Tax FAQs: What is Tax Debt?

June 15, 2020

Although the tax filing deadline has been extended due to the ongoing pandemic in the United States, you’ll still be expected to have your affairs in order by July 15th of this year. Otherwise, you could find yourself dealing with tax debt. So, what is tax debt, and how can you avoid it? And what should you do if you do find yourself deep in the hole with the IRS?

What Is Tax Debt?

Answering the question “What is tax debt” is actually quite easy. It’s when you owe the IRS taxes past the due date. Prior to the due date, the amount you owe is considered “tax due,” but once that deadline passes, it becomes a debt. The difference between due and debt is significant because the latter comes with consequences.

How Does Tax Debt Occur?

Although the obvious answer is not paying what you owe the IRS, this can happen in a number of ways. Not all of these situations are intentional, either. However, the IRS generally doesn’t care how it happened. They want their money, and you can expect them to get it one way or another.

Let’s look at some of the common situations that generate tax debt. These can happen to anyone, so make sure you are thorough come tax time.

Nonpayment or Underpayment

By far the most common way to find yourself in debt to the IRS is by not paying your taxes or paying less than what you owe. This could be because you didn’t plan well and now find yourself unable to make the payment on time.

Your payments are due on the filing deadline unless you have to make quarterly estimated tax payments. This means that you can file early and pay later.

It’s also important to note that if the tax payment deadline lands on a weekend or holiday, then the very next business day will be considered the actual deadline.

Miscalculation of Your Tax Liability

Perhaps you believe you paid your taxes in full only to find out later that you were woefully wrong. This could happen due to a number of reasons. Let’s look at a few common situations that could cause you some serious tax headaches.

Dependents and Spouses

You might have filed as a head of household claiming your entire family as dependents, while your spouse may have filed separately. Likewise, your children, especially if they are older, may have opted to file independently and claim themselves. Make sure you communicate with your family members and coordinate your tax filing status.

Erroneous Deductions

Perhaps you claimed a tax credit such as the home office tax deduction but failed to justify it by providing additional details about your small business. Or perhaps it wasn’t yours to take as it’s clear your small business doesn’t truly operate from home. Cases like these can result in unexpected tax debt.

Incorrectly Classified Income

Another common mistake is to classify certain profits as capital gains without actually meeting the requirements to do so. If you only held an asset for a year or less, then it will actually be classified as regular income, forcing you to pay your regular tax rate on it. That’s likely higher than the 0-20% capital gains tax rate.

When these discrepancies occur, your tax due is higher than you anticipated. If you haven’t filed a corrected return and paid the difference before the deadline, then you will find yourself asking “What is tax debt doing here?” when you get your notice in the mail.

This is why we always recommend filing earlier than the deadline so you have time to fix your mistakes if they occur.
 

Issues With Payment

Sometimes there are issues with your payment that prevent the tax due from being collected properly. This is more common with mail-in payments. Checks do sometimes get lost in the mail and occasionally printing errors on checks or money orders could lead to the IRS being unable to process your payment.

It’s always a good idea to pay electronically using your bank account. Not only will you have a clear confirmation that your money was withdrawn, but the process is much faster, usually taking no more than 48 hours.

Always document payments made regardless of the form. You may be able to defend yourself if the error was outside of your control.

Interest and Penalties

What is tax debt going to do your final tax bill? Well, if you find yourself in a tax debt situation, you’ve almost certainly got interest and penalties coming your way.

The IRS levies both a penalty for filing past the deadline and for paying past the deadline. This is why you should absolutely file before the deadline. Your total tax debt will grow as each month passes. Here’s how:  

Penalties That Can Increase Your Debt

There are four kinds of penalties that the IRS can levy. They are failure to file, failure to pay, failure to pay the proper estimated tax, and dishonored check fees. The most common ones are failure to file and failure to pay, so let’s start there.

Failure to File

If you fail to file, the IRS adds 5% to your tax bill. So, if you owed $1,000, you now owe $1,050. This 5% fee is added for every month or part of a month that you fail to file. So, if it’s July 16th and you’re just now filing, you’ve got 5% extra to cough up.

This gets particularly nasty at the 60-day mark. The current minimum fee is the lesser of the following two amounts: 100% of your tax due or $435. The previous 5% penalties don’t apply to this calculation, so our $1,000 example would owe the minimum $435 if they fail to file within 60 days of the deadline. That hurts.

Failure to File fees max out at 25% of the tax due or the aforementioned minimum of $435.

Failure to Pay

Suppose you file on time, but you fail to pay at the deadline. What happens next? The IRS imposes a 0.5% interest rate on the debt you owe, meaning that your tax debt increases by that much every month. You can reduce this to 0.25% should the IRS approve an installment plan for you.

This fee is also capped at 25% of the total tax due, which would mean that you were in arrears for approximately 4 years. If that’s the case, you likely owe from other tax years, making your total tax burden that much worse. Whatever you do, avoid this situation.

Failure to pay estimated taxes follows a similar structure, except each estimated payment has unique deadlines, so the debts will be calculated separately.

Dishonored Checks

Should your check bounce or contain faulty data that prevents it from clearing, the fee is 2% on payments over $1,250 or $25 for payments less than that number.

Save Yourself From Tax Problems

Believe us when we say you do not want to be on the IRS’s bad side. Call the experts at Geaux Tax Resolution of Lafayette, Louisiana. We specialize in handling cases of tax debt in the United States and will fight to defend you from the ruthless collectors at the IRS. If you’ve received a notice of tax debt, act now, and let us go to work for you.