Paying taxes this year is going to be more confusing than ever. If you received a grant or unemployment due to COVID-19, you could end up with an unexpected tax bill.
About 38% of Americans don’t realize that unemployment is taxable income. If you lost your job and had a side hustle to make ends meet, that income is taxable, too.
What can happen if you can’t pay your tax bill? Read on to find out how happens if you don’t pay taxes and how you can get your finances back on track.
What Happens if You Don’t Pay Taxes?
There’s a difference between avoiding paying taxes and having the inability to pay taxes. There’s also a difference between tax evasion and tax avoidance.
The inability to pay taxes is due to bad luck or poor planning. This is when you earned more than expected and got hit with a high tax bill because you didn’t understand tax laws or didn’t plan properly.
For example, if you retired and cashed out your 401(k), the IRS considers that as income. You might not realize that income is taxable and have a huge tax bill that you didn’t prepare for.
Tax avoidance is using the tax code to your advantage. You take as many legal deductions as you can to lower your tax bill.
Tax evasion is deliberately misreporting income or taking deductions that you shouldn’t take to lower your tax bill. You might have earned money from a side-hustle that you decided not to report. That is illegal.
The IRS has a collection process to collect its debt. As soon as you file taxes, the IRS notes how much money is due. If you don’t pay the full amount, you’ll get a bill from the IRS.
If you don’t respond, you’ll get another letter. Your tax bill will increase because of penalties and interest. You’ll continue to get letters from the IRS for several months.
The IRS has a few legal options at its disposal for collecting a debt. The agency can garnish your wages, seize your bank accounts, place a lien on your home, car, or other properties.
Depending on your situation, the IRS may decide to handle your situation a little differently. Someone accused of tax evasion is likely to face criminal charges, while someone who has the inability to pay taxes could have wages garnished.
Tips for Avoiding Tax Trouble
It’s stressful to have tax troubles. The IRS is no joke when it comes to collecting past debts. There are a few things that you can do to avoid getting into tax trouble in the future.
If you had any type of life change, you should hire a CPA or at least have a consultation. A job loss, change in income, marriage, divorce, and kids will change your tax situation.
You have to understand how your taxes are impacted in order to prepare for tax season.
Check Your Withholdings
Many people were surprised a couple of years ago when they didn’t get the tax refund that they usually get. That’s because they didn’t check their tax withholdings after the Tax Cuts and Jobs Act went into effect.
You want to make sure that your employer is withholding enough state and federal tax from your paycheck. Run your earnings through the Tax Withholding Calculator and adjust your withholdings if you need to.
Save Every Client Payment
Self-employed people have different tax obligations. They don’t have employers to withhold earnings, so they have to do it themselves.
Self-employed people who owe more than $1,000 in annual taxes are expected to pay estimated quarterly taxes. You should work with a CPA or tax advisor to make sure you pay the correct amount.
It’s helpful to create a system where you set aside a percentage of earnings every time a client pays you. This way, you’re not in a position where you’re borrowing funds to meet your tax obligations.
How to Get Back on Track
What can you do if you find yourself owing the IRS more money than you have? The IRS would rather work with you to find a resolution than levying your bank accounts.
However, it’s up to you to take the first step to resolve the tax issue. The longer you ignore it, the problem only gets worse. It’s not going to go away, either.
Consult a Tax Advisor
If you received a certified letter from the IRS, it’s not good news. You are likely to be close to having your wages garnished or a lien placed on your home.
Even if you know that you can’t pay your tax bill, don’t wait. A tax consultant will let you know what your repayment options are. They can stop the collections process and work with the IRS on your behalf.
You might be in a position where you can’t pay your tax bill, but you can do something about it. You can ask the IRS to enter into an installment agreement.
You’ll pay a set amount each month, which is automatically withdrawn from your bank account. You should pay as much as you can and then enter an installment agreement to lower the interest and penalties.
Offer in Compromise
An offer in compromise is an agreement where the IRS agrees to accept less than the total amount owed.
This is part of the Fresh Start Program where you can pay off your tax debts and get a fresh financial start. This is also difficult to get accepted, so you’ll want to work with your tax consultant on it.
You Don’t Have to Avoid Paying Taxes
Paying taxes is hard when you don’t understand the tax code. You can get into serious trouble with the IRS if you avoid paying taxes.
You can have your bank accounts seized, and the IRS can claim a legal right to take your property until the debt is resolved. It’s in your best interest to work with a tax professional to avoid this scenario.
For more legal insights about taxes, visit the IRS Tax Attorney section of this site.