What Is Tax Debt?

The IRS has many different payment options for taxpayers who owe money. The important thing is to reach out and arrange a payment plan. As long as you address it, tax debt is almost always manageable. If you ignore it, though, tax debt can grow out of control. Here’s what you should know.

For help managing tax debt and other financial matters, consider matching with a vetted financial advisor for free.

The IRS Will Never Call You

First and foremost, understand that the IRS does not call. Not ever. The agency only sends letters to notify you of a problem or a debt.

If you have received a telephone call claiming to be from the IRS, or making any other claim regarding a tax debt, it is a scam.

Tax debt occurs when you don’t pay your taxes in full by your filing deadline, typically April 15. For most workers, this isn’t a concern. If you have a W-2 job, your employer will automatically withhold your income and payroll taxes. As long as they calculate this withholding correctly (not always a guarantee), your taxes will already be paid by April 15.

But if you’re self-employed, own a small business or just have an employer that screws up your withholding, then you’ll owe money come tax time. If you don’t pay that bill in full, you’ll owe tax debt.

There are three main reasons that people get into tax debt:

Miscalculation – You paid the full amount listed on your taxes, but made a mistake calculating the amount owed
Underpayment – Despite calculating and filing your taxes correctly you paid less than the amount listed
Evasion or Fraud – You deliberately attempt to hide your assets or deliberately tried not to pay your taxes owed

The difference between underpayment and tax evasion has to do with intent. With underpayment, you’re honest about the full value of your tax bill even if you don’t pay on April 15. With evasion, you attempt to hide your tax bill or otherwise try not to pay those taxes. In other words, the key difference is whether you operate in good faith.

What Are the Consequences of Tax Debt?

Tax debt is incredibly common. In 2017 alone, the IRS reported more than 850,000 accounts with money owed. In almost all cases this happens because someone made a mistake when it came to filing or paying his or her taxes.

When you owe a tax debt, the IRS will typically charge interest and penalties on the account. But the exact amounts can range widely depending on the circumstances of your case. Among other issues, the IRS will charge penalties for:

Failure to file your taxes on time
Failure to pay your taxes in full on time
Inaccurate information on your taxes
Misleading information on your taxes
Claiming erroneous credits or refunds
Failure to deposit employment taxes
Underpayment of estimated taxes

The exact amount of penalties ranges widely depending on the issue, with common penalties ranging from 1% to 20%. In most, if not all, cases the IRS charges the most significant penalties for intentional misconduct. For example, while the agency may charge a 1% penalty for making a mistake on your taxes, it typically charges 75% for intentional fraud.

Finally, the IRS charges quarterly interest rates that are compounded daily on all unpaid debt. This applies regardless of the circumstances of under/nonpayment. Interest rates change based on the year and the quarter and are typically set at 3% plus the federal short term rate.

How Can You Pay Tax Debt?

This is the good news. Owing money to the IRS is stressful. In fact, just getting a letter from the tax agency can scare anyone. So the important thing to remember is that the IRS actually has a lot of different options to help you pay your bill.

If you owe money to the IRS, here are some of the most important things to know about the collections and payment process.

Don’t Panic, Don’t Lie

Popular culture is filled with stories about tax cheats and jail time, and to an extent that’s true. Tax fraud is a felony, and the IRS does prosecute.

But fraud requires intent.

You can’t accidentally commit tax fraud and you can’t make a mistake that will land you in jail. As long as you’re honest, and as long as you don’t try to intentionally hide assets or income, you’ll be fine.

Call The IRS

On the other hand, the bad news is that you will have to call the IRS.

The IRS requires that you voluntarily try to address any issues with unpaid/underpaid taxes. Unfortunately, decades of budget cuts have gutted the agency’s taxpayer services. Unless you have an accountant or financial professional to help, the best way to resolve tax debt is by talking to an IRS agent who can walk you through your options. But that probably means a very, very long time on hold.

The hold times are frustrating, but it’s worth the call.

Penalty Abatements

Of your payment options, a good place to start is asking about a penalty abatement. Some taxpayers can qualify for a first-time abatement if they haven’t owed money before. Others can get their penalties waived if they have a good reason for not filing or paying their taxes. This can save you a significant amount of money depending on the circumstances, although it cannot help you with the interest charges.

Temporary Delay

In some cases, the IRS will delay collection for up to 180 days. If you delay payment, you will owe nothing until the new payment date, although you can make installment payments if you choose. To qualify for this, you must generally not have entered a payment or installment plan within the last several years and you must owe no more than $100,000.

This is otherwise known as a short-term payment plan.

Installment Plan

This is by far the most common option. With an installment plan, you pay off your entire tax bill, including penalties and interest, over time. This can range from a period of months to several years depending on your individual circumstances and the amount owed. When you make an installment plan the IRS can also waive some penalties and costs depending on your financial circumstances. Most taxpayers who can’t pay their taxes in full rely on installment plans.

Offer In Compromise

An offer in compromise (OIC) is an agreement to settle your tax bill for less than the full amount owed. This is relatively uncommon. For taxpayers who can’t afford their bill the IRS is far more likely to offer an installment plan with very low monthly payments. However, in some cases, frequently where the taxpayer shows both good faith and significant financial hardship, the IRS will accept the OIC.

To qualify for an offer in compromise you must have filed your taxes in full before the IRS will make any agreement.

Not Collectible

This is even less common than an offer in compromise.

If the IRS determines that you cannot pay your taxes due to financial hardship, the agency might flag your file as temporarily not collectible. This is not a debt waiver, just a suspension of any collection for the time being. What’s more, any applicable interest or penalties will continue to accrue during the not collectible status, which means that you’re much better off finding an installment plan or offer in compromise if at all possible.

Liens/Levies

A tax lien is when the IRS attaches a legal claim to your property. If and when you sell that property, the agency will receive a portion of the sale to cover your debts. In some extreme cases they can force a sale in order to trigger that liquidation. A tax levy occurs when the IRS seizes assets. This can include garnishing wages, deducting money from your bank account or even taking physical assets like your car.

The IRS typically will use a lien or levy in two situations. First, if someone has committed tax fraud or evasion. Second, if you do not respond to repeated attempts to voluntarily settle your tax debt. As long as you contact the IRS and voluntarily try to resolve the issue, it’s very rare that the IRS will issue a lien or levy.

The Bottom Line

Here’s the golden rule when it comes to tax debt: Don’t freak out. You might owe the IRS more than you paid. You might even owe more than you have. But don’t worry. Just be smart. Keep in mind that a tax debt is when you don’t pay your taxes in full by your filing deadline. While there are many options for resolving tax debt, it’s critical that you voluntarily attempt to do so.

Tips For Handling Your Taxes

They might be manageable, but they’re still not fun. When it comes time to file your 2022 taxes, start with our guide to some of the best tax breaks you may not know about.
But the best way to find those hidden tax breaks is with good financial advice. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.