By Justin Smith
Most taxpayers know by now that the Internal Revenue Service has provided an automatic filing and payment extension to July 15 for this year. Federal and state tax payments due by April 15 can be deferred for three months without penalty, but refunds are still being processed normally.
However, the temporary delays will not solve your underlying dilemma if you have a large tax bill for the year, face back taxes or have not filed in recent years for fear of the tax bill coming due.
No one likes to hear they have a large tax bill. As an accountant, I do not look forward to communicating large tax bills to a client. However, once your tax return is prepared, completed and filed with a payment due, you have several options available for consideration.
The first option is to pay the full amount due in a single payment. Be sure to send your payment with a payment voucher (Form 1040-V) to ensure it is properly credited to you. Taxes are technically due by Dec. 31 of the year in which you earn income, but April 15 (July 15 this year) is traditionally referred to as the formal due date.
Taxpayers may often find themselves in a difficult situation in the event they owe significantly more than expected or are able to pay in a single payment. This may occur because of self-employment taxes (often the result of successfully operating a side job or moving from a W2 job to being an independent contractor), significant increases in compensation, a large capital gain or failing to withhold and remit sufficient taxes when you withdraw funds from a retirement account and cannot avoid the 10% early withdrawal penalty (although the 2020 CARES Act is providing relief on many of these fronts). Whatever the case may be, the most important thing to do in these situations is not to panic, and not ignore the situation!
Do not avoid filing your tax return in this situation – the IRS is much more lenient to taxpayers who file their taxes but don’t pay them immediately (0.5% late payment penalty for each month, plus 5% interest) as opposed to those who do not file their taxes at all (5% failure-to-file penalty for each month past the due date you don’t file, plus the late payment penalties and interest). The maximum penalty on your taxes can be quite substantial at 47.5%!
So, go ahead and file your tax return timely, and then deal with how to pay.
Several methods of dealing with large tax bills are available. First, pay as much as you can by the due date. If you can and do pay off your tax bill within a few months, you will likely not hear from the IRS beyond a regular payment due letter with some penalties and interest tacked on.
If you need a longer period of time (more than 120 days), the IRS will generally let you set up an installment agreement through automatic bank withdrawals. It’s best not to use a credit card to pay your taxes – the interest you pay on most credit cards vastly exceeds the interest charged by the government. The IRS is typically very willing to work with you to pay off your tax bill, and you’ll find the best results occur if you stay in communication with them and regularly pay on your tax bill. Taxing authorities will also keep your refund to offset any amounts due from prior years.
Lastly, you may be able to establish an offer in compromise, in which you settle with the government for a fraction of what you owe. This is a combined legal and accounting matter, and should typically only be used after you have exhausted other options.
Visit www.irs.gov/payments for more information and resources on how to pay, or call a professional for help.
Justin Smith is a licensed certified public accountant in Opelika, specializing in individual and small business tax and accounting. He can be contacted at 334-400-9234 or Justin@JSmithCPA.net. His website is www.jsmithcpa.net.