The Meaning of Back Taxes and How to Pay Them

The term “back taxes” refers to tax liabilities that were not paid in full by their original due date. This can happen for any prior year and applies to money owed to federal, state, or local governments.

Common Causes of Back Taxes

One of the most direct causes of back taxes is the failure to file a tax return. When a taxpayer neglects to file, the Internal Revenue Service (IRS) may create a Substitute for Return (SFR). This document is prepared by the IRS using information from third parties, like employers and financial institutions. An SFR often results in a higher tax assessment because it only includes income and lacks the deductions and credits the taxpayer might have been entitled to claim.

Another frequent reason for owing the government is the underpayment of taxes throughout the year. This scenario often affects individuals with insufficient tax withholding from their paychecks, such as those who change jobs or receive bonuses. It is also a common issue for self-employed individuals or those with gig economy income who fail to make adequate quarterly estimated tax payments. Unexpected income from investments or other sources can also lead to an underpayment.

An audit by the IRS can result in a taxpayer owing back taxes. During an audit, the agency reviews a previously filed return for accuracy. If the examination uncovers errors, such as underreported income or improperly claimed deductions, the IRS will issue a notice of proposed changes. This reassessment can create a new or additional balance due for that tax year.

Associated Costs of Unpaid Taxes

The original amount of unpaid tax is only the starting point of the debt, as costs are added over time. The IRS charges interest on any underpayment, and this interest can also be applied to the penalties that have accrued. The interest rate is determined by the federal short-term rate and can be adjusted quarterly. This interest compounds daily, which can substantially increase the total liability the longer the tax remains unpaid.

A failure-to-pay penalty is applied when taxes are not paid by the deadline, even if the taxpayer filed their return on time. This penalty is calculated at a rate of 0.5% of the unpaid taxes for each month or partial month that the taxes remain outstanding. The penalty continues to accumulate until it reaches a maximum cap of 25% of the unpaid tax liability.

A more severe penalty is the failure-to-file penalty, which applies when a taxpayer does not file their return by the deadline. This penalty is calculated at 5% of the unpaid taxes for each month or part of a month that the return is late, also capped at 25%. If both penalties apply in the same month, the failure-to-file penalty is reduced by the amount of the failure-to-pay penalty.

Potential IRS Collection Actions

If a tax debt remains unpaid after the IRS sends a bill, it can initiate collection actions. One of the first steps is filing a Notice of Federal Tax Lien. A lien is a legal claim against all of a taxpayer’s current and future property, including real estate and financial assets. It serves as a public notice to creditors and can damage a person’s credit rating, making it difficult to obtain loans or sell assets.

If a taxpayer continues to ignore their debt after a lien has been filed, the IRS can issue a levy. A levy is the actual seizure of property to satisfy the tax debt. Common examples include a bank levy, where the IRS instructs a financial institution to turn over funds from an account. Another action is wage garnishment, where the agency requires an employer to send a portion of the taxpayer’s wages directly to the IRS.

For taxpayers with a “seriously delinquent tax debt,” the consequences can extend to international travel. Under federal law, the IRS certifies these debts to the U.S. Department of State. Once certified, the State Department generally will not issue a new passport and has the authority to revoke an existing one. This action is reserved for taxpayers who owe a significant amount, adjusted annually for inflation, and have not responded to IRS attempts to resolve the debt.

Methods for Resolving Back Taxes

Taxpayers unable to pay their debt in full have several ways to resolve their liability, one of which is an Installment Agreement. This is a structured monthly payment plan that can be short-term, allowing up to 180 days to pay, or long-term, extending for years. Taxpayers can often apply for a streamlined agreement online, provided their total debt falls below a certain threshold.

Another resolution is an Offer in Compromise (OIC), which allows certain taxpayers to settle their tax debt for less than the full amount owed. An OIC is considered when there is doubt as to whether the IRS can ever collect the full amount. To qualify, taxpayers must provide detailed financial information to demonstrate that their income and assets are insufficient to cover the entire liability.

For individuals experiencing significant economic hardship, the IRS may grant Currently Not Collectible (CNC) status. This designation temporarily suspends collection efforts, meaning the IRS will not pursue levies or garnishments while the taxpayer’s financial situation is dire. CNC status does not forgive the debt; penalties and interest continue to accrue, and the IRS will periodically review the taxpayer’s financial circumstances.