10 Ways to pay off tax debt and rebuild your finances

Tax debt can impact your finances in more harmful ways than any other debt. Learn more about what causes tax liabilities, how to determine what is owed, and how to pay off tax debt.

Lee Huffman
June 14, 2023

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Tax debt can impact your finances in more harmful ways than any other debt. In addition to fees, penalties and interest, some tax authorities can take extraordinary steps to collect this debt. However, there are ways to address this financial burden and prevent further consequences. If you owe tax debt, take steps to pay it off or get into a payment plan immediately. Learn more about what causes tax liabilities, how to determine what is owed, and how to pay off tax debt.

Understanding tax debt

Taxes are a common way to fund a variety of government programs at the city, state, and federal levels. There are numerous types of tax debt that you may owe. Each one may affect you in different ways. Examples of tax debt include:

  • Income tax. When people do not pay their taxes owed on income.
  • Property tax. Annual taxes based on the value of your home, vehicle, or other property.
  • Sales tax. Local taxes on the sale of items, typically from a retail business or estate sale.
  • Capital gains tax. The taxes on profits from the sale of an asset.
  • Employer taxes. Taxes withheld from an employee's paycheck and taxes owed based on your business payroll.
  • Estate taxes. The taxes owed on the estate of someone who died.

Common reasons for accruing tax debt

Taxpayers often have unpaid taxes due to a cash crunch. They know that they have a tax liability, but they don't have the money to pay the bill. This situation typically arises from a loss of income or unexpected expenses.

Some taxpayers have tax debt because they haven't filed their tax returns. They either don't have the information to file or keep putting off the task. Even if you don't have the money to pay, you should still file your taxes on time to minimize penalties.

In some cases, tax debt occurs when you don't realize the action is a taxable event. For example, an estate sale is similar to a yard sale in many ways. However, many states require that you register for a sales tax permit and collect sales taxes on the items you sell.

Consequences of unpaid tax debt

If you have unpaid taxes, the tax authority often charges fees, penalties, and interest that make your debt increase significantly. When left unpaid, some taxpayers owe more in fees, penalties, and interest than the original tax debt.

Tax debt must be repaid. If you don't address your tax situation, you'll experience several negative consequences. The tax authority could place a lien on your assets, including your home and bank accounts. Your wages, Social Security checks, and tax refunds could be garnished. Plus, your credit may suffer from federal tax liens and other negative items placed on your credit report.

Assessing your tax debt

Before you can pay your tax debt, you need to know how much you owe. In many cases, the tax authority is sending a bill for the amount due. However, they may not know what your tax debt is because you haven't filed your tax returns.

Gathering necessary financial documents

To file your taxes and calculate your tax debt, you need to have all of your necessary documents in one place. Gather your W-2 and 1099 to verify income. Then, print online statements from your bank, investment accounts, property taxes, and other relevant information to identify tax-deductible expenses.

Calculating the total amount owed

Organize this paperwork to make it easy to input into your accounting system and tax preparation software. Some tax agencies have online systems that help you calculate your tax debt. This process can be overwhelming to do on your own. If so, consider hiring an accounting clerk to enter the data or a tax professional to prepare your tax returns.

Reviewing payment history and penalties

Keep track of your payment history of estimate taxes to ensure that you receive credit for your payments. Add up the penalties, interest, and fees you've been charged. In some cases, you may be able to negotiate a reduction or waiver for some or all of these additional charges.

Exploring payment options

There are numerous options available to repay tax debt, depending on what type of debt it is. Even if you don't have all of the money to pay right now, explore these options to start making payments as soon as possible.

Negotiating with the tax authority

Like most bills, it is possible to negotiate the amount due with the tax authority. Your balance may include fines, interest, and other charges that can be reduced or waived altogether to encourage repayment.

Offers in compromise

An offer in compromise is a program that allows for a tax settlement of their debt for less than what they owe. These settlement options are available when you're struggling to pay the full amount of your tax liability or if repayment creates a financial hardship. To qualify, you'll need to prove why you can't repay your debt. This may include sharing income, expenses, and asset equity with the tax authority to qualify for IRS offers in compromise.

Installment agreements

An installment agreement is a written contract that explains how you'll repay your tax debt over time. This option is ideal for taxpayers who have the ability to make monthly payments consistently to handle their debt.

Penalty abatement

A penalty abatement is a request to remove penalty charges for unpaid taxes. Many taxpayers can qualify for an abatement if this is the first time they've incurred tax debt. Additionally, they may also qualify if they can prove that it was a simple mistake.

Considering tax relief programs

Tax authorities may offer tax relief programs in certain circumstances, such as for low-income seniors or disabled homeowners. You can apply for the IRS directly for these tax forgiveness programs, or you can turn to third-party tax relief firms to seek their help. Beware of scams and promises that are too good to be true, especially if they ask for large payments upfront.

