When you owe the government unpaid taxes, we use the term back tax to describe the debt. Usually, this applies to the last financial year. The simplest way to get out of the debt is to pay your back taxes. This saves you from forcing the IRS (Internal Revenue Service) from coming to collect. Well, you know what happens when they do. They are likely to seize your property and even freeze your account.
In most cases, the IRS investigates you for back taxes mainly when you fail to report all your earnings. In this case, the IRS may get your financial information from banks and affiliate businesses. The IRS can also investigate you for back taxes when you fail to pay your taxes in full. For most people, however, the biggest concern is their credit history. Let’s look at how back taxes impact your credit:
The Relationship between Back Taxes and Your Credit History
In the US, good credit history is your life. If it’s stained because of the failure to pay back taxes, the following things are likely to happen:
- Home installations may be difficult – If you have a poor credit score, it may be hard to call a utility company to come and do an installation or service maintenance. Both your home and business are affected.
- A bad relationship with creditors – Creditors fear individuals and businesses with bad credit. So, they’ll try to avoid getting into any kind of business dealings with you.
- Borrowing power is affected – The biggest concern is that you may not get a loan from most financial institutions. Your credit score is usually the first thing that they consider.
Though not many people share this perception, the IRS is human. They don’t just put a stain on your credit record until after they have allowed you some time to make payments or to negotiate for a settlement. So, expect them to send you multiple notices. Only until you ignore the notice will your credit history be affected.
Paying Back Taxes as a Way to Maintain Your Credit Score
As earlier mentioned, paying your back taxes is the simplest way of avoiding sanction by the IRS and staining your credit record. Generally, you should follow these steps when making the payments:
- Confirm tax debt – Before you can even consider paying your back taxes, it’s important that you verify if you do have such debt and how much you owe. You may find it useful to consult a tax accountant to help you establish your deductions and exact tax debt.
- Establish a plan – Once you have confirmed that you really owe the taxman, the next thing is to look at your financials and come up with a payment plan. In addition to your income and assets, you also need to consider your current expenses.
- Call the taxman – With a perfect payment plan already established, you can now get in touch with the IRS. You need to first own the mistake of not paying your taxes when they were due and offer the taxman a payment proposal. We’ll look at the payment options that you have later. At this stage, you need all the best negotiation skills that you can assemble. A tax professional may help you. It can be a tax attorney or a tax accountant.
- Ask for a waiver – The truth is that penalties for back taxes noncompliance are really hefty. You also need to remember that your credit history is at stake. So, you need to use your payment proposal as a tool for asking a waiver of the IRS penalty. It’s also a time to negotiate for a lower tax bill. With a great tax attorney on your side, it’s easy to turn things around to your favor.
Payment Options for Back Taxes
The IRS accepts different payment plans depending on your financial power and your credit situation. The payment plan may save your credit record. Here are the most recommended options:
- Pay in Installments – If the IRS agrees that you pay your taxes in installment, you may have about 72 months to clear the debt. However, you’ll need to first pay the taxman $50,000 (and sometimes less) to qualify for this payment plan. You are expected to make a formal request by filing Form 9465.
- Ask for an Extension – This option gives you up to 120 days to pay your back taxes in full. It applies when you know you’ll be getting the money in the coming days.
- Amend Return – Filing an Amend Return allows you to reduce your back tax debt. It happens when the IRS overstates your tax liability.
- Offer in Compromise – This is a payment agreement that allows you to pay a lower tax amount than what you actually owe. Nonetheless, the agreement is only accepted if it’s more than the reasonable collection potential (RCP). The RCP is the total value of your current assets. So, if you don’t have the financial muscles to pay your back taxes in full, an Offer in Compromise is the most reasonable payment option to consider.
- A Private Loan – IF you can manage to get a loan from a financial institution, then you can use it to pay your back taxes debt.
Usually, the basis of opting for a payment plan is to protect yourself and your business from a tax lien or an IRS investigation. These two normally don’t turn out good but it’s the lien that you should be afraid of. It shows on your credit score and doesn’t go away easily even after paying your tax debt.
What If You Just Can’t Pay?
In financial hardship situations, you may not be able to pay what the taxman is demanding even if you have the above payment plans. The most reasonable thing to do at such a time is to:
- File for CNC (Currently Not Collectible) – This allows you to keep the little assets that you have. Nonetheless, the IRS has to determine if your assets will be a liability to them as you claim before they agree to a CNC.
- File for bankruptcy – You can also show the taxman that there’s nothing to collect by filing for bankruptcy.
Generally, it’s important to pay your taxes when they are due to prevent messing up your credit record. But still, owing back taxes doesn’t mean that your credit record is stained right away. It takes time. You are always allowed the opportunity to pay up and you should do so. That’s the secret for maintaining a good credit score.