In my last post, I talked about ways to use your tax refund to jump-start your savings. But what if you aren’t getting a refund this year? What if — gulp! — you will be paying your taxes this year?
If you were surprised to discover that you owe money this year, you’re not alone. Sweeping tax law changes mean that many people are getting less than they expected. If you owe money and are worried about covering your tax bill, here’s what you need to know.
Face the Music
The worst thing you can do is ignore the problem. The IRS is pretty smart, and eventually they will track you down and charge you a failure-to-pay penalty plus interest on the amount you owe — up to 25% in some cases. They have the power to garnish your wages or even come after your property, so don’t even think about trying to walk away from this debt.
Get Help Paying Your Taxes
We’re used to thinking of the IRS as the enemy, but they’re willing to work with people who can’t pay their tax bill in full. Here are your options:
- Temporarily Delay Collection: If paying your taxes will keep you from eating, buying crucial medications, or generally ruin your life, your may be able to put a hold on your collections until you’re able to pay. You’ll still be charged interest for the delay, but no one will come after you to garnish your wages.
- Get a 120-Day Pay-in-Full Extension: If you think you’ll be able to pay off your full tax debt within six months, this is a good option. You’ll still be charged interest, though, so paying sooner rather than later is important.
- Set Up an Installment Plan: The IRS lets you basically suggest your own terms for a monthly payment plan. These payments can come directly from your paycheck, your bank account, or you can write a check each month.
If you’re not sure which method is right for you — or which ones you’re eligible for — call the IRS at 1-800-829-1040. You’ll almost certainly need to sit on hold, but that’s much better than ignoring the issue.
Plan Ahead for Next Year
For better or worse, this year’s taxes are water under the bridge. But it is within your power to make changes for next year so you don’t get stuck owing again. Follow these steps to avoid paying taxes next year.
1. Review Your Withholding
Complete a new W-4 form and get it to your employer ASAP. When you fill it out, don’t claim any exemptions, and opt to withhold at the higher single rate if you’re married. You can also designate an addition amount to be withheld per paycheck.
Pro Tip: Calculate your extra withholding amount by taking the amount of taxes you owed the year and dividing it by the number of paychecks you get each year.
2. Pay Estimated Taxes
If you’re a freelancer or have any side gigs that cause you to receive 1099 income, you need to pay estimated taxes each quarter to make sure you don’t get hit with an underpayment penalty. If you’re doing your taxes with software on or online, you should be prompted to set this up. If not, you can work directly with the IRS to set up your quarterly payment plan.
3. Build Your Emergency Fund
Ultimately, your goal is not to end up in a situation where an unexpected bill upends your financial life. That’s why you need a solid emergency fund as a cushion for future tax bills and other expenses. Try automating your savings for faster results.
Owing money to the IRS doesn’t have to derail your financial plans. Make paying off that debt your top priority, then build your savings for the future. With smart planning, you can tackle this problem and avoid repeating it.