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SmartMoney Podcast: “Help! I Owe the IRS!”

April 13, 2020
Personal Finance
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Welcome to NerdWallet’s SmartMoney podcast, where we answer your real-world money questions — in 15 minutes or less. 

This week’s question is from Demi, who says, “I just did my taxes, and I ended up owing the IRS, which I really wasn’t expecting. I know there were some recent tax changes, but I thought I was going to end up getting more back in my refund, and that obviously didn’t happen. What are my options to pay off what I owe, and how can I prevent this from happening next year?”

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Our take

It can be tempting when you owe the IRS to run and hide, but don’t. The failure-to-file penalties are much, much bigger than the penalties for failing to pay. Plus, the IRS has a number of payment options to help you pay off your bill over time.

One installment option is for people who can pay off their bill within four months. It’s easy to sign up and there’s no setup fee, but you can’t owe more than $100,000.

If you need more time, there’s a longer-term plan for those who owe less than $50,000. If you agree to automatic monthly payments from your bank account, the setup fee is $31 if you apply online or $107 if you apply in person, via phone or mail. Fees are waived for low-income taxpayers, generally those whose adjusted gross incomes are 250% or less of the federal poverty level.

The government charges interest and penalties on your unpaid balance. You may be able to save money if you have good credit and can get a 0% credit card offer. To make this work, you’d typically need to pay off the balance before the 0% teaser rate expires.

For those facing an unwelcome surprise on their 2019 taxes, there is a bit more breathing room because the federal deadline for filing and paying taxes has been pushed back to July 15 amid the coronavirus pandemic. But don’t let that become an excuse to put off taxes altogether.

To avoid this situation next year, consider adjusting your withholding. If you’re a W-2 employee — which means you work for someone else and get a W-2 form at the end of the year showing what you earned from your employer — you can have your withholding adjusted using another “W” form: the W-4. You can download the form from the IRS site or pick up one at your company’s human resources department. There are calculators on the IRS site and at NerdWallet to help you figure out the right amount to withhold. You’ll need to gather your most recent pay stubs and last year’s tax return before you begin.

If you have a side gig in addition to your job, you should be withholding taxes from that money too, rather than planning to pay up at the end of the year. The IRS wants you to pay taxes as you earn the money. Fortunately, if you have a W-2 job, you can adjust your withholding at that job to reflect your side income.

The other alternative is to make estimated quarterly tax payments. That means you’re calculating and sending in tax money every three months. That’s what people who are entirely self-employed typically need to do.

If all of this sounds confusing or a lot of work, consider hiring a tax pro to help you.

Our tips

Don’t hide from the IRS. Failure-to-file penalties are much higher than failure-to-pay penalties, and you have options that can help you pay what you owe. 

Work ahead to avoid a tax bill next year. Review your W4 if you’re an employee and make estimated tax payments if you’re self-employed.

Get help if you’re confused or overwhelmed. A tax pro can make this a lot easier.

Have a money question? Text or call us at 901-730-6373. Or you can email us at [email protected]. To hear previous episodes, return to the podcast homepage.

Liz Weston: Welcome to the NerdWallet’s SmartMoney Podcast, where we answer your money questions in 15 minutes or less. I’m your host, Liz Weston.

Sean Pyles: And I’m Sean Pyles. As always, be sure to send us your money questions. You can call or text us at (901) 730-6373. That’s (901) 730-NERD. Or you can email us your questions at [email protected]

Liz: This week’s question is from Demi. Demi says, “I just did my taxes, and I ended up owing the IRS, which I really wasn’t expecting. I know there were some recent tax changes, but I thought I was going to end up getting more back in my refund and that obviously didn’t happen. What are my options to pay off what I owe, and how can I prevent this from happening next year?"

Sean: Demi, I’m so sorry to hear that you’re dealing with this. I’ve been in the same situation in the past and it can be pretty tricky. But to help you answer your question, resolve your tax debt and avoid one in the future, we’re going to be talking with one of our favorite tax investing and retirement nerds, Andrea Coombes, who’s really a nerd of many talents, to discuss the best ways to manage your tax bill and then help you avoid one in the future. Let’s get to it.

Liz: Hey, Andrea, welcome back.

Andrea Coombes: Thanks so much, Liz, and thanks for the nice intro there, Sean.

Sean: Well, Andrea, we are super happy to have you back because Demi, our new friend here, is in quite a pickle. She owes the IRS, which she was not expecting, and we want to help her figure out how she can resolve what she owes and then also avoid a future tax bill. What do you think should be her first step here?

Andrea: Well, the first step is really just to make sure you file your return. The failure-to-file penalty is much higher than the failure-to-pay. And I know a lot of us, if we see a bill, we get nervous. We’re not sure what to do. It’s kind of scary, it’s the IRS. But really the first thing to keep in mind is always file a return.

Liz: The one bit of good news is that the federal deadline to file and pay your taxes has been moved back to July 15. All of the states have also moved back their deadlines, although not all have moved it to July 15, so you have to check with your individual state to see what the deal is.

