You may be eligible for a loan from the taxman — and at a decent rate.
Here’s what to consider.
By Bill Bischoff | SmartMoney
Say your overall cash-flow situation is good, but you need to
cover a short-term deficit over the next few months. In today’s still-strict
credit environment, taking out a loan may not be much fun. It may not even be
possible — unless you have access to an untapped home equity line of credit or
a helpful relative. If that’s the case, great. If not, you may be able to turn
to a surprising source for some help: the taxman.
If you’re self-employed, an investor or someone who lives off Social Security
benefits, pension payments, retirement account withdrawals, and the like, you
can apply for loan from the Internal Revenue Service. Better yet: To borrow
from the IRS, you don’t have to fill out any annoying applications, prove your
income or fence with a balky loan officer. While this may sound too good to be
true, it is true. Read on for the details.
Increase Cash Flow by Temporarily Postponing Estimated Tax Payments
What you do is simply postpone some federal income tax payments that you would
otherwise make to the IRS via estimated tax installments. You don’t need the
government’s permission. You just do it and then make up the difference later.
Of course, the IRS will charge interest on the difference between what you
should have paid in for each installment and what you actually paid. However,
the current interest rate on estimated tax underpayments is only 3%. While the
rate can potentially change each quarter, it will probably remain at a
reasonable level for a while.
The IRS calls the interest on estimated tax underpayments a
“penalty.” But since the current interest rate is only 3%, it’s not
really a penalty. In fact it’s actually a pretty good deal for someone with a
short-term cash crisis. I’ve been there myself a few times, and I’ve done the
borrow-from-the-IRS drill. (Please don’t tell my Mother!)
Note: If you are a salaried employee, you must pay in federal income taxes via
payroll withholding. You may be able to adjust the withholding downward a bit
for the rest of this year by turning in a revised Form W-4 to your employer.
However, the strategy of borrowing from the IRS is basically unavailable to
Estimated Tax Payments in a Nutshell
There is no federal income tax withholding on income from self-employment
activities conducted via sole proprietorships, partnerships, or LLCs. Nor is
there generally any required federal income tax withholding on interest income,
dividends, capital gains, Social Security benefits, pension payments, or
taxable retirement account withdrawals. Instead folks with income from these
sources are expected to make four installment payments of estimated taxes for
each year. The installments for the 2012 tax year are due on Apr. 17, June 15
and Sept. 17 of this year, and Jan. 15 of 2013. Obviously the first date is now
in your rearview mirror, but the next three are still in the future. So you can
work with the installments due on those dates by paying in less than you owe or
even nothing at all.
As mentioned, you will be charged interest based on the difference between the
amount you should have paid in for each installment and the amount you actually
pay for as long as the underpayment remains outstanding. The amount that you should
pay in for each installment generally equals the lesser of: (1) 22.5% of what
you expect to report on your 2012 Form 1040 for total federal income and
self-employment taxes or (2) 25% of what you reported on your 2011 return
(27.5% if your 2011 adjusted gross income was over $150,000).
Make Sure to Catch Up by April 15, 2013
Borrowing from the IRS in this fashion is only a short-term fix. By no later
than April 15th of next year, you must catch up for any estimated tax payment
shortfalls for the 2012 tax year. If you don’t, the IRS will start charging
additional interest of half a percent per month on the shortfall–which equates
to a 6% annual rate. That 6% is on top of the “regular” interest
charge, which is currently only 3%. So you could be looking at a rate of 9% or
maybe more. In any case, owing the IRS for 2012 taxes after April 15th of next
year is just not a good position to be in. So, if you are not ready, willing,
and able to pay up by that date, please pretend you never saw this article.
One last thing: you don’t have to wait until April 15th to catch up. You can do
so as soon as you are able. For example, say you decide to skip your 6/15/12
installment. You can catch up by doubling your 9/17/12 installment. The sooner
you catch up, the less interest you will owe.