What is Tax Debt?

If you know how tax debt is incurred, you can avoid it.

What is tax debt?

Tax debt is only scary when you do not know how to manage it.

Tax debt is any taxes that you owe to the IRS after the filing deadline. It does not matter if you filed your tax return before the filing deadline and paid a partial amount of your tax bill. The remaining balance will still be considered tax debt.

Pop Quiz

What percentage of tax filings are audited each year?

a) Less than 2%

b) Around 5%

c) Roughly 7%

d) Just under 10%

Reveal Answer

The IRS usually runs audits on somewhere between 1-2% of all income tax returns filed each year.

a) Less than 2%

Return to question

How tax debt increases with time

Unpaid taxes always attract penalty. The IRS usually charges a 0.5% penalty on the total tax debt amount for failure to pay. At most, the IRS can charge 25% penalty on the total tax debt amount. Each month, the IRS charges not only penalty on tax debt, but also interest on the total tax debt. As the total tax debt increases each month due to penalty and interest, over time, it can grow into a significant amount.

Even though the IRS may reduce the amount of penalties on tax debt if they believe the reason for non-payment of taxes was understandable, they never reduce or remove interest from tax debt.

Fact: In addition to a payment penalty and added interest, unpaid tax debt also causes a credit report penalty.

To achieve penalty abatement, you will need to offer to the IRS a “reasonable cause” for the non-payment. Usually, the IRS considers theft, a natural disaster, divorce, death in the family, etc. as reasonable causes. If the reason for non-compliance was unpredictable, beyond your control and pushed you into a crisis, it is likely the IRS will consider reducing or forgiving the penalties for late payment of taxes.

IRS collection actions on tax debt

When the IRS discovers that you owe taxes, they will first file a substitute tax return on your behalf to determine your tax liability. After they have estimated how much you owe in taxes, they will send you a notice informing you about the amount of taxes you owe and how to pay.

Remember that the IRS will not inform you about tax debt reduction, penalty reduction or removal, or other methods of reducing your tax debt amount. The IRS also does not include the deductions or credits that you qualify for when estimating your tax liability. Therefore, it is vital that you prepare your case preferably with the help of a professional tax service before responding to the IRS notice(s).

You can file your own tax return with the deductions you qualify for even after the IRS has filed a substitute tax return. You may also qualify to pay less in tax debt using penalty abatement, tax debt reduction plans, and other relief programs.

After sending notices regarding the payment of tax debt, the IRS proceeds to the seizure and selling of the property and/or assets of the taxpayer under debt. The IRS has the power to garnish a taxpayer’s wages and to levy their financial accounts, seizing up to the total about of taxes owed. The IRS may also place a federal tax lien to inform other creditors of the IRS’ legal right to a taxpayer’s assets and property. Federal tax liens are public record and can seriously damage a taxpayer’s credit.

Fact: The credit penalty on unpaid tax debt lasts 15 years. It is the longest running credit penalty you can incur.

If you cannot pay your tax debt in full in a single payment, consult a tax service to explore payment plans and relief programs of the IRS to achieve the most beneficial resolution for you.