Sean: On top of that, I would add that it’s probably for the best to file as soon as you can just to get all of this taken care of because you can face penalties monthly of up to 5% of your unpaid taxes and up to a maximum of 25% of your balance. And that adds up really quickly and can make a somewhat scary situation extremely terrifying, and just make this whole thing worse. So just really make sure that you file, first and foremost. And then I think you can begin to figure out what sort of payment option you might want to pursue. There are a number of these, right, Andrea?

Andrea: Correct. So the IRS offers a couple of installment plans. One is for people who can pay off their bill within four months. That’s a short-term payment plan. It’s really easy to sign up. One caveat is you can’t owe more than $100,000 if you want to sign up for that plan. But there’s no setup fee. You go online to irs.gov, and you set up a plan to pay off that bill within four months. Now if you need more time, there’s a longer-term plan. That’s if you need more than four months to pay. With that plan, though, you can’t owe more than $50,000. Also, there is a setup fee for that plan, though it is waived if you’re lower income. If you have to pay the fee, it’s $31 if you agree to automatic monthly payments from your bank account.

Liz: And, Andrea, where can people find more details about this?

Andrea: We have some great stories at nerdwallet.com, and of course, the irs.gov website also has information on these payment plans.

Liz: OK, cool.

Sean: And one thing that I’ve heard debated is whether it would be worth it to use a zero-APR credit card. These are cards that have a promotional period of typically between 15 to 18 months where there’s no interest on the card. And sometimes people advocate for using those to pay off a tax bill. But there are some trade-offs, as well.

Andrea: Yeah, you kind of have to run the numbers. So if you qualify for a zero-interest-rate card, you could use that card to pay off your IRS debt in one fell swoop, and that can feel really good. But then you have this balance on this card. And one thing you want to make sure is you can pay off that balance within that introductory zero-rate period, because you do not want to have that balance subject to credit card interest rates.

Sean: Right. The interest rates can shoot up from 0% to 15 or 20 or 25% overnight. And that can make this a really expensive form of debt, more expensive than the IRS payment plans would be. But I will say, it is kind of nice to transfer the debt from an IRS tax debt to what is basically now just credit card debt, because the IRS has all sorts of mechanisms to really twist your arm and make sure you pay like liens, wage garnishment, all of these scary things that they don’t even need to take you to court for. They can just do them. And a credit card is just a little easier to navigate. And we’re all more familiar with that kind of debt, I think. So just psychologically, it can be a good option. But you have to consider if the potential fees that you might pay to use the card are worth it for the peace of mind of not having to owe the IRS anymore.

Andrea: Exactly. What you really want to do is run the numbers to see what works best for you. If you can pay off that balance on the interest-rate card within that introductory period, then it could make a lot of sense because with the credit card, you’re avoiding IRS interest and penalties. Another thing, though, to keep in mind is that there are convenience fees for using a credit card to pay your tax bill. So the IRS payment processors charge up to about 2% of the money owed to use a credit card.

Sean: It really comes down to reading the fine print and making sure you know what you’re getting into fully, and you can anticipate any kind of costs that you might incur. I will be totally honest here. Back a few years ago, I had a pretty big tax bill. I was a contractor and was freshly out of college. I’d never had a job or any kind of money before and was just spending it willy-nilly. And then tax season came, and I owed a good amount to the IRS. It took me almost two years to pay it off, and that was a lot in fees and also just stress having that much taken out of my account.

Liz: Yeah, I think a lot of side hustlers are in the same position the first time they file their taxes after they start being self-employed. It’s a big surprise. One of the things that we need to mention is if you can pay off a chunk of what you owe, even if you can’t pay the whole thing, it’s a really good idea to do that. That will reduce any kind of fees and interest you pay down the line, is just paying as much as you can when you file your return.

Sean: Yeah, that’s a really good point and something I wish I knew back then. But fortunately for people like Demi and all kinds of workers who think they might be facing a tax bill or are facing one, there are steps they can take to actively prevent this. And for W-2 employees, the W-4 form is really where this begins and ends, right Andrea?

Andrea: That’s right. Your W-4 is really your best tool for making sure you don’t overpay or underpay on taxes. And the reason I say overpay there is because a lot of us like to get refunds, but they’re not really a great personal finance strategy. I mean if you got a $3,000 refund, that’s $250 you could have had in your bank account every month last year. So I’m just bringing that up to note that whether you get refunds or owe the IRS, it can be a really good idea to revisit your W-4.

Sean: Absolutely. But I think some people might not know exactly what the W-4 is. How would you guys frame what this form is?

Liz: Well, the W-2 is what you get at the end of the year. That shows what you’ve already made. Your W-4 is the withholding certificate you probably filed when you started your job and haven’t thought about since. But that’s what you go to HR for, you ask for your W-4, and there’s actually, there’s a calculator on the IRS website that can help you fine-tune what numbers to put in that W-4 so that you don’t get much of a refund.

