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What to Do When You Owe Taxes to the IRS

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Owing a debt you can’t pay is a situation nobody wants to find themselves in, and it can be especially stressful when that debt is owed to the IRS. Many people fear the IRS and not without reason.

The IRS has collection powers that many creditors don’t have, including garnishing wages, seizing bank accounts, and even putting liens on property. Yet many people occasionally face a situation where they have a tax debt they just can’t pay. There are many options for dealing with tax debt, but ignoring it and hoping it goes away is not one of them. If you find yourself in this unfortunate situation, check out these tips for facing tax debts.

Filing for a filing extension will not give you more time to pay back the debt

Some people mistakenly believe that if they extend their tax return, they’ll have additional time to pay the amount due with their return. But an extension is just an extension of time to file, not to pay. You are still obligated to calculate the amount you’ll owe and pay that by April 15, even if you’re not yet ready to file.

Pay as much of the debt as possible by the filing deadline

When you file an extension but don’t pay 90% of the tax you owe for that year, the IRS will charge a failure-to-pay penalty. The penalty is generally 0.5% per month on the balance of your unpaid balance, and it starts accruing the day after taxes are due. It can grow to as much as 25% of your unpaid taxes.

In addition, interest will accrue on any unpaid tax from the due date of the return until you pay your balance in full. The interest rate is determined quarterly and is the federal short-term rate plus 3%.

If you can’t pay the amount you owe, filing your return without making a payment won’t avoid penalties and interest, but it’s important to know that filing an extension won’t help you avoid them either. Just file on time and pay as much as you can to reduce penalty and interest charges.

Now that you’ve filed your return and know how much tax you owe, it’s time to consider your options for paying the balance due.

How to pay your tax debt

By credit card

If you don’t have the money to pay the amount due immediately, the IRS does accept credit cards, but be wary of paying your tax debt with plastic. Although the IRS doesn’t charge a fee to pay by credit card, the company that processes your payment will charge a fee ranging from 1.87% to 2.00% of the payment amount. Plus, you’ll need to consider the interest your credit card company will charge until you pay off the balance.

The IRS will charge a far lower interest rate than your credit card, which means you can pay off the debt much quicker.

Enroll in an IRS repayment plan

Paying a tax debt via credit card may not be an option if the amount due exceeds your credit limit, or it may not be the best choice if your credit card has a high interest rate. In that case, you may be able to work out a payment arrangement with the IRS. Just be aware that your account will continue to accrue penalties and interest until the balance is paid in full.

Here are three types of IRS repayment plans:

Short-term extension to pay

If the amount you owe is relatively small and you believe you can pay it off within 120 days, call the IRS and ask for a short-term extension of time to pay. This is not a formal payment plan. The IRS will just make a note on your account that you’ve been granted additional time to pay the full amount. During this period, they will not take any collection action against you.

Installment agreement

If you aren’t able to pay your debt in full within 120 days, Scott Taylor, a CPA with Piercy Bowler Taylor & Kern in Las Vegas, Nev., recommends that you contact the IRS to arrange an installment agreement. An installment agreement is basically a monthly payment plan. You can apply online for an installment agreement if you owe $50,000 or less in combined tax, penalties, and interest. For balances over that amount, you will need to complete Form 9465 and Form 433-F and send them in by mail.

With an installment agreement, you decide how much money you will pay each month and on what date you’ll make the payment. As long as your debt will be paid off within three years and you owe less than $10,000, the IRS has to accept your payment plan.

Fees

Keep in mind that the IRS also charges user fees for installment agreements. “Unfortunately for taxpayers, the fees have gone up as of January 2017,” Taylor says. The cost to set up an installment agreement is $225. If you apply online and choose to have the monthly payments directly debited from a bank account, the fee drops to $31.

If your ability to pay the agreed upon amount changes later on, you’ll need to call the IRS immediately. When you miss a payment, your agreement goes into default and the IRS can start taking collection action. For example, if your agreement calls for a $300 payment and you lose your job and aren’t able to make the payment, call the IRS before you miss a payment. They may be able to reduce your monthly payment amount to reflect your current financial situation.

Partial payment installment agreement

What if you owe so much that you can’t pay it off in a reasonable period of time? In that case, you may be eligible for a partial payment installment agreement. Like a regular installment agreement, you will make regular, agreed upon payments for a set period of time. However, the payments will not pay off the entire debt. After the agreement period ends, the remaining debt will be forgiven.

