When it comes to taxes, you're supposed to pay them gradually throughout the year so that in April you either don't owe very much or are entitled to a refund of overpaid taxes. But sometimes your life situation changes or an unusual one-time event takes place during the year and when you prepare your annual return, you get an ugly surprise - you owe hundreds or thousands of dollars that you not only didn't see coming, but that you simply don't have. While this isn't a good situation to be in, it's not the end of the world - there are a number of ways to resolve it. Here are your options.
Borrow Money to Pay Your Taxes
For a convenience fee of about 2% to 4%, you can charge your tax liability to your credit card. You could also apply for a debt consolidation loan from a bank or credit union.

If you choose one of these options, you'll have made good with the government, but you'll be shifting your debt to an expensive source. Unless you have a credit card with a very low annual percentage rate (APR) or are able to secure a personal loan at a very low interest rate, you might be making your situation worse. For example, if you owed $5,000 in taxes, the convenience fee to charge this amount to your credit card would amount to $100 to $200. If you had to carry that $5,100 balance on your card for a year at, say, 20% APR, that would add another $1,020 to your bill, bringing the total you owed to $6,120. This is a rough, simplified example of how the math would work, but you get the idea.

Request a Payment Extension
Filing a six-month tax extension using Form 4868 won't help. This extension only gives you more time to file your paperwork; it doesn't give you more time to pay what you owe. Filing your return on time can help minimize the penalty and interest charges the Internal Revenue Service (IRS) will assess on your late payment, however. The IRS's late payment fees are 0.5% to 1% per month up to a maximum of 25%; the late filing penalty is 5% per month up to a maximum of 25%. Simply filing your return on time can save you a substantial amount in penalties.

If you believe you have a legitimate case, you can try filing Form 1127 to request a six-month payment extension. Along with this form, you'll have to submit a statement of all your current assets and liabilities and an itemized statement of all the money you've received and spent in the last three months. The IRS rarely grants payment extensions, and only if you can demonstrate undue hardship. If you just bought a 60" flat-screen TV last month because you had no idea you were going to owe $5,000 in taxes, you're not going to qualify for a hardship extension.

If you think it will take you more than a few months to pay your tax liability, consider applying for an installment agreement. You can apply online at IRS.gov or by mail using Form 9465-FS. An installment agreement can prevent the IRS from taking enforced collection action. You'll still owe penalties and interest, but your monthly payments let the IRS know that you intend to make good on what you owe.

Borrow from Yourself
If you have an emergency fund, this might be a good time to dip into those savings. It's true that another emergency could come up and then you'll have to charge that emergency to a credit card, but if nothing bad happens, you can use your emergency fund as an interest-free loan to yourself to pay off your tax bill and then start replenishing your fund with each paycheck.

If you own a home and you have enough equity, another way to borrow from yourself is with a home equity loan line of credit (HELOC). These loans have relatively low interest rates compared to credit cards and personal loans, and the interest can be tax deductible. The downside is that your house serves as collateral. Defaulting on a home equity loan or HELOC is like defaulting on your mortgage - it can cause you to lose your house. However, borrowing money this way could turn the large lump sum you owe the IRS into a manageable monthly payment to a mortgage lender.

A third option is to borrow from a retirement account like a 401(k) or IRA. However, because retirement accounts have tax advantages, withdrawing money from them can trigger a tax liability if you don't follow protocol. Borrowing against your retirement nest egg can also interfere with your retirement savings plan.

Pay as Much as You Can, as Soon as You Can
Unfortunately, the IRS is going to charge you interest and penalties on the amount you pay late. Similar to charging what you owe to a credit card, these additional expenses are going to make it harder to pay what you owe. However, if there weren't any penalties, everyone would pay late.

The more you're able to pay on time, the smaller the balance on which you'll be assessed interest and penalties. The IRS will eventually send you a bill called Notice of Tax Due and Demand for Payment, but you don't have to wait to get the bill to make additional payments. Pay what you can when you file your return, then send in whatever additional payment you can afford each payday using Form 1040-V.

The Bottom Line
Whatever you do, don't ignore the problem. The government could find you guilty of tax evasion and has the authority to forcibly seize your assets if you don't try to make good on your income tax liability. The IRS can freeze your bank accounts, garnish your wages, seize physical assets, like your car, and place a lien on any assets you own, like your house. Go ahead and file your return and pay what you can, then work with the IRS, perhaps with the assistance of a tax professional, to formulate a plan for paying the balance of your tax bill over time.

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