Navigating the complexities of the tax system can be challenging, especially when it comes to understanding the potential consequences of underpaying your taxes. The IRS tax underpayment penalty is an essential fee to be aware of, as it can significantly impact your financial situation.
In this comprehensive guide, we will explore the ins and outs of the IRS tax underpayment penalty, including how it is calculated, the factors that contribute to it, and the proactive steps you can take to minimize your risk and avoid costly penalties. By gaining a thorough understanding of this crucial tax concept, you can make well-informed decisions and ensure compliance with IRS regulations.
What Should I Do If I’m Unable to Pay My Taxes?
Stay calm – you might be eligible for a self-service, online payment plan (including installment agreements) that enables you to gradually pay off your outstanding balance. Upon completing your online application, you’ll be instantly notified of your payment plan’s approval status, without needing to contact the IRS. Online payment plans are processed faster than requests submitted with electronic tax returns, even when the new tax hasn’t been assessed yet.
Online Payment Plans Include:
- Short-term payment plan – This plan has a payment period of 120 days or less and requires a total amount owed of less than $100,000, including combined tax, penalties, and interest.
- Long-term payment plan – This plan has a payment period exceeding 120 days, involves monthly payments, and necessitates an amount owed of less than $50,000, encompassing combined tax, penalties, and interest.
If the IRS approves your long-term online payment plan (installment agreement), a setup fee may be applicable based on your income. If you already have a payment plan, you might be eligible to use the online payment plan option to modify your existing agreement. Online changes can include updating payment dates, amounts, and bank information for Direct Debit Installment Agreements.
If you’re not eligible for an online payment plan, you can also request an installment agreement (IA) by submitting Form 9465, Installment Agreement Request, to the IRS. Upon IA approval, a setup fee may be charged depending on your income. For more information, refer to Tax Topic No. 202, Tax Payment Options.
When requesting an IA, the pending period extends or suspends the initial ten-year collection period. An IA request typically remains pending until it is reviewed, the IA is established, or the request is withdrawn or denied. If the requested IA is rejected, the collection period’s progression is suspended for 30 days. Similarly, if you default on your IA payments and the IRS intends to terminate the agreement, the collection period is suspended for 30 days.
If you choose to appeal either an IA rejection or termination, the collection period’s progression is suspended during the appeal process until the appealed decision becomes final. For more information, refer to Tax Topic No. 160, Statute Expiration Dates.
What Are the Consequences of Not Filing or Paying Taxes Owed to the IRS?
You might question the need to submit your tax return if you are unable to pay your tax bill. However, it is crucial to do so. If you have unpaid back taxes or current taxes, you could face substantial penalties and interest accumulation over time for non-payment. The Failure to Pay Penalty begins at 0.5% of your outstanding balance per month (limited to 25% of the back taxes you owe). The interest rate for underpayment of taxes is 6% as of May 2019, but it may vary quarterly.
Actions to Take When You Owe Money to the IRS
Being aware of your choices can help you decide what steps to take if you owe money to the IRS, allowing you to develop a strategy. Here are some prevalent options for individuals who owe taxes but are unable to pay them:
1. Establish a Payment Plan With the IRS
Taxpayers have the option of establishing payment plans with the IRS, known as installment agreements. Depending on your individual circumstances — such as the amount owed and how long you can take to pay it off — there are different types of agreements available. For instance, if you are able to pay your balance in full within 120 days, it may be more beneficial to make a lump-sum payment rather than setting up an installment agreement. If your financial situation does not allow you to pay the full balance within 120 days, however, an installment agreement can help spread out the payments over a longer period of time.
Fees and Costs
If you are looking for a way to manage your tax debt more effectively, one of your options is to apply for an online payment agreement. The application fee for an online payment agreement is $149, or you can opt for an electronic payment of $31. Those who qualify as low-income taxpayers can receive a reduced fee of $43, by submitting Form 13844.