As you can imagine, the IRS doesn’t take debt forgiveness lightly, so applying for a partial payment installment agreement is more complicated than applying for a regular installment agreement. Instead of letting you decide how much you can afford to pay each month, the IRS will calculate your monthly payment by taking into account your outstanding balance, the remaining statute of limitations for collecting the debt, and the reasonable potential of collection.

To request a partial payment installment agreement, it’s best to consult a tax professional with experience handling tax debts. Before the IRS approves a partial payment installment agreement, you will need to have filed all of your tax returns and be current on your income tax withholding or estimated payments.

How to settle your tax debt (offer in compromise)

You’ve probably heard the television commercials promising to help you “settle your tax debt for pennies on the dollar.” These ads refer to an offer in compromise (OIC), and they’re not as easy to get as those ads would have you believe.

With an OIC, you agree to a lump-sum or short-term payment plan to pay off a portion of your debt in exchange for the IRS forgiving the remainder of the debt.

To qualify, you must prove that you are unable to pay off the entire debt through an installment agreement or other means. It can be difficult to meet the income and asset guidelines to qualify for an OIC, so it’s best suited for taxpayers with low income and very few assets.

You can check to see if you are eligible for an OIC by using the IRS’s pre-qualifier tool. To apply, you’ll need to complete Form 656 and Form 433-A and submit them along with an application fee of $186. You’ll also be asked to provide documentation to support the financial information provided in the forms.

Again, it’s a good idea to get help from a tax professional with experience working with OICs to help you complete the forms and walk you through the complex process. Be wary of tax resolution firms making promises that sound too good to be true. Check with the Better Business Bureau and the state attorney general’s office for complaints before you pay a retainer.

Tax debt discharge

There is a 10-year statute of limitations on tax debt collection, so if you are having serious financial issues and can’t pay at all, letting that statute run out may be an option. To do this, you’ll need to get your tax debt in currently-not-collectible (CNC) status by demonstrating that you cannot pay both reasonable living expenses and your tax debt.

To request CNC status, the IRS will ask you to provide financial information on Form 433-A or Form 433-F and provide documentation to support amounts listed on the statement. If you have any assets that the IRS believes could be sold to pay your debt, they may not grant CNC status.

While your account is in CNC status, the IRS will not pursue collection, but if you are owed any tax refunds on returns filed while your account is in CNC status, the IRS may keep your refunds and apply them to your debt. They may also file a Notice of Federal Tax Lien, which can affect your credit score and your ability to sell your property.

The IRS will review your income annually to see if your situation has improved. If you maintain CNC status until the 10-year statute of limitations runs out, you may no longer be required to make payments, regardless of whether your financial situation improves later on.

What if you don’t agree with the amount due?

If you owe a lot more than you expected, take a moment to review your completed return carefully to look for errors. Make sure you didn’t accidentally enter the same income twice or forget an important deduction, and make sure you answered all of the questions correctly. One missed question or checkbox can cause you to miss out on valuable tax benefits. Also, compare this year’s return to last year. If your tax bill went up drastically even though your situation hasn’t really changed, find out why.

Occasionally, taxpayers receive notices from the IRS indicating an amount due that they don’t agree with. Don’t feel like you have to pay an amount you don’t believe you owe just because it comes on IRS letterhead. Taylor says each notice will include a section detailing how to respond.

“The IRS may have made an error in matching up 1099s or W-2s, and the amount owed needs to be adjusted,” he says, and he recommends that you send a letter via certified mail in response, with a full explanation. “A CPA can help you with this letter, but if you follow the guidelines provided by the IRS, you should be able to respond appropriately and have the fees resolved or adjusted.”

IRS collection enforcement

If your taxes are not paid on time and you do not communicate with the IRS, they can issue a Notice of Levy. An IRS levy permits the legal seizure of your property. They may garnish your wages or seize your bank account, vehicles, real estate, or other personal property to satisfy the debt.

Taylor says IRS notices will only come via U.S. mail, so be sure you check your mail and read all IRS notices. “It seems like a simple thing,” Taylor says, “but with many financial and personal transactions occurring online, many people ignore their mailbox for long periods of time.”

