When the taxpayer files a Form 1127, in part 1 of the form they must indicated whether they are requesting an extension for the total amount calculated as deficiency, or the tax shown. In part 2, the taxpayer must provide “a detailed explanation of the undue hardship that will result” if their application is denied.

Part 3 of the form is where the applicant provides supporting documents to the IRS to support their claim for extension based on undue hardship. The taxpayer must provide a statement of both liabilities and assets at the end of the last month. The statement must show “book and market values of assets and whether securities are listed or unlisted.” In addition, the taxpayer must provide an itemized list of their income and expenses for each of the three months preceding the due date of the tax.

When completing a Form 1127, the goal of the taxpayer is to provide a convincing and compelling story as to why they are unable to pay their taxes on time due to their financial circumstances. This takes on the same tone as the cover letter a taxpayer should write when submitting an offer in compromise.  Taxpayers should explain unexpected events that may have occurred that resulted in their financial hardship such as the medical emergency or loss of a job. They must explain the current financial situation including all assets, income, and expenses. Critically, taxpayers should explain their effort to pay all of their taxes by the due date. For example, they may include in their explanation an attempt to set up a payment plan with the IRS. They must also include an explanation of their individual efforts (unique person to person) to improve their own financial circumstances. Taxpayers should explain that they understand the importance of paying their taxes on time, and how they plan to pay the full amount of their tax debt going forward. In addition, the taxpayer should provide any official documents which provide evidence of financial hardship. Some of these documents could include a job loss notice from their former workplace or medical bills that show unexpected expenses.

Form 1127: Part 1

When the taxpayer files a request for an extension, they must indicate the specific length of time they would need to pay their tax debt. As stated in I.R.C. §  6161(a) , an extension request should be “for a reasonable period not to exceed 6 months… from the date fixed from the payment thereof.” The IRS could consider a longer extension for longer than 6 months if a person is living abroad. This means that according to I.R.C. § 6072, if a person is requesting for the maximum extension, they should request it from the filing and payment due date. Under I.R.C. §  6161(b), a taxpayer can receive an extension of up to 18-months on a deficiency. As such, if a taxpayer needs the maximum amount of an extension on a deficiency, they should request from the date of the payment notice and demand up until the day which would mark 18 months. In certain “exceptional cases,” the IRS can grant another extension for a period of up to 12 months after the first extension.

The taxpayer must specify the amount for which they want the payment extension for. According to I.R.C. § 6161 it should be the “amount of the tax shown or required to be shown” on a tax return or to postpone a deficiency “any amount determined as a deficiency.” The general instructions of the Form 1127 instructs the taxpayer to file the form if they are trying to “postpone the full amount of tax shown or required to be shown… or an amount determined as deficiency.”

Form 1127: Part 2

The undue hardship burden is not an easy burden to meet because a general statement of hardship alone is not enough to satisfy. This means that the IRS can deny an extension on the basis of undue hardship unless that taxpayer could show undue hardship if they had to pay their taxes by the original due date. The instructions on the form state, “to establish undue hardship, you must show that you would sustain a substantial financial loss if forced to pay a tax of deficiency on the due date.” So, taxpayers planning to submit a form 1127 should not only to write a statement, but also submit supporting documents to provide evidence of their hardship.

Form 1127: Part 3

According to the instructions, the taxpayer must submit both a statement of their liabilities and assets at the end of the last month and an itemized list of their income and expenses for each of the three months preceding the tax due date. If this information is not included, the IRS will consider the form incomplete and will not consider extension for the taxpayer. Some other items to include as evidence would according to the article would be:

the total amount of liquid assets that the petitioner claimed would be available to pay the tax once the bank had approved the release of funds;

• whether any assets were available to pay some of the tax when it was due;

• when the petitioner expected that sufficient assets would become available; or

• whether the petitioner had explored other ways to obtain the funds, such as selling the real property before the payment due date

In addition, taxpayers are required to include the following documents in order to have the form processed properly. Should a taxpayer fail to provide such documents, the IRS would not be able to process the request extension. According to I.R.M. 5.1.12.26.2 the documents include:

• taxpayer’s name, address, and Tax Identification Number (TIN);

• whether the extension is being requested for a tax shown or required to be on a return, or for an amount determined as a deficiency;

• the due date of the return or the due date for paying the deficiency;

• the extension date proposed by the taxpayer;

• the tax liability for which an extension to pay is being requested;

• the form number relating to the tax;

• the calendar year or fiscal year of the tax;

• an explanation of the undue hardship that will result to the taxpayer if the extension is denied (see the discussion above);

 • a statement of the taxpayer’s assets and liabilities

Filing Form 1127

According to Treas. Reg. §§ 1.6091-2 when filing a Form 1127, an individual taxpayer should file it at a local IRS office which “serves the legal residence or principal place of business of the person required to make the return.” For a corporation, the form should be filed at the IRS office “that serves the principal place of business or principal office or agency of the corporation.”  This does not mean the taxpayer should send the form to the general attention of the closest IRS office.  The taxpayer needs to locate the address for the Collection Division Advisory Group that services their area of residence. You can find addresses and contact information for those offices in Publication 4235. The Advisory Group handles a host of discrete collection issues.  This is a logical place for the IRS to have the form filed since the Service Centers are not equipped to make the type of collection decisions necessary to grant a waiver.

The required documents must be filed by the due date for the tax returns in order to be considered timely filed, if not the IRS cannot process the form. According to I.R.M. 5.1.12.26.2(3), the post mark date of the application will be how the IRS determines whether or not the form was timely. This means that the form must be postmarked by the U.S. postal service either before or on the due date of their tax liability.

When the IRS considers whether or not the taxpayer has a case for undue hardship, they should approve or deny the request within 30 days according to Treas. Reg. § 1.6161(c). If the taxpayer is denied the request for extension on the basis of undue hardship, they will get a notice in writing stating the reasons for the denial (I.R.M. 5.1.12.26.3(2). Taxpayers wishing to dispute the decision must file an appeal within 10 calendar days of their denial.  Th request for an appeal must be in writing and submitted to the member of the advisory group that denied the request.

It is important to note that according to I.R.C. § 6601, if granted an extension of time for a taxpayer to file their tax returns, it still will not stop the accrual of interest on those unpaid taxes.

Conclusion

Taxpayers seeking relief on the basis of undue hardship must file a Form 1127, in a timely manner based on the tax return due date. When filing, they must indicate how long of an extension they are seeking as well as the amount of money they want the extension to be for. In order to have the form processed, taxpayers must provide a written statement of undue hardship that would be caused if they were to pay their taxes by the original due date, as well as number of supporting documents that support their claim. Taxpayers should receive a decision within 30 days of filing. If given a denial decision, the IRS will provide the taxpayer with a written explanation as to the reason for the denial and the taxpayer will have 10 calendar days from when the denial is mailed to file an appeal to that decision.

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.