Exploring Your Options for Paying Uncle Sam

The dreaded alternative minimum tax, or AMT as it's commonly known, has been plaguing more and more investors of late.

Not having the cash on hand to pay Uncle Sam will undoubtedly be a painful reality for many investors, especially those stuck with an unexpectedly high tax bill this year because of AMT. The good news is: There are some solutions available to keep the tax man at bay. The bad news is: Many of these can be as unpleasant as paying the tax itself.

First, a primer on AMT. This tax was created by the Internal Revenue Service years ago to make sure that everyone, including the Donald Trumps of the world, paid at least some income tax. So, the IRS requires people with large deductions to calculate their tax bill both the standard way and under AMT rules, which don't allow you any standard or personal deductions. You also don't get credit for any state taxes paid or any other miscellaneous itemized deductions.

However, the AMT has become a problem for many people in recent years because of rising incomes as well as the proliferation of incentive stock options, or ISOs. Under AMT rules, employees who have received ISOs have to include as income the difference between the stock's exercise price and market price on the day of exercise. If you're stuck paying this nasty tax and you're unprepared financially, there are a few things you can do.

Selling Stock

First, if you have some stocks, you can consider selling some of them to pay the bill. The only problem is, the drops in the stock market this year have made this option rather unattractive for most investors. But if you're stuck for cash, now might be the time to take a good hard look at your losers and try to cut your losses on those stocks that may never bounce back.

"If you have something that is down 60% that you do not think is coming back, why hold it?" says Bob Doyle, certified public accountant and personal financial specialist with Spoor Doyle in St. Petersburg, Fla. "Consider selling it. Don't become emotional about your equities. If you think it's a fundamentally flawed stock, why are you still holding it?"

This might also be a good strategy if your allocation to stocks has become too large for your portfolio. You can sell off some of your holdings, pay your tax bill and buy other asset classes with any funds that might be left over. The key, of course, is to put your investment decisions above paying your tax bill -- don't cash out of a smart investment.

Also, if you're taking a loss, you can balm the wound by knowing you just helped yourself for next tax season because that loss can offset some capital gains (remember them?).

Taking Out a Loan

If selling your stocks in a losing market is too much for you to bear, there's always the option of taking out a margin loan on those stocks, says Doyle. That's when you take out a loan from your broker using your stock holdings.

But this options has big, big caveats: When your stocks fall below a certain price, you will get a margin call, meaning that you might have to sell some of the stock in order to pay the broker some of the money you owe. For that reason, Doyle says you should margin only about 20% of your holdings at the most. Other advisers would suggest even less.

Payment Plans From Uncle Sam

Of course, if you don't want to mess with your stock holdings at all, you can always work out a payment plan with the IRS. You can apply for an installment payment plan by filling out Form 9465 and attaching it to the front of your tax return. On that form, you propose how much you can make for your monthly payment, and the IRS will respond with an answer within 30 days.

But note that this option is costly. The IRS charges a $43 fee for setting up the installment agreement, and you will also be required to pay interest (which is 8% for the current quarter), plus a late-payment penalty on the unpaid balance, which is usually 0.5% of the balance due per month. This balance drops to 0.25% when the IRS approves the installment agreement.

Costanza Method

For desperate folks, you can try the George Costanza method: File your taxes, do not send in a payment at all and wait for the IRS to contact you about establishing a payment plan. But this is not recommended, as you'll still incur the monthly 0.5% failure-to-pay penalty plus interest charges. This can add up, especially because it may take the IRS a while to realize you haven't paid and to catch up with you.

Further, if you haven't set up an installment plan with the IRS and just haven't paid, they have the right to withhold some of the balance that you owe from future refunds, says IRS spokesman Chris Kerns.

In considering the IRS payment plan option, the most important thing to remember is to get your tax return in on time. Even if you can't pay or can pay only some of your tax bill, file your return by April 16, the deadline for this year. If not, you will be subject to a late-filing penalty of 5% of the balance for each month the return is late, up to a maximum of 25%. That's on top of the late-payment penalty!

"The biggest issue is filing on time and letting them know what you owe," says Bill Fleming, tax manager at PricewaterhouseCoopers.

Charge It

Another costly option is to pay off your tax bill with a credit card. Of course, that's assuming you have enough credit available in your account. And remember you'll be charged a convenience fee by the credit card processor for this service (Official Payments, an electronic payment service, charges 2.5%) on top of your payment. Plus, there are the high interest rates that many credit cards charge.

This option may appeal to you if you don't want to be at odds with the IRS, but if you don't pay off your credit card debt, that will spell trouble for your credit history.

"That is not for the faint of heart," notes Doyle. "For the person who has poor credit, it's just going to get you into trouble."