Every tax return preparer probably has a few clients who complain about not being able to pay their tax bill. This usually is the case because of poor tax planning, forgetting to make quarterly tax payments, or because someone either partied too hard or had to get the roof fixed. But this year, I’ve heard of an increase of complaints from clients who cannot pay their taxes because of the effect of inflation.
Inflation rearranges household priorities. When the prices of groceries, rent or mortgage payments, utilities, gasoline, and insurance climb faster than income, eventually something must be cut. Because ordinary living expenses are in most cases not tax deductible, they reduce disposable cash without reducing taxable income. When the tax bill arrives, the taxpayer may not have the money to pay it.
This situation usually affects self-employed people, including those working contractor or gig jobs. Since they are paid in full, it is their responsibility to withhold taxes. But sometimes, W-2 employees can be in this situation as well. If they are used to getting tax refunds, they may adjust their withholdings to get a lower refund or pay taxes later.
The usual scenarios for not paying taxes mentioned above are usually temporary or a one-time mistake. They get back on track moving forward and pay the back taxes plus interest. If they can convince the tax collectors that they had reasonable cause for not paying the tax, then penalties can be waived.
Every tax professional or financial advisor will tell people facing this problem to pay their quarterly taxes or withhold more taxes, stop eating avocado toast, quit the vaping, and cancel their streaming subscriptions. Obviously that is easier said than done, and the last thing a person facing financial struggles needs is a lecture.
The problem with inflation is that it is not temporary. Someone can only hope that inflation stays at a manageable level and that their income will rise enough to cover it. Many people justify deferring taxes because other creditors can take more immediate action such as shutting down utilities, eviction, foreclosure, car repossessions, or lawsuits. Also, not eating really sucks.
So instead of a lecture on austerity, here is some practical advice coming from the perspective of someone who has dealt with tax collectors.
First, file your tax returns on time, even if you owe. If you do not file on time, you could pay a very large nonfiling penalty. Also, the IRS in recent years has been clamping down on nonfilers. Even if you miss one year, there is a good chance the IRS will send you a reminder letter. And if you want to set up a payment plan, you will be required to file all outstanding tax returns.
Second, if you owe, try to set up a payment plan as soon as possible. Even if you are not in a formal installment agreement, try to pay what you can every month. This can avoid further enforced tax collection action. However, make sure that your payment plans leaves you with enough money to pay future taxes and stop the bleeding.
Third, have a plan to get back into tax compliance while dealing with inflation. For self-employed people, you will need to find a way to increase revenue or decrease expenses. W-2 employees will need to adjust their W-4 withholdings. This may require people to make lifestyle changes, but you will have some time before the next tax return is due.
Lastly, while the IRS and most state tax agencies have an Offer in Compromise program where you can settle your back taxes for less than you owe, don’t be in a rush. You must first be able to pay taxes and file returns on time in the future. Otherwise, a settlement offer will not be considered. Second, consult with a tax professional as they know whether a settlement offer will be accepted in light of your financial situation both in the present and the future.
Over the past few years, inflation has hurt the purchasing power of the average American. It is tempting to put taxes on hold if you are facing eviction or starvation. But eventually the tax collectors will come get you, and they have formidable powers. So long as you file tax returns on time and try to pay down the tax debt, most tax agencies should give you some time to get your life back on track. Conversely, the federal and state governments should be willing to give struggling taxpayers some breathing room while they try to deal with inflation.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at stevenchungatl@gmail.com. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.
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