How to Manage Back Taxes
No matter what, the phrase about having to pay something to the IRS is always terrible. It hurts.
This is reality. You are a college student that never filed any tax returns for his business and has no idea what the Schedule C is. You earned your pocket money at a coffee shop or a college bookstore, or freelanced through Upwork, sold sneakers on StockX, and even drove for DoorDash. However, you never knew that all this activity requires paying taxes. Well, you got a letter from the IRS and now you owe an enormous amount of money.
So, take a deep breath first. You did not commit a crime unless you concealed some information from the IRS intentionally. Believe me; most of the students just were unaware of the fact that they should report some kinds of income. There is a difference between the mistake and the tax fraud. The 21-year-old guy that did not report his income from Etsy definitely falls under the first category. Before you freak out, just remember that back taxes is a financial problem that you can fix. 😅
Unfortunately, you should know about the fines and penalties and compound interests that the IRS charges for unpaid taxes. The failure-to-file penalties are 5% monthly, but you cannot owe more than 25%. Besides, the interest accumulates daily and adjusts quarterly. Your debt from last year might look like $400, but you might pay double amount for the same debt a year after because of the penalties and the compound interest rate. It is nasty stuff and the faster you will solve it, the better.
The first thing you should do is to get your real tax transcripts from the IRS. Go to IRS.gov and register on the website via ID.me in order to receive the Wage and Income transcript from the relevant period of time. It is going to show how much money the IRS thinks you earned according to your employers’ W-2s and 1099s. You will be able to see that your debt is not so big or maybe even that the IRS did not include your deductions. Whatever the case, information is always better than assumptions.
After you get the exact amount you owe, you can do three things. First of all, you may pay all your debt if you can. It is the only way when all the penalties and the interest will stop charging you at once. Second of all, you can apply for an installment agreement using the Online Payment Agreement tool provided by the IRS. You can apply for such an arrangement if the debt is under $50,000. The best thing about it is the possibility to set everything online without any contacts with the representatives of the agency. The third way is to submit Offer in Compromise via IRS Form 659 and offer to pay less than you really owe.
Offer in Compromise looks like a nice idea to pay some money and not to worry anymore. Unfortunately, it works differently in practice since the IRS rejects almost 60% of all applications for such settlements. They will examine your income, your expenses, and even your assets extremely carefully. However, there is a good chance that you can make an application successful as a student who has minimal income and almost no assets. Nevertheless, the application fee is $205 and you can apply for low-income waiver to avoid paying it. The process itself takes several months.
In case if your debt is really small (under $100), it might be a good idea to collect the money in a couple of days, for example, work more in Chipotle or sell your old textbooks. The faster you will pay the debt the bigger your savings are since each dollar pays your debt and not the interest. Tax debt has a nasty way of sitting in the back of your mind and stressing you without your realization. Solving it quickly will do you good. 😌
Currently, not collectible status is also a good solution for your debt in case you do not have enough money to pay it. If the IRS finds out that paying your debt will create a hardship for you financially, the agency can suspend collection activities for you. Such a status is valid for only a year, however, you will have another opportunity to continue living without stress of collecting agents. Penalties and interest rates still apply for your account in such case, but it might be useful for some period of time.
There is also such a possibility as a penalty abatement. It means that the IRS gives you some kind of a waiver from the fines for some reasons. For example, if you have filed and paid your taxes on time during three previous years, you automatically qualified for the first-time penalty abatement. However, there is also such thing as a reasonable cause abatement and you can use it if you are a full-time student and you did not realize the requirement of reporting some kinds of income. Fill IRS Form 843 and explain the circumstances clearly and shortly.
Just stay away from any tax resolution companies that charge you huge money ($3,000 or more) for solving your relatively small problem. These guys try to take your money on late-night TV ads and they do it successfully. The IRS has its own Fresh Start program and you can use it for free on IRS.gov website. You can also use the services of free tax clinic from the Low Income Taxpayer Clinic in your state. Universities usually also have Volunteer Income Tax Assistance programs to assist you in filing of your taxes.
The absolutely worst thing you can do is to neglect this problem. The IRS may be bureaucratic and frustrating agency but they will definitely remember your debt and will send you substitute return on the basis of the worst filing status and no deductions. They will attach lien on your refund and may garnish your wages in some cases. It takes some time for it to happen, but you will be in trouble anyway. The interest and penalties accumulate anyway. Just think about it like about the leaky faucet that will fill your apartment someday. 🔧
Here is what you should do step-by-step. Get your transcripts in this week, calculate your debt, decide how to pay it and contact IRS or free tax clinic before the end of the month. All of these actions take much less time than watching the whole season of The Office. The outcome is a tax situation that will not bother you for the next ten years.
Back taxes are unpleasant and slightly embarrassing, but it is one of the easiest problems you will ever meet. The IRS has a whole system for resolving such a problem and you have more opportunities as a student with little income compared with a working person with mortgage. The only thing you should do is to begin instead of hiding the problem.