Q: I had a hardship withdrawal from my 401(k) in 2012 to pay for my mortgage. I did not pre-pay any tax or penalty. I understand that when I file my 2012 tax return, I have to pay tax and penalty on the amount I withdrew. However, I can imagine that it is a rather hefty amount and I may not have enough money to pay it. What are my option(s)? -- Thank you, Elk Grove
A: If you cannot pay the entire balance due with your return when you file it, you have two options. Which option you choose may depend on your ability to make monthly payments.
The first option, assuming you can make monthly payments, is to request installment payment agreements with the IRS and FTB. IRS Form 9465 is used to request the federal installment payment arrangement. Use FTB Form 3567 to request a payment plan with the state.
If the federal balance due is under $25,000 and the monthly payment will allow the debt to be paid within 36 months, the IRS will automatically approve the request. Similarly, the state will generally approve requests if the debt is less than $25,000 and can be paid within 60 months. You will have to pay interest and late payment penalties, but you won't be subject to aggressive collection activities as long as you keep current with the monthly payments.
There are processing fees that must be paid with the forms requesting the payment plan. The federal fee is $105 if the monthly payments will be made by check, money order, or credit card; $52 if you pay through electronic funds transfer. The state fee is $34. See the instructions to the forms for more information. They can be obtained from the IRS and FTB's web sites or district offices. You can file them online through the tax agencies' web sites. See irs.gov and ftb.ca.gov.
If you don't have enough income to make monthly payments and you don't have assets that can be borrowed against or sold to raise cash, you may want to consider the second option, making Offers In Compromise to the IRS and FTB to settle the debts. I recently covered the federal Offer In Compromise process in a post on this blog on August 23, 2012 under the title,"How do I work out a settlement with the IRS for back taxes?" The FTB has a similar Offer In Compromise process. Use FTB Form 4905 PIT to make the offer. See the FTB 4905 PIT Booklet for more information.
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