Why Do I Owe Taxes?: Options for Payment and How to Avoid This Next Year

Why Do I Owe Taxes?: Options for Payment and How to Avoid This Next Year

With tax season finally upon us, millions of people are trying to figure out exactly how they’re going to pay off their annual bill to the IRS before filings are due on Monday, April 15th. Even if you can’t pay the amount owed in full by tax day, it’s still important to file your return by then, since the IRS has one fine for failing to pay and another for failing to file on time. Filing on time will also help you establish a game plan for paying off your taxes, instead of letting your debts linger while the fees add up.

If paying off your bill in full before the deadline (or even the end of the year) seems like a tall order, there’s no reason to panic — the IRS provides plenty of payment options, each of which is designed to help taxpayers get out of debt as quickly and easily as possible. Here, we’ve provided a quick guide on why you might owe money to the IRS, and your options for paying off taxes as quickly as possible:

Why Do I Owe Taxes?

Maybe you’re one of the millions of Americans who are newly self-employed, which means for the first time, you’re basically on your own when it comes to taxes. Whether you’re a freelancer or working a few side gigs, all independent contractors are expected to pay the IRS on a quarterly basis. So if you didn’t pay the IRS enough money over the course of 2018 — either because you underestimated your income or you failed to pay altogether — there’s a good chance you owe taxes and late fees. If you are self-employed and new to these rules, you can check out our freelancer’s guide to taxes or The IRS’s guide to estimated taxes to learn more about paying your taxes on time over the course of the year.

But working as a freelancer is far from the only reason people owe taxes. Many other members of the workforce have had to adjust to the altered tax rates put in place by The Tax Cuts and Jobs Act, which came into effect in January 2018. These changes have created confusion for employers and employees alike, as both have had to recalculate how much money to withhold from employees’ paychecks for federal income taxes. Any mistakes made in the recalculation process, whether by you or your employer, could have resulted in under-withholding. If this was the case and you did underpay, you’ll owe the IRS the remaining balance. Depending on what your tax bracket is and how much you still owe the IRS, under-withholding could also come with a penalty fee.

To avoid a situation like this in the future, it’s important to make sure that you’ve filled out your W-4 accurately and made the correct number of withholdings. If you’re already dealing with the aftermath of an incorrectly filled out W-4, though, we’ve got all of your available options here:

File for an Extension

Perhaps you don’t have the money to pay the IRS your full balance by April 15th, but you feel confident you’ll be able to pay up once summertime rolls around. If that’s the case, then you can file for an extension, which will give you an extra 120 days to get the money together. If it’s already after April 15th, you can still file for an extension, but you’ll only be given 60 days of wiggle room instead of 120.

Once you’re granted an extension, the IRS will tack on a failure to pay penalty (.5% per month) and 5% interest to boot. This means you’ll have to pay a little bit more in taxes, but you’ll have the time you need to get your finances in order and pay off your debt. You can start looking into payment plans with the IRS here.

Installment Agreement

If you don’t think that you can pay off all of your taxes by mid-August and you owe less than $50,000, then you might want to consider a Streamlined Installment Agreement, which will give you an extended period of time (usually 72 months) to pay off your taxes.

In order to receive one of these payment plans, the IRS will require you to provide documentation of your income and financial assets so that they can accurately evaluate your circumstance. You’ll have to fill out two new tax forms (a 9465 and 433-F) and pay a set-up fee. Once you’ve provided the necessary documentation (and assuming you’re approved), the IRS will create a plan in which you’ll be expected to pay monthly installments for the next three years.

The best part of any installment agreement is that you could have some of your debts waived through First Time Penalty Abatement. If this is the first time you’ve failed to pay your taxes and you manage to pay each of your installments for the duration of the plan, then you can apply to have any remaining fees and penalties forgiven once the term of the installment plan has ended.

