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Special Tax Situations: Audits, Extensions, Payment Plans, and Quarterly Payments

Editor’s Note: This is the last in our six-part No-Stress Guide to Filing Your Taxes. You can start at the beginning with Part 1: Your Tax Document Checklist.

For most taxpayers, completing your tax return simply means mailing off your 1040 and supporting schedules and calling it good. But there are a few tax situations that you may want to know about either to protect yourself, to avoid fines and penalties, or to give yourself more time to file your return or pay your bill.

In this article, we’ll discuss:

  • Tax Return Audits: Who is more likely to get audited and how to avoid audits.
  • Tax Extensions: What are your extension options and how to apply.
  • Quarterly Estimated Tax Payments: Who needs to pay estimated tax payments and why they’re important.
  • Payment Plans: Your installment plan options if you’re unable to pay your tax bill in full. 

TAX RETURN AUDITS

Just completing your tax return is stressful enough, but imagine having an IRS agent on your back demanding more answers and supporting documentation for your return? Doesn’t sound like a fun time does it?

But audits are a real possibility for many taxpayers, especially those that earn a lot of income. In 2010, 1% of all taxpayers were audited. From that number, 12.5% of taxpayers earning over $1 million were audited. The IRS goes where the money is which is why these high earners are more likely get audited.

In addition to high income levels there are 11 other red flags that the IRS monitors to decide whether to slap you with an audit or not. These 12 red flags are lovingly referred to as “The Dirty Dozen”. Here’s a high-level list of these 12 red flags:

    1. Making too much money.
    2. Failing to report all income.
    3. Claiming large charitable deductions.
    4. Taking the home office deduction.
    5. Claiming rental losses.
    6. Deducting business meals, travel, and entertainment.
    7. Writing off a loss for a hobby.
    8. Deducting 100% of a vehicle for business use.
    9. Running a cash business.
    10. Not reporting a foreign bank account.
    11. Participating in currency transactions.
    12. Taking higher-than-average deductions.

As you can see, those that are usually targeted are business owners and those taxpayers who deduct or write off items that are disproportionate to their overall tax return.

So how can you avoid the dreaded audit? Is it as simple as avoiding those items on The Dirty Dozen list?

Not exactly. For one thing, many taxpayers’ situations will simply fall into these categories, so you can’t just avoid them all together.

Not to beat a dead horse here, but the answer is: document, document, document. If you have proof of every single expense your claiming and detailed reports that proof that your return is 100% accurate, you’ll be much less likely to be audited.

Another thing to remember is that the numbers across your return must be proportionate both to your income AND to your lifestyle.  Do you report earning only $20,000 a year but deduct the full use of a BMW as a business expense? Yeah, that’s definitely going to catch the eye of an IRS agent. If things look normal across the board (and you don’t make $1 million or more per year), your chances of being audited are very slim.

One last thing. When most people hear the word “audit” they picture some emotionless IRS agent in a stale blue suit sitting in their living room tallying up how much extra you owe on a calculator. Although such in-person audits do happen, you may also be audited by mail, which is more common. The IRS will send you a notice stating how much extra they think you owe (including penalties and interest). You can either agree and pay the additional amount or contest the audit by submitting additional documentation.

TAX EXTENSIONS

Is April 15th a busy time for you? Are you travelling a lot during that time? Will you have a major life event this year that will prevent you from filing your taxes on time?

If so, you’re in luck: most taxpayers can file an extension that buys them another six months to file their tax return.

Amazing, right? So, why isn’t EVERY taxpayer jumping to put off filing their return and paying their bill another six months?

Well there is one very important catch: the extension is merely pushing back the deadline to file your return; if you owe any taxes, you must still pay up by April 15th, extension or not.

So, if you have to pay taxes and don’t send off this payment by April 15th, from that day on, the penalties and fines start racking up on a daily basis.

