
I then double my position, giving me a Cost Averaged purchase price of $7.50,
then when the stock passes the $7.50 mark I sell 50% returning to my original
1000 shares.
My question, is this sale taxed at $7.50 or is cost averaging only a benefit
when you sell the entire position?
A: When you deal with stocks, you are required to use only one of
two methods to compute your basis:
1. FIFO (first in, first out) 2. Specific shares method
"Averaging" does not apply. Obviously, if you sell the entire position, you
have effectively averaged your purchases. But if you sell only a portion
of the position, you'll have to select one of the two methods mentioned above
to compute your gain or loss.
3. Finally, RPU27284 posts…
Q: I bought stock, it went up. What is the basic rule on paying
taxes on the increase in the share price when I do sell?
A: The rule is that you only have to pay taxes on appreciated stock
when you actually sell the shares. The mere appreciation of the stock is
not a taxable event. In order to get hit with taxes, the shares must be sold.
For additional information on this, and other investment issues, see IRS
Publication 550.
Please note that Roy cannot answer individual questions via e-mail. If you have tax questions, please ask them on the taxes message board. Thanks!
The "failure to file" penalty accrues at the rate of 5% a month (to a maximum
of 25%) on the amount of tax your return shows that you owe. This is the
penalty that you'll get hit with if you decide to ignore your problem and
simply not file your return.
It's important to remember that an extension of time to file your tax return
does not mean you have an extension of time to pay your tax bill. An extension
of time for payment may be available, however, if you can show payment would
cause "undue hardship." You will avoid the "failure to pay" penalty if an
extension in granted, but you will still be charged interest. If you qualify,
you will be given an extra six months to pay the tax shown as due on your
tax return.
There is another avenue that you can consider to delay your tax payment:
The installment agreement request. This is a request to the IRS to enter
into an installment payment agreement with you. This request is made on Form
9465, which requires much less information than a hardship extension application.
If the tax liability is under $10,000, you will not even be required to submit
financial statements. The downside is that Uncle Sammy will charge a small
fee for installment agreements, but this fee can be added to the tax balance
due. But you need to understand that IRS penalties and interest will accrue
on the outstanding portion of your tax liability while the installment agreement
is in effect. Because of the application of the penalties and interest, you
should attempt to make the installment payments as large as reasonably possible
to minimize these additional charges.
Too many taxpayers hide their heads in the sand when they run into financial
difficulties and they fail to file their tax returns. But tax liabilities
do not go away if ignored. It is very important that you file a properly
prepared tax return even if full payment cannot be made. Include as large
a partial payment as you can with the return and start working with the IRS
for a hardship extension or installment agreement as soon as possible. If
you don't, you can expect escalating penalties, plus the risk of having liens
assessed against your assets and your income. Down the road, the collection
process could also include seizure and sale of your property. In many cases,
these tax nightmares can be avoided by taking advantage of arrangements readily
offered by the IRS.
Now, on to some questions from the Tax Strategies
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