Paying Your Past Due Taxes and Prioritizing Payments

It's been almost a month since my last post, as I was enjoying the end of busy season a little too much and for too long.  So now it's time for some more of my valuable advice.Past due taxes are an unpleasant problem.  However, it’s a problem that must be given a high priority. The Internal Revenue Service and state tax departments have tremendous powers to make your life  difficult if you do not cooperate or make any effort toward paying what is owed.  My website explains the different ways to approach the problem. The option most people will employ is to arrange an installment plan that gradually pays off the balance owed over several months or years.  Any future tax refunds will also be applied to the outstanding debt as well.  Other remedies  generally require you to show extreme hardship with living expenses that exceed current income or non-liquid assets against which you can borrow to pay the debt.

While it’s important to pay the tax debt as soon as possible, you should negotiate an installment plan with  the smallest monthly payment possible.  You always have the option to pay an extra amount every month, but there may be a month where you incur other unexpected expenses.  The smaller the required tax payment, the easier it is to pay it and avoid defaulting on your installment plan. If you are required to set up a new plan, the IRS and some states charge a setup fee.  Of course, your monthly payment should always at least be enough to cover the interest that accrues and reduce some of the principal.  The minimum monthly payment required by the IRS is currently $ 25.

What if you owe both past due state and federal taxes? I recommend you apply any extra funds you have toward your state tax debt first (with a couple exceptions), provided you’ve already paid enough on your federal tax debt to prevent wage garnishment or bank account levy.  The majority of states charge higher interest rates on past due taxes than the IRS does (currently 3% annually).  New Jersey, for example, charges 6.25%, and Rhode Island has the highest interest rate, currently charging 18% (higher than some credit cards!).  Unless you owe past due taxes to Indiana or Utah, which currently charge a rate of 2%, I recommend you push to get your state tax debt paid ahead of your federal tax debt.  Also, just like current state taxes any past due state taxes paid are deductible on your federal tax return.  If you itemize your deductions, paying past due state taxes can reduce your taxable income and ultimately reduce your federal tax liability in the current year.  The federal tax deduction you get for past due state taxes serves as a sort of “tiebreaker” for the numerous states that charge the same 3% interest rate as the IRS on past due taxes.

It is also important pay taxes from later years ahead of earlier years.  For example, suppose you owe federal taxes for the 2010, 2011 and 2012 tax years and the total balance owed is just under $ 50,000.  It is important you be current on your 2016 taxes and be ready to pay any balance owed when it is time to file.  If the balance owed at filing time brings the total amount from the current and prior years to over $ 50,000 and you are unable to pay what is owed for 2016, your installment agreement will automatically default.  You will need to re-apply for a new installment agreement, paying another fee to the IRS and monthly late payment penalties will temporarily increase from 0.25% of the balance owed to 0.5% until a new installment plan is in place. Without an installment plan in place late payment penalties accrue at a rate of 0.5% of the outstanding balance every month. With a plan penalties are 0.25%.  Penalties are ultimately capped when they reach 25% of the balance owed for any given year.  After penalties from prior year  federal taxes reach the maximum 25% of the balance, only interest will continue to accrue on the taxes.  Making payments toward taxes owed on a later year, however, that hasn’t reached the 25% maximum penalty yet will reduce the penalties that are still accruing.

Setting up an installment plan doesn’t always require the services of a tax professional, but the larger the balance owed and the longer the time period over which you hope to spread the payments, the more likely you are to need one. Don’t ignore your unpaid taxes. Communicate with the tax authorities or risk serious consequences.