You're putting the finishing touches on your tax return. You swell with pride (and a little relief) knowing that you're getting down to the bottom line.

"Cha-chunk" is the sound your calculator makes as it displays what you hope to be a nice little refund. Then it happens... (insert theme from Jaws here)... HORRORS!!!

You find that you owe Uncle Sammy a tidy sum of loot. Much more than you ever expected. In fact, it's more than you can afford to pay. You've asked your friends, relatives, and your local bank for a loan, and all you got was $26.55 and a lot of good wishes. You simply can't get the funds. What now?

"No problem," you say to yourself, "I'll just file for an extension."

Nope. Wrong answer. Thanks for playing. Pick up your lovely parting gift on your way out.

Filing an extension will do you no good at all. We'll talk much more about extensions in next week's article. But, for the time being, just know that an extension simply extends the time to file the tax return. It does not extend the time you have to pay the tax. Filing an extension without making the tax payment is virtually the same as filing no extension at all.

That said, don't let your inability to pay your tax liability in full keep you from filing your tax return properly and on time. The IRS has different rules for those who simply owe tax dollars versus those who owe tax dollars and don't file their tax returns on a timely basis. It's going to be bad enough to file the return without the payment, so don't make things worse (and increase the penalties you'll owe) by not filing the return. Do everything you possibly can to get the return filed on time. Even if you don't pay one thin dime with the return, a timely filed return can reduce subsequent penalties substantially.

Now, about that balance due. Well... there are a few options you might consider.

A Short-Term Cash Problem

If your inability to pay the taxes you owe is simply a short-term cash-flow problem, and you'll have the funds to make the payment in a few weeks or months, the solution is reasonably simple. Pay as much as you can when you file your tax return. That payment will help reduce the penalties and interest you'll be charged.

In about 45 days, the IRS will send you a bill for the remaining balance due. If you can pay it then, great... do it. If you can't, then send as much as possible (again, reducing penalties and interest) and hang on. In another 45 days or so you'll get another bill from Uncle Sammy. Hopefully you can then pay the balance due.

You'll likely be able to go through two or three of these billing "cycles" before the IRS bugs you for some type of "formal" payment method. But, if you can clear up the matter using bigger "chunks" of payments over two or three IRS billing cycles, you'll pay some interest and penalties, but you'll save some time by not being required to complete any additional IRS paperwork. No good? Okay...how about another idea?

Borrow to Pay Over Time

As we playfully discussed above, try to put the bite on your friends or family. Seriously. If you can pay the entire amount with funds that you've borrowed from friends or relatives, you'll reduce the penalties and interest you'll owe Uncle Sammy. And, I'm sure you'll find making repayments to friends and/or relatives a much more pleasant experience than making payments to the folks at the IRS.

If the friends or family thing doesn't work out, consider a bank loan. Again, paying your friendly banker is generally preferable to making payments to the IRS over a long period of time.

Use (gasp) a Credit Card

Still no good? Well, alrighty then. If none of the above solutions work for you, remember that you can always go the credit card route. As an alternative to paying by check, the IRS (and many states) will gladly accept payment by credit card. We generally don't like recommending credit card payments, because the fees and interest rates associated with this type of payment are pretty high. But sometimes you gotta do what you gotta do.

You can use your American Express, MasterCard, or Discover card (but not your Visa card) to make your payments. You simply call 1-888-2PAYTAX (or 1-888-272-9829 for people who, like myself, simply hate to locate those little letters on the telephone keypad). Once you dial this number, simply follow the recorded instructions. You'll be given confirmation numbers for your credit card transactions, which you'll want to keep for your records to prove that the payment has been made should anybody ask.

Finally, you should know that you can also make your federal (and some state) estimated tax payments using your credit card, should you need to do so.

One other word about making your tax payments with credit cards. If you think that your financial problems are just beginning, or may come to a point where you'll find yourself in federal bankruptcy court, understand that it's generally much easier to obtain bankruptcy relief and/or discharge from unsecured credit card debt than from secured federal (and state) tax debt.

