What Are Back Taxes?

Back Taxes Explained in Less Than 5 Minutes

A man frowns as he looks at a pile of tax paperwork

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You might find that you owe back taxes if you didn’t have enough money withheld for taxes or you neglected to file a tax return in a previous year. Fortunately, you have options. In this article, we’ll cover why you could have past-due taxes, what happens if you don’t pay, and the best strategies for dealing with back taxes.

Back Taxes Definition and Examples

Back taxes are taxes that weren’t paid at the time they were due, typically from a prior year. You can owe back taxes at the federal, state, or local level, and you can owe them for a number of reasons.

Many people owe back taxes because they didn’t have enough money withheld for taxes from their paychecks throughout the year. Some people may also owe because they were unaware that unemployment benefits are taxable most years, and didn’t have money automatically withheld. Selling stock or other investments at a profit could result in capital gains taxes, which you must report. You could also wind up owing back taxes because you made a math error or deliberately under-reported your income.

The IRS has indicated that up to $10,200 in unemployment compensation is tax-free in tax year 2020 if your modified adjusted gross income is less than $150,000. This provision is part of the American Rescue Plan Act of 2021. But the law doesn't apply to state-level taxation of benefits. Some states have tweaked their own laws to conform with federal government, but others are still taxing benefits. Keep an eye on your state through the filing season to be sure where yours stands.

If you’re self-employed or a freelancer, you could wind up owing if you don’t pay both the employee’s and employer’s share of Social Security and Medicare taxes. Plus, freelancers are required to make quarterly estimated tax payments if they expect to owe at least $1,000 when they file their return, and they could face penalties for failing to do so.

How Back Taxes Work

There’s a difference between failing to file a tax return and owing back taxes. Generally, the consequences of owing back taxes are less severe if you’ve filed on-time returns, so it’s essential to submit a return even when you can’t pay your taxes in full. The penalties are as follows: 

  • Failure to file: You’ll owe interest plus a 5% penalty for each month the return is late, up to a maximum of 25% of the tax bill.
  • Failure to pay: You’ll owe interest, plus a 0.5% monthly late fee.

The IRS can submit a substitute return for you if you don't file a tax return, which might not include credits and deductions that could offset the taxes you owe. It will send you a bill demanding that you pay in full, and interest and late penalties will begin to accrue, if you file a return but don’t pay the full amount you owe.

Do I Have to Pay Back Taxes?

Not everyone will owe back taxes if they’ve neglected to file a return. In fact, a lot of people will find the IRS owes them a refund when they file a tax return. You might receive a tax refund if you had more taxes withheld than you needed to, or if you qualify for certain tax credits, such as the Earned Income Tax Credit.

But you're required by law to pay them if you do owe back taxes. The IRS has 10 years from the time your taxes were due to collect them.

Some companies claim they can settle your tax debts for you, but very few taxpayers will actually qualify for the programs these companies advertise. Working with the IRS when you can’t pay your taxes is typically a better option. In fact, the Federal Trade Commission warns that tax settlement companies often leave people with even more debt.

If you’re owed a tax refund or a tax credit, you must file a return within three years of the return due date to claim it.

What Happens if I Don’t Pay My Back Taxes?

Due to penalties and interest, your tax bill will continue to grow each month until it's paid. Future tax refunds that you're eligible for will be applied to your back taxes through the Treasury Offset Program. 

The consequences can be even more severe if your tax bill becomes seriously delinquent. The IRS can garnish your wages or Social Security benefits, or seize your bank accounts and other property. It can also attach a tax lien to your property so the government gets its cut before you receive your money if you sell it. Under some circumstances, your passport application can be rejected due to delinquent taxes.

How To Pay Back Taxes

Your first step is to file back tax returns if you owe back taxes. Locate the IRS forms for the years you didn’t file returns, because tax laws and forms can change from year to year. You can request past years’ tax documents, like old W-2s and 1099s, by submitting Form 4506-T, Request for Transcript of Tax Return to the IRS.

You can often set up an IRS payment plan when you've caught up on tax returns. You can enroll in a short-term plan for free if you can afford to pay your entire balance within 180 days. Otherwise, if you need 180 days or more to pay your debt, you can apply for an IRS installment plan. 

Interest and late penalties will continue to accrue under both types of plans, but you'll incur late fees at a reduced rate of 0.25% per month instead of the typical 0.5%. The IRS won’t pursue collection actions like seizing assets or garnishing your wages as long as you make your payments as agreed.

If you can’t afford to pay anything toward your tax bill, you may have other options. You can request that your account be reported as currently not collectable, which means that the IRS will temporarily pause collection efforts. You’ll still owe the tax debt, plus interest and late payments. In some circumstances, the IRS might agree to an offer in compromise, where you settle your debt for an amount lower than what you actually owe.

Key Takeaways

  • It’s essential that you always file your tax return on time, even if you can't afford to pay your taxes in full.
  • Penalties and interest will accrue until you’ve paid off your back taxes.
  • Working with the IRS is usually a better strategy than using a tax settlement firm if you owe taxes.
  • You can apply for a short-term payment plan if you can pay off your tax debt within 180 days, or a long-term installment plan if you need more time.