Unpaid Taxes: Consequences & Resolutions to Owing Tax
When people don’t pay their taxes, the IRS & states notice. Even if you don’t file, the IRS’s computerized system is likely to see that fact—remember, employers, financial institutions, and others are sending financial information to the IRS, and thanks to the automated matching system, the IRS tends to notice if it’s missing a return.
If you haven’t heard anything from the IRS and/or your state, that doesn’t mean that the agency hasn’t noticed. It just means that computers are taking a while to catch up. In either case, to minimize penalties and to avoid collection activity, it’s best to be proactive and work with the tax authorities sooner rather than later to limit penalties and severe collection actions.
What to Do and Expect with Unpaid Back Taxes
Having unpaid back taxes and not being able to pay is a very common thing to the IRS. In an average year, 19% of the people in the United States have back taxes. Since this is such a common problem, you can be assured there are many solutions. The IRS (as well as many states) will work with you so it can ensure that it gets paid. Typically the IRS will try to collect the maximum amount of taxes owed from you with the least amount of effort, and this is a good thing to keep in mind if you intend on settling your back taxes for less than the actual amount owed. The earlier you acknowledge the problem with back taxes and take action, the easier it will be to settle them with the IRS. If back taxes go unpaid you can be assured that the IRS will find you and will eventually take action. The IRS has a very automated process that it goes through routinely in order to make people pay. See below to find a very brief description of the events you can expect to happen if action is not taken to resolve unpaid back taxes.
IRS Actions For Unpaid Back Taxes
Receive Assessment Letter and CP Notices (Computer Paragraph Notices, or 500 Series Notices)
Once the IRS determines that you have back taxes, it enters you into the automated computerized notice cycle. These letters will let you know how much you owe, including additional penalties and interest. The first letter you will receive is an assessment letter that will state the amount of taxes you owe. This letter will then be followed by a series of CP notices. There are four of these letters you will receive from the IRS. These letters are a series of automated messages that the IRS sends to anyone who has unpaid back taxes. If you do not respond to these letters the IRS will begin taking collection actions against you. The letters start with CP-501 and go through CP-504. CP-501 starts off as an undemanding letter and goes to CP-504 which is very threatening and mentions their intent to levy.
Receive Notice of Federal Tax Lien (NFTL, IRS Form 668)
Once you receive this notice the IRS will have already encumbered your property. A tax lien can greatly affect your life. The purpose of it is to prevent you from selling or borrowing against any of your major assets.
A tax levy is the actual seizing of assets that you own. This can be just about any asset that you own with a few exceptions. The IRS will continue to seize your assets until your tax liability is completely paid off or until you have arranged another agreement with them. Depending on what they are seizing, a levy can be called many different names.
When You Can’t Pay Unpaid Taxes Owed
When you have unpaid tax and you cannot pay, you are still expected to pay the IRS. For those individuals that cannot pay in full, the IRS offers many other methods of payment. These methods range from making monthly payments toward the tax amount owed to paying only a fraction of what is actually owed and calling it even. Depending on your financial situation, the IRS will always be willing to work with you.
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The first step is to find out how much you owe. To find out how much you owe and you haven’t filed, you should file your back taxes. If you’ve already filed, you can use the IRS’s online tool to find out what you owe, or you can call the IRS at (800) 829-1040. Sometimes the online system is not available, in this case, you may want to request a transcript of your tax return.
If you owe state taxes as well, you will likely have to call your state agency to get the details. Many states don’t offer an online portal to access this information like the IRS
Consequences Having Unpaid Taxes
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The effects of owing taxes vary greatly depending upon the unique tax situation. The consequences the taxpayer faces will be determined by if tax returns are filed and the tax amount owed. The IRS has multiple types of penalties that are charged for unpaid taxes, and the two main ones are the failure to file tax penalty and the failure to pay tax penalty. The failure to file tax penalty is the penalty for owing taxes and not filing taxes. When taxes are filed, but not paid, the IRS charges the failure-to-pay penalty. The penalty for not filing and not paying taxes is about ten times greater than the penalty for filing and just not paying. Below is more information on the penalties and other collection actions that may be taken by the IRS.
