Extension of Time for Payment of Tax Due to Undue Hardship: Part 1

First, the IRS has the general authority to grant an extension of time to pay tax liability according to 6161(a)(1) of the Internal Revenue Code.

The Secretary, except as otherwise provided in this title, may extend the time for payment of the amount of the tax shown, or required to be shown, on any return or declaration required under authority of this title (or any installment thereof), for a reasonable period not to exceed 6 months (12 months in the case of estate tax) from the date fixed for payment thereof.

Section 6161(a)(1) also provides that a viable exception when an extension can exceed 6 months is when a person lives abroad.

Under section 6161(b), unless a deficiency is due to negligence, intent to disregard or fraud, the IRS can extend the payment of a tax deficiency if the payment would result in the taxpayer facing undue hardship. In other words, 6161(b)(1) allows the IRS the ability to grant a longer extension to taxpayers who pay an incorrectly calculated amount of their taxes but who actually owe more based on IRS calculations.

Section 6161(b)(1) states:

Under regulations prescribed by the Secretary, the Secretary may extend the time for the payment of the amount determined as a deficiency of a tax imposed by chapter 1, 12, 41, 42, 43, or 44 for a period not to exceed 18 months from the date fixed for the payment of the deficiency, and in exceptional cases, for a further period not to exceed 12 months. An extension under this paragraph may be granted only where it is shown to the satisfaction of the Secretary that payment of a deficiency upon the date fixed for the payment thereof will result in undue hardship to the taxpayer in the case of a tax imposed by chapter 1, 41, 42, 43, or 44, or to the donor in the case of a tax imposed by chapter 12.

Second, most taxpayers can request an installment agreement if they are unable to pay their taxes by the original filing deadline. This would allow the individual taxpayer to pay their tax debt through a series of monthly payments, with interest on the unpaid balance.

Third, section 7508A of the Internal Revenue Code allows the IRS the ability to extend the time to pay in the event of certain disasters. Taxpayers should check to see if they qualify for an extension due to a disaster before trying to set up installments or seeking relief because of undue hardship.

Undue Hardship

If granted an extension by the IRS due to undue hardship, the taxpayer would receive an extension both for the amount a taxpayer voluntarily assesses, and any deficiency arising from IRS compliance, such as an audit or adjustment from say the IRS’s automated underreporter program. In other words, the taxpayer is granted the extension based on whether paying the whole amount calculated by the IRS would result in an undue hardship to that taxpayer. 26 CFR § 1.6161-1(b) does not provide an exact definition for undue hardship, however, it does state an extension “will not be granted upon a general statement of hardship.” In addition, 26 CFR § 1.6161-1(b) states that the term undue hardship, “means more than an inconvenience to the taxpayer”. For the IRS to recognize undue hardship, it must be evident that a “substantial financial loss” will occur were the taxpayer to pay the tax liability on the original due date without extension. For example, 26 CFR § 1.6161-1(b) shows, that the IRS will not force a taxpayer to sell property below its value just to make the taxpayer have enough funds to pay the tax liability on time. What specific circumstances would the IRS consider enough to qualify a taxpayer for a relief due undue hardship?

Though neither the Code nor Regulations previously mentioned give a definition of undue hardship, 26 CFR § 1.6161-1 et. suggests that the IRS will consider specific circumstances when evaluating. The IRS may consider:

1) serious illness or medical condition affecting the taxpayer or an immediate family member;

2) unemployment or a significant loss of income;

3) natural disaster or other unforeseeable events beyond the taxpayer’s control that have a significant impact on their financial situation;

4) divorce or separation, particularly if the taxpayer is responsible for paying support or alimony;

5) significant business hardship or a decline in the value of assets.

In evaluating undue hardship claims, courts have not adopted a uniform test and evaluate based on the facts and circumstances of each situation. In Estate of LeMeres v. Commissioner, 98 T.C. 294 (1992) the court ruled that the taxpayer faced undue hardship because “most of its assets were tied up in a closely held business” and that “sufficient funds with which to pay the estate tax…were not readily available.” In addition, the taxpayer acted “in good faith” in following their attorney’s erroneous advice that more than one six-month extension could be obtained. In addition, the court acknowledged the declining value of the petitioner’s assets due to the current economic situation. Based on the erroneous legal counsel, lack of liquid funds, and declining asset values, the court believed the case had enough evidence that undue hardship would befall the petitioner should they not be granted another extension.

In Babcock Center, Inc. v. United States, 111 A.F.T.R.2d 2013-1865 (D. S.C. 2013), the court rejected the taxpayer’s undue hardship case because if a taxpayer enjoyed a luxurious lifestyle in a way that the spending causes the “remainder of his assets and anticipated income will be insufficient to pay his tax” then that taxpayer cannot reasonably argue that he failed to pay the tax due to an undue hardship.

Conclusion

The IRS can grant penalty free extensions to the tax payment deadline due to certain disasters, through installment agreements, and due to proof of undue hardship to the taxpayer if the taxpayer were to pay the taxes owed. Undue hardship must be “more than an inconvenience to the taxpayer” but is granted by the IRS based on individual circumstances. For many taxpayers the process of seeking a payment waiver due to hardship requires filing of filing a form 1127, an extension based on undue hardship.  The preparation and filing of that form will be the basis for tomorrow’s post.