What happens if you file your tax return and discover that you are unable to pay the amount owed?
This is not meant to occur. You’re meant to pay your income taxes progressively throughout the year so that you don’t owe much in April and may even be eligible for a refund of overpaid taxes. Income tax is deducted from employees’ paychecks. Self-employed individuals pay quarterly estimated taxes to the Internal Revenue Service (IRS).
However, your personal condition may alter or an exceptional one-time occurrence may occur throughout the year. When you file your yearly tax return, you may be surprised to see that you owe hundreds or thousands of dollars that you did not anticipate and simply do not have.
While this is a bad circumstance, it is not the end of the world. There are many options for dealing with it.
- If you do not pay your taxes by the due date, you will begin to incur interest and penalties on the unpaid balance.
- As time passes, you may be susceptible to liens on your property or wage garnishment.
- In the most severe cases of tax evasion, you might face up to five years in prison.
- To avoid extra failure-to-file penalties, submit your tax return on time, even if you can’t pay your tax burden at the time.
- You might charge your tax burden to your credit card for a convenience fee or seek for a debt consolidation loan to pay your tax due on time.
- You may also take from current resources, such as an emergency fund, a home equity line of credit, or a retirement account.
What Happens If You Don’t File or Don’t Pay
If you get into difficulties, you don’t want to postpone submitting your tax return or fail to pay your taxes entirely. If you do not endeavor to make good on your income tax due, the government has the jurisdiction to take your assets. In the most severe cases, you may face incarceration.
A variety of circumstances may result in fines and interest costs. The two most common are late filing and late payment of taxes.
For victims of large hurricanes and other natural disasters, the IRS often delays tax filing deadlines. You may check IRS disaster relief notifications to see whether you are eligible.
Filing Your Taxes Late
If you are unable to file your tax return by the deadline, you should obtain an extension of time to file with the IRS by filing Form 4868 by the due date (typically April 15th).
It is crucial to remember that submitting this form does not provide you a time extension to settle your tax due. You must still submit any money you owe before the deadline.
Even if you submit Form 4868, you must ensure that your tax burden has been paid (or more conservatively, overpaid, with a refund due at the time you actually file your return).
Failure-to-file fines apply if you file your tax return late or do not file at all. These penalties are levied on returns that are not submitted by the due date (or extended due date, if you filed Form 4868).
The penalties are calculated at 5% of the unpaid taxes for each month or portion of a month that a tax return is late. After five months, the charges are capped, and the failure-to-file penalty is 25% of the outstanding tax debt.
If you submit your return more than 60 days after the due date (or extended due date), the minimum failure-to-file penalty is $435 or 100% of your total tax obligation, whichever is less (for tax returns due after December 31, 2020).
As you can see, filing late, with or without an extension, does not pay off. Even if you do not have the cash to pay your existing tax bill by the due date, you should still submit your tax return to avoid further failure-to-file fines and interest.
Paying Your Taxes Late
You may be tempted to file your tax return but fail to pay the money you owe. If you do not pay your taxes by the due date, interest and penalties will begin to accumulate on the unpaid amount.
Failure to pay incurs interest at the federal short-term rate + 3% each day beyond the due date, compounded daily (whether or not you filed an extension of time to file your return).
The failure-to-pay penalty is computed at 0.5% of the outstanding tax due every month the debt stays unpaid, up to a maximum of 25%. Failure-to-file and failure-to-pay penalties apply if you have not submitted your tax return and have not paid your tax due. In this situation, the monthly fee is capped at 5% (4.5% for failing to file and 0.5% for failure to pay).
The highest penalty for failing to file and failure to pay is 47.5% of your entire tax obligation (22.5% for late filing, which is waived after 5 months, and 25% for late payment, which is waived after 50 months).
The government will eventually send you a letter seeking payment for your overdue tax debt. If you disregard this letter, the IRS may file a Notice of Federal Tax Lien to notify creditors that the IRS has a legal claim to your personal property, real estate, or other assets. The government’s interest in your property is secured by a lien.
If the obligation remains unpaid for an extended period of time, the IRS may impose a levy. An IRS levy is a lawful seizure of your assets to settle an outstanding tax bill. Levies may take numerous forms, including garnishing your salary via your job, collecting your assets directly from a bank account, or seizing and selling your property, such as a car or a house.