Penalties for Unpaid & Unfiled/Late Filed IRS Taxes
Once the taxpayer (or the IRS) files the tax return(s), the IRS will assess a tax amount owed. The IRS assesses penalties from the date that the tax return was due. The sooner the taxes are filed, the lower the penalties and interest will be. If you fail to file a tax return at all and the IRS believes that you will owe taxes, they will file a substitute for return. When the IRS files a substitute return, they will file your taxes for you based on the info the IRS has from other sources and won’t include any additional expenses or exemptions that you may be entitled to. For this reason, the tax amount the IRS will assess in these situations will be overstated and therefore make the penalties even higher as well.
If there is no fraud or negligence involved with failing to file and failing to pay taxes, then the failure to file tax penalty will be charged. This penalty is 5% per month that is calculated based on the total tax amount owed. The maximum for this penalty is 25% of the total tax amount owed. If the tax return is filed sixty or more days after the deadline, the minimum penalty is the smaller of $135 or 100% of the tax liability.
Penalties for Unpaid Taxes with a Tax Return Filed on Time
When the taxpayer files a tax return but does not make payments, the IRS will charge the failure to pay penalty. The failure to pay penalty is .5% (half of one percent). Like the failure to file penalty, the maximum penalty is 25% of the total tax amount owed. Since this is a much lower percentage, it will take a lot longer to accumulate the maximum amount.
Interest Charged on Unpaid Tax Amounts Owed
On top of the penalties, the IRS also charges interest on the tax amount owed. The interest compounds daily. The interest rate charged is equal to the Federal short-term rate, plus 3%. There is no cap on the interest amount like there is for penalties. When the taxpayer pays the balance in full, the interest will stop accruing.
Possible Tax Collection Consequences & Other Punishments
Having unpaid taxes generally will come with consequences other than penalties and interest if no action is taken to get back into compliance. The IRS and other state tax authorities realize there are times where people can’t pay their taxes, and they are willing to work out arrangements. If the taxpayer fails to work with them to make arrangements, they will use various tactics to force the taxpayer to work with them. Below are some of the most common consequences of ignoring requests to work with the tax authorities on an unpaid tax bill.
A tax lien is a claim against your property which is used to protect the US Government’s or State Government’s interest in the tax that they are owed. Your creditors or potential creditors will see the lien recorded. The lien will make it very difficult to borrow money or get any credit. Both the IRS and the majority of states use this tactic for unpaid taxes. It will not be a surprise when the notice of tax lien arrives because it is likely that many attempts have been made before this via letters to resolve the taxes owed.
One of the harshest methods used by the taxation authorities is a tax levy. This is the actual seizure of assets owned by the taxpayer. A tax levy can come in various manners, below are the most common forms of a levy.
- Wage Garnishment: This is the most common form of levy if you are a W-2 wage earner. The taxation authorities will contact your employer directly and require them to withhold a certain percentage of your pay to apply it towards the tax owed.
- Bank Levy: This is when the taxation authorities contact your bank directly and require them to put a hold on the funds in the account. After a brief hold, the money will be seized and sent directly to the taxation authorities, and the amount they collect will be applied to the unpaid tax balance.
- Asset Seizure: This is a less common tactic used, but does happen mostly when a bank levy or wage garnishment is not effective. The taxation authorities may seize certain assets and sell them to apply that value to the tax amount owed.
- Social Security Levy: The IRS can garnish social security payments. This garnishment amount can be up to 15% of the social security payments you receive.
- 1099 Tax Levy: In some instances, if you are an independent contractor, the IRS may demand that 1099 income owed to the contractor or business be sent directly to the IRS.
Criminal or Misdemeanor Charges
Every year the IRS sends a small number of taxpayers to jail for tax-related charges, this is rare though. In certain severe cases of blatant fraud or tax evasion, the IRS may file charges criminally. Most of the time, the IRS gives misdemeanor charges. The charges carry separate set tax penalties associated with them.
Options to Resolve Unpaid IRS Taxes
Once you have a total tax amount owed and you know you cannot pay in full, you need to decide how to resolve your tax liability. The IRS has a lot of different options, and the right choice depends on how much you owe and how much you can afford to pay. Here are some of the possibilities depending upon your income and assets.
You Have Limited Income and Minimal Assets
If you currently do not have the ability to make monthly payments towards your taxes, the two options below may be options for you. Even if you can make payments, but spend less than the IRS allowable standards, the options below may still be an option.