Whatever your situation, Taylor says it’s important to remain in contact with the IRS to show your intent is to pay your debt. “Don’t ever ignore IRS notices,” Taylor says. “The IRS is willing to coordinate payment plans, and the consequences of ignoring them are always difficult to adjust.”

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Janet Berry-Johnson
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Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Are Scholarships Taxable? Here’s Everything You Need to Know

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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The cost of higher education can be astronomical for many students, and while there are many ways to pay for college, scholarships and grants are two of the best ways to make it more affordable. If you are awarded a scholarship, whether it’s merit-based or need-based, congratulations! However, the next thing to consider after receiving a grant is your tax liability on the money — not as much fun but nonetheless important.

Some scholarships and fellowships are tax-free, but some are subject to income taxes. We’ll walk you through the ins and outs of scholarship taxation and how to pay taxes on grants that are taxable.

When scholarships are not taxable

There are fellowship or scholarship grants that are tax-free, according to the IRS, and you don’t need to report them as a source of income, when you meet both of the conditions below:

  • You are studying toward a degree at a higher education institution.
  • All the funds you receive are used for qualified education expenses: You either use the money to pay tuition and fees required for enrollment or attendance at the college or university, or cover course-related expenses, such as textbooks, supplies and equipment.

For example, if you receive a $10,000 scholarship and pay it toward the $20,000 tuition, then you won’t owe taxes on the money. However, if your scholarship is $30,000 and you use $20,000 for tuition and cover your rent with $10,000, that $10,000 is taxable income.

Some other types of grants, such as Fulbright grants and need-based grants like a Pell Grant, are also treated as scholarship funds for purposes of determining their tax treatment: They are tax-free if grantees use them to cover qualified education expenses during the time when a grant is awarded.

April Walker, lead manager for Tax Practice and Ethics at the American Institute of CPAs, told MagnifyMoney that it doesn’t matter if a scholarship is granted by your school or sent to you directly from an organization — you follow the same rules above to determine whether it’s taxable or not.

Take a few minutes to complete this IRS questionnaire to determine whether your scholarship money is taxable: Do I Include My Scholarship, Fellowship, or Education Grant as Income on My Tax Return?

When scholarships are taxable

However, grants should be included in your gross income if they are non-qualifying education expenses, meaning they don’t meet the conditions we just talked about.

Using scholarships for incidental expenses

The IRS explains that scholarship or fellowship funds that are used to cover incidental expenses are taxable. Incidental expenses are the money you spend for non-academic activities that are not required as part of your education, such as rent, insurance, transportation and living expenses.

Compensation for services

If students receive a scholarship or fellowship grant that requires them to be a teacher assistant, research assistant or perform other services, the funds are also taxable as salaries. There are exceptions, though. The IRS said grant recipients of the National Health Service Corps Scholarship Program and the Armed Forces Health Professions Scholarship and Financial Assistance Program do not have to include the scholarship funds they receive for service in their gross income.

Similarly, a grant or fellowship awarded to a non-degree-seeking individual to finance a certain research project, a report or a product is taxable, according to tax specialists interviewed by MagnifyMoney. But you could deduct expenses related to the work, such as travel and supplies for research, from your taxable income.

How to pay taxes on scholarships

Students should expect to receive a Form 1098-T that states their tuition and scholarship amounts from their schools by Jan. 31. If your tax-free scholarship or fellowship grant is your only income, you don’t have to file a tax return or report it, however, if part or all of the grant is taxable, then you are required to file a tax return, according to the IRS.

If you file Form 1040, Form 1040A, or Form 1040EZ, include the taxable amount in the total amount reported on the “Wages, salaries, tips” line of your tax return.

If the taxable amount wasn’t reported on Form W-2, enter “SCH” along with the taxable portion in the space to the left of the “Wages, salaries, tips” line. Form W-2 is the form an employer sends to an employee and to the IRS at the end of each year that reports an employee’s annual income and the amount of taxes withheld from their paychecks. Most likely, graduate students who perform teaching or research services at their institutions will receive a W-2.

If you file Form 1040NR or Form 1040NR-EZ, report the taxable amount on the “Scholarship and fellowship grants” line.

Even if you don’t get tax forms, you must pay taxes on your scholarship income that’s subject to income taxes.

