When the last pine needles of Christmas have been vacuumed up and we’ve thrown in the towel a week into our New Year’s resolutions, many of us reach a horrifying realization: Tax Day is approaching.
Another scary thought, what if you owe money and don’t have the funds to pay?
After two years of extended filing deadlines because of the global pandemic, we are back to our more traditional April date. This year, Tax Day is April 18. Traditionally, Tax Day is April 15, but due to Emancipation Day in Washington, D.C., the deadline has been moved forward.
Who Owes and Who Gets a Refund?
Last year, 61% of American households wound up owing the federal government nothing when filing their tax returns. That means they either 100% correctly predicted what they’d owe the government and paid it correctly over the course of the previous year or walked away with a nice refund check.
The other 39%? They owed Uncle Sam some money. And experts believe that that number will grow as we move away from some of the relief programs implemented for the pandemic.
But what if you can’t pay your taxes? Are there options for families who don’t have the money when it’s time to file? Below, we’ll explore why families still owe money on taxes even if their employer is taking money out of their paycheck — and how you should proceed if your tax debt is more than you can afford.
8 Tips for Paying a High Tax Bill
You will want to do everything in your power to pay your taxes. The ramifications of tax evasion are extreme and can ruin your life.
So what do you do if you can’t afford your taxes but want to avoid the penalties, asset seizure and potential jail time? We have a few suggestions:
1. Dip Into Your Emergency Savings
While most people struggling to pay their taxes likely don’t have an emergency fund available, it’s worth saying: This is a true financial emergency. If you have an emergency savings account, utilize whatever funds are available to pay down your taxes, even if you only have enough for a partial payment. Every little bit helps.
2. Borrow From Yourself
You might not have enough in emergency savings, but if you have started a retirement fund, you can borrow early from this. There are large fees associated with borrowing from your retirement savings — and it will obviously give you trouble in your golden years — but if the money is available and you need it, use it.
3. Ask Friends and Family
While it can be challenging to ask for money from people whose respect you have worked hard to earn, now is the time to swallow your pride and ask for a loan. Just be understanding if they say no.
4. Pay With a Credit Card
You may be tempted to do this but it’s not a good idea even though using a credit card in an emergency is sometimes the only option. Just make a plan to pay off the credit card debt as quickly as possible, and be wary of using a card with an unreasonably high annual percentage rate (APR).
5. Take Out a Personal Loan
You might be able to get a better interest rate on a personal loan than what your credit card offers. Work with a bank or credit union to get approved for a loan to pay off your taxes before the deadline.
6. Apply for a Payment Extension
Form 4868 gets you a filing extension, but you still owe your total tax amount by April 18. If you are able to prove true financial hardship to the Internal Revenue Service, however, the IRS could grant a payment extension. For that, you’ll need Form 1127.
Payment extensions are rarely approved and challenging to apply for. You’ll have to send the IRS a statement of all your assets and liabilities, as well as an itemized list of all the money you’ve earned and spent over the previous three months. All it takes is one flashy purchase in the preceding months for the IRS to reject your request.
7. Apply for an Offer in Compromise
If you are able to prove that you truly can’t pay your taxes because of undue financial hardship, you can apply for an “Offer in Compromise.” The Offer in Compromise approach allows you to suggest an amount you think you can pay; if the IRS accepts, that’s your new tax debt that must be paid.
The IRS considers your ability to pay, income, expenses and asset equity when making an Offer in Compromise determination.
8. Request an Installment Plan
As mentioned above, you can apply for an IRS payment plan wherein you make a monthly payment on taxes owed. You’ll still be responsible for penalties and interest, but if the IRS accepts your request for a monthly payment plan, you won’t have to worry about asset seizure and imprisonment.
Why You Might Owe More Taxes
If you work a traditional job with a steady paycheck and W-2, your employer takes money out of each paycheck and give it to the federal, state and local government on your behalf.
However, the amount they withhold from your paycheck depends on how you filled out your W-4. On this form, you’ve indicated to your employer your filing status, how many withholding allowances you want and any additional amount you’d like withheld. Each time you encounter a life change (marriage, divorce, birth, retirement, a move, etc.), you should fill out a new W-4 with your employer.
If your W-4 is not accurate, your employer could be withholding too much (which results in a refund) or too little (which means you’ll owe money on your tax return).
If you are self-employed or run a side hustle, you must pay quarterly estimated taxes. Spread across four installments, you can either pay 100% of what you will owe for a given year (which can be challenging to predict if your work is not steady) or 90% of what you owed the previous year. If you intend to make around the same amount as the year prior, paying the 90% is a safe bet.
However, because it’s estimated, it is possible you will have underpaid. That means you may owe more on Tax Day.
What Happens If You Don’t Pay Your Taxes?
