If you owe back taxes and cannot afford to pay, you may feel overwhelmed and stressed about the consequences. Fortunately, you have a few options.
In this article, you will discover what to do when you owe back taxes.
What to Do When You Owe Back Taxes?
The IRS has several tools at its disposal to pursue taxpayer debt and can often tell when a taxpayer hasn’t filed their required tax returns.
Even if you can’t pay your taxes, it is still in your best interest to file your returns on time or as soon as possible, file for a tax extension if applicable, or seek help in remediating your issues with the IRS and relieving your debt.
If your tax debt is negligible, late fees and penalties can quickly stack up and turn a minor headache into a nightmare. And if your debt is substantial, seeking professional help as soon as possible is your best way out.
Here’s what to do when you owe back taxes …
How Much Do You Owe?
The first thing you should figure out is how much you owe. Your best course of action will differ depending on the details of your situation, including your total tax debt (with penalties and late fees), the number of years you’ve neglected to file a return, and your current financial situation.
If your taxes weren’t withheld from your income, then you should have been making estimated tax payments. Your tax return will determine whether these were enough, or too much, requiring either additional payment or mandating a tax refund.
If you aren’t sure of what you owe the IRS, they may be able to tell you directly. The IRS has an online tool allowing taxpayers to review their tax situation and determine how much they owe. They’re also likely to send you a notice regarding your debt if you fail to pay past the due date.
The IRS will add a failure-to-file penalty of 5 percent of your total tax liability onto your tab for every month that you fail to file after July 2020 (rather than April, due to a Coronavirus extension) up until the fifth month, for a maximum of 25 percent, plus a penalty of the lesser of 100% of your total tax liability or $210 in the second month.
This is separate from the interest that tax debt starts accruing after its due date, at a rate of about 5 percent per year. Failure-to-pay penalties are yet another way in which your tax debt can grow, at a rate of 0.5 percent per month, up to a maximum of 25 percent. If this sounds like a lot to calculate, you can check with the IRS to get an accurate estimate of what you owe or speak to a tax professional.
Filing Back Taxes
If you haven’t filed any tax returns in the last year or so, chances are the IRS has filed one for you – this might sound convenient, but these automatic returns are often less than ideal and may cause you to lose out on potential deductions and exemptions because they’re based on approximations rather than your actual earnings and losses over the past year. The IRS has likely filed a substitute return for you if you’ve received a Notice of Deficiency CP3219N.
This can affect your total tax debt. You can file for correction by attaching the corrected returns for those years with your next tax return, or by calling the IRS at 1-866-681-4271. If you don’t have the necessary forms to fill out a tax return for the last few years, you can complete Form 4506-T, which is a Request for Transcript of Tax Return. Your employer may also have the forms you need.
Once you have the necessary forms filled out, you will have to send them to the IRS via physical mail. While the IRS does accept electronic tax returns, it does not accept late electronic tax returns.
What Happens if You Don’t File/Pay?
The IRS’s advice to most taxpayers filing returns late or facing potential tax debt is this:
- File your late returns with the appropriate paperwork
- File for an extension (until October 15th) if you’re behind on filing your most recent tax return
- Prepare a payment plan to cover your tax debt if you have any
- Do it as soon as possible
If you ignore this advice and ignore the IRS’s Notice of a Demand for Payment, the IRS can and will turn towards liens and levies to collect.
A tax lien is a claim by the IRS on your property and assets, taking precedence over any current or future creditors, and thereby meaning the IRS can take a chunk out of the proceeds of a sale if you sell property. This can affect your credit score, and your chances at seeking financing in the near future.
A tax levy is a claim on an account or property to satisfy a tax debt, essentially giving the government the right to empty an account or sell your real estate and use the proceeds to pay your debt. A wage levy means that the IRS may take a monthly cut of your wages until your debt is paid, instead.
By working with the IRS directly or seeking help from a tax professional, you can avoid liens and levies, as well as accumulating penalties and fees.
If you have not filed a tax return for multiple years, your situation may be more complicated. The statute of limitations on a tax debt is a solid decade, meaning the IRS can pursue you for ten years of back taxes, and may ask you to file returns from the last three-to-six years depending on various circumstances. Bankruptcy or living in a foreign country for a period of time can further complicate things. It is recommended that you coordinate with a tax professional to get all the paperwork you need to accurately estimate your debt and set up a payment plan.
Negotiating a Payment Plan
The total size of your tax debt will limit your payment options and determine your best course of action. The IRS will usually put a halt on any liens or levies if you have struck up a payment plan with them, but any applicable interest or penalties will continue to pile up. You have two major routes for eliminating your tax debt:
A short-term payment plan:
- A short-term payment plan requires that you owe less than a total of $100,000 in combined tax, penalties, and interest.
- Any amounts over $25,000 must be paid through Direct Debit.
- There are no setup fees for short-term payment plans, but they require that the full tax debt be paid within 120 days or less.
A long-term payment plan:
- A long-term payment plan requires that you owe less than a total of $50,000 in combined tax, penalties, and interest.
- Any amounts over $25,000 must be paid through Direct Debit.
- Payments are made monthly until the debt is satisfied.
- All tax returns must be filed.
- For information and long-term payment setup fees, visit the IRS’s website.
Under very special circumstances, the IRS may completely eliminate your tax debt, but this is usually only possible if your debt was your spouse’s fault without you knowing (Innocent Spouse Relief), or if they made some kind of major mistake, and attributed taxes to you that didn’t apply. Outside of these rare circumstances, the IRS will attempt to collect as much as it can without financially crippling you.
What If You Can’t Pay?
You can appeal to the IRS to either forgive a portion of your debt, or halt any attempts at collecting (such as liens and levies) until you’re in a better financial situation, and ready to set up a payment plan. These two paths are known as an Offer in Compromise and the Currently Not Collectible status, respectively. Some things to note:
- Currently Not Collectible doesn’t mean your debt or interest is written off. Instead, it simply means that the IRS will temporarily back off from utilizing liens or levies until you get back on your feet. Penalties and interest will continue to grow.
- The IRS will only accept an Offer in Compromise if it matches their Reasonable Collection Potential, and if they can determine that, based on your financial information, you won’t otherwise be able to pay your tax debt. Use this pre-qualifying tool to see if you’re eligible.
Ignoring your back taxes is a very bad idea, but that doesn’t mean your situation is hopeless or unsalvageable. Depending on individual circumstances, you may be able to negotiate a reasonable payment plan or seek a way out that allows you to get your life back without your tax debt hanging over your head. If you aren’t sure on which steps to take next, get in touch with a tax professional today.