To initiate an online payment agreement, you will need to complete Form 9465. For installment agreements of $50,000 or less, you do not need to submit a financial statement. However, it is important to consider what is best for your individual circumstances, so it is recommended to consult with an expert in tax debt to assess your situation and identify the best solution.
Advantages and Disadvantages
By setting up an installment agreement, the penalty on your unpaid balance decreases to 0.25% per month until the full balance is paid on schedule. Interest is charged at the short-term federal rate plus 3% (interest rates may vary each quarter). The IRS can generally void agreements if payments are not made on schedule.
Forms
If the balance is more than $50,000, Form 433-A or Form 433-F is required. You can also make payments through payroll deductions using Form 2159, Payroll Deduction Agreement.
2. Ask for a Brief Extension to Settle the Entire Amount
The IRS offers taxpayers up to 120 days to pay their entire tax balance.
Fees and Costs
There is no fee for requesting the extension. However, a penalty of 0.5% per month applies to the unpaid balance.
Required Action
Complete an online payment agreement, call the IRS at (800) 829-1040, or seek assistance from us.
Advantages and Disadvantages
This option is suitable for taxpayers who require a brief period to pay their full tax bill. The IRS charges interest at the short-term federal rate plus 3% (interest rates may vary each quarter). With short-term extensions, you avoid the installment payment application fee (see #1), but not late-payment penalties and interest.
3. Request a Financial Hardship Extension for Tax Payment
The IRS provides options for individuals facing financial hardship, including currently not collectible status and the Offer in Compromise. To qualify for a hardship-based extension, you must demonstrate that paying the taxes owed would result in financial hardship, as per the IRS financial standards.
Fees and Costs
There is no cost to apply for a hardship extension. While no penalties apply, interest is calculated at the short-term federal rate plus 3% (interest rates may vary each quarter).
Required Action
Submit IRS Form 1127, Application for Extension of Time for Payment of Tax Due to Undue Hardship. Include a statement detailing your assets and liabilities.
4. Get a Personal Loan
You may consider requesting a loan from a personal contact, such as a friend or family member, to help cover your tax debt. Fees and costs can vary significantly depending on the lender. This option might be cost-effective, but it’s essential to use your best judgment when making such a decision.
5. Borrow From Your 401(k)
If your 401(k) plan permits this type of loan, you are generally limited to 50% of your account balance, with a maximum of $50,000, and must repay the funds within five years.
Fees and Costs
There may be a minimal fee, and the plan is required to charge interest.
Required Action
Consult your plan administrator for details.
Advantages and Disadvantages
If allowed, a loan from your 401(k) plan can serve as a convenient and affordable source of cash to pay current or back taxes owed. However, the loan may negatively affect your future retirement savings if not repaid. Failure to make timely payments, leaving your company without repaying the loan, or plan termination will result in the loan being treated as a taxable distribution. Additionally, if you are below the age of 59½, a taxable distribution is subject to a 10% early distribution penalty.
6. Use a Debit/Credit Card
Various service providers offer payment options for tax balances.
Fees and Costs
These vary, typically around $2.49 to $3.95 for debit card payments or 1.87% to 2.35% of the tax balance due for credit card payments.
Required Action
Consult the IRS for a list of approved service providers.
Advantages and Disadvantages
This payment method offers the convenience of making payments anytime, anywhere with greater control and flexibility. You may also enjoy other benefits such as the ability to earn points, miles, or other credit card rewards. However, always keep in mind that having high credit card balances may hurt your credit score and can make it difficult to handle unmanageable debt. Be sure to use your credit card responsibly and understand the risks before you choose this payment method.
Uncertain About How to Handle Your IRS Debt? Let Us Help!
Our tax specialists can assist you in determining the appropriate course of action if you owe taxes but are unable to pay. Seek guidance from our reliable IRS experts.
If you’re unable to pay your taxes, the initial step is to recognize that there’s an issue at hand. To put it plainly: You have a tax obligation, but you lack the funds to fulfill it. Instead of focusing on fear or uncertainties, tackle the situation one step at a time.
