Tax day is just around the corner. And while 83% of filers get refunds according to the IRS, so people do owe. What do you do if you find out that you still owe a large chunk of money to the Internal Revenue Service (IRS)? And what happens if you can't afford to pay your taxes?
For example, if you make $50,000 in self-employment income, and fail to make estimated tax payments during the year, you could end up owing $10,000 or more at the end of the year. If you are a wage earner with a salary of $50,000 with no withholdings, you could end up owing close to $8,000, depending on your other deductions and credits.
But what do you do when you don’t have the money to pay the IRS at the end of the year?
Can the IRS go after my wages or bank account? Can they take my house?
Before you panic, let’s look at your options.
Understanding Your Payment Options
Many people have a negative view of the IRS. Maybe it's the old movies of G-Men breaking down your door and making your life miserable. But in reality, the IRS will most likely work with you if you're being honest about your taxes and situation.
As such, the IRS has several options to help people pay their taxes.
60 Day Extension to Full Pay
A 60 Day Extension to Full Pay is a “one shot deal” where the IRS will give you 60 days to full pay the balance. Only use this option if you are certain you will have the funds to full pay the balance in 60 days, or in the event of an emergency.
Important Points About 60 Day Extension to Full Pay:
- It is a one shot deal.
- Only use it when you are sure you can pay off the tax balance within 60 days.
- If you are not able to pay off your tax debt within 60 days, you can still set up an installment agreement, but the IRS may hold it against you.
If the balance is under $50,000, you can set up a streamline installment agreement over the course of 72 months. However, you do not have to use direct debit if the balance due is $25,000 and under. If the balance is over $25,000, you will want to use Form 433-D direct debit or payroll deduction to avoid liens. You can also do a financial-based installment agreement, but liens will be filed.
Read more on IRS installment agreements here.
Streamline Installment Agreement For Balances $25,000- $49,999: You will need to submit Form 433-D Direct Debit Authorization by phone, mail, or fax in order to avoid liens being filed.
Financial Based Installment Agreement For Balances $25,000- $49,999: If you cannot afford the 72 month streamline installment agreement option, then you can set up an installment agreement based on your financial information. However, tax liens will be filed. You will be required to submit a financial statement, or Form 433-F by phone, mail, or fax.
Financial Based Installment Agreement For Balances Over $50,000: You will be required to submit a financial statement, or Form 433-F by phone, mail, or fax. Tax liens will be filed.
Important Points About Installment Agreements:
- The payment method and requirements for installment agreements vary based on the balance due.
- If you select a financial based installment agreement, tax liens will be filed.
Temporary Hardship Status (Also known as Currently Non Collectible, or Status 53)
This is a financial based resolution where tax liens will be filed for all balances over $10,000. Temporary Hardship Status is, as the name suggests, temporary. Temporary hardship status is good for up to 2 years, and then subject to review. If you incur additional liabilities, the new balances will default your hardship status, and cause the balances to go into collections, causing you to have to submit financial information all over again.
Important Points About Temporary Hardship Status:
If you have assets, such as a home, the IRS will expect you to borrow against the equity in your home to pay down the tax debt. If you have a 401k or investment income, the IRS will expect you to borrow against the accounts, or even liquidate them before qualifying for hardship status.
Tax liens will be filed for balances over $10,000. A federal tax lien is a notice to creditors that you owe money to the IRS.
Offer in Compromise
An offer in compromise is an effective way to settle your tax debt. However, there are financial qualifications, and the IRS will be able to uncover any income or assets attached to your name, so you have to be forthcoming in your application and provide complete information.
The IRS has a pre-qualifier assessment that will make it easy to determine if you qualify for an Offer in Compromise.
There is a specific formula, but if your disposable income can pay off your total tax debt in 10 years, then your offer is likely to be rejected. Also, your offer amount should be within the range of acceptance.
Considerations For Filing An Offer In Compromise
An offer in compromise allows you to settle your tax debt for less than the full amount you owe. This is the best option when you cannot fully pay your tax liability, or doing so creates a financial hardship.
Unlike Currently Non Collectible / Hardship Status, once the offer is accepted, your case is settled, so long as you abide by the terms and conditions of an Offer in Compromise. In your offer application, the IRS considers your unique set of facts and circumstances:
- Ability to pay
- Asset equity
For more information, review the IRS Offer in Compromise Booklet 656.
