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Tax nightmare: What if you can't pay the IRS?



BY AMY FELDMAN

(Reuters) - There are many tax-time nightmares, but here's one of the most common: You don't have the cash to pay what you owe on April 15.

"A couple of weeks ago, I ended up talking a young woman off a ledge, as it were, because she discovered she had screwed up on her withholding and owed a bunch of tax," says Melody Thornton, a certified public accountant in Cardiff, California.

If you find yourself in that situation, don't ignore the problem. The worst thing you can do is put off filing your return, without at least requesting an extension, because you're afraid of the bill. The penalties for not filing a tax return are far harsher than those for not paying what you owe.

How bad could it get? The penalty for not filing a tax return normally runs 5 percent per month that your return is late, up to a maximum of 25 percent. That means if you owe $2,000, and don't pay it until the fall, you could owe a $500 penalty.

The penalty for not paying is just a fraction of that, at 0.5 percent a month of the unpaid tax at April 15.

Either way you'll also owe interest, though the current rate is a modest 3.0 percent a year.

FILE AN EXTENSION

The simplest thing to do is to file for a six-month extension, using Form 4868, to get some breathing room. If you can, send in a partial payment to reduce the penalties and interest due.

"The most important thing is making sure that you have a valid extension," Thornton says. "If you file an extension and say, 'I owe nothing,' and then you do owe, that extension is not a valid extension."

HOW TO PAY

You'll need to decide whether to pay the Internal Revenue Service first - the standard advice - or to swallow the penalties and interest.

What's ideal for you depends on what your options are for coming up with the funds. If you can scrimp a little to find the cash, borrow from friends or family, or have access to cheap credit (through a home-equity loan, for example), your best option is to pay the tax bill first.

But if you'd have to pay your taxes with a high-interest-rate credit card - today's national average interest rate on credit cards is 15 percent, according to CreditCards.com - it may be better to borrow briefly from the government (see below), especially if you'll have additional income coming in soon.

When you pay your taxes on a credit card, you also have to pay an added "convenience fee" that could add up to 2.35 percent to your transaction.

IF YOU'RE IN DEEP FINANCIAL DISTRESS

While it may sound counter-intuitive, let the IRS know you've got financial problems. You can request an installment plan to pay those taxes, and it's pretty much automatic that you'll be approved if you owe less than $50,000. While there's no hard-and-fast rule on when to do this, generally the more you owe and the longer it will take to pay off, the better off you'll be to request a formal payment plan rather than simply paying late.

"If you are not paying, the IRS can come after your property or garnish your wages, so you definitely want to contact them and work with them," says Lindsey Buchholz, principal analyst at the Tax Institute at H&R Block. "The IRS is usually willing to work with people because they would rather you pay voluntarily than have to come after you."

To set up an installment plan, you'll file Form 9465, and pay an application fee of between $43 and $120, depending on your income level and whether you're setting up a direct debit agreement. You'll then have a monthly payment schedule, that you better stick with, and a much-smaller, 0.25 percent, monthly penalty on those unpaid taxes.

As for the client of California accountant Thornton, she calmed down once they worked out a solution to her tax travails. Thornton says her client applied for a credit card with a teaser zero-percent interest rate in order to pay her tax bill.

Says Thornton: "There will be a fee, but as long as she gets it paid off within that grace period, and she thinks she can, then she will not owe any other interest."

(The opinions expressed here are those of the author, a columnist for Reuters.)

(Follow us @ReutersMoney or here

Editing by Beth Pinsker, Lauren Young and Andrew Hay)

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