Having unpaid taxes or back taxes can lead to various tax problems, including significant tax penalties.
The IRS and most states offer a variety of methods to limit collection actions and penalties to financially distressed taxpayers that owe taxes. Below are the various consequences and solutions to having unpaid taxes.
Unpaid Tax Consequences
The consequences of unpaid taxes vary significantly depending upon the situation of the taxpayer. One of the most significant consideration factors is whether taxes have been filed. The total penalty for having unfiled and unpaid taxes is 10x greater than having unpaid taxes alone. If taxes remain unpaid, the IRS and most states follow a standard collection procedure for most taxpayers that often ends with liens and levies. Below are details on tax penalties and other possible collection actions that the IRS will take with unpaid taxes.
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Unpaid and Unfiled Tax Penalties
When taxes have not been filed by the due date and taxes are owed, they can lead to the IRS charging some of the steepest tax penalties. The penalty the IRS charges for unfiled taxes with a balance due is the failure-to-file tax penalty. Failing to file a penalty is usually charged at a rate of 5% of the tax amount owed each month, with a maximum penalty of 25%. If the tax return is filed 60 days or more after the due date (or extended due date), the minimum penalty that is due is the smaller of $135 or 100% of the tax liability amount.
If taxes remain unfiled, the IRS and many states will file a substitute tax return on behalf of the taxpayer to assess the tax liability and penalties. In most situations, the amount assessed will be more significant with a substitute return than if the taxpayer filed themselves because deductions and credits will be limited. The higher the assessed tax liability, the greater the tax penalties.
Unpaid Tax Penalties (If tax return was filed by due date)
The tax penalty for owing taxes but filing on time is significantly less than owing taxes with unfiled tax returns. The penalty for having unpaid taxes is called the failure-to-pay penalty which is charged at a rate of 1/2 of 1% of the tax liability each month (or part of the month) that the taxes remain unpaid. The maximum amount for this penalty is 25% of the unpaid taxes.
If you filed an extension to file taxes then the failure-to-pay penalty will not be charged if 90%of the taxes owed are paid by the original due date and the remaining balance is paid by the due date of the extension.
Other Possible Consequences or Implications
The collection process starts by sending a letter demanding payment and assessing additional penalties and interest. Typically after multiple letters and taxpayer inaction, harsh collection tactics begin. Below are a few of the methods that may be used by the taxing authorities to collect unpaid taxes.
A tax lien is the government’s claim on the taxpayer’s property. The existence of the lien ensures that they get first rights to your property over other creditors.
The taxing authority will contact your employer and demand they withhold a certain percentage of your pay to cover unpaid taxes.
The tax authorities will contact your bank and demand a hold be put on the funds that are in the account and then seize the funds to cover the unpaid tax liability.
The tax authorities may seize assets such as your car, boat, house or other asset of value that can be sold to cover the unpaid tax liability.
Incarceration is possible but very unlikely. Depending on the circumstances, taxing authorities can have a taxpayer arrested and put in jail.
Although not technically, the IRS can request that the State department can revoke, or deny your passport if you owe at least $50,000 or more.
Most taxpayers have unpaid taxes because unforeseen events do not allow them to pay what is owed in full. The taxation authorities realize that these situations arise and are willing to work with the taxpayer to figure out an arrangement. The significant penalties are done to pressure the taxpayer to work with the IRS or state tax authorities as soon as possible. Once an arrangement is agreed upon, the penalties and interest will cease or get charged at a much lower rate. Below are some standard methods to resolve unpaid taxes that cannot be paid in full.
- Installment Agreement (payment plan):
- Offer in Compromise (OIC):
- Partial or Part Pay Installment Agreement:
- Penalty Abatement
An installment agreement allows the taxpayer to make monthly payments towards the taxes that are owed. Once a taxpayer is entered into an installment agreement they are considered to be in good standing with the IRS and most state taxing authorities.
This is a program that is offered to taxpayers that have a high likelihood of not being able to pay their taxes off before the statute of limitations on the tax debt expires. With this program, taxpayers can settle their taxes for less than the total amount owed.
This payment agreement allows taxpayers to pay a smaller monthly amount than would otherwise be required with an installment agreement. This amount is generally determined by their disposable income or financial situation. In many cases, the amount is so small that it does not allow the taxes to be paid off in full before the statute of limitations or Collection Statute Expiration Date (CSED) expires on the debt. As a result, any taxes unpaid by the CSED will not have to be paid back (the remainder of the debt is wiped clean).Currently Not Collectible (CNC): Getting declared uncollectible puts a hold on collection activities on the taxpayer until their financial situation improves enough to allow them to pay money towards the debt without causing financial hardship. In many cases, the statute of limitations expires before the debt is collected and the taxpayer no longer owes the tax debt. Be aware that certain taxpayer actions can extend the CSED. Therefore, working with a tax professional here is a taxpayer’s best interests.
This option is typically used in conjunction with other methods mentioned above. If the taxpayer has a good enough reason for not being in compliance with tax laws, also known as reasonable cause, then penalties could be removed or reduced.
Getting Help With Unpaid Taxes
It is essential to remember that there is a resolution for every situation. The taxing authorities do not want to cause financial hardship to the taxpayer. Mainly the only time the IRS or state taxing authorities will cause financial hardship is because they do not know they are pushing this hardship. After the IRS or State assess your financial situation and discovers that the collection of taxes will cause undue hardship, they will often work with the taxpayer (or their chosen tax professional) to find a resolution.