What Happens If The IRS Accepts My Offer In Compromise?
If your offer in compromise is accepted:
- You must pay the offer amount in accordance with the terms of your acceptance agreement.
- The IRS will keep any tax refund, including interest due, as the result of an overpayment of any tax or other liability due through the calendar year the IRS accepts your offer in compromise. You may not designate a refund and/or overpayment to be applied to estimated tax payments for the following year. This condition does not apply if the offer in compromise is based on doubt as to liability only. If a Notice of Federal Tax Lien has been filed against you, the IRS will release it when the payment terms of the offer in compromise have been completed.
- You must remain in compliance with filing and payment of all tax returns for a period of five years from the date the offer in compromise is accepted, including any extensions. If you do not pay the offer in compromise on time and remain in compliance during the five-year period after the offer in compromise is accepted, including any extensions, your offer will default. This means that you cannot owe any tax balances for the five-year period after your offer is accepted- this is a very important point that most people miss.
Important Points About Offer in Compromise
- Assets must be borrowed against or liquidated.
- Compliance and no additional tax liabilities for 5 years after the offer in compromise has been accepted.
- Refunds filed in the year the offer in compromise is filed will be taken.
You could also find a way to pay the debt yourself by borrowing funds to pay it.
Take advantage of any low interest loan options to pay off your tax debt. You can borrow from your credit cards or apply for a private loan. If you pay off IRS debt with a credit card, beware of the additional processing fees.
How To Prevent Owing The IRS Money In The Future
Now that you have familiarized yourself with your options, let’s take a look at how to prevent this from happening in the future. Remember, most people get a tax refund, but the goal really is to break even (that means withholding enough through the year to balance at tax time).
Usually, if you owe the IRS, it is for one of the following reasons:
- Inadequate withholding (you didn't have enough taken out of your paychecks throughout the year)
- Failure to make estimated tax payments (this typically applies to small business owners)
- Failure to take advantage of tax deductions or tax credits
Here are the main ways to change that.
Adjust Your Withholdings to Avoid Owing Taxes At The End of The Year
If you find yourself owing money and you work a job, you likely aren't having enough money taken out of your taxes. When you get your W-4, you have the option to claim exemptions based on your status (for example, single zero, married with 3 dependents, etc.).
You will want to select the withholding that reflects your actual status, but if you are trying to be prudent and proactive to prevent owing in the future, you can claim single zero in extreme cases. If you are in a high-income bracket, even claiming single zero will result in a balance due, and you may have to make estimated tax deposits on top of that.
You can also adjust your W-4 to have an additional amount beyond the exemptions taken out. This can help if you have multiple income streams, such as investments or real estate.
Make Estimated Tax Payments To Minimize Balances And Avoid Penalties
Based on how much you owe the last year, you should estimate how much you will owe for the upcoming year and divide it into quarters.
In order to avoid any estimated tax penalties, follow the steps below:
- Estimated tax safe harbor for higher income taxpayers. If your 2016 adjusted gross income was more than $150,000 ($75,000 if you are married filing a separate return), you must pay the lesser of 90% of your expected tax for 2017 or 110% of the tax shown on your 2016 return to avoid an estimated tax penalty.
- Deposits are normally made quarterly, but you can also make payments weekly, monthly, or semi-monthly.
- Form 1040-ES includes an Estimated Tax Worksheet to help you calculate your federal estimated tax payments.
- IRS Direct Pay provides for a fast and easy way for you to make your payments for either estimated tax payments, installment agreement payments, or payments for your tax return.
Maximize Your Tax Deductions To Minimize Your Tax Liability
Your CPA may not have taken advantage of all the credits and deductions you are entitled to take, so you will want to review this with them.
Keep track of your business deductions, and refer to this list of commonly missed business deductions to make sure you don’t miss anything. For 10 ways to save on your taxes that you can implement fast, click here.
While there are many options to pay your current year and back year taxes, there are also many steps you can take to make sure you minimize your taxes and maximize your savings.
When you select a repayment plan for your tax liability, select the option that will cause you the least hardship and least impact on your financial track record and credit.
And remember, if you have questions, seek advice from a tax professional!
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.