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It’s been estimated by the IRS that over 8 million Americans owe over $80 billion in back taxes, penalties, and interest. Those numbers are staggering. Yet, despite the threat of owing thousands of dollars to the U.S. government, millions of Americans continue to fall behind on their taxes.

There are many reasons why people fall behind in filing and/or paying back taxes. Perhaps they neglected to make estimated tax payments on a side business. Maybe they under-withheld one year and fell behind. They may even have simply made a mistake on their taxes and underpaid. 

There are certainly very legitimate life disruptions that can cause someone to fall behind with their taxes, such as a death in the family, illness, divorce, or a job loss. Yet, no matter what the situation, finding yourself owing money to the IRS can be very intimidating, not to mention, adding to what may be an already stressful situation.

So let’s talk about some of the potential consequences for being in debt to the IRS.

One of the biggest factors is whether taxes have been filed or not. The total penalty for having unfiled and unpaid taxes is 10x greater than having unpaid taxes alone. 

Unpaid and Unfiled Tax Penalties - When taxes have not been filed by the due date and taxes are owed, they can lead to the IRS charging some of the steepest tax penalties. The penalty that the IRS charges for unfiled taxes with a balance due is called the failure-to-file tax penalty. The failure to file penalty is usually charged at a rate of 5% of the tax amount owed each month with a maximum penalty of 25% of the total tax amount owed. If the tax return is filed 60 days or more after the due date (or extended due date), the minimum penalty that is due is the smaller of $135 or 100% of the tax liability amount.

If taxes remain unfiled, the IRS and many states will file a substitute tax return on the behalf of the taxpayer in order to assess the tax liability and penalties. In most situations, the amount assessed will be greater with a substitute return than if the taxpayer filed themselves because deductions and credits will be limited. The higher the assessed tax liability, the greater the tax penalties will be.

Unpaid Tax Penalties (If the tax return was filed by due date) - The tax penalty for owing taxes but filing on time is significantly less than owing taxes with unfiled tax returns. The penalty for having unpaid taxes is called the failure-to-pay penalty which is charged at a rate of 1/2 of 1% of the tax liability each month (or part of the month) that the taxes remain unpaid. The maximum amount for this penalty is 25% of the unpaid taxes.

If you filed an extension to file taxes then the failure-to-pay penalty will not be charged if 90%of the taxes owed are paid by the original due date and the remaining balance is paid by the due date of the extension.

Other Possible Consequences or Implications - The collection process starts by sending a letter demanding payment and assessing additional penalties and interest. Normally after multiple letters and taxpayer inaction, harsh collection tactics begin. Below are a few of the methods that may be used by the taxing authorities to collect unpaid taxes.

  • Tax Lien: A tax lien is the government’s claim on the taxpayer’s property. The existence of the lien ensures that they get first rights to your property over other creditors.
  • Wage Garnishment: The taxing authority will contact your employer and demand they withhold a certain percentage of your pay to cover unpaid taxes.
  • Bank Levy: The tax authorities will contact your bank and demand a hold be put on the funds that are in the account and then seize the funds to cover the unpaid tax liability.
  • Property Seizure: The tax authorities may seize assets such as your car, boat, house or another asset of value that can be sold to cover the unpaid tax liability.
  • Jail time: Incarceration is possible but very unlikely. Depending on the circumstances, taxing authorities can have a taxpayer arrested and put in jail.

Let’s then touch some steps you should take if you owe taxes on the previous year:

  1. Make Sure You File - First and foremost, make sure to submit tax filings for previous years. The worst-case scenario is owing money and neglecting to file your return. Also, don’t make the mistake of waiting until you have the money to pay your taxes. File your return or at least an extension. Even if you are already filing late, it is better to do it now than to wait even longer.
  2. Adopt Strategies for Paying Back Taxes - Once you have your taxes filed, your focus needs to be on what you can do to pay off your back taxes. There are a few paths you can follow:
    • Start Saving: If you only owe a relatively small amount of back taxes, the smartest option is to simply start saving. Even if you can’t save the full amount, try to save an extra 10% to 20% of your gross income to knock out your tax debt.
    • Consider a Personal Loan: You could take out a personal loan to help pay your taxes. If you expect to be racking up a lot of interest and fees from the government or even facing legal trouble, this may make sense. 
    • Explore a Repayment Plan: The IRS may be more willing to work with you than you think. Tax collectors understand that people get behind. Their top priority is making sure people file and pay their owed taxes. They don’t want to have to chase you down. Try asking about a tax payment plan. The IRS does have some options that you can easily file for online.
    • Get Tax Relief: Sometimes you need more help than the above options can provide. If you’re facing illegal action, such as wage garnishment or bank levies, you may need more significant help such as a tax relief program. In these cases, you should turn to a tax relief company. These organizations cut down your tax burden and pay off the rest with a tax relief loan.
  1. Determine How To Deal With Your Business's Back Taxes - How you deal with your business taxes depends on your entity structure. Does your business pay taxes directly or is it a pass-through organization? If it is the latter, you are essentially just dealing with personal back taxes. If your business owes taxes, you can apply many of the same techniques listed above. Stay in touch with the IRS, and ask about options for paying off what you owe. Again, they may be more willing to help than you expect.
  2. Request an “uncollectible” status. For this, you will have to show that you are unable to pay your taxes. The IRS will stop bugging you for a little while and will not start collections. However, you will still be racking up interest and penalties.
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