On a scale of things we want to do—the top being something like cruising up and down the California coastline in a svelte corvette and the bottom being poking ourselves in the eye—paying taxes probably comes somewhere after having to eat a bowlful of your least favorite food (lima beans, anyone?).
Yet almost everyone has to do it. And not just once; it’s an annual tradition. Just as sure as fireworks will go off on July 4th and mistletoe will be hung in the month of December, the tax man cometh in April.
The most any of us can hope for is to receive a big, juicy refund at the end of the year due to an accounting error. But you know what? Many people actually owe taxes at the end of the year.
Reasons You May Owe Taxes
There are many reasons why someone might owe taxes to the IRS:
Withholding Too Little Money from Your Paycheck: When you first started your job, you most likely had to fill out Form W-4: Employee’s Withholding Allowance Certificate so that your employer would know the amount of Federal Income Tax to withhold from each of your paychecks. You’re supposed to estimate your income but people don’t always estimate accurately. Depending on how you filled out this form, you may have had too little in taxes withheld from your paycheck and that would mean you now owe money to make up for this shortfall.
Cheating (and Getting Caught): The IRS has made it more of a priority over the last four years to recoup the money it is owed by individuals and businesses who are not truthfully reporting their earnings. This includes creating great monetary incentives to snitch on tax cheaters. As of 2008, the IRS will pay between 15%-30% to people whose tip-off to the IRS involves a case of $2 million+ from a cheater who makes at least $200K in income. Tax evasion can include things like false exemptions/deductions, kickbacks, false/altered documents, unreported income, organized crime, etc.
Not Filing a Tax Return When You Were Required to: Perhaps you simply did not file a tax return over the last year, or prior years, and now have found out that you should have done so (not to mention you owe money).
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What May Happen if You Ignore the IRS
The IRS has a pretty decent system in place for dealing with people who do not pay their tax bill (knowingly or unknowingly). The system includes a variety of penalties and actions against you:
Penalties: The Failure to Pay Penalty is one-half of 1% of the unpaid tax for each month the tax is owed (not exceeding 25%). The Failure to File Penalty is 5% of the unpaid tax, and the interest rate is the federal short-term rate plus 3%.
Actions against You: The IRS can put a freeze on your bank account as well as drain it to pay the bill. If you have property, then they can place a tax lien on your property. Also, they can put a levy on your wages of between 30-70%, depending on your living expenses.
Sounds pretty scary, right? Let’s see how to avoid these situations.
How to Pay Off Your Tax Debt
The best way to pay off your tax debt is to pay it all in one chunk. But what if you cannot afford to do that? Fortunately, the IRS offers several payment alternatives to help ease your burden:
Online Payment Agreement: If you owe $25,000 or less (combined taxes/penalties/interest), you can use the Online Payment Agreement (OPA) to request an additional 30 to 120 days to pay.
Installment Agreement Request: If you owe $25,000 or less (combined taxes/penalties/interest), and you need up to 60 months for repayment, then you can set up an installment agreement request through the OPA form above, or by filling out Form 9465: Installment Agreement Request. For balances over $25,000, you will be required to complete a financial statement to determine the monthly payment amount for an installment plan.
Offer in Compromise: The IRS may consider allowing you to pay less than your bill through an Offer in Compromise. The IRS will, “generally approve an offer in compromise when the amount offered represents the most we can expect to collect within a reasonable period of time.” Your ability to pay, income, expenses, and asset equity will all be taken into consideration for this route. If you are considering this, then check out the Pre-Qualifier to see if it’s an option for you. Find out more plus see the application package through Form 656 Booklet: Offer-in-Compromise.
If you want to avoid a menacing tax bill in the future, then be sure to discuss your W-4 withholding options and any circumstances in your life with your HR person at work (here is a W-4 Withholding Calculator from the IRS to help you). Always ensure that you fill out a federal income tax return if you meet the income thresholds for doing so, and be sure to set aside some money in a savings account specifically for the taxes you will owe on any extra income earned throughout the year. And for general tips on paying off your debt, check out this blog post or try signing up for ReadyForZero.
Image Credit: Canadian Pacific