As the April 15 deadline to file your taxes approaches, many Americans are understandably worried about getting hit with a surprise tax bill. Especially in light of the major changes in tax law recently put into effect — you can learn more about them here.
The IRS reports that roughly 1 in 4 Americans had a tax bill in 2018. If you happen to get unlucky, here are some ways to handle it.
File your taxes as soon as possible & on time
You may think shirking your responsibility to file your taxes on time will delay the pain until a later day. Unfortunately, that is not the case. Penalties and interest start accruing from the moment that you miss your filing deadline.
The interest rate for underpayment on your taxes is 6%, compounded daily. Even worse, you’ll get hit with two penalties: one for late filing and another for late payment.
If you file late, you could be subject to a penalty of up to 25% of the taxes owed. Separately, if you pay late, you could be subject to a penalty up to 25% of the taxes owed as well. And remember, interest and penalties are all separately assessed. Filing as early as possible will help you avoid an unexpected bill and give you more time to pay it off. (Here’s a primer on why it’s a good idea to file in January.)
Enter into a payment plan
If you can’t pay your tax bill upfront, the IRS offers three alternative payment arrangements.
The most common is the individual payment plan. If you qualify, the IRS could allow you to pay your taxes through a long- or short-term payment plan. Short term payment plans are 120 days or less. Long term payment plans are 120 days or longer, referred to as an installment agreement. Either way, you’ll need to apply to the IRS to initiate a payment plan and wait for a decision to be rendered. And keep in mind that there is a modest fee assessed to enter into a payment plan. (You can find the application here.)
If you do not have the means to pay your tax bill, the IRS may choose to delay collecting on that bill. You’ll need to apply by contacting the IRS directly. Just remember, you’ll be subject to a review of your financial situation and you may be subject to a lien — a notice the IRS files that says it has a claim to your property.
Learn more about what happens if you don’t file your taxes here.
The last alternative payment arrangement is called an offer in compromise. It will allow you to settle your entire tax debt for less than what you owe but is also the most drastic of options. You’ll need to prequalify and apply for a compromise, as well as make an offer. Some individuals defer to a tax attorney for help with this.
You should only consider payment arrangement as a last resort, as there are fees and applications to fill out. You also continue to accrue interest and penalties during your repayment period.
Put your taxes on your credit card
While the interest rates on your credit card may be high, paying your taxes on your credit card may buy you some time if you can’t fully pay your tax bill. Getting into more debt is never a great option, so you’ll need to carefully weigh whether paying your taxes on your credit card is more financial advantageous than any of the other options payment arrangement options.
You can learn more about paying your taxes with a credit card here.
Review your tax situation & withholding
Make sure you don’t make the same mistake twice in 2020. If you’re hit with a surprise tax bill this year, look back and see what caused it. Then make changes going forward.
For many individuals, it may be that you’re not withholding enough from your paycheck. For others, it could be a more complicated circumstance. Sit down with a tax advisor to better understand how you can avoid this problem during the next tax year.
Here’s what you need to know about withholding and taxes.
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