Fresh Start Initiative

A fresh start tax program provides taxpayers with a clean slate based on qualifying criteria. The IRS Fresh Start Initiative is just one of many programs that reduce or eliminate interest and penalties. These programs may also include lenient repayment terms to facilitate tax debt repayment.

Currently Not Collectible status

If your tax debt has a "Currently Not Collectible" status, this means that the tax authority feels that it is unable to collect on the debt. The debt does not go away, and penalties and interest may continue to accrue on the balance owed. While you may be tempted to ignore this debt, you are better off trying to work out an Offer in Compromise (OIC) or an Installment Plan to repay your balance.

Using home equity to repay tax debt

When tax bills are due, it can be a challenge to come up with the money. Some taxpayers tap their home's equity to resolve their tax debts.

Cash out refinance

Refinancing your home to pull cash out can be a good option to repay your debt. However, many borrowers have mortgages with rates that are much lower than the current rates that are available. Many borrowers are hesitant to do a cash-out refinance and lose out on their ultra-low interest rates.

Home equity loan

A home equity loan can be a good option if you have the income to support the extra payments. Keep in mind that rates are typically variable, which means that your payments will increase as rates go higher. If your credit is already damaged due to the tax debt, you may not be able to qualify for a refinance or home equity loan.

Home Equity Investment

A home equity investment allows homeowners to tap their home's equity without requiring a monthly payment. These programs do not have income requirements, nor do you need perfect credit to qualify. Learn more about Point.com's Home Equity Investment program.

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Tackling your tax debt

When you're ready to pay off your tax debt, there are numerous ways to come up with the money. Depending on your financial situation, you'll pay your tax debt in one lump sum or repay them over time.

Collecting required documentation

Collect the documentation that explains your tax debt, and compile a list of your income and expenses. These documents will help you create a budget and a plan to repay your debts. It will also help you substantiate your plan to the tax authority if they request supporting documentation.

Determining your budget

Before you can tackle your tax debt, it is important to know how much you can pay each month. Review your income and expenses to determine how much is left over after paying your bills. Think about what you can cut out to free up extra money. Some cutbacks will be temporary until you can repay your debt, while others may be permanent.

Prioritizing tax debt within your financial goals

While saving for retirement and other goals is important, eliminating your debt should be your number one priority. Having this debt hampers many of your other goals due to its impact on your credit.

Boosting your income

Another way to create extra money to tackle your tax debt is to earn extra money. Consider selling unused items around the house. Start a side hustle to earn money in your spare time. Apply for a promotion or a new job that offers a higher paycheck.

Creating a repayment plan

Contact the tax authority and request a repayment plan. They understand that most taxpayers do not have all of the money upfront. Present your financial condition and discuss repayment options.

Taking action

Once your payment plan is approved, follow through with all of your monthly payments. Take the steps necessary to generate extra cash by selling items, working your side hustle, or getting a promotion. Reduce your expenses by switching to generics, canceling subscriptions, and eating at home more often. All of these small steps add up to make a big difference in your finances.

Avoiding future tax debt

Follow these steps to avoid having tax debt in the future. They will reduce your stress and minimize interest, penalties, and fees that come with unpaid tax bills.

Keeping organized

Staying organized with your income and expenses is key to proper tax planning. Have one place where all of your important information is stored so you don't lose any paperwork. Set aside time on a regular basis to update your accounting. Have regular meetings with your tax professional to ask questions and forecast major expenses.

Monitoring progress

Be sure to file all of your tax forms on time. Add calendar reminders for when tax forms and tax payments are due. Compare the current year's revenue and expenses against last year to forecast your potential tax liability.

Adjusting your withholding

Contact your employer to adjust your withholding from your paycheck. Some employees withhold too little from each paycheck and end up owing money at the end of the year. The IRS website has a tool that helps you estimate your taxes and proper withholding allowance based on a brief questionnaire.

Budgeting for taxes

For small business owners or those without a regular paycheck, you need to budget for potential tax liabilities. Open a separate account and make regular deposits to create a tax savings account. Use this money to make quarterly tax payments to stay current with your taxes.

Seeking professional advice

It can be challenging for the average person to understand the tax consequences of their decisions. Working with an enrolled agent, Certified Public Accountant (CPA) or other tax professional can help you understand how tax laws affect you. If you don't already have a tax professional, ask your friends and family, co-workers, or business associates who they recommend. Otherwise, contact your state's society of CPAs for options.

Final thoughts

Tax debt is a serious problem that can severely impact your finances and credit report. You need to take care of the money owed right away to minimize the damage and get out from under this debt. There are many ways you can repay your taxes, including an Offer in Compromise, Installment Plan, or tapping your home's equity. Explore all of your options to determine which method works best for your finances.

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