What can you do if you can’t pay the taxes you owe come April? Should you borrow from your 401(k) or is there an IRS tax payment plan option? This is especially important for many Americans that collected unemployment for the first time this year, and didn’t realize that unemployment benefits are taxable. Many of them are in precarious and vulnerable position. In this article, H&R Block walks you through a few options — from borrowing from your 401(k) to arranging an IRS tax payment plan.
“Any taxpayer who is unable to pay his or her tax bills should still complete a return or file a tax extension by April 18, to avoid costly penalties and interest,” said H&R Block social media manager Leigh Mutert, CPA. The monthly penalty for not filing a tax return is 5%, while the penalty for not paying in full is one-tenth of that, or 0.5%. Even if you cannot pay all of your taxes, you should send what you can with your tax return or extension to file.
An H&R Block professional tax advisor can help you determine what’s best for you; get a free 30-minute tax consultation at an H&R Block office near you.
Three Ways to Pay Your Taxes
If you cannot afford to pay your taxes, there are three ways to deal with this.
Tax payment solutions close to home
- Borrowing money from your 401(k) — There is no early distribution penalty and you the taxpayer would pocket interest paid for the borrowing rather than paying interest to a 3rd party lender.
- Accessing funds using a credit card — But you often face double-digit interest rates and must pay IRS service providers’ processing fees ranging from 1.90 to 2.35%.
- Borrowing money from family or friends — For some taxpayers, the best bet may be borrowing money from family or friends.
Working with the IRS
Taxpayers can work with the IRS to file a tax extension to pay or to arrange an IRS tax payment plan. Interest rates and fees depend on the route taxpayers choose.
- Taxpayers who can pay their debt within 120 days can file a tax extension. If a $1,000 tax debt is owed, the total amount paid over four months would be $1,033* with penalties and interest.
- Those who need more than 120 days can use an IRS tax payment plan. If a $1,000 tax debt is paid off in six months, the total amount paid would be $1,066**. Tax debt must be repaid within five years through an installment agreement.
Taxpayers who file a tax extension or opt for an IRS tax payment plan may incur debts on their credit reports, but these debts do not cause the same harm as a property lien.
Solution for those with financial hardships
An IRS offer in compromise (OIC) settles a tax debt for less than the amount owed. The IRS will negotiate with eligible taxpayers to collect what it can. However, only 24% of OICs were accepted in FY2008, and the application process can take up to two years. “It’s not as easy as just asking the IRS to forgive the debt,” Mutert said. “Seeking an offer in compromise is time consuming and requires as much work painting your financial picture as getting a home loan.”
Here are some specifics about OIC:
- New this year, the IRS weighs present and future earnings when deciding OICs, instead of just prior years’ earnings.
- Taxpayers must be current on filing tax returns, not in bankruptcy, and meet one of three conditions to be eligible:
- Taxpayer’s assets and income combined equal less than tax debt owed.
- Taxpayer believes the tax debt assessed is incorrect and there is no legal decision on the matter.
- The full tax debt is owed and is collectible, but a special circumstance exists, such as serious illness or the likelihood to deplete finances.
Get Expert Tax Advice on Tax Payment or Any Topic
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* Includes a $20 failure-to-pay penalty and $13 in interest. Interest is the federal short-term rate (currently 0.67%t) plus 3 percent.
** Application fees range from $43-$105, example uses $52. The failure-to-pay penalty is $6 and interest is $8 (up to 25%).
Pinyo Bhulipongsanon is the owner of Moolanomy Personal Finance and a Realtor® licensed in Virginia and Maryland. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, financial literacy author, and Realtor®.