3-30-07
When You Can’t Render Unto Caesar
Some of the most awkward conversations I ever have with clients occur this time of year. They happen when I phone a client to say that he owes taxes, and how much.
I never know what sort of response I will get. Popular options include: “Wow, that’s much less than I expected”; “Are you sure?”; “That can’t be right”; and “Holy #$%&!”
Those are normal and not a problem unless the client wants to shoot the messenger. Luckily for me, that is rare.
The really tough conversations are the ones which then continue, “I don’t have the money, and there is no way I can get the money by April 15. What can I do?”
The Pain
What is almost universally true is that you will pay penalty and interest if the taxes are not fully paid by the due date. Penalties (but not interest) will sometimes be waived if you have “reasonable cause,” but that means circumstances beyond your control, such as being comatose or a hostage. You do not have reasonable cause if you are merely broke.
Owing the Internal Revenue Service is not necessarily a disaster. The late payment penalty works exactly like interest, at a rate of 6 percent a year. The part they actually do label “interest” is calculated at a rate which varies with the rate on U.S. Treasury securities. Currently, the IRS rate is around 8 percent.
A combined rate of 14 percent is significantly better than some of the alternatives, such as many credit cards, payday loan companies or some guy named Guido in Melrose Park. Sometimes the wisest thing to do is to just pay the IRS their rate.
How Bad Is It?
Your choice of tactics in dealing with the IRS turns on how quickly you can pay off the tax debt.
If it is going to take a while, you will probably want to do an installment agreement, under which you agree to pay $X per month. If you have not made a habit of doing these agreements, the IRS has said they will automatically approve any request that pays off a debt of $10,000 or less in a year or less. My experience suggests that $20,000 and/or two years is equally routine. For longer periods or bigger debts, they will want financial information to show you really can’t pay quicker, which can get sticky.
All is not nirvana. They charge a fee ($105 for all but the poorest taxpayers) to set up an installment agreement. They also assume that you can pay the exact same amount every month. People with routine, stable jobs can easily do that. Actors – well, that’s another story entirely. The least-bad approach is often to go for the lowest payment amount the IRS will approve, and throw extra money at it when you can.
Fast and Cheap
Not everyone needs a longish time to pay. Sometimes all you need is a couple of months, not much longer than the four to six weeks the IRS typically takes to set up an installment agreement. In that situation, the best tactic may just be to stall for time. Rather than filing the return on April 15, file an extension request, preferably with a partial payment. When you have the money assembled, file the return and pay the balance.
Make no mistake: you will pay the same penalty and interest clock as you would on an installment agreement. But you will have saved $105. And if you were wrong, and you cannot get the money together by the time the extension lapses, you can always request an installment agreement then.
States, Too
States are not as generous. Oh, there might be one or two that work on the IRS model, but none that I deal with regularly. Installment agreements are rarely granted, and penalties are often steep.
Illinois’s penalties, for example, rise quickly: 2 percent if the tax is paid within 30 days after the due date; 10 percent for 31-90 days late; 15 percent for 91-180 days; and 20 percent after that. Their interest rate is lower than the IRS’ for the first year a tax is due, but that scarcely offsets the much higher penalties.
My usual advice, then, is to pay the state first. The amount is normally smaller, and then you only have one bureaucracy to navigate.
Other Ideas
Obviously, if you can borrow money on better terms than the IRS offers, the rational economic decision is to do so. A home equity line of credit, for example, is not only likely to be at a lower rate, but the interest is probably tax-deductible.
Credit cards are not usually a good idea. A merchant who accepts credit cards pays the credit card company a fee. The government cannot discount taxes that way, so the third-party companies which process credit card tax payments add a 2.49 percent fee to the taxpayer. If you pay the debt off in three months, that “no interest” offer on your credit card still comes to an annual rate of 14.9 percent.
The best solution, of course, is to not find yourself in this bind in the first place. If you are going to owe significant taxes beyond what is withheld from your paycheck, you are supposed to be making quarterly estimated tax payments anyway. Do that, and when I call, we can just gossip about the show you are doing.
Free Offer
If you would like a copy of my free “Checklist of Potentially Deductible Items” for those in the arts, just write, call or e-mail my office. We’ll be pleased to send you one.
Are there money or tax questions you would like to see discussed in this column? Let me know, at 2835 N. Sheffield, Suite 311, Chicago, IL 60657, or call 773/525-1778 (888/525-1778 toll-free outside the Chicago area) or e-mail greg@gregmermel.com.
Greg Mermel is a certified public accountant whose clients in the arts range from individual performers to major theatre companies and suppliers. He has also been known to produce theatre.