In general, the taxable amount of scholarships would be included in the adjusted gross income on the federal return, said Mark Luscombe, principal analyst at Wolters Kluwer Tax & Accounting. But depending on your state of residence and other incomes you have, you may also have to pay state income tax on your scholarship income, Luscombe said. Some states don’t have an income tax. Many states with an income tax use federal Adjusted Gross Income as the starting point in determining their state taxes, Luscombe said, and if your gross income is higher than your state’s income tax base, you will pay state income tax on your scholarship.

How can I minimize my tax burden from scholarships or fellowships?

Tax tips for students

Tax specialists advised if you’re a student, whether you are a dependent on your parent’s tax return or an independent student, you should keep track of the scholarships you receive and your qualified education expenses to make sure you spend as much of your scholarship as possible on qualified education expenses. Keep an eye out for a 1098-T, and in the case of graduate teaching assistants or research assistants, watch out for a Form W-2 at the end of the year.

If your scholarship doesn’t cover all your tuition and fees, Walker suggested you still keep track of your expenses, as some may qualify for education credits, which we will talk about below.

Tax tips for working professionals

For non-degree-seeking individuals who received a grant for an independent research project, Luscombe said they may want to treat the grant as a business income.

If you are running a business on your own, you’re most likely seen as a sole proprietorship owner for tax purposes. You will have to report business-related income and losses on a Schedule C (Form 1040) each year. Luscombe said grant awardees may claim the fellowship activity as a business activity on Schedule C to deduct the related expenses from their taxable income.

Under the new tax law, pass-through business owners can deduct up to 20% of their qualified business income from a partnership, S corporation or sole proprietorship. Individuals earning $157,500 or less ($315,000 for married couples) are eligible for the fullest deduction.

Luscombe advised those who received a one-off grant during the year keep separate records of all the income and expenses related to it.

Education tax credits

If part or all of your — or your child’s or spouse’s — scholarships are taxable, one of the ways for you to offset education expenses is to claim education tax credits, which reduce the amount of your income tax. There are two types of credits available: the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC).

  • American Opportunity Tax Credit: This credit allows a taxpayer an annual maximum credit of $2,500 per undergraduate student of the costs for school or course-related expenses. Luscombe said AOTC is probably the most generous of tax breaks available for undergraduate education. To qualify for the full credit, your income must be $80,000 or less ($160,000 or less for married filing jointly). The credit is phased out for those whose incomes are above the thresholds.
  • The Lifetime Learning Credit: It allows a taxpayer a credit of up to $2,000 per year per tax return. This credit applies to an eligible student’s costs for undergraduate, graduate or professional degree courses. There’s no limit on the number of years you can claim the credit. You must earn $66,000 or less ($132,000 or less for married filing jointly) to qualify for this credit. The credit is phased out for those whose incomes are above the thresholds.
This interactive worksheet from the IRS can help you answer the following question: Am I Eligible to Claim an Education Credit?

To be eligible for either credit, students should receive a Form 1098-T. You also need to complete the Form 8863 and attach it to your tax Form 1040 or its variations. You cannot claim the credit if you are a dependent on someone’s tax return.

You cannot double dip if you qualify for both credits — you must compare options and choose one or the other. You cannot claim either credit if someone else claims you as a dependent on their tax return.

Tax deductions

If you don’t qualify for either credit, you can look into potential tax deductions to reduce your taxable income. There are two deductions that may be applicable: the Tuition and Fees Deduction and the Student Loan Interest Deduction. You can claim these deductions even if you do not itemize your deductions.

The tuition and fees deduction allows you to deduct qualified higher education expenses of up to $4,000 from taxable income per tax return for yourself, your spouse or your child. You need to claim your qualified deduction on Form 8917. You cannot claim this deduction if your filing status is married filing separately or if someone else claims you as a dependent on their tax return. The income threshold for this deduction is the same as that for the AOTC. (Note: This tax break was supposed to expire at the end of 2016, but the Bipartisan Budget Act of 2018 renewed it for tax year 2017. It’s unclear whether it will be continued for tax year 2018.)

Student loan interest deduction: If your income is less than $80,000 ($165,000 if filing a joint return) and you took out a student loan to pay for qualified education expenses for you, your spouse or your dependent, you may reduce your taxable income by up to $2,500 of student loan interest you paid. You cannot claim this deduction if your filing status is married filing separately or if someone else claims you as a dependent. You should receive Form 1098-E, the Student Loan Interest Statement, which can help you figure out your student loan interest deduction.