In this situation, you may want to apply for hardship or currently uncollectible (CNC) status. Basically, the IRS looks over your income and your living expenses, and if the agency agrees that you can’t afford to pay your tax liability, it labels your account as uncollectible. That stops all collection activity, but it doesn’t erase your liability. Basically, the IRS checks in every couple of years to see if you can afford to pay.
To qualify for hardship status, you have to meet strict income guidelines set by the IRS, and your expenses have to be reasonable. If the IRS thinks you’re living beyond your means, it will require you to pay the tax amount owed. The agency has federal standards that define how much you are allowed to spend on food, housekeeping supplies, clothing, personal care, and miscellaneous expenses, and it even has guidelines on out-of-pocket medical costs. Because the cost of living is so different around the country, the IRS uses a set of local thresholds for housing and utility costs. The thresholds for transportation costs are also locally based, and it’s updated monthly.
An offer in compromise is a tax relief program offered by the IRS that is designed to allow taxpayers to settle their tax liabilities for less. This program allows taxpayers to get back into compliance with unpaid taxes if it can be proven that the collection of the full tax liability would create financial hardship. The IRS considers your ability to pay, income, expenses, and asset equity when determining eligibility. When the IRS reviewing your submitted offer, they will determine if what you offer, represents the maximum amount they would be able to collect from you over a reasonable time period.
If your assets are extremely limited, it may be difficult to come up with the required payment amount that is needed. There are various payment terms offered with this type of resolution. Many times it is best to work closely with a tax professional to determine if you qualify, the amount that should be offered, work out payment terms, and complete the extensive paperwork required.
You Have Monthly Disposable Income
It’s a lot easier to deal with back taxes if you have disposable income and you can make monthly payments. Generally, a payment plan is your best option if you can pay off the amount of taxes owed, plus penalties and interest before the statute of limitations expire in monthly payments. The IRS has a wide variety of different payment plans including the following:
- Guaranteed Installment Agreement — Payment plan that is secured by direct debit or payments taken directly out of your paycheck. In some cases, this overlaps with streamlined installment agreements. This type of agreement is best if you owe less than $10,000 and taxes can be paid off in 3 years or before the statutes expire.
- Streamlined installment agreements — Payment plan for people who owe up to $100,000 and who don’t want to provide a lot of detailed financial information. It is required that you pay off the entire balance within seventy-two months (or before the collection statute expiration date).
- Financially Verified Installment Agreement — Payment plan that you can only get if you provide detailed financial information to the IRS. Usually, this means providing a collection information statement using Forms $33-A, 433-B, or 433-F. The IRS may require you to verify your financial situation if you owe too much to get a streamlined agreement or if you’ve defaulted on previous payment agreements.
- Partial Payment Installment Agreement — This is the one type of payment plan that doesn’t require you to make payments that will satisfy the entire tax balance the collection statute expiration date. Your payment amounts will be smaller than required with other forms of payment plans. Once the statute of limitations occurs, the IRS forgives the remaining taxes.
Resolving State Unpaid Taxes
State taxes that not paid in full will have to be addressed separately from IRS taxes owed. Each state has its laws and their own set of resolutions. Most states do follow closely to what the IRS has, but they all require separate filings. To find which state tax resolutions are available, review the state guide to see what is available in your state.
These are just some of the options. To find out about other alternatives, you may want to hire a tax professional. A specialist can help you find the best program that fits your unique tax situation. They can also help you apply for payment plans, offers in compromise, and other alternatives.
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Unpaid Taxes Help & Relevant Articles
Failure to Pay Tax Penalty
The penalty for not paying taxes or underpaying taxes ranges from 1/4% to 1 %. Understand what rate you will be charged and if you can remove the penalties.
IRS Underpayment Penalty and Interest Rates
Understand what IRS interest rates are for failing to pay or pay in full and what you can do to lessen penalties.
Delaying IRS Collections
If you need more time to pay back taxes, consider delaying the IRS. Some information the IRS would never tell you, but a very easy method to use to gain a few months of time to pay.
Unfiled Tax Returns
Not filing a tax return is far worse than filing a tax return and not paying. It is best to file before the IRS contacts you.
Protecting your Assets for Seizure
How to protect your assets from the IRS if you know they are planning on imposing a levy on your assets
IRS Payment Plans
Describes various payment plans available to pay back taxes if you cannot pay in full. However, you need to file your back taxes first before looking at any payment plan.