Do you owe back taxes to the IRS? Having tax debt can be scary because the IRS has a lot of power to collect - garnished wages, lost tax refunds, and more. Plus, the interest and fees can add up.
Perhaps your side hustle took off, and you never learned to make quarterly tax payments. Maybe you simply under-withheld at work or got a huge bonus that you need to pay taxes on.
No matter your situation, you have options when you have tax debt. Here are the steps you should take when you owe back taxes to the IRS.
File Your Taxes (Or an Extension)
When you know you’re going to owe money to the IRS, it’s important to file your return anyhow (even if you're going to be late filing taxes). When you don’t file your return, you’ll still have to pay the IRS for your delinquent taxes. Plus, you’ll have to pay 5% of the unpaid taxes each month that you’re delinquent on taxes. The minimum failure-to-file penalty is $330, and the maximum is 25% of the amount you owe.
If you can’t get your information in time for the tax filing deadline (usually April 15th), then file an extension. That will give you until October to get your information together. You’ll still owe back taxes (with interest currently set at 4.60% annually), but the blow will be much less.
Start Saving Now
Even when you don’t know the exact amount you owe, it’s important to start hoarding your cash until you figure it out. In most cases, you’ll need to save about 30% (or more if you’re high-income) of your income just to have enough money to pay your quarterly tax estimates. Since you’re playing catch-up, aim to save 40% to 50% of your gross income to put towards the tax debt.
Those percentages probably seem astronomical, but they are realistic for a lot of self-employed people. Between Social Security and Medicare taxes, you’ll put 15.3% of your profits towards taxes. Add to that Federal and state taxes, and it’s easy to see how you’re paying a real tax rate of at least 30% for many people.
Figure Out How Much You Owe
As soon as possible, you’ll want to file your real tax return, so you can learn how much you owe. Ideally, you can pay off back taxes using the money you’ve saved. But if you cannot pay the amount in full, you have options.
Consult a Professional
Once you know how much you owe, you may want to consult one of two professionals. If you think you have some legitimate deductions, talk with a CPA who can help you revise your taxes. A CPA can help you understand the legal ways to minimize your tax debt. This is especially helpful if you’re self-employed and you didn’t deduct all your legitimate business expenses.
If the tax debt can’t be reduced, but you cannot afford to pay it, talk with a Certified Credit Counselor or a bankruptcy attorney. Both professionals can help you determine what options you have when it comes to paying the debt.
Check out Solvable to help connect you with a professional that understands tax debt >>
Consider Your Loan Options
Once you know what you owe, and you’ve gotten professional advice (if needed), consider your loan options for repaying the debt. If I were facing tax debt, these are my top loan options in order.
0% Credit Cards
If you have a great credit score, you may qualify for promotional 0% credit card offers. Check out our list of the best credit cards.
The interest on a 0% credit card is great, but credit cards also offer several other benefits. First, the minimum payment on a credit card is low, so you can take your time paying off the debt if cash flow is a problem.
Second, credit card debt can be refinanced. Often, if you maintain a great credit score, you can transfer credit card debt from one card to another every year or so. That means you can keep your interest rate at 0% for several years or more.
Finally, credit card debt is eligible for bankruptcy. Unlike tax debt with the IRS, it could be wiped out if you file for bankruptcy.
Personal Loans
Personal loans have moderate interest rates. In most cases, the interest rate on a personal loan will exceed the rate from an IRS repayment plan. However, personal loans tend to be moderate, and the payments can be a bit more flexible than those from the IRS plan.
Like credit cards, personal loans can be refinanced or put through bankruptcy in a worst-case scenario.
HELOC
A home equity line of credit (HELOC) allows you to borrow against your house to pay back debt. Usually a HELOC is an open line of credit that needs to be repaid in 15 to 20 years (with interest-only payments on a month-to-month level).
Generally, I’m opposed to using your house for debt, but tax debt may be a worthy exception to the rule. Just remember, if you can’t make your monthly payments on the HELOC, you could lose your house.
IRS Repayment Plan
The IRS offers repayment plans that have moderate interest rates. The only problem with these plans is that they are difficult to refinance, and the monthly payments tend to be set in stone.
Keep Moving Forward
IRS tax debt is an annoying form of debt (you don’t even have a degree or a memory to show for it), but it’s normally something you can pay off quickly with frugality, earning, and dedication.
Hannah is a wife, mom, and described personal finance geek. She excels with spreadsheets (and puns)! She regularly explores in-depth financial topics and enjoys looking at the latest tools and trends with money.
Editor: Clint Proctor Reviewed by: Chris Muller