And I will say I don’t care if you get a refund or not. I know we always talk about you shouldn’t give the government an interest-free loan, but the reality is this is a way a lot of people save. This is the only way a lot of people save. So it’s kind of a forced savings throughout the year. And that’s fine if you use the money responsibly when you get it, blessings on you. But if you have a problem, if you do have debt like credit card debt, it can make a lot of sense to adjust that withholding so you get more money in your paycheck. Just make sure it’s going to your debt and not going for more spending.

Sean: Yeah, I think there’s a big difference between getting a refund of $1,000 and $3,000, just the amount taken out monthly is a big difference here. So I love the windfall. It just feels fun and I feel like it’s a gift from myself, weirdly. But yeah, you want to make sure that you’re not losing $200 a month that could be in your bank account.

Andrea: If you do want to adjust your W-4 so that you don’t have a tax bill next year or to reduce your refund, then you want to talk to your employer about filing a new W-4. You can use the IRS calculator to help you figure out how to fill out the W-4, but keep in mind that you do need to have some recent pay stubs with you and your last tax return so it can take a little bit of time. I just want to warn people, it’s not hard to do, but it does require some paperwork. So just be kind of prepared for that.

Sean: And you can adjust your W-4 at any time, but tax season is the perfect time to do it because you’re going to have to gather all of this stuff anyway. So while you have your papers in front of you, while you’re dealing with this thing you probably don’t want to deal with any other time of the year, just go ahead and knock it out. And then next year, you’ll be really glad that you did.

Andrea: I just want to note that the W-4 has changed. So if you haven’t looked at it lately, it’s a good year to go back and revisit it because the 2020 form is brand new and it no longer talks about these allowances, which I think confused everybody, including me. So now it’s a little bit more written in English that we can understand. It kind of guides you through the questions to help you answer the questions.

Something else I want to point out is that if you have a W-2 job, you’re getting a paycheck from an employer but you also have a side gig, then the W-4 is really your friend because you can actually add extra withholding on that W-4, and that extra withholding will help you pay your tax bill for your side gig. And so it’s a good strategy to keep in mind.

Liz: And if you are self-employed and new to being self-employed and don’t have that W-2 to do the withholding on, you need to save about half of what you earn. That feels like a lot. But between taxes and paying for your own benefits or retirement savings or whatever, that money’s going to go away. So it’s a really good idea to get in the habit of putting it aside so you’re not spending it and counting on it.

Sean: Yeah, and one really nice way to make this easier to endure is by putting it into a high-yield savings account. That way, you’re actually making money on top of this. And if you’re putting in 50% of your income, chances are you’ll actually make a decent amount in interest from the accounts that can have somewhere between one and a half to 2% APY. And that’s just an extra cushion so it feels like a bit of a tax refund of your own making when you’re putting in that much throughout the year. And then, when it comes time to pay off your taxes, you have that little bit leftover from the interest. So that’s a nice, easy way to make sure that you are saving enough and also feel encouraged to do so throughout the year.

Liz: Right. Just make sure that you do the quarterly estimated tax payments. That’s something else that’s new. If you’re doing a side hustle or doing self-employment for the first time, you do have to pay taxes as you earn the money. Can’t wait till the end of the year and then just throw in a lump sum. You can face penalties for that. So you need to figure out your estimated quarterly taxes, that means every three months you’re going to be sending money in to the IRS. If all this is confusing, by the way, it’s a really good practice to get a tax pro, if you do have a side hustle or you are self-employed, just because the tax laws are different. They’re changing all the time, and it can really help to have somebody bounce these ideas off of and let you know what you need to do.

Sean: This is like a best-of list of every mistake I made when I was making money. Didn’t file quarterly, didn’t save money, didn’t talk to a tax pro and I was miserable. So please learn from my mistakes. Well, Andrea, do you have any other final advice for Demi here to help her handle her tax bill and avoid one in the future?

Andrea: I just want to say, Demi, I feel for you. I think we know it’s just a really tough situation to be in. As we talked about earlier, it’s hard to owe money to the IRS. But if you can just, as Liz said, pay what you can right now and get onto a payment plan, and then go and adjust your W-4, then you’re looking at a brighter future.

Sean: Great. Well, thank you so much for talking with us. I really appreciate it.

Andrea: Thanks for having me.

Sean: And with that, let’s get to our takeaway tips. First up, if you owe the IRS, know that you have options, including payment plans with the IRS.

Liz: Next, work ahead to avoid a tax bill next year. Review your W-4 if you’re an employee and make estimated tax payments if you’re self-employed.

Sean: And if you’re feeling confused and overwhelmed by this entire process, hire a tax pro of some sort. They’re really worth the money and they can make this a lot easier.

Liz: And that’s all we have for this episode. Do you have a money question of your own? Turn to the nerds and call or text us your questions at (901) 730-6373. That’s (901) 730-NERD. You can also email us at [email protected] You can even email us voice memos of your questions. However you want to send them is fine with us. Also, visit nerdwallet.com/podcast for more info on this episode and remember to subscribe, rate, and review us wherever you’re getting this podcast.

Sean: And here’s our brief disclaimer, thoughtfully crafted by NerdWallet’s legal team. Your questions are answered by knowledgeable and talented finance writers, such as three of us. We are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.

Liz: With that said, until next time, turn to the nerds.

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