PART II: Return Filing Problems (Problems 2-5)
With 210 million business and individual tax returns filed annually, it should come as no surprise that many of us make mistakes that cost both additional taxes and penalties. The following are examples of the most common filing mistakes and what can be done to avoid them.
Problem 2 Fear of an audit
Problem 3 I cannot file my tax return on time
Problem 4 I cannot afford to pay all my taxes
Problem 5 I need more than a payment extension
Because I am afraid of being audited, I do not claim legitimate tax deductions.
You pay additional taxes you do not owe because you believe by overpaying, you can avoid problems later.
Audit-proof your tax return. You do not avoid audits by failing to claim deductions you are legally entitled to claim. All you accomplish is increasing your tax debt. Too many tax professionals insist that when you have deductions that "appear" to be too high, you should not claim them lest you "trigger an audit." Don't listen to them.
While it is true that high deductions can trigger an audit, it is not true that failure to claim them solves the problem. In fact, failure to claim deductions only creates a second problem: higher taxes. Instead of forbearance when it comes to claiming deductions, simply audit-proof your tax return at the time of filing. By audit-proofing the return, you claim every deduction you are legally entitled to claim and you reduce your tax debt to its lowest legal level and you do it all without risk.
To audit-proof your tax return, use IRS Form 8275, Disclosure Statement. Like many forms that actually help citizens, Form 8275 is not found in the IRS' forms package, nor is it found on the wall in the bank or the post office. This is a form the IRS does not like to discuss. I call it the audit-proof form because it allows you to provide information with your tax return that answers any potential questions in the return. By doing so, you give the IRS the answers needed to address its questions before the case is assigned for a face-to-face audit.
Use Form 8275 anytime you have a potentially questionable tax deduction. Anytime you hear your tax accountant or your own inner voice say, "Don't raise a red flag, think of Form 8275 instead of crossing the deduction off your list. By using Form 8275, you ensure that you do not pay more taxes than you owe.
Please note that Form 8275 is not a process of sneaking unlawful claims past the IRS. Do not claim a deduction you are not legally entitled to claim. But if you are legally entitled to the deduction, do not hesitate to claim it merely because the IRS might question it. Form 8275 gives you the best of all worlds. You can lower your tax, increase your deductions and do it without risk. For more information on the effective uses of Form 8275, please see my book The IRS Problem Solver.
Return is filed late or not at all, resulting in late filing penalties, interest and possible enforcement action.
Obtain an extension of time to file. An automatic extension of time to file the return is available by using Form 4868, Application for Automatic Extension of Time to File Individual Income Tax Return. Filing Form 4868 on or before the filing deadline provides an extension of four months to file. The deadline is thus moved from April 15 to August 15. No reason is needed to obtain the extension. As the title suggests, it is automatic. Use it when you are missing records or other information needed to file accurately.
Form 4868 requires payment of any tax due. The form is not an extension of time to pay. In fact, the IRS can disregard the filing extension and treat your return as though it were filed late if you fail to pay the tax by April 15. Do not use Form 4868 if you owe money you cannot pay. We discuss that later.
Form 4868 allows you to estimate the amount of tax due. Mail the estimate with the extension at the time of filing. As long as you pay what you reasonably estimate is your tax by April 15, you avoid the risk of the IRS disallowing the extension.
A second extension is available if you cannot get your return filed by August 15. That extension is sought with Form 2688, Application for Additional Extension of Time to File Individual Income Tax Return. Use this form if you run out time on the first extension. However, Form 2688 is not automatic and it affords a maximum two-month extension. File it in advance of the August 15 deadline so if the IRS denies it, you have time to file before August 15, avoiding late filing penalties.
- Penalties and interest are added and you subject yourself to a pattern of non-filing and non-payment.
Obtain an extension of time to pay the tax. One of the largest problems citizens face is the inability to pay the tax on time. Each year, in excess of 13 million penalties for failure to pay taxes on time are assessed. Even worse, the addition of compound interest on the entire unpaid balance often transforms a difficult situation into an impossible one.
The solution to the problem lies in a very simple procedure the IRS denies exists. It is the right to seek an extension of time to pay the tax. Do not confuse this with the extension of time to file which we discussed earlier. Please recall that Form 4868, the filing extension, does not provide an extension of time to pay. To obtain a payment extension you must use IRS Form 1127, Application for Extension of Time for Payment of Tax. The IRS denies that Form 1127 exists. That is why I have included Form 1127 in our Forms Kit and Resource Guide.
