You probably make federal income tax payments during the year – either through withholding or estimated taxes – to meet the bill you expect in April – April 18 in 2016 and 2017. But sometimes, you may get a nasty surprise: additional taxes owed.
One reason may be an under-projection of household income when claiming the premium tax credit when you signed up for health coverage from a government health insurance marketplace. Or perhaps you got higher-than-expected year-end distributions from mutual funds. Or had too little withheld from your paycheck or underpaid your estimated taxes. (See 7 Ways To Avoid Self-Employed Tax Penalties.)
Whatever the cause of the shortfall, be prepared to handle the problem. Here’s what to do if you don’t have the cash on hand on April 18th.
Address the Problem Quickly
To avoid any late filing penalties, submit your tax return on time – whether or not you can pay what’s owed on your tax return (identified on your tax return as “the amount you owe”). Interest and penalties on this underpayment for paying late start to run on April 18 (regardless of whether you obtain a filing extension) and continue until full payment has been made. The more you can pay with your tax return through your own devices (e.g., credit card, home equity loan, a loan from family or friends), the lower these added costs will be.
- Interest. The interest paid on late taxes is fixed by the IRS every three months according to a benchmark in the law. The rate for the first two quarters of 2016 is 4% (just up from 3%, the rate in effect since October 1, 2011).
- Penalties. Usually, the penalty is 0.5% of your unpaid taxes. The penalty applies for each month (or part of a month) after the due date of your return, beginning on the date after the due date. Penalties can be waived if you can show reasonable cause for late payment of taxes (not having the money isn’t considered a reasonable cause). And in some cases, the IRS may waive penalties automatically (e.g., there was a waiver of penalties for 2014 returns for those who claimed the premium tax credit on an advanced basis and under-estimated household income).
Request an Installment Payment Agreement
The government lets you pay your taxes over time under a structured installment payment agreement. You have to ask for it. You can request an agreement online from the IRS if:
- You owe $50,000 or less in combined taxes, interest, and penalties, and
- You’ve filed your return on time
The IRS automatically grants your request if:
- You owe $10,000 or less in taxes
- You (and your spouse if you’re married) have filed all income tax returns on time and paid all taxes due during the past five years (without using any installment agreement)
- You agree to pay what’s owed within three years and comply with tax laws while the agreement is in effect
- You are financially unable to pay the tax in full when due
But even if you don’t meet all conditions for automatic acceptance (e.g., you owe $15,000), the IRS usually grants installment agreements.
If you don’t qualify to make an online request, you can make a request for an installment agreement on Form 9465, which can be attached to your return or submitted separately to the IRS if you’ve already filed your return.
Whichever application method you use, there’s a fee for requesting and getting the installment payment agreement. When the IRS notifies you of acceptance, it bills you for the fee. The one-time fee, which is normally $120 for paying monthly by check, credit card or payroll deduction, is reduced to $52 if you agree to make payments via a direct debit from your bank account (the fee can be as low as $43 for those with income below a set level).
If you can pay your bill in full within 120 days of the deadline, you don’t need an installment agreement and you won't have to pay a fee. Instead, call the IRS at 800-829-1040 to notify the agency of your intentions. However, this action does not avoid interest and penalties.
Even if you don’t meet the conditions for requesting an installment agreement online, you can still make a request by filing Form 9465 with the IRS. Again, there’s a good chance that the IRS will grant your request. And you may get more than three years to pay off the tax bill.
Make an ‘Offer in Compromise’
If you can’t pay your bill and don’t think you’ll ever be able to (e.g., you had an unexpected medical condition that’s left you unable to work), you can ask the IRS to reduce your tax bill. This allows you to make a settlement of what’s owed, for less than the full amount.
In deciding whether to grant your offer, the IRS looks at various factors, including your ability to pay and your income, assets and expenses. The IRS usually grants an offer only when it believes that your offer is the most the government expects you’ll pay in a reasonable amount of time.
You can use a prequalifier tool to determine whether you’re eligible for an offer in compromise. You can’t make a request online (as you can with an installment agreement); you have to submit forms within the IRS booklet for requesting an offer in compromise and pay a nonrefundable application fee of $186. You also have to make a nonrefundable tax payment with your application based on the payment option you choose:
- If you want to make one lump-sum balance, you have to include 20% of this amount with your application.
- If you want to pay the amount in monthly installments, include the first installment and continue these monthly payments while your offer is under consideration.
Special rules for fees and payments apply to individuals who meet low income certification guides set by the IRS.
The Bottom Line
If you face financial difficulties that prevent you from paying your tax bill in full on time, don’t delay in finding solutions for payment. Your tax bill won’t go away and will only grow over time. If you need guidance, consult with a tax professional.