The Internal Revenue Service (IRS) is probably the last place you expect to find help during financial hardships.
However, thanks to certain provisions of the IRS code, help is out there. Many people are unaware that the IRS has a “hardship status,” meaning they have determined your account is currently not collectible if levy action will create a hardship.
Due to these provisions, you may find relief from various tax penalties, qualify for a filing extension and/or receive a reduction on your tax bill.
If you happen to find yourself struggling financially, it’s important to understand when you can take advantage of these provisions. To shed some light on this IRS policy, here are several things you need to know:
You have extra time to file when you are a victim in a federally declared disaster area
As a victim in such an area, you qualify for additional time to file your tax return. This benefit applies to individuals, businesses, those whose tax records are located in the disaster area and relief workers.
The IRS will give affected taxpayers until the last day of the Extension Period to file tax returns or make tax payments, including estimated tax payments, which have either an original or extended due date falling within that period.
Any interest or late filing and late payment penalties that would normally apply will be omitted.
Deduct capital losses
If you must sell capital assets, you may receive a tax break for a portion or all of your loss.
For example, if you sell stock for less than you paid for it, you can use it to reduce other income, such as wages, up to an annual limit of $3,000 or $1,500 if you are married filing separately.
If you have capital loss that is more than the yearly limit, you can carry it forward to the next year and treat it as if it was acquired that year.
You cannot take a loss on your personal residence or other personal items, such as your car, if not used for business purposes.
Cancellation of debt
Under ordinary circumstances, when you have debt cancelled or forgiven, that cancellation of debt is considered to be taxable income by the IRS. Debt cancellations may occur due to:
- voluntary return of a property to a lender,
- abandonment of property, or
- a principal residence loan modification.
You will receive Form 1099-C in the mail indicating the total amount of taxable income you have from cancelled debt.
There are several exceptions to the rule, however. The most common being you are labeled “insolvent” at the time the debt is forgiven.
This means you have more debts than assets. Complete Form 982 to show the IRS you qualify for this exception.
Additionally, you do not have to claim cancelled debt as income if the cancellation is a gift, bequest, inheritance, payment of the debt is deductible or for debt cancelled in a bankruptcy.
If you sell your house in a short sale, the cancellation of any remaining loan amount by your lender may qualify you for the Mortgage Debt Relief Act.
This IRS code relieves any income from the discharged debt from being subject to taxes.
Withdrawals from retirement plans
It’s painful to have to withdraw money out of your retirement plan when you are experiencing a financial hardship. It’s doubly painful having to pay a penalty for that early withdrawal.
Fortunately, the IRS offers a variety of exceptions to the 10 percent penalty depending on the type of retirement plan you have. For example, the penalty does not apply to traditional IRA distributions:
- after you reach age 59 and a half,
- if you are disabled,
- when taken in substantially equal periodic payments,
- to the extent you have unreimbursed medical expenses exceeding 7.5 percent of your adjusted gross income,
- when used to pay for health insurance during unemployment,
- if used for higher education expenses,
- when used to buy or build your first home (up to $10,000 lifetime limit), or
- when made as a result of an IRS levy.
If you have a Roth IRA, you can withdraw up to the amount of your contributions with no penalty.
However, this does not include the earnings from your principal until you reach age 59 and a half. Also, an exception to the penalty exists if you converted another retirement plan to a Roth IRA for the above qualifying reasons.
Withdrawals from retirement plans are tricky, and this is not an exhausted list of potential penalty exceptions.
To be on the safe side, double check the rules for your retirement plan before you make a withdrawal.
IRS installment agreements to pay
It’s easy to fall behind on taxes when you’re struggling financially. Choosing to make monthly payments through an installment agreement can give you some relief, and help you devise a plan to get caught up as soon as possible.
If you owe $50,000 or less, you may be able to establish an installment agreement online through the IRS.
If you are ineligible for an online payment agreement, you can use Form 9465, Installment Agreement Request and Form 433-F, Collection Information Statement, to come to an agreement with the IRS.
You must pay a fee of $52 for a direct debit installment agreement, or $120 for an installment agreement without direct debit. You may qualify for a reduced fee if you fall into a low income tax bracket.
Penalties and interest continue to accrue until your bill is paid in full. However, as long as you keep up your payments, the IRS will generally not take collection action against you.
Offers in compromise
Occasionally taxpayers fall too far behind in their taxes to ever catch up. This is likely to happen when a business fails, or when a person has large, nondeductible expenses.
In these situations, you can propose an “offer in compromise.” This is an agreement between you and the IRS that resolves the tax liability by payment of an agreed-upon reduced amount.
The IRS generally accepts Offers in Compromise when there is no other way tax debt can be resolved.
If this occurs, the payment options are a lump sum cash offer or periodic payments, which are based on the ability to pay, income, expenses, and asset equity.
Would you ever take money out of your retirement accounts because of a financial emergency?