Investigate extensions, installment payments if unable to pay your taxes

Do not allow your inability to pay your taxes to prevent you from filing on time.

Mark E. Battersby

Although the last bill anyone should ignore is a tax bill, that is exactly what many optometric professionals – and their practices – are doing. What will happen and what should you do if you cannot pay your taxes on time?

It is well documented that the Internal Revenue Service wants “its” money immediately and has many tools at its disposal for collecting any and all tax debts. Less well-known are the legitimate options that can help avoid the trouble, interest and penalties that accompany unpaid tax bills.

Contained in our tax laws and rules are procedures for requesting payment extensions as well as installment payment arrangements that keep the IRS from instituting its collection process (such as liens and property seizures) against an optometry practice or its principals.

Considering penalties

The IRS is only too happy to calculate the penalties and interest for all unpaid tax bills, considering few taxpayers are aware that there are, in general, three separate penalties:

• failure to file penalty
• failure to pay penalty
• interest

The “failure to file” penalty accrues at the rate of 5% per month or part of a month (to a maximum of 25%, reached after 5 months) on the amount of tax the return should show as owed. The “failure to pay” penalty is gentler, accruing at the rate of only 0.5% per month or part of a month (to a maximum of 25% reached after 50 months) on the amount actually shown as due on the return.

If both apply, the failure to file penalty drops to 4.5% per month, so the total combined penalty remains at 5%. Thus, the maximum combined penalty for the first 5 months is 25%. Thereafter, the failure to pay penalty can continue at 0.5% per month for 45 more months, yielding an additional 22.5%. In total, these combined penalties can reach 47.5% of the unpaid liability in less than 5 years.

Both of these penalties exist in addition to interest charged for all late payments. If estimated tax payments were also missed, an additional penalty is tacked on for missed estimated tax payments. This penalty is computed at 3% above the fluctuating federal short-term interest rate for the period.

When it comes to paying the tax bill, and hopefully avoiding penalties and interest, the options include borrowing or paying by credit card.

Borrowing to pay taxes

Given the rate at which the above-mentioned penalties and interest grow, it is no surprise that many optometric professionals often choose to borrow money to pay their taxes. In many situations, the rate of interest paid to a family member, or even to a bank, is less overall than that which would have to be paid to the IRS.

Loans from relatives or friends are often the simplest method to pay the bill. When loans from relatives, friends or the practice’s principals/shareholders are not available, a loan from a bank or other commercial lender might be the answer, although such loans are unlikely to be made on favorable terms to any hard-pressed taxpayer. Moreover, unless business-related, interest on a loan to pay taxes is usually nondeductible personal interest.

Charging it

There are a number of advantages to paying taxes by credit card, including the fact that it is convenient. An optometrist, optometric professional or practice can file early and make a payment by credit or debit card later, thus delaying out-of-pocket expenses.

Credit card loans are however, likely to carry high rates of interest, interest that is, in most cases, not tax deductible. While the IRS does not receive or charge any fees for card payments, so-called “convenience” fees are charged by the credit card service providers. While the IRS cannot pay or reimburse any convenience fee to taxpayers, service providers’ convenience fees are a deductible business and individual expense.

Keep in mind that federal tax deposits cannot be made through these options. Furthermore, amounts not properly deposited may be subject to a 10% penalty for failure to deposit through an authorized financial institution or the IRS’s Electronic Federal Tax Payment System.

Arranging an extension

The IRS is quite clear: it wants all taxes paid when due or sooner, even demanding immediate payment when granting extensions of time in which to file the tax return. Under some circumstances, however, a short-term (120-day) extension may be arranged. A short-term extension gives an optometric professional or his or her practice up to 120 days to pay. No fee is charged, but the late-payment penalty plus interest will apply.

An extension of time to pay is also available to those who can show that payment would cause “undue hardship.” Qualifying for an undue hardship extension means an extra 6 months in which to pay the tax shown as due on the tax return. The failure to pay penalty will be avoided, although interest will still be charged.

Should the IRS determine a “deficiency,” taxes owed in excess of the amount shown on the return, the undue hardship extension can be as long as 18 months and, in exceptional cases, another 12 months can be tacked on. However, no extension will be granted if the deficiency was the result of negligence, intentional disregard of the tax rules or fraud.

It is not enough to show that it would just be inconvenient to pay your tax when due; payment must be shown to be a real hardship.

Paying in installments

The IRS will often accept installment payments for some tax debts. Generally, the IRS allows taxpayers to make installment payments on the taxes owed – if they are $25,000 or less. In fact, the IRS is required to enter into a “guaranteed installment agreement,” where the tax liability is $10,000 or less, not counting interest and penalties.

If more than $25,000 is due, payment plan options also exist, although the IRS must first determine eligibility.

Unfortunately, while partial-pay installment agreements are relatively easy to obtain, the IRS can re-evaluate the terms every 2 years. If, for example, the IRS thinks a taxpayer can afford bigger payments, then the partial-pay installment agreement might have to be renegotiated. The taxpayer can also request re-evaluation at any time should circumstances change to such a degree that the agreed-upon payment can no longer be made.

Negotiating with the IRS

Yes, negotiating is an acceptable practice when it comes to tax bills. An offer-in-compromise is an IRS program that many optometric professionals and their practices have used to settle their tax debts for a fraction of face value. It cannot, however, be requested beforehand.

Naturally, the taxpayer must be in compliance and must have the ability to pay and to borrow. For example, the taxpayer must be current on estimated tax payments or federal income tax withholding, must be making payroll tax deposits on time and must have filed all tax returns when making an offer-in-compromise.

Like any creditor, the IRS prefers a partial payment to no payment at all. Thus, the IRS might be willing to settle a tax bill for less than the full amount if the conditions listed in the accompanying table are met.

Establishing reasonable cause

If the principal or the optometry practice can demonstrate that a reasonable cause exists to abate or remove tax penalties, they may be surprised to find those penalties forgiven by the IRS. The IRS determines if reasonable cause exists by considering all the facts and circumstances.

Ignorance of the law is generally not an excuse to avoid meeting one’s tax obligations. However, when combined with other factors such as the taxpayer’s level of education, whether the taxpayer was subject to this tax before, if the taxpayer was previously penalized by the IRS, if there were recent changes in the law or forms that the taxpayer could not reasonably have known about, or if the complexity of the issue involved was substantial, penalties may be abated.

Avoiding serious consequences

No optometry practice or its principal should allow an inability to pay their tax liability in full keep them from filing all tax returns properly and on time. It is also important to remember that an extension of time to file tax returns does not extend the time to pay the tax bill.

Generally, optometry practices or their principals have several alternatives for resolving unpaid taxes: installment agreements, partial-pay installment agreements or an offer-in-compromise. Two other options, filing for bankruptcy or being declared “not currently collectible” by the IRS are far less desirable strategies.

The complexity of the tax rules and the many options available to every optometric professional and practice unable to pay their tax bills obviously require professional guidance.

• Mark E. Battersby can be reached at PO Box 527, Ardmore, PA 19003-0527; (610) 789-2480; email: MEBatt12@earthlink.net.