Haven’t seen your CPA since you filed your tax return in early 2013? Paid the minimum in estimated taxes to avoid being penalized by the IRS? Made approximately the same amount of money in 2012 as 2013? You may have a problem - a tax debt problem. Don’t panic, review all your options before taking drastic action to pay that tax bill.
So what happened? A lot. 2013 brings with it many tax increases for those in higher income tax brackets. Individuals earning over $250,000 and couples earning over $300,000 will start to lose their itemized deductions. Individuals earning over $400,000 and couples over $450,000 hit the new 39.6% top marginal tax rate. Additionally, they are subjected to the 3.8% medicare surtax on investment income. Finally, they lose the personal exemption of $3,900 this year. These quickly add up. Capital gains rates have taken a “bump” too for those earning more than $400,000 as a single person and over $450,000 as a couple, from 15% to 20%.
These new changes may cause some to be surprised when they pick up their tax returns. Taxpayers who have owed little or none before may find themselves in a situation where they don’t have liquid cash to simply write a check the U.S. Treasury. If you don’t have the cash, the last thing you want to do is take action that increases your 2014 tax bill. In other words, you wouldn’t want to take an early withdrawal from your IRA or 401(k). These withdrawals could cause you to incur both taxes and penalties. Further, you want to avoid a cash out of non-retirement assets that drive up your capital gains taxes or cause you to incur other ordinary income tax consequences.
Perhaps you have access to a line of credit to pay your taxes - either secured or unsecured - such as a home equity loan or line of credit through a bank card. These could carry hefty closing costs if you are trying to establish them for the purpose of accessing cash to pay the taxes. And, home equity loans on average carry a 6% interest rate at this time. Other lines of credit could carry interest rates in the double digits. A problem with using the line of credit, especially if you don’t have it established, is that it could take time to obtain the cash. Delay in paying the tax bill could cause further penalties and interest.
One option that you can consider, if you need time, is asking the IRS for a “full pay delay.” It is not uncommon for the IRS to place a 120 day hold on collection action while you acquire funds. Another option is to establish a payment agreement directly with the IRS. In many cases, the payment agreement can be established without full financial disclosure and without the filing of a tax lien. The interest rate at the IRS is actually pretty low, currently about 3%. Additionally, penalties for failure to full pay your tax bill will accrue. Regardless, this is another viable option that may very well be your cheapest overall option.
When analyzing this type of situation, regardless of what option the taxpayer chooses to resolve the debt, the taxpayer must plan for 2014 current taxes. This will be necessary to avoid a similar shortfall like the one in 2013. So, from a cash-flow perspective, the taxpayer will have to balance some mechanism to retire the 2013 taxes while not creating a new balance for 2014.
If a taxpayer has a $25,000 shortfall for 2013, that will likely also be the case for 2014. As such, an increase of greater than $2,000 per month in estimated taxes will be required to close the gap. This type of foresight is necessary when looking at options to deal with the 2013 debt.
If you would like more assistance with resolving your 2013 tax balances and planning for 2014, please don’t hesitate to contact our office.