What Happens If You Can’t Pay Your Taxes?

It’s not uncommon to find yourself in a situation where you owe more taxes than you can pay. Whether you’ve experienced a change in your financial situation or underestimated what you owed, the Internal Revenue Service (IRS) has procedures in place to collect the money. Failing to pay your taxes can lead to penalties, interest charges, and, in extreme cases, jail time.

Ideally, you pay income taxes gradually throughout the year so that you won’t owe much in April or receive a refund of overpaid taxes. Employees have income tax withheld from their paychecks. Self-employed taxpayers pay quarterly estimated taxes directly to the IRS.

If you get stuck owing more than you can pay, acting quickly and responsibly is important. Here’s what happens if you can’t pay your taxes and what options you have to avoid major financial consequences.

What Happens If You Don’t File or Don’t Pay?

If you find yourself in trouble, you do not want to skip filing your tax return or fail to pay your taxes altogether. The government has the authority to forcibly seize your assets if you don’t try to make good on your income tax liability. In the most extreme situations, you may be subject to jail time.

Several scenarios can lead to penalties and interest charges. The two main ones are filing your tax return late and paying your taxes late.

Filing Your Taxes Late

If you are unable to file your tax return by the deadline, you should file an extension of time to file by submitting Form 4868 to the IRS by the due date (typically April 15th).

It is important to note that filing this form does not give you an extension on the time to pay your tax liability. You’re still expected to send any money you owe by the deadline.

If you file your tax return late—or fail to file at all—you will be subject to failure-to-file penalties. These charges accrue on returns not filed by the due date (or extended due date if you’ve filed a Form 4868).

The charges accrue at a rate of 5% of the unpaid taxes for each month or part of a month that a tax return is late. The charges max out after five months, at which point the failure-to-file penalty is 25% of the unpaid tax liability.

If your return is filed more than 60 days after the due date (or extended due date), the minimum failure-to-file penalty is $450 or 100% of your total tax liability, whichever is smaller.

As you can see, filing late does not pay off, with or without an extension. Even if you do not have the funds to pay your outstanding tax liability by the due date, you should still file your tax return to avoid extra failure-to-file penalties on top of failure-to-pay penalties and interest.

Paying Your Taxes Late

You might be tempted to send in your tax return but not pay the money you owe. If you fail to pay your taxes by the due date, you will begin to accrue interest and penalties on the outstanding amount.

The interest rate for failure-to-pay is the federal short-term rate plus 4%, compounded daily after the due date (whether or not you filed an extension of time to file your return).

The failure-to-pay penalty charge is calculated at a rate of 0.5% of the outstanding tax liability for every month the debt remains unpaid, up to a maximum of 25%. Failure-to-file and failure-to-pay charges are applicable if you have not filed your tax return and have not paid your tax liability. In this case, the charge each month is a maximum of 5% (4.5% for failure-to-file and 0.5% for failure-to-pay).

At a certain point, the government will issue you a letter demanding payment for your unpaid tax balance. If you ignore this letter, the IRS may file a Notice of Federal Tax Lien to alert creditors that the IRS has a right to your personal property, real estate, or other assets. A lien secures the government’s interest in your property.

The IRS may issue a levy if the debt goes unpaid for much longer. An IRS levy initiates the legal seizure of your assets to satisfy your outstanding tax debt. Levies come in many forms, including garnishing your wages via your employer, seizing your assets directly from a bank account, or seizing and selling your property, such as a vehicle or a home.

In extreme cases, the IRS may pursue criminal charges against you for tax evasion. Deliberately avoiding paying your tax liability, more commonly referred to as tax evasion, is a serious crime with a penalty of up to five years in jail.

Although this final step is often reserved for the most severe tax evasion cases with large outstanding balances, it is best to err on the side of caution. If you get an initial letter for late payment, set up a plan with the IRS to get your taxes paid as soon as possible.

Options for Paying Your Taxes

If you find yourself unable to pay your tax bill, there are several options to manage the debt:

Borrow Money

For a convenience fee that varies between 1.85%-1.98% based on the payment processor, you can charge your tax liability to your credit card. You could also apply for a debt consolidation loan from a bank or credit union.

If you choose one of these options, you’ll have made good with the government, but you’ll be shifting your debt to an expensive source. Unless you have a credit card with a very low annual percentage rate (APR) or can secure a personal loan at a very low interest rate, you might be making your long-term situation worse.

For example, if you owed $5,000 in taxes, the convenience fee to charge this amount to your credit card would amount to about $100. If you had to carry that $5,100 balance on your card for a year at, say, 20% APR, that would add another $1,020 to your bill, bringing the total you owed to $6,120.

Request a Payment Extension

Filing a tax extension (Form 4868) gives you an additional six months to file your return, but doesn’t extend your time to pay what you owe. You’re still required to pay by the original deadline to avoid failure-to-pay penalties.

Filing your return on time can help minimize the penalty and interest charges assessed by the IRS. The IRS’s late payment penalty is 0.5% per month, up to a maximum of 25%; the late filing penalty is 5% per month, up to a maximum of 25%. So, simply filing your return on time can save you a substantial amount in penalties.

If you’re facing undue hardship, you might qualify for a six-month extension to pay your taxes, but this is rare. You can file Form 1127 to see if you’re eligible. Along with this form, you’ll have to submit a statement of all your current assets and liabilities and an itemized statement of all the money you’ve received and spent in the last three months.

Apply for an Installment Agreement

If you think it will take you more than a few months to pay your tax liability, consider applying for an installment agreement. You can apply online at IRS.gov or by mail using Form 9465-FS.

An installment agreement can prevent the IRS from taking enforced collection action. This option will prevent the IRS from taking legal action (like a levy) while you make payments, but penalties and interest will continue to accrue.

Borrow From Yourself

If you have savings or access to home equity, you might be able to borrow from yourself to pay your taxes:

• Emergency fund: You could tap into your emergency savings as an interest-free loan to yourself to pay off your tax bill and then replenish it over time.
• Home equity line of credit (HELOC): A HELOC might offer a lower interest rate than credit cards, but it uses your home as collateral, so you risk foreclosure if you can’t repay the loan. However, borrowing money this way will turn the large lump sum you owe the IRS into a manageable monthly payment to a mortgage lender.
• Retirement accounts: Borrowing from a retirement account like a 401(k) or IRA is an option but generally a last resort. Because retirement accounts have tax advantages, withdrawing money from them can trigger a tax liability, including a 10% early withdrawal penalty, if you don’t follow protocol. It can also jeopardize your retirement savings.

Anticipate Late Fees and Penalties

Unfortunately, the IRS will charge you interest and penalties on any amount you pay late. Like running a balance due on a credit card, these charges will make it harder to pay what you owe. Here are some more tips:

• The more you can pay on time, the less interest and penalties you’ll be assessed.
• The IRS will eventually send you a bill, but you don’t have to wait to get the bill to make additional payments.
• Pay what you can when you file your return, then send in whatever additional payment you can afford each payday using Form 1040-V.

The Bottom Line

The IRS can be relentless in its pursuit of unpaid taxes, so ignoring the problem is never a good idea. The IRS can freeze your bank accounts, garnish your wages, seize physical assets, and place a lien on any assets you own, including your home.

If you find that you can’t pay your taxes, file your return on time and reach out to the IRS to work out a payment plan or explore other options. Whether you borrow money, request an extension, or apply for an installment agreement, there are ways to manage your debt and avoid more serious consequences.