While you probably don’t have any problems paying your tax bills, you may wonder: What happens in the event you (or someone you know) can’t pay taxes on time? Here’s a look at the options.

Most importantly, don’t let the inability to pay your tax liability in full keep you from filing a tax return properly and on time. In addition, taking certain steps can keep the IRS from instituting punitive collection processes.

Common penalties

The “failure to file” penalty accrues at 5% per month or part of a month (to a maximum of 25%) on the amount of tax your return shows you owe. The “failure to pay” penalty accrues at only 0.5% per month or part of a month (to 25% maximum) on the amount due on the return. (If both apply, the failure to file penalty drops to 4.5% per month (or part) so the combined penalty remains at 5%.) The maximum combined penalty for the first five months is 25%. Thereafter, the failure to pay penalty can continue at 0.5% per month for 45 more months. The combined penalties can reach 47.5% over time in addition to any interest.

Undue hardship extensions

Keep in mind that an extension of time to file your return doesn’t mean an extension of time to pay your tax bill. A payment extension may be available, however, if you can show payment would cause “undue hardship.” You can avoid the failure to pay penalty if an extension is granted, but you’ll be charged interest. If you qualify, you’ll be given an extra six months to pay the tax due on your return. If the IRS determines a “deficiency,” the undue hardship extension can be up to 18 months and in exceptional cases another 12 months can be added.

Borrowing money

If you don’t think you can get an extension of time to pay your taxes, borrowing money to pay them should be considered. You may be able to get a loan from a relative, friend or commercial lender. You can also use credit or debit cards to pay a tax bill, but you’re likely to pay a relatively high interest rate and possibly a fee.

Installment agreement

Another way to defer tax payments is to request an installment payment agreement. This is done by filing a form and the IRS charges a fee for installment agreements. Even if a request is granted, you’ll be charged interest on any tax not paid by its due date. But the late payment penalty is half the usual rate (0.25% instead of 0.5%), if you file by the due date (including extensions).

The IRS may terminate an installment agreement if the information provided in applying is inaccurate or incomplete or the IRS believes the tax collection is in jeopardy. The IRS may also modify or terminate an installment agreement in certain cases, such as if you miss a payment or fail to pay another tax liability when it’s due.

Avoid serious consequences

Tax liabilities don’t go away if left unaddressed. It’s important to file a properly prepared return even if full payment can’t be made. Include as large a partial payment as you can with the return and work with the IRS as soon as possible. The alternative may include escalating penalties and having liens assessed against your assets and income. Down the road, the collection process may also include seizure and sale of your property. In many cases, these nightmares can be avoided by taking advantage of options offered by the IRS.

If your business was fortunate enough to get a Paycheck Protection Program (PPP) loan taken out in connection with the COVID-19 crisis, you should be aware of the potential tax implications.

PPP basics

The Coronavirus Aid, Relief and Economic Security (CARES) Act, which was enacted on March 27, 2020, is designed to provide financial assistance to Americans suffering during the COVID-19 pandemic. The CARES Act authorized up to $349 billion in forgivable loans to small businesses for job retention and certain other expenses through the PPP. In April, Congress authorized additional PPP funding and it’s possible more relief could be part of another stimulus law.

The PPP allows qualifying small businesses and other organizations to receive loans with an interest rate of 1%. PPP loan proceeds must be used by the business on certain eligible expenses. The PPP allows the interest and principal on the PPP loan to be entirely forgiven if the business spends the loan proceeds on these expense items within a designated period of time and uses a certain percentage of the PPP loan proceeds on payroll expenses.

An eligible recipient may have a PPP loan forgiven in an amount equal to the sum of the following costs incurred and payments made during the covered period:

1. Payroll costs;
2. Interest (not principal) payments on covered mortgage obligations (for mortgages in place before February 15, 2020);
3. Payments for covered rent obligations (for leases that began before February 15, 2020); and
4. Certain utility payments.

An eligible recipient seeking forgiveness of indebtedness on a covered loan must verify that the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage, make payments on a covered lease or make eligible utility payments.

Cancellation of debt income

In general, the reduction or cancellation of non-PPP indebtedness results in cancellation of debt (COD) income to the debtor, which may affect a debtor’s tax bill. However, the forgiveness of PPP debt is excluded from gross income. Your tax attributes (net operating losses, credits, capital and passive activity loss carryovers, and basis) wouldn’t generally be reduced on account of this exclusion.

Expenses paid with loan proceeds

The IRS has stated that expenses paid with proceeds of PPP loans can’t be deducted, because the loans are forgiven without you having taxable COD income. Therefore, the proceeds are, in effect, tax-exempt income. Expenses allocable to tax-exempt income are nondeductible, because deducting the expenses would result in a double tax benefit.

However, the IRS’s position on this issue has been criticized and some members of Congress have argued that the denial of the deduction for these expenses is inconsistent with legislative intent. Congress may pass new legislation directing IRS to allow deductions for expenses paid with PPP loan proceeds.

PPP Audits

Be aware that leaders at the U.S. Treasury and the Small Business Administration recently announced that recipients of Paycheck Protection Program (PPP) loans of $2 million or more should expect an audit if they apply for loan forgiveness. This safe harbor will protect smaller borrowers from PPP audits based on good faith certifications. However, government leaders have stated that there may be audits of smaller PPP loans if they see possible misuse of funds.

Contact us with any further questions you might have on PPP loan forgiveness.