In the most severe circumstances, the IRS may seek criminal charges for tax evasion against you. Avoiding paying your tax due on purpose, often known as tax evasion, is a severe offense punishable by up to five years in prison.
Although this last stage is often reserved for the most severe tax evasion cases with huge outstanding sums, it is advisable to be cautious. Set up a plan with the IRS to have your taxes paid as quickly as possible if you get an initial notice for late payment.
Options to Help You Pay Your Taxes
Here are a few ways to get you out of your predicament.
You may charge your tax due to your credit card for a 2% convenience fee. You might also apply for a bank or credit union debt consolidation loan.
If you pick one of these alternatives, you will have satisfied the government, but you will have transferred your debt to a more costly source. You may be making your long-term position worse unless you have a credit card with a very low annual percentage rate (APR) or are able to acquire a personal loan with a very low interest rate.
For example, if you owing $5,000 in taxes, the convenience cost for charging it to your credit card would be about $100. If you were to carry that $5,100 amount for a year at, say, 20% APR, it would add another $1,020 to your bill, bringing the total to $6,120.
Request a Payment Extension
Filing Form 4868 for a six-month tax extension will not help. This extension just allows you to submit your papers; it does not allow you to pay what you owe.
Filing your return on time will help you avoid IRS penalties and interest costs. Late payment penalties are 0.5% per month, up to a maximum of 25%, and late filing penalties are 5% per month, up to a maximum of 25%. Simply submitting your return on time might save you a lot of money in fines.
You may submit Form 1127 to obtain a six-month payment extension if you feel you have a genuine case due to excessive hardship. Along with this form, you must provide a summary of all current assets and obligations, as well as an itemized record of every money received and spent in the previous three months.
Payment extensions are seldom allowed by the IRS, and they will only be granted if you can establish extreme hardship. If you purchased a 60″ flat-screen TV last month because you had no clue you’d owe $5,000 in taxes, you won’t be eligible for a hardship extension.
Apply for an Installment Agreement
Consider filing for an installment arrangement if you believe it will take you more than a few months to settle your tax debt. You may submit your application online at IRS.gov or by mail using Form 9465-FS.
An installment arrangement may keep the IRS from pursuing collection action. You’ll still owe fines and interest, but your monthly payments show the IRS that you plan to pay up.
Borrow From Yourself
If you have an emergency fund, now is an excellent moment to tap into it. You may utilize your emergency fund to make an interest-free loan to yourself in order to pay off your tax obligation, and then begin refilling it with each paycheck.
A home equity line of credit is another method to borrow from yourself if you own a house and have adequate equity (HELOC).
In comparison to credit cards and personal loans, these loans offer comparatively modest interest rates. The disadvantage is that your home is used as collateral. Failing on a home equity loan or HELOC is similar to defaulting on a mortgage in that it may result in the loss of your home.
Borrowing money in this manner, on the other hand, will convert the enormous lump amount you owe the IRS into a reasonable monthly payment to a mortgage lender.
Another option is to borrow from a retirement account, such as a 401(k) or an IRA. Because retirement accounts provide tax benefits, removing funds from them may result in a tax consequence, including a 10% early withdrawal penalty, if procedure is not followed. It also harms your retirement savings strategy.
Anticipate Late Fees and Penalties
Unfortunately, the IRS will charge you interest and penalties on any late payments. These charges, like carrying a credit card debt, will make it more difficult to pay what you owe.
The more you can pay on time, the less interest and penalties you’ll have to pay.
The IRS will send you a bill eventually, but you don’t have to wait for it to make further payments.
Pay what you can when you submit your return, then use Form 1040-V to send in any extra payments you can afford each paycheck.
The Bottom Line
Do not, under any circumstances, overlook the issue. If you do not endeavor to make good on your income tax due, the government has the jurisdiction to take your assets. The IRS has the authority to freeze your bank accounts, garnish your earnings, confiscate tangible assets such as your automobile, and lien whatever assets you possess, including your house.
If you discover that you are unable to pay what you owe, submit your return and pay what you can. Then, with the help of a tax expert, engage with the IRS to develop a plan for paying the rest of your tax liability over time.
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