Taxes From A To Z 2020: U Is For Undue Hardship

It’s my annual Taxes from A to Z series! If you’re wondering how to figure basis for cryptocurrency or whether you can claim home office expenses during COVID, you won’t want to miss a single letter.

U is for Undue Hardship.

If you’d read any posts on extensions – like this one – you are aware that filing for an extension is generally an extension of the time to file, and not the time to file. It’s almost the extension mantra.

But did you know that there actually is an extension available for payments – but there’s a pretty high bar.

First things first. The form is Form 1127, Application for Extension of Time for Payment of Tax Due to Undue Hardship (downloads as a PDF). It’s used to request an extension of time under section 6161 for payment of the tax shown on your return or an amount determined as a deficiency (an amount you owe after an examination of your return). It’s not meant to be a substitute for a regular extension or to set up an installment agreement.

You can file Form 1127 if you will owe any of the following, and paying the tax when it is due will cause an undue hardship.

Income taxes
Self-employment income taxes
Withheld taxes on nonresident aliens and foreign corporations
Taxes on private foundations and certain other tax-exempt organizations
Taxes on qualified investment entities
Taxes on greenmail (popular in the 1980s but not so much now)
Taxes on structured settlement factoring transactions
Gift taxes (but not estate taxes)

Form 1127 can also be filed if you receive a notice and demand for payment (or tax bill) for any of the following if paying them at the time they are due will cause undue hardship:

Normal taxes and surtaxes
Taxes on private foundations and certain other tax-exempt organizations
Taxes on qualified investments
Gift taxes

But here’s the key. You can only use the form if you can prove undue hardship. “Undue hardship” means more than an inconvenience: you must show that you would sustain a substantial financial loss if required to pay a tax or deficiency on the due date. The mere inability to pay does not ordinarily result in penalty relief. Under Treas. Reg. 301.6651–1(c), you must also show that you exercised ordinary business care and prudence for the liability. The IRS will look at all of the facts and circumstances, including your financial situation, and the amount and nature of your spending compared to your income. The IRS will consider whether you made reasonable efforts to conserve sufficient assets in a marketable form (you can’t have converted them to illiquid assets or restricted them in some way) and still could not pay all or part of your tax when it came due.

But you know how I noted earlier that an extension to file isn’t an extension to pay? The reverse is also true: undue hardship generally does not affect your ability to file. You can substitute this form for an extension to file (and it usually doesn’t provide a basis for penalty relief in a failure to file situation).

You should file Form 1127 as soon as you know of a tax liability or a tax deficiency that you cannot pay. If the liability is for an upcoming return, file on or before the due date of that return, not including extensions. If you are requesting an extension of time to pay an amount determined as a deficiency, file on or before the due date for payment indicated in the tax bill.

Typically, the IRS won’t give you more than six additional months to pay the tax shown on a return. However, other than taxes due under sections 4981 (excise tax on undistributed income of real estate investment trusts), 4982 (excise tax on undistributed income of regulated investment companies), and 5881 (greenmail), you may be granted an extension for more than six months if you are out of the country. And you must pay the tax before the extension runs out: do not wait to receive a bill from the IRS.

You can find the rest of the series here: