What If You Can't Pay Your Taxes?

File your return on time anyway to minimize the penalties.

What if you owe money to the IRS but don't have the cash to pay the bill? Don't panic &emdash; but don't ignore the problem, either. File your 2012 tax return (or an extension — more below) by the April 15, 2013, deadline, even if you can't pay the full amount you owe. You'll pay a late-payment penalty of 0.5% of the unpaid amount per month, up to 25% of the balance. But that's a lot better than the failure-to-file penalty of 5% a month.

To hold down the penalties and interest that will continue to add up until the balance is paid in full, pay as much of your tax bill as you can when you file your return. Then wait for the IRS to send you a bill for the balance. That should take about 45 days and give you some time to come up with some or all of the remaining cash.

Minimize the damage. Interest and penalties can add up quickly. Say you owe $9,000 in taxes on your 2012 return. If you file your return by the April 15 deadline and send no money &emdash; but pay your tax debt in full three months later &emdash; you'll owe $9,202.50, including interest and late-payment penalties, according to estimates calculated by Lisa Greene-Lewis, Lead CPA of the American Tax and Financial Center at TurboTax.

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But if you delay filing your taxes until you come up with the money, and file and pay your taxes three months after the due date, your tax bill will balloon to $10,417.50, including interest (currently 3% on unpaid balances compounded daily) and failure-to-file penalties, Greene-Lewis says.

Filing an Extension

If you act before April 15, you can file Form 4868 to delay your tax-filing deadline until October 15. But it won’t delay the deadline for paying your taxes. Interest will continue to accrue on the unpaid balance. However, the late-payment penalty does not apply during the six-month extension period if you paid at least 90% of your actual tax liability before the original April 15 due date and pay the balance when you file the return..

Where to get the money. If you own a home, consider tapping a home-equity line of credit to pay your tax bill (assuming you still have equity). You can probably deduct the interest you pay on the home loan on next year's tax return.

Paying by credit card is another option, and it could be cheaper than incurring IRS penalties and daily compounded interest. You'll owe a convenience fee &emdash; paid to the card issuer, not the IRS &emdash; of up to 2.35% of the entire transaction, but if you're enrolled in a rewards program, the tax payments qualify for points, rewards, airline miles or cash back.

If you can't come up with the cash on your own, contact the IRS at 800-829-1040 or apply online to discuss your payment options &emdash; which may include an extension of up to four months or an installment plan for up to three years (as long as your tax debt doesn't exceed $25,000).

Don't get suckered by cable TV ads that promise to settle your tax bill for pennies on the dollar. In extreme cases, you &emdash; or a tax-resolution company acting on your behalf &emdash; may be able to file an Offer in Compromise with the IRS and settle your tax debt for far less than you owe. But only a small percentage of tax-reduction offers are accepted, and you must prove that you don't have the means to pay and probably never will, usually because you're too old, too poor or too sick. If you are employable and have assets you can sell to raise cash, be prepared to pay the tax man.

Mary Beth Franklin
Former Senior Editor, Kiplinger's Personal Finance