Managing Back Taxes: 7 Tips for Sorting Out Your Tax Obligation

  • Accracy
  • 26th Nov, 2023

Losing track of your small business's financials can happen for many reasons. In fact, even the most experienced entrepreneurs can get behind when unforeseen circumstances arise.

Managing Back Taxes: 7 Tips for Sorting Out Your Tax Obligation
Tax Tips

When tax time comes along, sometimes the last thing on your mind is sending Uncle Sam his cut of your profits. It makes sense—when you're trying to stay on top of a thousand moving parts, it's tempting to push the thought of taxes aside for another day.

But that tax liability cloud hanging over you won't magically disappear just because you don't want to think about it. Delaying your income tax payments, even for just a little while, will only increase the debt as it snowballs with added interest and penalty charges.

What are back taxes?

Your unpaid tax liability is also known as "back taxes." Back taxes are all income taxes owed from prior years that you have not paid by the due date.

If you find yourself behind on your taxes, the first rule is not to panic. Stories of the IRS throwing people in jail for delinquent taxes are greatly exaggerated. That consequence is usually reserved for those who purposely commit tax evasion, not small business owners like you.

In fact, the IRS offers several flexible solutions to help you with your back tax burden.

What happens if you don't pay your taxes?

The IRS is a stickler about getting paid on time. But if you don't meet their deadline and let your tax debt continue to accumulate, the IRS initiates the following process:

You'll hear from them with a reminder letter

If you miss the filing deadline and neglect to file your return, the IRS collection process begins with a letter detailing the penalties and interest you will be charged for nonpayment.

Worried you'll miss the deadline? Learn how to file for an extension, or mark your calendar using our list of tax filing and extension deadlines and avoid this process altogether!

Penalties begin to apply

If you have not contacted the IRS in good faith about your inability to pay, they will add the following penalties to your tax amount.

  • The "failure to file" penalty is 5% of your unpaid tax debt. It applies each month your return is late, not including filed extension month, but cannot exceed 25% of the total in unpaid taxes.
  • The "failure to pay" penalty is 0.5% of your unpaid tax debt. It applies each month that your overdue taxes remain unpaid. This penalty also will never exceed 25% of your unpaid tax amount.

Interest starts accruing

The IRS doesn't stop at applying penalties. You will also pay accrued interest on the amount you owe with the penalties included. Interest starts to apply as soon as you miss your income tax return due date.

The IRS may apply tax levies against your assets

The IRS has the power to apply tax levies against your assets until your tax bill is paid in full. They're considered something of a last resort, but a levy is a seizure of your wages, bank accounts, real estate, vehicles, and other personal property. Even if you are entitled to a tax refund on your state taxes, the IRS can seize those funds to offset your federal tax debt.

As a federal agency, the IRS can also apply levies to any federal payments you receive, such as retirement annuities, social security benefits, and military retirement funds.

Before the IRS puts a levy on any of your assets, they must first file a tax lien. A lien is how the IRS stakes a claim of ownership on enough of your assets that would be required to pay back the debt. These assets can include bank accounts, business property, or even personal property (if you are self-employed and file as a sole prop or partnership).

If a tax lien is ignored long enough, the IRS gives you written advanced notice of the levy, which allows you the opportunity to contest or appeal the decision. If a levy would cause extreme financial hardship, or you are able to enter into an installment agreement with the IRS, the funds can be released.

The IRS will file a substitute return for you

Two to three years from the date your original return was due, the IRS may file on your behalf under their Substitute for Return Program. The IRS doesn't share your interest in maximizing your deductions, though, and won't necessarily have your best interests at hand when filing your substitute return. They won't look for any applicable tax credits, deductions, exemptions, or write-offs, which can substantially increase your tax debt.

Options for managing your back taxes

There are several ways you can get back into the IRS's good graces with your tax situation. Here are the payment options available to you for back tax relief.

1. Take out a personal or business loan

Depending on the outstanding tax debt amount and loan interest rate, taking out a personal or small business loan can be a feasible option. If you are approved for the loan, you will have the same monthly installment and interest rate for the life of the loan. A loan can cost you considerably less to pay off than the IRS's added application fees, penalties, and accrued interest.

