Budget Tips for Covering A Surprise Tax Bill
Tax time is always a bit unnerving, but when you’re hit with a large, unexpected tax bill, it can be shattering. There are few people who have the resources to simply pull out their checkbook and write a check for thousands of dollars, yet it can feel like that’s your only choice.
The truth is that even people who owe significant amounts of money have several options available to them, including taking advantage of the IRS’ Fresh Start Initiative, which was specifically created for this purpose back in 2011. Though the lien program won’t make your tax obligation go away, it does offer solutions to make things a bit easier, including offering expanded installment plan options, the ability under a program called Offers in Compromise to negotiate a lower tax bill under severe circumstances, and even the opportunity to avoid having to pay some assessed penalties.
Start by Checking the Math
Though it’s a relief to know that these options exist, your very first step when faced with an overwhelming and unexpected tax bill is to check the math. It’s unlikely that you’ll have big changes to your tax obligation unless there’s been another significant shift in your life. Unless you’ve sold a business or property, or no longer can claim a child as a dependent, there’s a very good chance that there’s a math error that needs to be fixed, so start by comparing this year’s return to last year’s, and contact the tax professional who prepared your latest return to enlist their help both in understanding the big bill and to help you determine the best way to address it if it is correct.
What If the Math is Right?
If the math is right and you really do owe the amount that set off those alarms, your choices are really limited to figuring out the best way to pay it. It may be tempting to simply skip sending in the return, but doing so is not going to help – the IRS will quickly figure out that you haven’t filed and the amount that you owe, and that will land you in big trouble – and owing even more money because of penalties and interest. It is much better to take control of your situation rather than let the IRS take the lead and contact your employer to garnish wages or file a lien on your home or other property. Many people make the mistake of filing for an extension and thinking that will delay the need to pay; unfortunately, an extension does not negate the obligation to make your payment – it just extends the time for your paperwork.
Some people submit a small amount of the amount owed along with an indication that more will be forthcoming when you can afford it. Though this can serve as a stopgap to a problematic situation, the truth is that the best way to approach this situation is to find a way to pay your debt immediately, no matter how painful doing so may be.
Ways to Pay
If you decide to pay in full without having the funds immediately available, there are really only a few options. These include:
- Charge your tax debt on a credit card – Though you may be able to earn whatever points your credit card entitles you to by charging your tax debt, that bonus will likely be negated by the fact that the IRS charges a 2% fee for that service, and of course you’ll have to pay whatever interest rates your credit card is charging. Still, if you can get a credit card with zero percent interest for a limited period, or even one that offers a cash bonus for charging a certain amount, this may be the smartest way to go (as long as you actually find a way to pay the debt).
- Ask the IRS about an installment plan – This option is available to taxpayers who owe less than $50,000 and who can pledge to pay their debt in full within six years by making payments online. This option carries a fee and a variable interest rate that can be excessive, especially because the interest compounds daily, and the risk of having a lien placed on your property or your wages garnished remains very real should you fail to make a scheduled payment.
- Take out a home equity loan – If you have the time to apply and enough equity in your home, you may want to apply for a low interest rate home equity loan for which you can deduct any interest that you pay on future tax returns.
It can be frightening to be in debt to the government and tempting to withdraw money from your retirement accounts. Though this might seem like the easiest way to eliminate the problem, doing so can be a very big mistake, as it not only severely limits the amount of money that you will have available once you stop working, but also puts you in a position of having to pay additional fees for early withdrawals.
Thinking Ahead
At the same time that you are dealing with a surprise tax bill from last year’s tax return, you are already several months into this year’s earnings, and may unwittingly be furthering your fiscal problems. Take the time to learn how you got into the position you’re in and then take steps to ensure that you are setting aside money for next year or have the proper amount of withholding being taken out by your employer.
Self-employed individuals who are required to pay quarterly estimated taxes are strongly encouraged to set up a special tax savings account so that they don’t find themselves at a loss when their tax payments are due. The IRS provides a withholding calculator to help with this. Contact our office so we can help you determine the best steps going forward.
Want tax & accounting tips and insights?
Sign up for our newsletter.