So what if a tax professional or your tax preparation software does due diligence to get your tax bill down as low as possible — but you still owe taxes. Can you just not file?
The answer (and you probably knew this) is no. No matter what, you should file your taxes every year. The financial and legal ramifications of not filing taxes can be life-changing — and not in a good way.
For starters, you’ll owe interest on your taxes owed, plus penalties for late payment and filing. Over time, unpaid tax bills can lead to a federal tax lien on your assets (car, house, etc.), and the government can garnish your wages. Eventually, you could face up to five years in prison for tax evasion.
There are two elements to consider when you can’t pay your taxes: filing late and paying late. Each has its own implications; even if you can’t afford to pay the full tax liability, you will still want to file the return to avoid separate penalties and interest related to late filing.
When You File Late
The Internal Revenue Service (IRS) does grant filing extensions if you won’t be able to make the April 18 deadline. You’ll need to submit Form 4868 to get up to six additional months to file your taxes.
The kicker? You still have to submit payment for what you owe (or, to be safe, more than what you owe) by the tax deadline. That, of course, can be challenging to do until you’ve actually sat down and calculated your tax liability. And once you’ve done that, why wouldn’t you just file?
If you are certain that you will not owe taxes but are just not able to file by Tax Day, filing for an extension can make sense. If you don’t file for an extension but also don’t file in time, you could be subject to fees and penalties.
Known as the Failure to File Penalty (or, colloquially, late-filing penalty), this fine should not be taken lightly. Typically, the IRS charges 5% of the tax you owe every month (or part of a month) that you wait to file your taxes after the deadline. The maximum late-filing penalty is 25% of your tax burden, which equates to five months of the failure-to-file penalty. You will also owe interest on your penalty.
If Uncle Sam owes you money and you miss the filing deadline, you won’t be assessed any penalties. However, hurry up and claim what’s yours. Typically, you only have three years to get your refund.
You should always file your taxes on time (or ask for a filing extension), even if you can’t pay on time.
When You Pay Late
So you’ve worked with a tax professional or tax preparation software to complete your federal tax return, and you’re at the finish line. There’s only one problem: You can’t afford the tax bill. What do you do?
At the very least you should still file to avoid the Failure to File Penalty. And you should exhaust every reasonable option you have to pay on time as well (we’ve got plenty of tips below). But, if you truly cannot pay your tax bill come April 18, you can expect late-payment penalties and interest on your tax debt.
Note: There are two Failure to Pay Penalties. One is for failing to pay the amount shown on your tax return. The other is for failing to report income and thus not paying the right amount. The latter typically involves purposeful tax evasion, so we’ll focus instead on the former scenario.
Financial Implications of Paying Late
A Failure to Pay Penalty, assessed for not paying the amount shown on your tax return, results in a fine of 0.5% of the total tax bill for each month the taxes go unpaid. Like the Failure to File Penalty, this penalty tops out at 25% of the total tax debt.
If you owe a Failure to File Penalty and a Failure to Pay Penalty, the late-filing penalty drops to 4.5% and the late-payment penalty stays at 0.5% for a total of 5.0%.
If you apply for an approved payment plan (an installment agreement with the IRS that allows you to make monthly payments on your tax bill), the monthly penalty decreases to 0.25%. But if you don’t pay your taxes or apply for a monthly installment agreement, the IRS will send you a notice with their intent to levy (more on this below); at that point, the penalty increases to 1% a month or partial month.
In addition, the Internal Revenue Service applies a 3% interest rate on all unpaid taxes. You will also owe interest on the penalty amount.
Legal Implications of Paying Late
If you ignore IRS communications demanding payment, the IRS may issue a Notice of Federal Tax Lien. This lets creditors know that the IRS now has a right to your personal property, assets and real estate.
Eventually, the IRS could issue a levy, which means the government may begin to actually seize your assets directly from your bank account, seize and sell your home and/or vehicle and garnish your wages from your employer.
If at that point, you still have not paid the government, you can face jail time of up to five years.
Paying Your Taxes: Bottom Line
If you’re concerned about being able to afford your tax bill, consider these points:
- The IRS charges fees for filing late and paying late.
- Paying late could eventually lead to seizure of assets and jail time.
- The IRS has options for those who are truly struggling financially, like a monthly payment plan or Offer in Compromise.
- Exhaust all options (credit cards, personal loans, emergency savings, even friends and family) to pay your taxes on time and in full.
Timothy Moore covers bank accounts for The Penny Hoarder from his home base in Cincinnati. He has worked in editing and graphic design for a marketing agency, a global research firm and a major print publication. He covers a variety of other topics, including insurance, taxes, retirement and budgeting and has worked in the field since 2012 with publications such as The Penny Hoarder, Debt.com, Ladders, WDW Magazine, Glassdoor and The News Wheel.