2. Pay the tax debt with a credit card

This is an effective solution as long as you use a card with 0% APR, which many credit companies offer new cardholders. This method enables you to pay off the full amount you owe, interest-free. The catch? You'll need to pay the amount off before the introductory period expires, or you will incur high monthly interest charges.

Looking for a new business credit card? Check out our list of the Top 16 Greatest Small Business Credit Cards.

3. Ask for a short-term extension

This is probably the easiest, most straightforward way to buy some time with the IRS.

By completing a simple online payment agreement application, you buy another 120 days to pay your taxes. There is no fee for this extension, but a penalty of 0.5% per month on the unpaid balance will still apply. While there is also an interest charge plus 3%, this option allows you to avoid the payment plan application fee.

4. Agree to an installment plan

The IRS offers two types of installment plans to help you pay off your taxes.

The short-term payment plan is for 120 days with a maximum of $100K in combined taxes, penalties, and interest. If needed, this plan can be extended to 180 days. Payments can be made through automatic withdrawals from your checking or savings accounts. You can also pay by check, money order, or debit/credit card.

The long-term payment plan is for over 120 days and a maximum of $50K in combined taxes, penalties, and interest. If paying with automatic withdrawal, there is a $31 online application fee. Otherwise, the application fee is $107 to apply by phone, mail, or in person. If you use another form of payment, the plan is $149 to apply online and $225 to apply in person.

Note that installment plans with back taxes totaling over $25K must be paid through monthly automatic bank withdrawals.

The installment plan doesn't get you off the hook for filing. The IRS requires you to keep current on all future filings to maintain the agreement. Additionally, all self-employment estimated taxes and other taxes must be continually paid on time.

5. Make a deal with an Offer in Compromise (OIC)

An Offer in Compromise (OIC) gives taxpayers a chance to cut a deal with the IRS and pay less than they owe. This option isn't open to just anyone, though.

To be approved for an OIC, the IRS must have doubt that they can collect the full tax bill amount from you in the foreseeable future. An alternative condition is if the full payment of your back tax bill causes you economic hardship.

An OIC can't be completed with a simple call to the IRS. It's a formal process that requires you to complete IRS Form 656 with a $205 application fee.

On top of that, the IRS requires Form 433, Collection Information Statement, which details your current financial situation. Extensive documentation, including bank records, vehicle registrations, and other items that prove your inability to pay your full back tax amount, is also required.

Sometimes, the best way to get the IRS's attention is to enclose a letter describing your dire situation with the Collection Information Statement. If illness is a factor in your case, attaching a doctor's statement can also help.

The IRS must give you a written explanation if the offer is not accepted. Usually, it's because the offer was too low. If so, the IRS will state an acceptable amount for the OIC.

6. Request a "Currently Not Collectible" status

You can request a "Currently Not Collectible" status be placed on your account if you are unable to pay your back taxes and living expenses. As in the OIC arrangement, the IRS may request that you complete the Collection Information Statement and prove your financial status.

Unlike the OIC, this is a temporary status. The IRS may do an annual review of your financial status to see if your situation has improved enough to collect the tax debt.

7. Work with a qualified tax resolution specialist

If you find the idea of dealing with the IRS on your own a bit too overwhelming, you can recruit a qualified tax resolution specialist to assist you.

When searching for this assistance, be wary of tax resolution firms that may employ unlicensed or inexperienced personnel that promise you the results you want to hear. On top of that, they may charge you thousands of dollars just to investigate your case.

Instead, your best bet is to consult with a tax professional who is authorized to represent clients before the IRS. They can answer questions about your back tax situation and explain the process before requesting a fee. An Enrolled Agent, for example, is a tax practioner who either has passed an exam that covers all aspects of tax representation and business tax laws or has worked for the IRS for five or more years.

The bottom line

Unexpected life events can interfere with your ability to oversee your business, including filing your taxes on time. While facing your back tax obligation can be challenging, taking action sooner than later will head off additional penalties and accrued interest.

There are several manageable ways available to help you pay off your back taxes. The IRS can work with you to establish an installment payment plan or even lower your debt, making repayment more affordable without severely impacting your quality of life.

Moving forward, start setting aside money for your small business taxes to avoid falling behind. If you need help getting started, use our free calculator to determine what your quarterly estimated taxes will be.

In addition to federal taxes, however, you should also plan to pay state and local taxes. You can learn more about these taxes by visiting your state's taxing authority.

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