Budget Tips For A Surprise Tax Bill

 

Budget Tips For Covering A Surprise Tax Bill

You may not think of budgeting for taxes unless you're self-employed, but whatever your situation, you may someday find yourself facing an unexpectedly large tax bill.

Believe it or not, the IRS realizes not everyone has a few thousand dollars lying around to cover a big tax bill. In 2011 they made changes to the lien program and announced the Fresh Start Initiative to help struggling taxpayers. This program offers penalty relief in some situations, expands installment payment options, and permits Offers in Compromise, which allows some taxpayers to negotiate a lower tax bill under specific circumstances.

If you're overwhelmed with a big tax bill and don't think you qualify under the Fresh Start Initiative or Offer in Compromise program, here's how to cope.

Double- and Triple-Check Your Return

Make sure you actually owe what you think you owe. Look at last year's tax return, and see if you can identify what change is responsible for your tax bill being bigger. Perhaps a child moved out and can no longer be declared as a dependent, or you're no longer eligible for a child tax credit. Or you could have entered information erroneously, so comb through it carefully to ensure accuracy.

If you can't determine what's causing the big change, make an appointment with the preparer who completed your return to discuss out what happened. You may be able to file an amended return if a mistake is found.

File and Pay What You Can

Not filing until you can cover your tax bill is a huge mistake. Failing to file results in fees and interest that increase your bill even more. Moreover, the IRS can garnish wages or put a lien on your property if you don't make an effort to pay your taxes. Filing for an extension gives you more time to file, not more time to pay, so don't look for an extension to buy time.

Your can choose to pay as much as possible as a good faith effort to show the IRS you intend to pay, which can help you once they come for the rest of it. But your best move is to figure out a way to pay what you owe. This, of course, is easier said than done if you need to borrow to pay your bill.

Start now: Budgeting software from Mint helps you customize your budget and plan for the unexpected. Click to get started.

Option 1: Put It On a Credit Card

If you charge your taxes to a credit card, you'll also have to pay the IRS a fee of around 2% for doing so. To avoid high credit card interest, pay off your balance as quickly as possible. Budgeting to prioritize paying off this debt is smart, and free apps like Mint can help you do so.

Option 2: The IRS Installment Plan

If you owe less than $50,000, you can sign up for an installment plan online and pay the bill over a period of up to 6 years. You'll pay an enrollment fee, and a variable interest rate. Be aware, however, that even though the IRS interest rates are low, interest compounds daily, making the installment plan more expensive than you think. In fact, even the IRS suggests that the installment plan be a last resort. Also, if you miss a payment, the IRS can immediately place a lien on your property or garnish your wages for the remainder of your bill.

Option 3: Home Equity Loans

For homeowners with plenty of equity in their homes, a home equity loan carries a much lower interest rate than a credit card, and you can deduct the interest you pay on next year's taxes. Getting a home equity loan, however, can take time.

Don't Touch Your Retirement Funds

Borrowing from or tapping into retirement funds should only be a last ditch effort when no other options are available. Using your retirement funds to pay taxes can not only jeopardize your retirement, but could trigger further tax penalties on next year's return. Explore every other option (including borrowing from family) before considering using retirement money to pay taxes.

Prepare for Next Year's Tax Return

Once you identify why you had an unexpectedly high tax bill, it's time to prepare for next year. You can adjust withholding from your paycheck so you'll have a smaller bill next April, for example. The IRS has a withholding calculator you can use to determine how changing withholding can help you have the right amount withdrawn from your paychecks to avoid surprises.

If you're self-employed, consider setting up a segregated bank account for your quarterly estimated tax payments. If you don't know how much to send in each quarter, the IRS has a worksheet you can complete to make your estimate.

Finally, consider meeting with an experienced tax planner who can show you how to handle your hard-earned money in such a way that you minimize your tax burden in the future.

Start now: Budgeting software from Mint helps you customize your budget and plan for the unexpected. Click to get started.