In 1789, founding father Benjamin Franklin famously noted, “(…) nothing can be said to be certain, except death and taxes.” Franklin wasn’t the first person to associate taxes with a fearful reality. Being in debt with the government can be a nerve-wracking experience: one in five Americans fear owing money to the IRS. If you do owe taxes, you’re not alone. According to U.S. Internal Revenue Service data, over 14 million Americans owed more than $131 billion in back taxes, penalties, and interest in 2018. From being too busy to file to feeling confused about tax strategy, there are plenty of reasons someone might fall behind and end up owing the IRS back taxes. To get over the fear of owing money to the IRS, learning how to tackle owing taxes can help.
Don’t Be Afraid of Owing the IRS
After the latest tax reform, more people have ended up owing money in taxes. This has led to some individuals finding themselves unable to pay taxes within the established deadlines. If this is your case, focus on filing the return to avoid penalties ranging from 5% to a maximum of 25% of the tax value that wasn’t paid. Contrary to the scary image that comes to mind when thinking about the IRS, they do offer several alternatives to make your tax payment without incurring penalties. These include short-term payment extensions, installment payment agreements, and temporary deferment of collection.
How Does Each Option Work?
Before deciding on any of the alternatives offered by the IRS, consult an independent fiduciary financial advisor. They can help shed some light on which tax repayment strategy is most in line with your cash flow and long-term, holistic financial plan.
Short Term Extension
Taxpayers who use this option have up to 120 more days after the established tax filing due date to pay the full balance of their taxes. This alternative does not carry a fixed rate but generates a 0.5% penalty interest per month on the outstanding balance. If you owe taxes, short term extensions can be an excellent solution for those who can have the funds readily available in the near future.
Installment Agreements or Payment Plans
Installment agreements are built according to a taxpayer’s unique situation. It all depends on the amount owed and the defined time to make the payment. According to the IRS, the defined time is typically greater than 120 days. Otherwise, it’s more convenient to take advantage of the Short Term Extension. Note that this agreement has an application fee of $149. While you may still be fined, the fine is reduced to 0.25% per month until the outstanding value is settled. Interest is charged at the federal short-term rate plus 3% (interest may change quarterly). Additionally, you may be able to work out payment through payroll deductions.
Temporary Postponement of Collection
The IRS offers temporary postponement of collection for people in difficult financial situations. To apply for this alternative, the taxpayer must demonstrate that the payment of the tax would generate serious financial difficulties, following the financial standards of the IRS. This alternative does not carry penalties and its interests are calculated according to the Federal Short-Term Rate, plus 3%.
Other Financial Alternatives
While there are other financial alternatives to paying your taxes, such as pulling funds from a retirement account or using a debit/credit card, it’s never a wise decision to get into more debt or risk your financial future. For example, borrowing money from your 401k can end up both negatively affecting your retirement savings and potentially garnering you future taxes on those funds that you’ve withdrawn.
Best Practices for Paying Your Taxes
While it may feel scary or overwhelming, reporting and paying your taxes is always the best option. If you do owe taxes, there are various strategies offered by the IRS to help relieve your tax burden. There are plenty of financial tax strategies to avoid being caught in this uncomfortable position in the future. With the help of a tax strategy expert, you can align your tax planning with a holistic financial life plan.
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