What should I do if I can’t pay my taxes?
People who have worked as freelancers on the side, started a new business or gotten estimated payments wrong on their taxes may realize that instead of getting money back from the IRS as many Americans do, they’ll be owing money. Depending on circumstances, it could be quite a lot of money if they haven’t been making payments ahead of time. Owing the IRS a large lump of money can be an intimidating and scary prospect. Many consider putting off filing taxes as a result.
This is the wrong thing to do. There are options if you can’t afford to pay your taxes, and they need to be explored right away to avoid penalties and legal trouble. In fact, communicating your situation to the IRS as soon as you can is the best thing to do. Here are the things that should be done if taxes due can’t be paid on April 15th.
File for an extension right away
Many people don’t know that they can get a six month extension on having to file their taxes. Everyone is supposed to file by April 15th, but filing IRS form 4868 can get taxpayers an automatic six month extension on filing their taxes. That means the new deadline becomes October 15th. That six months can give a freelancer the time to build up the amount of cash they need in order to pay the IRS. Just moving the big deadline down the road can help with stress and worry over the impending deadline.
But the taxes will still come due. And while filing for an extension will give you six months, there will still be some penalties and interest owed for the six month extension. The IRS charges half a percent interest per month on the amount you owe. However, these penalties are nowhere near as high as the penalties for not filing. Not filing has penalties set at 4.5% interest per month. That’s nine times as much as the interest penalty for filing an extension!
To file for an extension, you need to fill out and send in IRS form 4868.
Get on an IRS payment plan
If someone gets to October 15th and still cannot pay their taxes or if they already know right now they will not be able to pay their tax bill, the taxpayer needs to file their taxes anyway. First of all, this avoids the extremely high 4.5% a month penalty from hitting them. That’s 69.59% interest a year! After the first month of being hit with 4.5% interest, you’ll have to pay interest on what you owe plus the previous month’s interest and what you owe rapidly ads up. By filing as soon as possible, the penalties and interest charged to their tax bill are limited. Basically, filing the taxes on April 15th or by October 15th with an extension is always going to save money in the long run. No matter how large and scary the bill is, filing will protect them.
Once the person has filed, it will take the IRS somewhere up to a month to send a bill in the mail for the amount due. If filed on April 15th, it will be for the amount of taxes determined by filing. If later thanks to an extension, the IRS will calculate what is owed for extending the filing and send a bill for that amount plus the original filing amount. Once the taxpayer gets that bill, they need to contact the IRS right away and explain that they cannot pay the tax bill in one lump sum.
This sounds scary and dangerous; admitting to the IRS that you cannot pay. Many worry about arrest, or legal consequences. But the truth is, the IRS has systems for helping taxpayers out and surprisingly excellent in-country phone support. The sooner someone explains to the IRS that they can’t pay and the sooner they can get on a repayment plan, the better off they are. Simply, fees for the repayment plan are even less than the tax extension plan, and they’re far less than not filing and trying to hide from the IRS.
The fee on an IRS repayment plan is .25%, a quarter of a percent, which is half what it is for the tax extension. So the sooner someone can start a repayment plan for the IRS the better off they are.
There are two repayment plans the IRS offers. One is a 120 day extension. Again, this is more time for someone to gather up what they owe.
The other, more common plan, is a repayment plan. This is like paying back a loan, only it’s from the IRS. For a one time fee of $105 (or $52 if you agree to automatic electronic deductions) the IRS will work with a taxpayer to determine a payback plan while charge interest of a quarter of a percent a month. That works out to 3% interest a year. This is better than not filing, which is 54% interest a year. It’s better than trying to get loans.
Now the IRS does have limitations. From their website:
- Individuals must owe $50,000 or less in combined individual income tax, penalties and interest, and have filed all required returns.
- Businesses must owe $25,000 or less in payroll taxes and have filed all required returns.
- If you meet these requirements, you can apply for an online payment agreement.
So, the sooner someone files, and the sooner they get on an IRS payment plan and talk to the IRS, the less damaging it will be. Delaying on either of those points could mean the IRS garnishes wages, or takes legal action. But communicating early and filing with the IRS offers a good faith chance of getting a very fair interest rate and payment plan.
Of course, taxpayers have to be careful not to keep repeating not being able to pay or the IRS may not offer this to them. But if someone needs to handle a suddenly large, unexpected tax bill, they need to file and talk to the IRS.
File and pay from a line of credit (it’s likely cheaper than penalties)
In the event that that a taxpayer owes more than $50,000 in taxes and the IRS refuses to work with them on a repayment plan, a taxpayer should still file their taxes. Taking out a loan would be a last-ditch option, but the interest and penalties for not filing would still be even higher than the interest that most credit cards or loans charge. Getting hit with over 69% interest for not filing taxes adds up quickly. Filing first and then figuring out how to pay is still going to be a cheaper option.
If a taxpayer cannot get a loan, and the IRS won’t work with them on repayment plans, the very last option the taxpayer needs to seek is legal help. First consult a certified accountant, and from there get a recommendation for legal counsel. There are many ads for tax help that prey on the desperate, so a recommendation is often the best route. A lawyer and accountant who are experts with IRS negotiation would be able to give the best advice.