Millennial Money: How to handle, and head off, a tax bill
Tax season can be a windfall or a wipeout for your budget. Which camp you fall into likely depends on whether you get a refund — or a tax bill — from the IRS.
If you find that you owe taxes, you’re not alone. Over 23 million Americans owed the IRS a balance in 2019, a nearly 6% increase from the year before, according to a 2019 report from the Taxpayer Advocate Service, a government organization that represents taxpayers.
Owing the IRS isn’t fun, sure, but handling your debt the right way prevents more expenses and trouble. Then, you can take a simple step to avoid a tax bill next year.
FACING A TAX BILL? MAKE SURE YOU FILE
So you’ve run your tax information through your favorite online service or hired a tax professional and found that you owe the IRS. Your first reaction may be to avoid filing, but that makes things worse, says Kathy Pickering, chief tax officer at tax preparation company H&R Block.
“When people find out they owe, they sometimes just get panic-stricken and they don’t file because they can’t afford to pay,” Pickering says.
But not filing is risky. You can leave yourself vulnerable to fraud: If a scammer has your Social Security number, they can file a return in your name, making up false numbers to grab a refund. And not filing on time will limit your payment options with the IRS.You also may incur penalties and fees.
FIND THE BEST (AND CHEAPEST) PAYMENT OPTION FOR YOU
Even if you’re paying off other forms of debt, put the IRS at the top of your list. Failing to pay can be costly and result in liens.
“You should prioritize tax debt because the interest and penalties you owe to the federal government or a state is not tax-deductible and it can be expensive debt,” says Luke Sotir, a Massachusetts financial advisor at Equitable Advisors.
The IRS offers payment plans if you can’t cover your balance in a single lump sum. Your options include:
— SHORT-TERM PAYMENT PLAN: This is best for those who can resolve their balances within 120 days. This plan has no setup fee, though you may accrue penalties and interest until your balance is paid off.
— LONG-TERM PAYMENT PLAN: An option if you need more than 120 days to pay off your balance. Fees for this plan vary depending on the setup and payment options you choose.
— OFFER IN COMPROMISE: You settle your debt with the IRS for less than you originally owe. This may be best if you can’t afford your bill and don’t foresee an ability to pay in the future. Use the IRS pre-qualifier tool to see if this might work for you.
MAKE NEXT YEAR BETTER
Tax season 2020 might be a bummer, but you can take steps to avoid this fate again next year.
FOR THOSE WHO RECEIVE W-2 TAX STATEMENTS: The W-4 form is your best friend. This form, which you filled out when starting your job and likely forgot about, determines your withholding, or the part of your pay that your employer sends directly to the government to cover your tax obligation. Withhold too little from each paycheck, and you’ll owe the IRS.
You can alter your withholding level at any time, but Pickering suggests revisiting your W-4 right away: “(Readjusting your withholdings) is a straightforward process, and doing it when you’re reviewing your taxes is the perfect time ... because you have all your information right there.”
Use the IRS tax withholding estimator to get a feel for the process and make sure you have the right amount of taxes drawn from each paycheck. Even if you got a refund, consider adjusting your withholding. The refund you got is simply how much you overpaid the government, and having that money in your paychecks throughout the year can help your finances.
IF YOU’RE A 1099 WORKER: You’re responsible for sorting out your tax payments. The self-employment tax rate is roughly 15%, so be sure to set aside at least that portion of what you earn to cover what you owe the IRS. Make it easy on yourself by setting up automatic deposits into a high-yield savings account. That way, you’re more likely to have enough money at tax time and you can earn a little extra in interest throughout the year.
This column was provided to The Associated Press by the personal finance website NerdWallet. Sean Pyles is a writer at NerdWallet. Email: email@example.com. Twitter: @seanpyles.
NerdWallet: How to Set Up an IRS Payment Plan or Installment Agreement http://bit.ly/setting-up-IRS-payment-plan
Internal Revenue Service: Tax Withholding Estimator https://www.irs.gov/individuals/tax-withholding-estimator
Internal Revenue Service: Offer in Compromise Pre-qualifier tool https://irs.treasury.gov/oic_pre_qualifier/