How to Take Action If You Cannot Pay Your Taxes
April 21, 2014The tax filing season has come and gone for everyone that didn’t already file an extension. Even if you filed an extension, you still have the obligation to pay your taxes by the filing deadline of April 15. If you were unable to pay off your tax bill in full then IRS tax debt concerns may linger longer than necessary and at a significant cost.
Failure to pay federal income taxes by the tax deadline of April 15 results in a failure to pay penalty of ½ of 1 percent of your unpaid taxes. This may not sound like much but the penalty is applied to each month or part of a month after the tax due date and begins accruing on April 16. It is important to point out that if you requested an extension of time to file your individual income tax return before the deadline and paid at least 90 percent of the taxes owed along with your request, you may avoid the failure to pay penalty. However, you are still required to pay any remaining balance due by the extended due date.
Any significant debt concerns can lead to financial stress and anxiety. Tax debt concerns add a different layer of concern because the IRS can take aggressive collection measures that place resolving tax debt near the top of the priority list (along with paying the mortgage and student loans). So what can you do if you find yourself unable to pay your income taxes?
Take action and don’t panic. IRS tax notices and balances due on recently filed tax returns can bring out a wide range of emotions. I recall times earlier in my career (before learning to be more proactive with my financial planning) when I used to pace back and forth around the room as I entered additional information into the tax filing program on our computer. The wave of emotions rolled back and forth from “we’re getting a refund” to “oh no, we owe.” It is a natural response to get a little emotional when we see the amount owed exceed our expectations and ability to pay.
Once you recognize that you owe taxes to the IRS, it is important to take action immediately. Just because you cannot afford to pay the taxes due immediately does not mean there are no effective solutions. Many people make a tax problem worse by procrastinating or avoiding it altogether.
File your taxes. One essential step to avoid bigger tax headaches is to file a tax return even if you cannot pay the taxes owed in full. This will eliminate the failure to file or late filing penalties. The penalty for filing late is normally 5 percent of the unpaid taxes for each month or part of a month that a tax return is late. That penalty starts accruing the day after the tax filing due date and will not exceed 25 percent of your unpaid taxes. If you filed an extension, you have until October 15 to submit personal income tax returns.
Explore all available tax resolution options. If you owe taxes and find yourself in a position where you cannot pay them in full, the most common tax resolution alternative is to establish a payment plan or installment agreement. Other alternatives include partial payment installment agreements, currently not collectible status, bankruptcy, or requesting an offer in compromise. If you are considering an option other than setting up a payment plan, you should consult an enrolled agent, CPA, or tax attorney.
Seek professional help as needed and with caution. Dealing with the IRS to resolve tax problems can be an emotionally exhausting experience. That is why the “do-it-yourself vs. use a professional” decision is important. Sometimes it is necessary to use a qualified tax professional to help address tax debt issues with an effective and timely response. Unfortunately, the tax resolution industry is unregulated and many companies do not operate in their clients’ best interest.
CPAs, enrolled agents, and tax attorneys are the only professionals authorized to represent their clients before the IRS. If you are seeking assistance with a tax problem, be sure to ask as many questions as possible regarding the tax professional’s qualifications, experience, fees, and client expectations. Run quickly from companies that promise “pennies on the dollar” settlements or guaranteed acceptances of an offer in compromise. As this Forbes post points out, there are still some less than reputable companies out there preying on vulnerable people that owe taxes to the IRS. Try to find a tax professional that values the financial planning process and one who will help you focus on life beyond the current tax debt situation. If you have other debt concerns outside of state and federal taxes, check out this guide to getting (and staying) out of debt.
Stay current with future tax obligations. While you are working to resolve your tax debt problems, you must stay current with your tax obligations. For self-employed individuals, this requires you to continue (or begin) making estimated tax payments. If you are an employee, you need to make sure that you are having sufficient taxes withheld from your pay. The IRS withholding calculator is a useful tool to help you determine if you are having enough taxes withheld from your pay.
Create a financial life plan. The creation of a financial plan is the single most important step to take when you owe taxes to the IRS. Why? A financial plan provides the guidance needed to help you address the tax situation and other important financial life goals.
Unfortunately, most people tend to avoid this step altogether. When working with clients experiencing tax debt problems, I refer to their financial plan as a tax resolution plan. Here is a recent blog post that I wrote about making the financial planning process work to help you take control of your financial future.
Following the financial planning process will help you obtain a good understanding of where you stand financially. Be sure to complete a net worth analysis that explores everything you own and everything you owe to others. You will also need to complete a cash flow analysis that looks at your income and expenses. These two factors are critical when exploring all of your available options to resolve the tax debt.
The ultimate goal of any debt reduction strategy should be to get out of debt quickly so you can focus on other more important aspects of your financial life. Goals such as saving for emergencies, building a retirement nest egg, paying off credit card debt, buying a house, etc. are difficult to achieve if you owe the IRS. However, financial life goals can serve as strong motivators to stay focused on paying off tax debt. A financial plan will also help you with future income tax planning. Some areas of focus could include maximizing all potential tax deductions, reducing future taxes, tax efficient investing, and planning ahead for future tax related events.
Follow the plan and take action. Tax debt resolution requires a little bit of patience, discipline and planning. If you follow basic elements of the financial planning process, you will be able to get out of debt sooner and move on with your life. Tax problems can add to our financial stress. However, effective solutions do exist if you take action and use the financial planning process to resolve the tax issue while also focusing on improving your overall financial well-being.
Resources:
Eight Facts on Late Filing and Late Payment Penalties