Updated for tax year 2020.
The ultimate tax question: what should I do if I owe more money in the form of taxes to the Internal Revenue Service (IRS) than I can afford?
Discovering you owe more than expected can leave you feeling defeated. Not getting a tax refund is bad enough. But finding out you owe a lot of money is even worse.
Fortunately, you can pay off or resolve that federal tax bill by following these steps.
1. How Much Do I Owe The IRS
Use this free tax refund calculator while preparing your federal tax payment plan to get an idea of how much money you owe to the IRS this coming tax season. Of course, you won’t know exactly how much you owe until you complete your tax return.
Once tax season rolls around, read your completed tax return carefully before you submit it. Look to see if you actually owe the government money. It’s easy to add the same income twice or to forget an important deduction.
If your tax return is missing a deduction or credit you thought you qualified for, make sure you answered all the questions correctly.
One missed question or checkbox can cause you to miss out on tax benefits you may be entitled to. Double-check the forms to ensure you included all of the right information.
Another way to determine if something is amiss is to compare your current year’s return to your prior year’s tax return as per your federal tax payment plan. If your tax situation did not change drastically, but your tax bill did, that’s a red flag. You should stop and investigate the change.
If you received a letter from the IRS stating you have tax due, don’t automatically assume the IRS is correct.
They can make mistakes, too. Call or write to the IRS for clarification.
2. Minimize Penalties and Interest
Large tax bills are worse if you have to pay taxes in the form of penalties and interest on top of the original amount owed. Luckily, you can minimize these extra charges in three ways:
Exceptions to underpayment of tax penalties
If you underpaid your taxes this year but owed considerably less last year, you typically don’t pay a penalty for underpayment of tax if you withheld at least as much as you owed last year. That, of course, is only true if you pay by the due date this year.
TaxAct can help determine if the safe harbor rule reduces your penalties and interest. Simply enter last year’s tax liability and the software will do the calculations for you.
You may also reduce your penalties and interest using the annualized income method if you received more of your income in the latter part of the year.
Ask for an abatement of penalties
The IRS often reduces or removes penalties and interest on the penalties if a taxpayer writes a letter explaining the situation.
For example, if you had an unusual tax event, you made an honest mistake, or you or your spouse had a serious illness, the penalties that you owe to the IRS may be waived off.
Be sure to ask for an “abatement” in your letter.
Pay as quickly as possible
If you owe tax that may be subject to penalties and interest, don’t wait until the filing deadline to file your return.
Send an estimated tax payment or file early and pay the IRS as much tax as you can.
Even if you choose to file an extension, any taxes owed are still due on the filing deadline. Therefore, if you don’t pay by April 15, you are subject to those extra penalties and fees.
3. What If I Can’t Pay My Taxes
If you can’t pay your tax bill by the time it is due, don’t avoid the bill. File Form 9465, Installment Agreement Request, to set up installment payments with the IRS. You can complete the installment agreement online too. Completing the form online can reduce your installment payment user fee, which is the fee you owe to the IRS for setting up a payment plan.
The IRS must allow you to make payments on your overdue taxes if:
- you owe $10,000 or less, or
- you prove you can’t pay the amount you owe now, or
- you can pay off the tax in three years or less.
Additionally, you must agree to comply with the tax laws. You also can’t have had an installment agreement with the IRS in the past five years.
Payments can be made by direct debit to your bank account, check or money order, credit card, debit card, or one of the other accepted payment methods. To be charged a lower fee, you may want to set up an online payment agreement and/or agree to make your payments by direct debit.
4. Offer in Compromise
You’ve probably heard ads for experts promising to help you settle the IRS bill for less than you owe. It’s true that the IRS will negotiate back taxes through an Offer in Compromise (OIC).
However, you’ll have to offer at least as much as your net worth – which is everything you own, reduced by your debt. An OIC is a lot like bankruptcy – you should only use it as an extreme last resort.
What Not to Do
Say no to credit cards
Don’t put your tax bill on a high-interest credit card.
The IRS charges a far lower interest rate than credit card companies. That means you can spend more of your money paying off the balance instead of just keeping up with the interest.
Don’t take money out of your retirement accounts to pay a tax bill.
If you withdraw money from a retirement account, you may end up owing a penalty in addition to income taxes on that amount. By the time you pay the penalty and income tax, you won’t have as much left to pay your previous tax bill as you thought.
Besides, retirement accounts are for retirement!
If you play by the rules, stay in touch, and are scrupulously honest, the IRS can be a fairly reasonable creditor.
Do everything you can to resolve and pay off your balance due. They won’t be your creditor for long!