Start With a Partial Payment

Even if you choose to request an extension or sign up for an installment agreement, it’s always a great idea to pay as much as you can before Tax Day rolls around. This way, you’ll minimize the amount of debt that’s accruing interest and lessen the fees you pick up over the coming months. You’ll also show the IRS that you’re acting in earnest and trying to pay off your debts as quickly as possible.

Other Payment Plans

If you owe more than $50,000 or don’t feel like you’ll be able to keep up with a streamlined payment plan, then you might want to look into other payment plans. Because these alternative plans are built around your exhibited “ability to pay,” the IRS requires extensive documentation that proves your monthly income, expenses, and overall financial picture.

After looking at the documentation provided, the IRS will create a payment plan based on how much they believe you’re able to pay per month. These payment plans might come as a burden since the IRS will often demand that you pay through equity in assets like a retirement account or stock portfolio. H&R Block helps you understand your payment plan options here.

Offer in Compromise

An Offer in Compromise (OIC) is exactly what it sounds like — after evaluating your financial situation and determining that you can’t realistically pay off your current debt, the IRS will agree to forgive your taxes if you pay a smaller sum upfront that you’ve proposed. And while various commercials might have you believe that an OIC is easy enough to attain, this option should always be considered a last resort.

When you submit an OIC, you’ll have to provide extensive documentation of your monthly income, expenses and current assets. You’ll also have to pay a non-refundable fee of $186 to the IRS, in addition to any payments you make to the tax service that helps you prepare your documents and create an offer.

Once you’ve finished filling out your paperwork and making all of the payments, chances are good that your application won’t be accepted — the IRS doesn’t want to cut anyone a break unless they feel there’s almost no chance the person can pay off their debts in full. This explains why the vast majority (approximately 70-80%) of all Offers In Compromise are rejected. The IRS’s Pre-Qualifier tool can give you a more realistic idea of whether this is an avenue worth pursuing.

Partial Payment Installment Plan

Partial Payment Installment Agreements are just like other ability-to-pay installment plans, except for the fact that the IRS will waive any remaining balance and penalties once you’ve finished paying your installments. These are naturally harder to get than traditional payment plans and require you to have at least $10,000 in owed taxes, but they are still far more realistic than an Offer in Compromise. For more information, check out The Balance’s guide on signing up for a Partial Payment Installment Agreement.

Other Options

If none of the above options seems viable, you can always turn to other financial resources to help pay off your tax debt. Putting the balance on your credit card might not be such a bad idea, especially if you’ve recently signed up for a card with a 0% promotional APR period and you’re confident you can pay off your debts in a reasonable timeframe. Credit card companies feast off of their hefty interest rates, so it’s important to make sure you have a realistic payment plan before turning to them for help.

If you do decide to go through your credit card instead of the federal government, the IRS makes it easy to pay via credit card on their website — they’ll add on a fee that’s between 1.85-2.00% of your owed taxes and then quickly transfer the balance over to your credit provider. Since you’re limited to only two 1040 Form payments per year, you should first make sure that your credit limits are high enough so that you can put all of your owed taxes onto one or two cards. If your credit limits aren’t high enough, you could always request an increase from your credit provider.

Alternatively, it is possible to pay off your taxes by refinancing your home. Since interest rates on mortgages remain relatively low, this could be a cheaper option than any installment plan offered by the IRS or your credit card company. Before pursuing this route, though, it’s important to be prudent. Make sure that you can make your monthly payments so that you don’t run the risk of defaulting on your mortgage — no one wants to suffer foreclosure because they couldn’t pay their taxes on time. If this does seem like a viable option, check out NerdWallet’s guide on smart refinancing for some key pointers.

Moving Forward

Paying off taxes owed isn’t always an easy process, but that doesn’t mean it’s not feasible. The IRS caters directly to people who might not be able to pay by laying out several options for payment, so chances are good that a plan out there will suit your financial needs. Do your research, get in touch with a tax consultant, and build a realistic payment schedule sooner rather than later. By the time April 15th rolls around, you’ll be glad you planned for the future.