If you owe the IRS, fees and penalties can stack up quickly.
Each year around the middle of April or earlier, every American is required to file an income tax return with the IRS. Based on your tax bracket, deductions, and tax credits, you owe a certain amount of money to the IRS. In most cases, you should have already paid that money through your payroll tax withholding; if you’re a 1099 self-employed worker, then you should have made quarterly contributions.
However, in some cases you can end up owing the IRS. This happens if your payroll tax withholding is set too low or you don’t contribute enough as a 1099. In some cases, you may get audited and the IRS may decide you owe them more. Whatever the case, this additional money that you owe the IRS is known as back taxes. Back taxes, plus all penalty charges applied to that balance is what creates tax debt.
Penalties and interest
Penalties and penalty interest charges can stack up quickly on back taxes. These penalties start from the tax filing date of the year you owe money. That means even if you filed a tax extension and didn’t formally file until October, penalties would be retroactively applied to your balance starting in April of that year.
The IRS can apply penalties that range anywhere from 0.5% all the way up to 25% of your unpaid tax balance. Each month, they apply penalties based on your situation. In general, the less cooperative and transparent you are, the higher you can expect your penalties to be. For instance, it’s an automatic 5% penalty
And it’s important to note that penalties will continue to apply to you pay off all your back taxes. Even if you set up a repayment plan or qualify for something like Currently Not Collectible (CNC) status, penalties and interest will continue to accrue until you are paid up.
Consequences of tax debt
The IRS has a lot of leverage to pursue you and find ways to force you to pay. This includes:
- Wage garnishment. Unlike other types of collections, the IRS doesn’t have to take you to court to garnish your wages. They can do it automatically based on any W-4 filing.
- Property liens. This gives the IRS legal right to a property or asset, such as your home. If you sell the property, the IRS has a claim to take all funds you receive from the sale.
- Property levies. In this case, the IRS has a right to seize a piece of property and sell it to recoup the proceeds. This can include a house, car, boat or anything of tangible value.
- Bank account levies. The IRS also has a right to seize your bank accounts and take funds to pay what you owe.
These types of financial consequences are severe, so it’s best to deal with tax debt head-on. You need to retain a tax attorney and take care of back taxes quickly – before they become an even bigger problem.
Statute of limitations on tax debt
There is generally a 10-year statute of limitations on collection actions for back taxes. After 10 years, penalties will stop accruing on what you owe and the IRS will no longer attempt to collect.
However, you should not take this as a license to hide from the IRS! This is not like a normal debt collector. This is a federal government agency that has plenty of ways of finding you and forcing repayment. And trying to hide usually means you’ll face higher penalties when they find you.
But if you’re working with the IRS instead of hiding, the 10-year statute of limitations can still benefit you. For example, if you set up an Installment Agreement (IA) and you still have back taxes left to pay after 10 years, the remaining balances are forgiven without penalties. Or if you file for Currently Not Collectible (CNC) and the statute of limitations expires before you have the means to pay, your debt is also forgiven.
Learn about your options for tax debt relief