If a whopper of tax bill ambushes your wealthy client this filing season, a number of tools and strategies can help them pay it off. Each has its own advantages–and restrictions, advisors said.
Acting fast is key, they said.
“You have to respond quickly. [The IRS] can take forever to respond back,” said Ryan Losi, shareholder and executive vice president at Piascik CPAs in Glen Allen, Va.
Your high-net-worth client can get a six-month extension to file a federal income tax return using IRS Form 4868. (Your client still must pay the taxes owed by April 17th.) If your client intends to pay the bill, the IRS allows direct payments from a checking or savings account, and installment plans allow your client to make a down payment and the pay the rest over time.
Another repayment method, the offer in compromise (OIC), can settle tax debt for less than the full amount owed. This probably won’t work for most HNW clients as considerations include the ability to pay, income, expenses and asset equity.
An OIC can come with other restrictions. “A taxpayer may think he or she is running tight on cash flow and can only pay a certain amount on a debt,” Losi explained. “But basically they’re going to determine if you’re spending on the right things. They can really come in and look at your spending habits.”
Interest accrues on unpaid tax from the due date of the return until the date of full payment. The interest rate is set quarterly and is the federal short-term rate plus three percent, compounded daily. Penalties start at 5 percent on top of an unpaid tax amount for failure to file. Your client may qualify for administrative relief from penalties if he or she didn’t previously have to file a return or had no penalties for the three tax years prior, in addition to other conditions that have to be met.
Starting this year, the IRS is also enforcing a new law that allows the denial of passport applications or renewals of taxpayers who owe more than $51,000 in taxes, interest and penalties.
“If I had choice of creditors, the IRS is the last one I’d choose,” said Eric MacCollum, a CPA with SC Associates in Middletown, Del. Taxpayers also need to be aware that state and local tax authorities also go after debt. “While state and local governments can be friendlier to deal with, they may lack the option for repayment that the federal government offers,” MacCollum said.
“Fortunately for most HNW taxpayers, the ability to pay is not as much of a concern as from what bucket does it make the most sense to draw the funds,” said M. Jean McDevitt CFP and principal with Baker Newman Noyes in Portland, Maine.
Be careful: Liquidating securities may involve realized gain being taxable. Withdrawing from a cash account will have no income tax cost and, with current interest rates, probably won’t damage earnings too much, McDevitt added. “Withdrawing from a retirement account is probably the worst way to pay a tax debt,” she said.