This means that only one type of taxpayer should file for an extension is the taxpayer that knows with 100% certainty that they will get a refund this year. If you know you’ll get a refund and want to file an extension to put off your return another six months, you have this option, but you’re letting the IRS hang onto your money. Unfortunately, you won’t be able to charge them interest!

If you’re interested in filing for an extension, it’s simple. Fill out IRS Form 4868 and you’ll be notified if you’re allowed an extension (generally six months – so until October 15th, 2011).

One last thing – if you are desperate for an extension and know you’ll need to pay, you can send in a check with your extension form to pay your balance owed. You’ll need to estimate the amount of taxes you owe, though, so it might as well be worth it to go ahead and complete your return.

QUARTERLY PAYMENTS OF ESTIMATED TAXES

Many of us dream of being professional freelancers: Working for yourself, making your own hours, doing what you love—all those wonderful things.

But as a freelancer, your income taxes are not deducted from your paychecks. Remember, you are responsible for paying all your taxes–including the full amount of Social Security and Medicare taxes (many people don’t realize that when you work for somebody else, your employer kicks in half of these taxes).

Because income taxes are not automatically pulled from your regular paychecks if you were to work for an employer, you’ll need to pay the IRS income taxes on a quarterly basis. Unfortunately, you cannot simply pay all your income taxes once a year when you file your tax return.

On April 15, June 15, September 15, and January 15 each year, you will be required to send a check and a 1040-ES form to pay quarterly estimated taxes.

Work for both an employer and yourself?

You may still be required to pay estimated quarterly taxes even if you earn some of your income from an employer who deducts these taxes from you paychecks. In general, if you expect to owe $1,000 or more on your tax return, you should make quarterly tax payments to avoid facing penalty fines or interest.

PAYMENT OR INSTALLMENT PLANS

It’s no secret: being slammed with a $900 tax bill on April 15th is a hard pill to swallow. If you weren’t expecting it, finding the money to pay the bill might be pretty tough or impossible.

The IRS isn’t completely heartless. They understand it’s sometimes hard for people to pay their taxes. That’s why they offer tax payment plans allowing you to pay off your bill in monthly installments.

The biggest catch? The fees and interest, of course. Any time you don’t pay the IRS when your payment is due, they will slap you with any fine or penalty they can. But if monthly payments are your only option during a financial hardship, at least you have this option to consider.

Before you give up and sign up for the installment plan, the IRS advises you to complete and consider several things:

  • File your tax return.
  • Consider other sources to pay your bill like loans or credit cards. (Note: The interest charged on IRS installment plans is around 7 percent—many credit cards charge way more than this. The IRS would rather get its money now than have you do a payment plan which is why they tell you to turn to credit cards, but this isn’t always the smartest option.)
  • Determine how much you can pay on a monthly basis.
  • Be aware that future tax refunds will be subject to offsets – meaning they’ll be applied to the amount you owe before you can receive them.

How do you get set up on an installment plan? If you owe less than $50,000 overall, you can apply online here. If you owe more than $50,000, you’ll need to fill out several forms which can be found here.

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That wraps up our series on taxes. We tried to give an overview of the issues facing most of young tax payers this time a year and hope it was helpful. Do you have questions about audits, extensions, quarterly payments or payment plans?  Have you ever been audited or filed for an extension? Feel free to share your story or ask a question in a comment.

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About Amber Gilstrap

Amber is a twenty-something CPA from Kansas City, Missouri who loves writing, working out, and---of course---finding fresh ideas for saving money. Follow her on twitter @ambergilstrap.

Comments

  1. If you can pay Federal taxes over time and you need longer than 120 days some type of Installment Agreement may be a good fit for you. Each differs slightly by the term of the period, the paperwork required, how difficult each is to obtain, and whether the balance must be paid in full. With state tax debt, payment plans can also be pursued. See if you qualify for an Installment agreement because if you don’t there are other options. However, realize that Interest and penalties are reduced but are still effective with an Installment Agreement. Therefore, sometimes a bank loan is recommended as you need to see which interest rate is higher if you do not want to try to settle your tax debt.