Your 2020 taxes are due in exactly one week. That means an envelope with your check has to be postmarked by midnight on May 17, 2021. Or you’re late.
What if you owe money you don’t have? Maybe you calculated things poorly. Or you didn’t realize you were supposed to be paying quarterly self-employment taxes. You owe, but there isn’t enough in your bank account to pay the bill. What do you do?
File Your Return Anyway
First of all, FILE YOUR TAX RETURN ANYWAY. Yes, I put that in all caps on purpose. It’s that important. Why? It’s bad enough that you can’t pay your taxes, but not filing your return is double-bad.
Penalties
You see, the IRS has two different penalties related to this. One is for not filing your tax return and the other is for not paying your taxes. Filing your tax return is a free and easy way to get out of one of those penalties, even if you don’t have the money to pay your taxes yet.
If you don’t pay your taxes on time, you are subject to a penalty of 0.5% of the amount due for each month (or part of a month) that you are late, up to a maximum of 25%. So, if you owe $1,000 on May 17 and don’t pay it until July 4, then your penalty is $10 (0.5% x 2 months x $1,000). In addition to the penalty, the IRS will charge you daily compounding interest as well.
What happens when you decide not to file your return until July because you know you won’t be able to pay until then? You will be subject to the IRS failure-to-file penalty on top of the failure-to-pay penalty. The failure-to-file penalty is 5% of the taxes due per month (or partial month), with a maximum of 25%. That means in addition to your $10 failure-to-pay penalty and interest in the previous example, you would also have to pay $100 for not filing on time (5% x 2 months x $1,000). For returns over 60 days late, the minimum failure-to-file penalty is the smaller of $435 or 100% of the tax required to be shown on the return.
Extension To File
Basically, FILE YOUR TAX RETURN even if you can’t afford to pay your taxes yet. The failure-to-file penalty is ten times the failure-to-pay penalty. There’s really no excuse not to do it. However, if you do have a really good excuse, I’ve got a backup plan for you. The IRS offers a free, six-month extension to file your return each year.
You have to ask for the extension, it is not automatically granted. All you have to do is file Form 4868, which is really easy, and you’ll have an additional six months to avoid the failure-to-file penalty. Taxes are still due on the regular deadline, so you’ll still end up with a failure-to-pay penalty. But that’s so much better than having to pay both penalties!
Communicate With The IRS
Now that you’ve filed your return to avoid the 5%-per-month failure-to-file penalty, what do you do? If you know you’ll be able to pay your bill in the next couple of months, then go ahead and wait until you have the money and pay the bill. If it won’t be that easy to clean up, you need to get on a payment plan with the IRS.
You see, the IRS’s goal is to collect all the tax money that is owed. They aren’t interested in teaching you a lesson or shaming you or punishing you and making you suffer. They just want their money. If you are forthright and communicative, they will work with you to develop a payment plan. When you get on an installment plan with the IRS, they even cut your failure-to-file penalty in half to only 0.25% per month.
Of course, if you stick your head in the sand and refuse to acknowledge your tax liability, it can get ugly. The IRS has the power to clean out your bank accounts without warning and without prior legal action. You don’t want to go there. Just act like an adult and talk to them about it. I’m sure you’ll be able to work it out.
Make Sure It Doesn’t Happen Again
“The definition of insanity is doing the same thing over and over again and expecting different results,” is a popular quote commonly misattributed to Albert Einstein. While I don’t know that I’d go so far as to call that insanity, it still doesn’t reflect well on your wisdom and judgment. We’ve talked already about what you should do right now about your tax problem. But what are you going to do going forward so that it doesn’t happen again?
The answer to what to do to avoid this dilemma in the future will depend on how you got into this mess in the first place. Maybe you need to adjust your employer’s tax withholdings. Maybe you need to start paying quarterly estimated taxes. Maybe you need to work with a professional tax preparer.
One thing for certain is that you probably need to build up some emergency savings. Yes, an unexpected tax bill counts as an emergency and justifies dipping into your savings. But you can only dip into savings during an emergency if you have savings.
The first step is to live on a budget. Don’t know how to make a budget? Read this article. Having trouble with your budget? This article might help. Once you get your budget going, the next step is to spend less than you make. Those two things are not only the keys to avoiding this problem in the future, but they are the foundation of biblical stewardship and wise money management. They are essential. And, once you are using a budget and spending less than you make, you will be able to build up emergency savings for such a time as this.
Speaking of budgeting, I’m curious about something. If I put together an online course to teach not only how to put together a budget but also how to use it to improve your life instead of making it harder, how many of you would want to take it? Let me know in the comments or at Amy@pastorswallet.com. Thanks!