Now, please don't send us angry letters accusing us of advocating stiffing the credit card companies for taxes owed. Or telling us that we're helping to perpetrate some type of bankruptcy shenanigans. We're not doing that at all. All we're saying is that, if your finances are completely underwater and you've taken your last gasp of air and are going down for the third time, extraordinary circumstances might require extraordinary measures. If this sounds like your situation, you really should speak with a qualified bankruptcy attorney about the pros and cons of making your federal (and state) tax payments via credit card.

Negotiate an Installment Agreement

If you're still reading, it's possible that none of the above solutions fit. If that's the case, you still have one option left. You should consider a formal installment agreement with the IRS. But now you may be talking about dealing with the IRS directly, and possibly completing some additional forms and paperwork. These issues might intimidate many folks, so let's take a few minutes to review the installment agreement issues.

The IRS is authorized to enter into written installment payment agreements with any taxpayer if the IRS determines that the agreement will help them collect the liability. The agreement may be terminated earlier than the term negotiated by the IRS if:

1. Information that the taxpayer provided to the IRS was inaccurate or incomplete, or

2. The IRS believes that its ability to collect any tax covered by the agreement is in jeopardy.

The IRS also may alter, modify, or terminate the agreement:

1. If the IRS determines that the financial condition of the taxpayer has significantly changed (for example, if you win the lottery, expect Uncle Sammy to demand his payment immediately).

2. If the taxpayer fails to pay any installment when due. Remember, you've made a deal with the devil here. If you decide to drop your end of the bargain, Uncle Sammy will become irked and may cancel your agreement and demand payment immediately.

3. If the taxpayer fails to pay any other tax liability at the time such liability is due. (In other words, don't continue the process of underpaying your taxes in the future. Uncle Sammy doesn't want to play banker and is not amused if you request installment agreements year after year.)

4. If the taxpayer fails to provide a financial condition update as requested by the IRS. This has to do with the additional paperwork we mentioned above. Getting a loan with anybody is not an easy task. Getting a loan with Uncle Sammy is no easier.

But, for certain taxpayers, a "yes" from Uncle Sammy might come easier than a "yes" from your local banker. Why? Under certain circumstances, the IRS is required to enter into an installment payment agreement if such an agreement is requested by the taxpayer.

How to Qualify for Installment Agreements

Note the words "under certain circumstances." If the amount owed is large and/or you haven't been squeaky clean with the IRS in the past, the IRS may not be required to do anything. So let's look at what your obligations are to force the IRS into an installment agreement.

The IRS must grant (to an individual... but, not to other entities such as corporations) an installment payment agreement if:

1. The aggregate amount of the income tax liability (determined without regard to interest, penalties, additions to the tax, and additional amounts) does not exceed $10,000.

2. The taxpayer has not, during any of the preceding five taxable years:

(a) failed to file any income tax return;
(b) failed to pay any tax required to be shown on any such income tax return; or
(c) entered into another installment agreement for payment of any income tax.

3. The IRS determines that the taxpayer is financially unable to pay such liability in full when due (and the taxpayer submits any information the IRS may require to make such a determination);

4. The agreement requires full payment of such liability within three years; and

5. The taxpayer agrees to comply with all provisions of the Internal Revenue Code for the period of the agreement.

If you think an installment agreement is for you, make your request on IRS Form 9465 (Installment Agreement Request). This form is available on the IRS website. You can file this form separately, or you can simply attach the form to your tax return (that you'll want to file by April 17th). The form is only one page long and requires a minimal amount of information, although the IRS may request more information from you down the road.

There you have it. I hope you've already got your IRS payment issues covered and don't have to make use of this article. But, if the information benefited even one person out there or at least made you aware of the options (just in case you ever do need them), then it was certainly worth the time to write it.

If you like the way Roy Lewis simplifies confusing tax issues, check out his just-published book, The Motley Fool's Investment Tax Guide 2000: Smart Tax Strategies for Investors. This handy 360+ page guide covers just about every tax aspect of a typical Fool's life: investing, marriage, children, education, homes, home offices, retirement accounts, medical expenses, and much more.)

April 07, 2000

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