BY GREG MERMEL, C.P.A.
Among the hardest conversations I have with tax clients are the ones when I tell someone what he owes in taxes, and the response is: "I don’t have it. What do I do now?" There is, unfortunately, no good answer.
Sometimes I try to lighten the mood by dryly noting that Costa Rica is said to be quite lovely this time of the year. That joke has a purpose: to point out that running away is not an option. You might, conceivably, expatriate yourself if fleeing criminal prosecution or a near-lynch-mob of defrauded investors. You would not spend the rest of your life trapped in a single third-world country over a tax bill of a few hundreds or thousands, or even tens of thousands of dollars.
Ignoring it is another really, really bad option. Yes, there are people who get away with never filing a tax return and never paying taxes, but you are not likely to be one of them. There is a paper trail of W-2 and 1099 forms telling the Internal Revenue Service (IRS) you had income, and they will eventually come after you.
Beg, Borrow or Steal
How to best handle the situation of owing taxes you cannot pay by April 15 depends on how much you owe, what jurisdiction you owe tax to (i.e. federal, Illinois, New York) and how quickly you can raise money and at what cost.
Your federal taxes, and those of almost all states, are due on April 15. If they are not paid on time, you will be charged both penalty and interest calculated from the due date. Filing for an extension of time postpones that day of reckoning because the authorities don’t know how much you owe until you file the return, but they will eventually send you that penalty and interest bill.
I generally advise clients to give priority to paying the states. The state amounts are generally smaller, and their methods of calculating penalties and interest much harsher than the IRS’s. The IRS bases its late payment penalties only on the amount unpaid at April 15, but many states calculate theirs on the entire amount of tax for that year. No state would allow any type of consumer lender to do that, of course, but they do it with impunity. Most states are also much less willing than the IRS to negotiate payment terms, even with interest.
My clients’ options for raising money then have to be considered, and some can be eliminated pretty quickly. Unless the amount is small enough that adding a part-time McJob at Starbucks or Borders will solve the problem, money must be borrowed. The question is, "from whom?"
Choices, All Crummy
A loan from your bank or credit union, is usually the first idea to emerge, and it is not necessarily a bad one. By all means, check it out–particularly the credit union, if you are a member. What you will probably find, though, is that the interest rate will be high if they are interested in making the loan at all. Smallish, unsecured personal loans tend to be a line of business that banks prefer not to pursue.
For homeowners, a home equity line of credit can be a pretty good option. Interest rates are usually reasonable, and the interest is, in most circumstances, tax deductible. But equity lines of credit take time to arrange, so if you do not already have one in place, it will not be an option for April 15. Fees may also be involved, and they have to be weighed against the interest rate.
Another option is to charge the taxes on a credit card. The only way to pay by plastic is use one of two agencies authorized by the IRS, and they each charge a fee of 2.49 percent of the amount charged. Retail merchants pay a percentage of charge transactions to the credit card processor; governments cannot do this, and pass the cost back to the "customer." This fee significantly raises the effective interest rate, especially if the balance will be outstanding for only a few months, so credit cards are not a good choice for most people. Of course, if you have one of those offers of "no interest till next January" sitting on your desk, the deal looks a lot better. And since the card companies treat this as a purchase rather than a cash advance, you still get your airline miles.
The quickest and surest source of money for many people is what I call "First National Bank of Family." No applications, no delays, cheap interest (if any). But depending on the family, it can also be humiliating, lead to lectures about getting a real job, and permanently poison relationships. Be careful.
And you can, of course, just pay the IRS its penalties and interest. By their own stated policy, they will automatically approve any installment agreement which pays off a tax debt of $10,000 or less in a year or less; in my experience, you can double both the amount and the time period. The problem here is cost. The IRS will charge a fee of $43 to set up any installment agreement. A bigger problem is the effective interest rate, which has two components: a late payment penalty and interest. The interest rate (currently five percent) floats with the rate on Treasury securities, but the penalty rate is fixed at six percent. This means that when interest rates are low, as they are now, the combined rate is comparatively high at 11 percent. A few years go, the combined rate of 13 or 14 percent seemed a lot more reasonable. And there was a brief time in the late 1970s when the combined rate was several percentage points below bank prime rate. That year, people actually chose to pay their taxes late rather than take money out of high-yielding money market funds.
No Money Needed ’Cause It’s Free
If you would like a copy of my "Checklist of Potentially Deductible Items for Actors, Designers and Others in the Performing Arts," just call or write me with your name and address.
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 also sometimes produces theatre.