Dealing With an Unexpected Tax Bill

Each year many-a-breath is held as Americans file their taxes. Will the process end in a big tax refund? Or will an unexpected tax liability wipe out your bank account? Or maybe your situation will land somewhere in between.

Getting an income tax bill that is larger than you expected is far from a fun surprise -- especially if you don’t have the cash to cover the amount you owe -- but there may be payment options available. One possibility to consider is working out a payment plan with the Internal Revenue Service (IRS) so you can handle your tax debt in manageable monthly payments.

Whether you have to deal with a big tax bill in the current year, are worried an unmanageable tax bill could be in your future, or you’re just an installment agreement enthusiast, this is the article for you.

Clarify your tax payment obligations

No matter if you’re looking for a solution to manage your tax situation or shopping for parachutes, the same principle applies: One size does not fit all.

“One's approach strategy depends on [whether] you actually owe the money or not,” explains Donna Merrill, business tax expert and founder of Business Untangled, Inc. However, she makes clear that regardless of whether or not you think you owe the money, a tax due notice needs to be addressed in some way. If you ignore paying the balance due, the IRS could take collection actions against you by levying your bank account or wage garnishment.

If you do believe there is an error in how your tax liability was calculated, Merrill recommends calling the IRS and explaining the issue as well as asking for an extension to properly figure out the situation.

Generally, however, Merrill recommends working with a tax professional if you can afford it -- especially if you owe back taxes and face penalties.

IRS payment plans

Regardless of whether you decide to work with a tax attorney or other tax professional, an installment plan could be a good choice to deal with a larger tax bill.

“If you find yourself in a situation where you have a higher-than-expected tax bill, you can submit an installment agreement request with your tax return,” says Mike Savage, founder and owner of 1-800Accountant.

What is an installment plan?

An installment plan will allow you to break up the amount of money you owe into regular, equal payments until you pay off your bill in full. However, taking advantage of this option with the IRS may still come with a penalty in terms of fees and interest. The cost of these extra charges can vary, depending on your financial situation and how you decide to pay.

Short-term payment options

You can apply for a short-term payment plan, which is an agreement that allows you to pay off your debt in under 120 days.

Long-term payment options

Longer-term plans are also available, but will likely require a setup fee, depending on the specific plan. If you qualify as a low-income taxpayer, your setup fee may be waived. If you don’t qualify, your fee may range from $31-$225, depending on the method you use to submit your installment agreement request form.

Regardless of which plan you choose, you will still be responsible for any interest or penalties the IRS charges you during the installment agreement period. To learn more about these online payment agreements and what your personal requirements will be, visit the IRS.gov website or reach out to a tax professional.

How do I fill out an Installment Agreement Request?

If you would like to pay off your tax liability with installment payments, fill out Form 9465, the Installment Agreement Request, when you file your return.

If the IRS approves your forms and you have provided the proper financial information, you can set up a direct debit from your checking account so you won’t have to worry about forgetting to make your minimum monthly payments. Payroll deduction is another payment method to consider if you prefer the IRS to deduct additional money from your paycheck to cover the payment amount. If that sounds appealing, check out IRS Form 2159.

If you need further financial assistance…

Unfortunately, even a payment plan may not be enough to overcome the tax burdens you are facing. The IRS offers the option to pursue an “offer in compromise” that lets low-income taxpayers settle their bill for less than the full amount. You can use the IRS’s prequalifier tool to see if you can receive an offer in compromise.

Put it on the card?

Is it possible to put your tax bill on a credit card so you don’t have to worry about it until later?

Short answer: Yes. Long answer: Yes, but it might not be a great idea. You can learn more about that here.

There are additional fees associated with using a credit card, and if you aren’t able to pay off the bill in full by the end of the month, interest will start kicking in on your tax payment.

2021: Note these special circumstances

The IRS is once again offering a due date extension due to COVID as they did last year, though only around an additional month. You can request a further extension here.

Did you make unemployment claims in 2020? You may not owe as much as you think this year. The American Rescue Plan Act of 2021 exempts taxpayers who were unemployed in 2020 from paying taxes on their first $10,200 of unemployment money -- as long as you fall under a certain income threshold. Make sure your tax return accounts for this one-time deduction before you file.

Plan for the next tax year

Ideally, you would like to avoid unpleasant surprises for future tax seasons. That means figuring out why your bill was as big as it is and taking whatever steps you can to make it more manageable in the future.

“Were your withholdings from your day job too low and you need to adjust your W-4 at work?” asks CPA Joshua Zirrili. “Did you have a side hustle that resulted in income with no taxes withheld? Once you determine that, you can correct it for next year so you don't wind up in the same situation during next tax season.”

A big tax bill isn’t impossible to manage, but it will help to know your options. Knowledge is 50% of paying taxes, after all. Or, you know, some much smaller percentage. But it’s still important!

Donna Merrill is president and founder of Business Untangled, Inc. She is the author of “Making Life Less Taxing – The Entrepreneur’s Guide,” and its newest version revised to reflect the 2018 tax law changes, “How Your Dream Business Can Make Your Life Less Taxing.” As well as a nationally known business strategist, author, and small business expert, Donna has been quoted by MSN Money, USA Today, World News, All Business, Huffington Post, Yahoo Finance, and more.

Mike Savage is the founder, owner, and CEO of 1-800Accountant, a virtual accounting firm. Mike is a 2018 recipient of the Glassdoor Top CEOs award. A savvy finance expert with more than 20 years in accounting experience, Mike’s proficiency in tax law is unsurpassed. He spent several years as a certified public accountant at PricewaterhouseCoopers, where he worked on high-profile audits in that firm’s fraud division. Along the way, Mike recognized that small ventures can benefit from the same tax services that big enterprises receive. Eventually, 1-800Accountant was born.

Joshua Zirilli, CPA is a virtual certified public accountant firm offering tax, accounting, and advisory services to individuals and small businesses. The firm also caters to individuals interested in pursuing financial independence.