This interactive worksheet can also help: Can I Claim a Deduction for Student Loan Interest?

You cannot claim the Tuition and Fees Deduction (if it’s available for tax year 2018) if you have claimed an education credit for the same expense, Luscombe said, but you can still claim the Student Loan Interest Deduction.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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Shen Lu is a writer at MagnifyMoney. You can email Shen Lu at shenlu@magnifymoney.com

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Where Most People DIY Their Taxes and Tips for Last Minute Returns

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

A new MagnifyMoney analysis found that 45% of Americans file their taxes without paid help, while the other 55% rely on a paid tax preparer. The analysis is based on IRS statements of income data for returns filed Jan. 1, 2012 – Dec. 31, 2016.

Taking the DIY approach to taxes is most popular in these metro areas: Austin, Texas (62%); Virginia Beach, Va. (61%), Seattle, Wash. (59%), San Antonio, Texas (58%), Richmond, Va. (58%), and Portland, Ore. (56%).

For those taking their taxes into their own hands, using tax preparer software is a perfectly fine alternative. The IRS expects 155 million tax returns to be filed this year and 70% of tax filers are expected to receive refunds. However, missing even one simple detail on your return could make a big difference in your refund.

At the very least, to avoid errors, the IRS recommends e-filing for DIY preparers. It takes out some of the risk for human error, especially since most e-filing programs can help spot mistakes. If you’re comfortable preparing your own taxes, there are some last-minute tax tips to follow as you near the April 17 deadline.

DIY vs. PRO: Which is best for you?

The DIY approach is smart for people with simple personal taxes, where you basically can copy and paste information into the return, said Eric Nisall, founder of accountlancer.com, which provides accounting and bookkeeping for freelancers. For example, if simply have a W-2 from your employer and you don’t itemize deductions or have investments, you could definitely do it yourself.

Online programs continue to offer new features to help customers comprehend their taxes as they go, such as prompts nudging them to fill out missing information, or explaining why certain information is needed

A DIY approach also works if you keep organized throughout the year with receipts and statements, and if you are comfortable going through those details to correctly enter your taxes.

On the flip side, you should probably consider hiring a paid preparer if you are concerned about the difficulty of filing a tax return, have complicated financial information or want to develop a long-term accounting strategy.

Where to find help

There isn’t just one catch-all category for tax preparers today. Preparers include enrolled agents, attorneys and CPAs.

If you’re simply looking for someone to crunch the numbers for you and make sure your taxes are submitted accurately and on time, a basic tax preparer or an IRS-enrolled agent is a perfectly fine solution. They will usually charge a flat rate for filing your taxes (it will vary by location).

If you are looking for a more well-rounded tax preparer who can also offer long-term guidance on your tax strategy, you should seek out a certified public accountant.

“A good CPA won’t just fill in the forms,” said Steve Osiason, a certified public accountant and member of the Florida Institute of CPAs. “A good CPA will give you advice going forward about what you should be doing to save money.”

If you do decide to hire a professional, make sure it’s a reputable preparer who is transparent about their pricing, Nisall said.

He said some tax preparers will charge on such arbitrary basis as per-form completed (some of which take just a few check boxes to complete), or based on what you made in the previous year.

Ask for a list of their qualifications, proof of licensing and if they keep up with changes by taking continuing education classes. At the very least, ask for referrals from trusted friends, family or work colleagues. Some firms may even have Yelp review pages where you can see how past customers have rated their service.

The IRS also has a helpful tool you can use here: Directory of Federal Tax Return Preparers.

Don’t rush

Rushing through a meticulous task like filing taxes can mean a smaller return or no return at all.

“That’s where people make the biggest mistakes,” said Nisall.

If you do feel like you’re crunched for time and may not finish by the deadline, Nisall recommends filing for an extension early. He warns not to confuse the automatic extension to file (Form 4868) with an extension to pay; you are still required to pay an estimate by the deadline.

However, if you still don’t have enough time to pay, there’s more good news.

“If you owe money, you can also ask the IRS for an installment agreement when you file your taxes,” said Lisa Greene-Lewis, a CPA with TurboTax. “The installment agreement will allow you to pay your tax debt over six years.”

 

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kat Khoury
Kat Khoury |

Kat Khoury is a writer at MagnifyMoney. You can email Kat here

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