Step 1: Submit Your Tax Return by the Regular Deadline
Submit your return even if you’re unable to pay the taxes on time. Contact a professional as soon as possible to assist you in filing your taxes. We might be able to identify credits and deductions that can reduce your tax obligation. Remember, every dollar counts when you owe the IRS!
You may assume it’s better to delay filing your taxes if you owe the IRS money. However, the penalty for not submitting a return or submitting it late can be ten times higher than the penalty for not paying on time.
Keep in mind that even if you complete your tax return in February or March, the tax payment isn’t due until Tax Day. Therefore, waiting until the deadline to pay may provide you with a few months to save or earn extra money.
You might wonder if a tax extension would grant you additional time to pay. Unfortunately, it does not. An extension only gives you more time to file, but your taxes are still due on Tax Day – meaning if you pay late, you’ll face interest and penalties on any outstanding taxes for the year. So, ensure that you file your tax return on time!
Step 2: Pay as Much as Possible by the Tax Deadline
If you find yourself unemployed, don’t panic. Temporarily set aside the tax bill and prioritize the essentials for survival. Focus on the “Four Walls” — food, utilities, shelter, and transportation — before anything else. Once you’ve provided for your basic needs, pay the IRS what you can.
Here are some other tips to reduce the amount you owe at tax time:
- Reduce Your Taxable Income: Look for ways to reduce your taxable income by making contributions to retirement accounts and taking all the available deductions and credits you qualify for.
- Prepay for Expenses: Consider prepaying your estimated taxes and any other expenses you can legally pay now to reduce your taxable income.
- Make Charitable Donations: Consider making charitable donations if you are able to. Donations to qualified charities are typically deductible so you will reduce your taxable income by the amount of the donation.
- Delay Income: Delay income where possible, including delaying any required bonus payments or other income that you know will come.
- Utilize Tax-Deferred Accounts: Take full advantage of tax-deferred accounts like Individual Retirement Accounts (IRAs), 401(k)s, and other types of retirement savings accounts. The taxes you’ll pay in future years will generally be lower than if you paid them today.
- Increase Your Withholdings: As long as you are the recipient of a refund, consider increasing your withholdings if you know you will end up with a large tax bill. This way you can spread out your payments.
Step 3: Continue Paying the Taxes You Owe Even After Filing, and Discuss a Payment Plan With the IRS
After Tax Day, you’ll have a month or two before the IRS contacts you regarding your outstanding taxes. During this period, aim to allocate every available dollar toward the balance with the goal of paying it off before they reach out to you.
If you can’t pay your tax bill by the deadline, consider applying for a payment plan on the IRS website. You can bypass lengthy phone wait times and establish the plan online. The IRS provides short-term payment plans (120 days or fewer) for bills under $100,000 and long-term monthly plans for balances below $50,000. A fee between $31 and $130 may be required, but this could be waived if you have a low income. Focusing on your tax debt within a debt snowball strategy can help you pay off your balance in under a year.
Step 4: Resolve the Issue: Avoid Unmanageable Tax Bills in the Future
Partner with us to avoid encountering unmanageable taxes in the future. This could include setting aside earnings from a side business, making quarterly tax payments, or modifying your paycheck withholding. Regardless of the issue, a tax expert can pinpoint it and help you address it proactively.
What Occurs if You Fail to File Your Taxes?
Neglecting to file a tax return when you have outstanding taxes is not just inadvisable but also unlawful, and the IRS will impose penalties. The Failure to Pay Penalty equates to 5% of your unpaid taxes for each month they are overdue, capping at 25% of your tax bill after five months. The IRS applies interest on top of these penalties. Failing to file a return could lead to imprisonment for up to a year for each year you omit filing. Nevertheless, the IRS generally pursues alternative solutions to address issues with taxpayers before considering imprisonment.
