What Is Tax Debt and How To Pay it Off
7 MIN READ
Published April 07, 2023 | Updated February 09, 2024
Tax debt can become a heavy financial burden when ignored or missed unintentionally. Sometimes you, as a taxpayer, are unaware of the actual tax liability, or perhaps you are facing financial hardships and can’t keep up with tax commitments.
What is a Tax Debt?
For each financial year - typically from April 1st to March 31st - citizens must pay the total amount of tax owed on or before the original filing due date.
When you fail to pay your back taxes as the federal income tax department requires before the due date, you create a Tax Debt.
If you fail to pay in time, you will be penalized for unpaid taxes by the IRS. Interest will be added to your debt. Even after you pay those penalties, your actual tax debt is still there, waiting to be paid.
The situation can get worse over time.
What happens when you have tax debt?
Even if you can not pay the debt you owe, pay attention to those tax bills and urgent notices sent by the IRS. There are plenty of solutions that you can opt for even when you have a tax debt.
Before forcing you to pay, the IRS offers you many chances to pay partial/ full tax and start from there. These include actions such as wage garnishments, federal tax liens, levies, and more.
When such circumstances arise, you will receive multiple notices requesting to make the payment.
If you fail to reply to those urgent notices, the IRS can implement forceful actions. The government can even seize your assets. While a distant possibility, you might even be looking at serious legal trouble.
What happens when you have tax debt:
Notices from IRS
The IRS will officially send you urgent notices stating your tax bill before taking action with harsh tactics.
The real problem arises when you start ignoring these notices from the IRS and fail to take significant action toward resolving these notices.
IRS will stop your refunds
Suppose you have a tax refund to be collected in a later year from your previous tax return. You will most likely lose it in that case, as the IRS will automatically deduct it.
However, if you look closely, this might be a good thing. If the IRS keeps your refund, you are more likely to have reduced interest rates for your remaining taxes.
Interest Buildup with Penalties
The IRS will charge you additional interest and penalties ifyou are already in tax debt.
Upon failing to answer those notices sent by the IRS, you might even be charged a penalty as high as 1% per month. On the other hand, when you decide to pay and set up an agreement, the rates can go as low as 0.25%.
Seizure of Assets by the IRS
Sometimes, the IRS seizes assets of significant or repeat offenders under special circumstances. These can include your property, vehicles, and bank account too.
Tax Debt Relief Options
If you have already incurred a tax debt, check out these debt relief options to eliminate it.
IRS Payment Plan(s)
- An IRS repayment plan is a solution to help you pay your back taxes in an installment agreement. Think of it as a personal loan that you should pay with interest. While paying your taxes to the IRS, there are two payment options: Short Term and Long Term.
- Short-Term IRS Debt Plans allow you to settle your tax debt within 180 days. To qualify for the short-term plan, your total tax debt balance, interest, and fees should be at most $100,000.
- Long-Term IRS Debt Plans last over 180 days and might go up to six years, depending upon the agreement. Your owed taxes, interest, and other fees must be less than $50,000 to pursue this plan.
Innocent Spouse Relief
If you filed a joint tax return with your spouse, and they made an error while filing taxes, you won't be in debt for their mistake.
The following scenarios are examples of when you might be able to take advantage of this type of relief:
- If you and your spouse have filed a joint tax return.
- Errors in filling your income, deductions, and asset values.
- You were not in the loop when your spouse filed the taxes incorrectly.
- When you are living under a community property state.
However, there's a catch: even if your spouse made tax payments with errors, relief would only apply to your spouses' income, not yours. Hence you won't be in any position to claim any tax relief from the following:
- Your income
- Other Household Employment Taxes (if any)
- Various Business Taxes
- Individual - Shared Responsibility Payments
- Trust Fund Recovery Penalties
The best way to avoid penalties on due IRS collection is to file your taxes after consulting a tax professional.
Offer in Compromise (OIC)
Another tax debt relief option offered by the IRS is OIC. It means you can pay less than your original debt and settle it with penalty abatement.
It is a rare occurrence but still a good opportunity, primarily if you have incurred a lot of tax debt over the years.
These are the deciding factors for your OIC Approval:
- A Stable Income
- Asset Equity
- Your Current Expenses
Currently Not Collectible (CNC)
In some situations, the IRS concludes that an individual cannot repay the tax debt. Such accounts will be marked as Currently Not Collectible.
While you still owe the tax debt accruing all the penalties and late fees, the IRS will only attempt to collect it from you later.
Alternatives to Tax Debt Relief
If the routine tax debt relief procedures do not work, you can choose these alternatives:
Get a Personal Loan
A personal loan is an easy way to get money quickly to pay off your tax debt. It can prove to be an effective solution if you manage it. If you go this route, you’ll want to have a good credit score, and stick to a debt management plan.
Pay through a Credit Card
There is an option to put your tax debt onto your credit card and then pay it off gradually. But that would be only possible with a credit card qualified for a 0% introductory purchase APR period. Still, you must pay additional annual fees, processing fees, etc.
Suppose you do not owe a significant tax debt. In that case, it can be a good option because credit cards are a type of revolving debt, and you can handle it through minimum monthly payments.
Home Equity Loan
Individuals who own a home can opt for an equity loan to pay the tax debt. It will use your home as collateral, and you can get up to 85% of your home's value as a loan.
Although this is an option, paying your tax debts with such secured debts is only recommended if you do not have a solid repayment plan.
Borrowing from Your 401k
You can opt for paying off the debt from your 401k pension fund and not paying the 10% early withdrawal tax while at it.
Redeeming a loan from your 401k before retirement might also attract a tax penalty from the IRS. Additionally, you must repay that 401k loan with interest in under five years.
Avoid Tax Debt Relief Scams
You might not be aware of this, but the market is full of tax relief companies that might trap you under their various scams. These companies will put your data at risk which could get you into even more trouble than you already are.
Hence, while looking for a tax relief company, be sure to check the following criteria:
- Do not fall for fake assurances given by any tax relief company.
- There will be a series of lies and delays when such companies are "processing" your application.
- Visit the BBB and other online review sites to ensure their legitimacy
Companies that can help with tax debt relief
Owing tax money can make you feel bad, but you’re not alone in this. At the end of 2021 more than 10 million Americans could not afford to pay their taxes.
Not paying your taxes could result in seizure of assets, wage garnishment, and other critical problems.