IRS or State tax debt is usually a symptom of a more serious underlying financial problem. Specific causes can be the loss of a job or a serious medical condition. But more typically, poor money management skills of the individual or a small business owner taxpayer are the reason. Aggravating a taxpayer’s poor financial management skills are the following:
- Interest and penalties the IRS or State will charge on tax debt are high. They are higher even than that charged on home mortgages.
- Interest and penalties on tax debt are not tax deductible, worsening the tax debt problem. Nondeductibility makes the after-tax effect much greater than on home mortgage interest.
- Interest and penalties on top of tax debt, increasing at prevailing interest rates, can double the total debt in as little as five years.
- Unnecessary delays of tax debt repayment are never a good idea. Postponing tax debt repayment altogether or selecting an installment payment plan that is longer than necessary are poor financial decisions. The IRS or State assesses interest charges against either the total tax debt balance or the declining balance if the debt is being repaid. The faster the taxpayer pays off tax debt, the lower the total debt will be.
For many taxpayers, an installment plan is the best alternative for paying off tax debt. This assumes the taxpayer does not qualify for an IRS or State Offer In Compromise (and most do not qualify).
Set up a monthly budget to discover what the correct monthly payment should be. Expenses will include the tax debt installment payment. Too high of a payment will lead to financial catastrophe. Too low of a payment will unnecessarily increase the overall debt.
Budgeting is the preferred method of dealing with the tax debt problem. It isn’t sexy and sounds boring, but is the most sensible way out of a tax debt mess. Budgeting is much more than just classifying income and expenses. Budgeting puts the taxpayer in charge of managing their own finances like any good company or government should do. It puts the taxpayer and family on the path of fiscal responsibility and toward financial freedom.