Life can throw curveballs, which has been readily apparent in the past few years. The coronavirus pandemic has impacted many families’ finances and taxes in several ways. Thankfully, Congress has helped with some relief. Even so, your tax situation may have changed drastically from the previous year.
When significant personal tax changes happen, there’s always a chance you could end up owing money when filing your taxes. If you find yourself with a balance due, don’t ignore it and hope it will go away. Instead, understand what it means, what it could cost you, and what your options are.
Steps to take if you owe
1. File your tax returns by the deadline
The first thing you should do is file your tax return on time. If it’s already late, filing it as soon as possible can potentially stop the failure to file penalty from increasing.
Luckily, doing your taxes isn’t as difficult as it once was. Tax software has come to the rescue, with companies like TurboTax. They’re one of the largest paid tax preparation software options out there. Their software is relatively easy to use and allows you to file your return without a ton of specific tax knowledge.
Cash App Taxes is another option, and it offers the ability to file your tax return for free for all situations they support. It’s refreshing to see a tax software not charge you to prepare and file your return.
Read more: Best tax software for 2023
2. Pay as much as you can
When you file your return, it makes sense to pay as much as you can afford to pay upfront. Doing this does two things:
- It reduces the amount of interest you’ll incur.
- It could reduce the dollar amount of the failure to pay penalty.
3. Consider alternative payment arrangements
You may not be able to pay in full when you file your return. If that is your situation, you do have options to work with the IRS.
Short-term payment plans
If you just need a few months to pay what you owe, consider a short-term payment plan. These plans can give you up to 180 days to pay in full. You can apply for this plan using the IRS’s online payment agreement page. Interest and penalties still accrue until your balance is paid in full.
If you can’t pay your taxes in 180 days, you may be able to set up a monthly payment plan. You use the same online payment agreement page to start the process, call the IRS, or submit Form 9465 with your tax return.
There is a fee to use this service, but low-income taxpayers may have the cost reduced or waived. You must be current on all filing and payment requirements to use this option.
Offer in compromise
In some cases, the IRS may agree to settle your tax debt for less than you owe, but you don’t need to use one of those creepy radio commercials to do it. There is an option called Offer in Compromise.
You must have filed all tax returns and made all necessary quarterly estimated tax payments for the current year to use this option. And, unfortunately, this is not an option if you are in an open bankruptcy.
The rules for this can be complex, so it’s best to use the IRS’s Offer in Compromise pre-qualifier tool to see if you qualify.
Temporarily delay collections
People in a challenging financial situation may not be able to put food on the table, let alone pay their tax bills. The IRS may temporarily delay collections if they find you cannot meet your basic living expenses.
Unfortunately, you still owe the tax due, and interest still accrues, as well as late filing and late payment penalties. This method can delay collection proceedings such as a lien or levy, though.
What happens when you owe taxes
If you can’t or don’t pay the taxes you owe with your return, you could incur a ton in interest and penalties.
The IRS can assess two different types of penalties depending on the situation you’re in. If you don’t file the tax return, you get a failure to file penalty. This penalty costs you 5% of the unpaid taxes for each month (or part of a month) that your tax return is late. The maximum failure to file penalty is 25% of the unpaid taxes, so it stops accruing after the return is five months late.
The failure to file penalty also comes with another penalty for tax returns that are at least 60 days late. You’ll pay either $435 or 100% of the tax owed, whichever is less. You can avoid this penalty by filing your tax return on time, even if you can’t afford to pay the bill you owe.
If you can’t file on time, you can file an automatic six-month extension. This doesn’t give you more time to pay your taxes owed, but it does give you six more months to file your return without incurring the failure to file penalty. For 2023, the deadline to file 2022 taxes is April 18 without an extension. If you file for an extension, you will have until October 16 to get your tax return submitted.
The second type of penalty you could have to pay is a failure to pay penalty. This penalty is usually 0.5% per month (or part of a month) your payment is late. This penalty can add up to 25% of the tax owed, so it takes 50 months to max out.
If the IRS issues a notice of intent to levy your property, the 0.5% rate increases to 1% per month for any amounts still unpaid ten days after the notice is issued. You can also reduce this penalty to 0.25% per month if you file your tax return on time and set up an installment agreement with the IRS.
In addition to penalties, you’ll have to pay interest on amounts not paid on time. The interest rate changes quarterly and is based on the federal short-term rate plus 3%. You can view the current rate on the IRS website in their Newsroom section. Also, note that your interest will compound daily. The current rate for 2023 is 7% for underpayments.
Should you take out debt to pay off tax debt?
IRS tax debt is one of the nastiest forms of debt you can owe, but thankfully the interest rates are extremely low right now. Even so, some people would sleep better at night by paying off Uncle Sam, even if it means taking out other debt to do so.
Sometimes a 0% introductory rate credit card may seem like a good idea to pay off the tax debt you owe. If you successfully pay off the balance before the introductory period ends without missing any payments, you may not have to pay any interest at all.
The downside comes if you miss payments or don’t pay the balance off in full. Credit card interest rates are often several times higher than the IRS’s interest rates. Incurring regular interest charges on a credit card could be more expensive than working to pay the debt off with the IRS.
Personal loans could be an option if you want a fixed monthly payment but don’t want to use or don’t qualify for the IRS’s installment agreement option. Check to make sure the interest you pay on the personal loan would be less than using the IRS’s installment agreement before you get started, though.
Ultimately, you must decide if taking out other debt to pay off your tax debt is something you want to do. If you decide to do this, try to find the lowest interest rate option you can and make sure to pay the loan off on time.
Finding out you owe the IRS money when you go to file your taxes is a nasty surprise, especially if you can’t afford to pay the bill. Unfortunately, it does happen. File your return on time even if you can’t pay to ensure you don’t incur failure to file penalties. You can file using paid software, such as TurboTax, or free software, such as Credit Karma Tax.
Based on your situation, you may want to pursue a short-term payment plan, installment agreement, offer in compromise, or temporary collection delay. If you’d rather owe someone else money than the IRS, you may want to consider using a 0% introductory rate credit card or a personal loan to pay off the amount you owe, too.