8 Practical Things to Do If You’re Hit With an Unexpected Tax Bill This Year, According to Experts
Filing taxes this season could prove to be especially challenging for some Americans, particularly freelancers and those that qualified for unemployment benefits. Organizing and filing the right tax paperwork can be stressful, to say the least, and the ever-changing tax codes only further complicate the process.
And as Boryana Zamanoff, a senior wealth strategist and fiduciary officer at BNY Mellon Wealth Management, points out, unemployment compensation, as well as all income received and reported on a Form 1099, is taxable and must be reported on a federal income tax return. “If you haven’t paid your income tax in full when you file your income tax return, the IRS will send you a bill for any outstanding tax liability,” she warns. (The three stimulus checks, otherwise known as “economic impact payments,” are not subject to income tax.)
Now for some slightly better news: Because many Americans that will likely owe back taxes for 2020, the IRS recently made a slew of adjustments to their tax repayment policies with the Taxpayer Relief Initiative. Couple that with the federal government’s recently-passed American Rescue Plan, and you might qualify for additional breaks that can ease the pain of tax season just a bit. “The ARP provides a retroactive change for unemployment benefits paid in 2020 that can help offset an unexpected tax bill,” Cari Manteiga, a CPA at Harness Tax, tells Apartment Therapy. “The first $10,200 in benefits will be nontaxable for households making less than $150,000.”
If you got hit with a big tax bill that you can’t immediately afford, it’s important to remember that you have options. From short-term payment plans to installment agreements and more, here’s what steps financial experts say you can take to tackle your tax debt, according to the latest IRS policies.
Don’t panic (or ignore it).
No matter how daunting it feels to face a big tax bill, Zamanoff says putting it on the backburner will only cost you more in the long run. “If you anticipate a large tax bill (or any tax bill that you don’t have current means to pay), don’t panic and don’t ignore it because doing so will only incur interest and penalties,” she warns.
If you can’t pay your income tax in full when you file your income tax return, Zamanoff says the best thing you can do is to pay whatever amount you can, regardless of how small, instead of waiting for the IRS to contact you. “After the tax payment deadline, any balance is subject to interest that compounds daily and a monthly late payment penalty,” she explains. “So if you can’t pay in full, it is best to pay what you can, keep proof of that payment, and explore the payment options that may be available to you.”
Request a temporary delay in collection.
If you know you’ll be low on funds for the foreseeable future, you can request a temporary delay in the collection of your tax debt until your financial condition improves. To qualify for a delayed collection, Zamanoff says the IRS will first need to determine that you are truly unable to pay any of your tax liability. “Before granting, the IRS may ask you to provide proof of financial status, including income, assets, and debts,” she explains.
While a temporary delay in collection could buy you some time to pay off your tax bill, Zamanoff says it’s important to remember that interest and penalties will continue to accrue on your debts. “The IRS may also reassess your ability to pay even after you’ve been approved,” she warns.
Create a monthly budget.
To establish an easy-to-follow budget routine, Kimberly Palmer, a personal finance expert at NerdWallet recommends designating 50 percent of your monthly take-home pay for essential needs, such as rent/mortgage and utilities; 30 percent towards “wants” (like cable and streaming services); and 20 percent towards debt payments or savings. “You can set funds aside from the 20 percent reserve to pay off your tax bill,” she explains.
Set up a short-term payment plan.
If you can’t pay your tax liability in full and owe the IRS less than $100,000, Zamanoff says you may qualify for a short-term payment plan of up to 180 days (extended from the previous allowance of 120 days). “This may be a good option for taxpayers who have additional income for tax repayment coming in within the period of the plan,” she explains.
To set up a short-term payment plan, you can either apply via the Online Payment Agreement tool available on the IRS website or by calling the IRS directly using the phone number provided on your bill. “There is no separate fee for entering into a short-term payment plan, but interest and penalties will continue to accrue until the balance is paid in full,” Zamanoff says.
Start a side hustle.
If you don’t have a unique set of skills to market, you might want to generate extra cash to pay off your tax bill by selling furniture, clothing, and home decor items you were looking to clean out anyway. Sign up to be an online seller on a site such as eBay, Etsy, or Poshmark, and simply upload photos of any gently-used goods you’re ready to let go of to get your side hustle income started.
Apply for an installment agreement.
If you owe $50,000 or less in combined income tax, interest, and penalties, and have filed all tax returns, Zamanoff says you may qualify for a long-term payment plan, known as an installment agreement, which allows you to pay down your debt in monthly installments over an extended period of time. “To apply, you can use the Online Payment Agreement application, or Form 9465 (Installment Agreement Request), and mail it with your tax bill,” she says.
Reduce your spending.
Taking a closer look at your spending habits and eliminating certain nonessential expenses can help you save money for paying off a tax bill. “Pull up your credit and debit card statements from the last two months and comb through them, looking for items you can cut,” Palmer advises. “In some cases, you may have recurring costs for things like streaming services or subscriptions that you can cancel right away.”
If cutting back on nonessential spending isn’t enough to pay down your tax debt, reducing the costs of your fixed monthly expenses can help you slow the outflow of cash. Apps like Trim and Truebill analyze recurring transactions linked to your checking and bank accounts, such as internet and cell phone bills, and then negotiate lower rates with the service providers for you.
Consider an offer in compromise.
If paying your tax bill in installments over time isn’t a possibility, Zamanoff says you can apply for an Offer in Compromise as a last case resort. “An Offer in Compromise is an agreement with the IRS to settle the tax debt for less than the full amount owed, assuming you are not in bankruptcy and meet certain requirements,” she explains.
As tempting as it may be to settle your tax debt for a smaller amount, Orem says that you must meet strict criteria to qualify for an Offer in Compromise — including proof of financial hardship that includes an ongoing review of your income and all of your assets — and that the IRS rejects most applications as a result. “The application process is generally more complicated, but it’s a way to try to settle your tax debt with the IRS for less than you owe,” she says.