The 2018 tax filing deadline came and went. Whew! But for some Americans, the tax headache has just begun. This year was the first filing under the Tax Cuts and Jobs Act and while some taxpayers saw larger refunds others received a rude awakening. If you’re reeling from a large tax burden, this article is for you.
The Root of the Problem
Remember how excited you were when you received your first paycheck—followed by dismay when you saw how much was taken out for taxes. If you’re a W-2 employee you probably have federal, state, and local income taxes, plus Social Security and Medicare (also known as FICA) withheld from your paycheck. Regular deductions allow you to cash-flow your tax owed over the course of a year instead of making one lump payment on the tax-filing deadline.
Most of the time this system works fine. This year, not so much. The conundrum with the Tax Cuts and Jobs Act was that some taxpayers who withheld money for taxes throughout the year ended up owing money to the IRS when they filed their tax returns. How did that happen?
The Tax Cuts and Jobs Act lowered tax rates and changed the way taxable income was calculated. In response, the IRS updated their withholding tables. For some people, these changes meant the amount being withheld for federal income tax was less than the amount withheld in previous years and, consequently, not enough to cover their 2018 tax liability. To avoid owing tax for 2019, adjust your withholding amount on IRS Form W-4.
Interest and Penalties: The Good and Not-So-Good News
If you got caught in this conundrum and have a tax liability for 2018, you need to make your tax payment a priority. Why? The IRS charges interest and penalties on late payments. It sets interest rates quarterly—the rate for Q1 2019 is 6 percent. Interest, compounded daily, accrues from the tax filing deadline until payment is complete. Ouch!
To make matters worse, the IRS slaps on a failure-to-pay penalty equal to ½ of one percent of your unpaid taxes. This amount is compounded monthly, with a maximum penalty of 25 percent. The good news is that the IRS allows you to file an abatement to reduce or eliminate the penalties. To file an abatement, write a letter to the IRS explaining the circumstances which led to the unexpected tax bill. If you are successful, the penalties will be waived; however, you’re still responsible for the accrued interest.
Methods of Payment
Founding Father Ben Franklin said it best: "In this world nothing can be said to be certain, except death and taxes.” You can’t avoid either. But when it comes to settling your debt with the IRS you have four options:
- If you have the cash, pay the bill now. This is what emergency funds are for. If you go this route, make sure to adjust your W-4 so you’ll be less likely to experience any nasty surprises on your 2019 tax return. (Note: Be sure to replenish your emergency fund.) Avoid using a credit card unless you can pay the balance off immediately since credit cards typically carry interest rates of more than 20 percent. Compare that to the 6 percent rate the IRS charges, and it’s a no-brainer which way to go.
- Set up a tax payment plan through the IRS. Most, but not all, taxpayers will be eligible to take advantage of this option. Payment plans are only available to filers who owe $50,000 or less and are capable of paying off the debt in a maximum of 72 months. These plans sometimes come at a cost. While there’s no charge for setting up an installment agreement of 120 days or less, longer payment plans charge a set-up fee which can range from $31 to $149.
- Request a temporary delay in collection. Consider using this option if you have hit a rough patch in your personal financial life. A delayed collection occurs when the IRS determines you’re incapable of paying at this time. The IRS may require you to submit information concerning your assets, liabilities, income, and expenses to make this determination. Be aware that penalties and interest continue to accrue while your tax debt is delayed.
- Submit an Offer in Compromise. The IRS can be forgiving. If you are truly incapable of paying off your tax liability this may be a potential solution. The Offer in Compromise program comes with many complex rules and requirements. But, if the IRS accepts your application, a portion of your tax bill will be forgiven. You are not completely off the hook, though. Uncle Sam still wants the rest of his money!
No one enjoys owing taxes, especially when it comes as a complete surprise. If this happens to you, take a deep breath and make the appropriate adjustments to your tax withholding for 2019. If making your payment is a financial problem for you, review the facts of your case and figure out a plan from the available options. If necessary, consult with a financial advisor and/or a tax professional.