The payment extension is not automatic. You must show that you do not have the money to pay the tax on time, that you exercised reasonable business care in providing for your tax debt but due to circumstances beyond your control, you are unable to pay on time. You must also show that coming up with the money will cause a financial hardship. This is not difficult to do when you have little or no cash available and no assets that can be readily liquidated to pay the tax. Form 1127 is quite simple and the instructions make it clear what must be done to comply with IRS' requirements.
File Form 1127 in advance of the April 15 payment deadline. If the application is granted, you are afforded up to six additional months to pay the taxes, without penalties. See my video on IRS Form 1127.
- I owe too much and need an installment agreement.
- IRS enforces collection by issuing wage and bank levies, potential property seizures and filing federal tax liens.
- Obtain an installment agreement to pay over time. One of the top ten reasons citizens contact the IRS' Taxpayer Advocate is for help in establishing installment agreements. The IRS is notorious for providing misinformation regarding the right to and procedure for obtaining installment agreements. In the meantime, it enforces collection with wage and bank levies, often putting people into a situation where they must choose between paying their taxes and feeding their families.
The right of an installment agreement exists when the citizen can demonstrate that he does not have the cash or liquid assets available to pay the bill. It is the citizen's duty to seek the agreement, however. The IRS need not present the opportunity though it sometimes may suggest that the right is available.
Use Form 9465, Installment Agreement Request, to seek an installment agreement. As IRS forms go, this one is about as easy as they get. You simply include your name, address, social security number and other identifying information. State the tax year in question and how much you owe. Finally, state how much you are able to pay each month.
There are two ways to use Form 9465. The first is if you cannot pay a current tax, which is the tax for the return you are about to file. Rather than failing to file the return (a mistake made by too many each year), file the tax return on time--thus avoiding the failure to file penalty--but include Form 9465 as an attachment to the return. Put it right on top, in plain view, so the IRS can readily see it. This forestalls enforced collection action and sets the wheels in motion to formalize the installment agreement.
Before the IRS formalizes the agreement, it often seeks financial data from the citizen. Remember, you must prove you do not have the income or assets to pay on time. Provide proof in the form of a financial statement. The IRS uses Form 433-A as a financial statement for individuals and Form 433-B as the financial statement for businesses. Both are included in our Forms Kit and Resource Guide.
The financial statement provides a listing of all one's income and monthly expenses, as well as assets and liabilities. From this data, IRS determines the amount of the monthly payment. The payment amount is fixed by subtracting your monthly living expenses from your net take home pay. The difference, referred to as "disposable income," becomes the amount of the payment. While the agency tries to impose arbitrary expense guidelines upon citizens, the reality is you have the right to fix your monthly expenses based upon your family's needs, not the IRS' whim.
Once an installment agreement is in place, the IRS can neither enforce collection nor modify or terminate the agreement unless,
- you provided false or incomplete information in Form 433-A or B,
- your financial circumstances have significantly changed,
- you fail to make a payment on time,
- you fail to pay another tax on time,
- you fail to provide updated financial data when asked, or
- the IRS believes that collection of the tax is in jeopardy; that is, you are taking affirmative steps to defeat payment of the tax, such as hiding assets or preparing to leave the country.
Now that the installment agreement is in place, you avoid the potential disaster of enforced collection action. However, because interest and penalties continue to build even while you pay on time, it is in your best interest to either pay the tax as quickly as possible or explore other avenues for settling the debt. The latter should include consideration of the so-called Tax Amnesty programs. These are programs that allow you to reduce or eliminate your tax debt based upon your ability to pay. They are especially helpful for those who have substantial back tax debts and are making just minimum payments. In that case, the interest and penalties often outstrip the payment and you actually end up going backwards. I discuss the Tax Amnesty programs in Part VI of this Problem Solver.
For those contemplating or currently negotiating an installment agreement, I strongly recommend my book, How to Get Tax Amnesty. Chapters five and eleven of the book take the reader step-by-step through the process of seeking, negotiating and living under an IRS installment agreement. I discuss specific strategies for dealing with the IRS' demands for exhaustive financial data, how to prove monthly living expenses and how to appeal the denial or termination of an installment agreement, if it comes to that.