Hence, regarding tax submission, the saying “better late than never” truly holds true! You will be in a more favorable situation with the IRS if you file your tax return, even if you cannot pay your bill right away. Avoid delaying until the IRS takes action against you. By filing, you will also gain the advantage of decreased penalties and interest.
What Happens If You Submitted Your Taxes But Can’t Pay Right Now?
If you have submitted your tax return but are unable to pay your bill, there are options for arranging a payment plan. The Failure to Pay Penalty amounts to 0.5% per month, reaching a maximum of 25% of your unpaid taxes. This penalty is considerably lower than the Failure to File Penalty, highlighting the significance of consistently filing your taxes in a timely manner. By actively setting up a monthly payment plan, the IRS will decrease your Failure to Pay Penalty to 0.25% per month until your bill is completely settled.
What If I Pay My Taxes Late?
If you are experiencing financial difficulties, such as the death of a partner or unemployment, you can request the IRS categorize your bill as “currently not collectible.” This provides you more time to pay off your debt while halting collection efforts for a certain period of time. Keep in mind, though, interest and penalties will continue to add up until your bill is settled. Another solution is to apply for an Offer in Compromise (OIC).
This enables you to consult with the IRS for a smaller payment than the amount you owe. While filling out an OIC, you present a payment calculation to the IRS, asking them to consent to your lower rate. The IRS evaluates your offer based on your income, expenses, ability to pay, and the value of your assets. It’s important to note that it is tricky to be eligible for an OIC, as approvals are generally rare. Typically, those in extreme financial distress are given this type of tax assistance.
Can You Go to Jail if You Don’t Pay Taxes?
Although the era of Charles Dickens and debtors’ prisons has long passed, with their abolishment in the United States in 1833, failing to pay your taxes can still lead to significant repercussions. If you have an unpaid tax bill and show no intention of settling it, the IRS may implement enforcement measures against you. These measures can involve wage garnishment, levying your bank account, putting a lien on your property, or even seizing your assets.
In case you deliberately hide significant income sources, submit fraudulent tax returns, or neglect to file a return to avoid taxes, you may be accused of tax fraud or tax evasion. The severity of your actions may determine whether you face imprisonment for these offenses. For example, the notorious mobster Al Capone was sentenced to 11 years in prison for tax evasion, as it was the only offense the FBI could successfully prosecute him for.
What Is the Duration to Settle Your Tax Debt With the IRS if You Owe Them?
The IRS offers taxpayers up to 120 days to settle their total tax balance, free of charge. However, the amount unpaid will incur a monthly penalty of 0.5%. To obtain an extension, an online payment agreement can be filled out, or the IRS can be reached at (800) 829-1040 for assistance. Alternatively, you can have one of our professionals take care of the process for you.
What Occurs if You Have an Outstanding Debt With the IRS and Fail to Make a Payment?
If you fail to pay your taxes, you will be charged a penalty of 0.5% for each month (or portion thereof) up to a maximum of 25% of the total balance due. If you establish a payment plan, the penalty rate is decreased to 0.25% each month. Both interest and penalties increase the amount that you owe.
What If You Owe the IRS Over $100,000?
For individuals owing a tax debt in excess of $100,000, the IRS may take various courses of action, such as issuing a Notice of Federal Tax Lien to make known the debt, garnishing wages, confiscating funds from bank accounts, and invalidating or rejecting passport applications.
How Do I Ask the IRS for Tax Forgiveness?
Use Form 843 to request a refund or apply for an abatement of specific taxes, interest, penalties, fees, and additional tax charges. If you owe the IRS and cannot pay, it is essential to take immediate action to address the situation. Do not wait until you have incurred an IRS tax underpayment penalty.
The IRS provides various options, such as payment plans and extensions, to assist taxpayers in managing their tax debt. Ignoring the issue will only lead to increased penalties, interest, and potential legal action. By being proactive, seeking professional advice, and exploring available solutions, you can minimize the financial impact and work towards resolving your tax obligations.
Keep in mind that the IRS is more likely to cooperate with those who show a genuine effort to fulfill their tax responsibilities.