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By Claire Hegstrom
April often brings a little monetary bonus for many in the form of tax returns. In fact, the average U.S. tax return was about $2,535 last year. But for some, tax season can result in an unexpected burden on your finances after receiving the news that you owe federal or state taxes.
If you’ve ever been surprised by a tax bill, you’re not alone. According to the most recent data from the U.S. Internal Revenue Service (IRS), Americans owed over $131 billion in back taxes, penalties and interest last year. So how do we avoid getting hit with IRS fees, while staying current on all our other expenses? Here are a few actionable steps you can take to pay your tax bill on time, and avoid this panic in the future.
First and foremost, take a few deep breaths. You have a few options that you might not know about! You may think, “I’ll just wait ‘til next year and they can deduct my bill from my refund,” but this can be a slippery slope of added interest and IRS penalties that can spiral out of control.
The IRS can charge anywhere from 0.50-5.00% in interest on unpaid taxes, so you’ll want to pay off your bill as quickly as possible.
If your bill isn’t too high and you have expendable income—or you have monthly savings you can temporarily reallocate—a “Short Term Payment Plan” is a great option for you. This payment plan with the IRS is free to set up, and gives you 120 days to pay your bill in full. Although this plan doesn’t include a setup fee, you will be charged penalties and interest until the bill is completely paid down with monthly scheduled payments.
Another option is creating an “Installment Agreement” with the IRS. This option is best for those who owe a substantial amount of money, as this agreement consists of monthly payments for up to six years.
If you agree to make payments through automatic withdrawals, the setup fee is only $31. If you opt to pay each month with non-automatic debit transactions, the setup fee is $149. Keep in mind that penalties and interest will accrue in both types of installment agreements.
Don’t be afraid to use the funds in your emergency savings account if you have it! While it can feel scary to completely empty your stash to pay for your tax bill, this is exactly what the account is for. You’ll feel better knowing you aren’t paying interest on an already unexpected bill, and you can start rebuilding your savings right away.
Even if you don’t have the entire tax bill saved up, pay what you can to the IRS right away to avoid paying more interest than you need to.
If you want to get this added financial stress out of the way as soon as possible, an unsecured personal loan could help get the IRS off your back, and provide you with lower payments over a longer period. Personal loans usually don’t require collateral, but they often have a higher interest rate than payment plans offered by the IRS.
This option is best for those who are really strapped for cash, and can’t make larger payments to eliminate tax debt quickly. Lenders can work with you to make sure your personal loan payment fits into your budget. For example, an Alliant Personal Loan can be paid back over the course of five years.
Do you have available funds on your home equity line of credit? This would be the perfect time to use it! Many HELOCs have a very low interest rate, some even lower than the IRS rates. Your HELOC funds can be used for virtually anything, including paying your taxes.
Simply withdraw from your HELOC and transfer the money to your checking account. You can then pay off your tax bill on the IRS website and make monthly payments on your HELOC when your repayment period begins.
Once you’re hit with an unexpected IRS bill, you’ll never want to be underprepared for tax season again. If you’ve never received an invoice from the IRS, start saving now so you’re ready—should that day ever come.
Setting aside money every month is the single best thing you can do to plan for the unknown. Depositing just $50 a paycheck into a high-rate savings account is a great place to start! If you have the ability to devote even more to savings, but don’t know where to start, check out these quick and easy budgets that prioritize saving for your goals, and for emergencies.
Putting “bonus money” to work can also boost your emergency savings quickly. When you receive your annual merit bonus, put it in savings right away! Another idea for those who are paid biweekly: Send your “extra” third paycheck you receive twice a year to savings. Those big chunks of cash can help you feel accomplished and keep your savings momentum going.
Claire Hegstrom is an advocate of the credit union movement through and through. Passionate about financial education, she approaches money conversations from a candid and inclusive space focused on growth and awareness. As our credit union founding father, Ed Filene, once said, “Progress is the constant replacing of the best there is with something still better.” Claire hopes reading Money Mentor will help transform your life from the best to even better.
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