This year, my tax situation isn’t looking great.
As I planned for the new tax law’s effects to kick in, I factored in the 20% Qualified Business Income (QBI) deduction for small business owners. I qualified, so it went into the equation.
In January, new IRS guidance was issued that significantly reduced the QBI deduction for sole proprietors like myself. In my case, the difference between my projected versus actual tax bill was thousands of dollars. For the first time in my life, I find myself scrambling to pay my taxes.
I’m not the only one who ended up with a bigger tax bill than they were anticipating. Many W-2 employees will be receiving less of a refund than they were expecting.
In some cases, they will owe money, both outcomes of a reduced withholding rate. Many freelancers and the self-employed find themselves up against the same problems as I do in regards to the IRS’s January QBI guidance.
So what do you do when you don’t have enough money to pay your taxes?
Freak out and file for bankruptcy?
That was my initial gut reaction, but it turns out you can’t discharge income taxes unless they were due at least three years before you file for bankruptcy. There may not even be a need for that dramatic of a reaction.
The IRS expects that not everyone will have the cash on hand to pay up every April, so they have systems in place to handle the situation.
1. File On Time Even If You Can’t Pay
If you can’t afford to pay your tax bill, you’re going to get hit with some penalties and fees. But one of these fees is totally avoidable: The failure-to-file penalty.
This penalty is assessed at 5% of your tax burden for each month you don’t file up to 25%. An additional fee of $210 or 100% of your tax bill—whichever is less—will be assessed if you do not file within 60 days of Tax Day, which happens to be April 15th in 2019.
As long as you file your taxes on time, you’ll be able to avoid these fees. You’re not out of the woods yet, though. If you file on time but cannot afford to pay your bill in full, you will run into some other penalties from the IRS.
2. Set Up a Full Payment Agreement
If you can’t pay your tax bill in full by April 15th but will be able to pay it in full within 120 days, contact the IRS and set up a full payment agreement. In addition to not having to pay a failure-to-file penalty, the fact that you’re paying it within 120 days means you’ll be able to dodge the user fee that comes with longer installment plans.
That’s not to say you won’t pay a price for not having a check ready on tax day. First, you will be charged interest starting the day your taxes were due in full. This interest rate is subject to change quarterly. You can get the most up-to-date rate information here.
You will also have to pay a failure-to-pay penalty, which is 0.05% compounded daily, up to 25%. You won’t hit that max, though, because you’ll be paying off your tax burden within about four months.
3. Set Up an Installment Plan
If you cannot afford to pay your tax bill within 120 days, you will need to set up an installment plan. You’ll find yourself paying the same penalties and interest on your unpaid taxes. It’s just that in addition, you’ll be paying a user fee.
This fee ranges from $52-$105 depending on whether you’d like your payments to be automatically sent to the IRS via your bank account or paycheck.
If you qualify as low-income, you may qualify for a reduced user fee of $43, or even a reimbursement of the fee after you have completed your installment agreement.
A lot of people see the words “low-income” and think such a program couldn’t possibly apply to themselves. Always make sure to read the fine print and do the math. For this particular program, if your adjusted gross income (AGI) is below 250% of the federal poverty level for a household of your size, you may qualify for that reimbursement.
For a family of four, your income could range from the low- to mid-sixty thousands per year up beyond $75,000 per year depending on where you live.
If you apply to open an installment plan online, the program should automatically calculate whether or not you qualify based on your AGI. If you believe you should qualify but the system is not offering you a discount or refund you can call the IRS to see what’s going on.
4. Balance Transfers
If you are fortunate enough to currently have a 0% balance transfer or purchase offer on a credit card, you may be able to save some money over IRS fees. If you opt to pay your taxes via credit card with an offer for 0% interest on new purchases, you will be charged a processing fee of nearly 2% by the IRS. Do the math to ensure that this 2% fee will actually cost you less than establishing a payment plan. You’ll also want to make sure you have a plan to pay off the balance before the 0% interest offer expires. Otherwise, you’ll end up paying outrageous interest rates on the remaining balance.
If you have a 0% balance transfer offer, you may be able to transfer an amount in cash from your credit card account directly to your bank account. You can then pay your taxes directly from your bank account without incurring any fees. You are likely to incur a 3%-5% balance transfer fee from the credit card company, though, and you will once again want to ensure you have a plan to pay off your debt before the 0% interest offer expires.
5. Up Your Withholding for 2019
If 2018 taxes have taught us anything, it’s that most Americans probably need to up their withholding. While some argue that you don’t want to receive a large refund as it’s essentially an interest-free loan you’re granting to the government, an arguably worse situation to be in is having a tax bill you cannot afford to pay.
If you are a W-2 employee, you can up your withholding by contacting your HR department. Your paycheck may look a little smaller, but you’re less likely to owe next April.
If you’re a freelancer or sole proprietor, make sure to take the new QBI guidance into account as you organize your quarterly taxes for 2019. If you’re anything like me, you’ll be setting aside a larger chunk of change moving forward.