What Happens If You Owe Taxes Two Years in a Row?

Owing taxes for two consecutive years can lead to serious financial consequences. The IRS and state tax agencies have enforcement measures to collect unpaid taxes, which become more severe the longer a balance remains unresolved.

Ignoring tax debt can result in escalating penalties, interest, and collection actions. Understanding the consequences of owing taxes multiple years in a row can help taxpayers take proactive steps to address the situation.

Accumulated Penalties and Interest

Unpaid taxes grow due to penalties and interest. The IRS charges a failure-to-pay penalty of 0.5% per month on the unpaid tax, up to 25%. If a taxpayer also failed to file, the failure-to-file penalty is 5% per month, also capped at 25%. These penalties can significantly increase the total owed.

Interest accrues daily on both unpaid taxes and penalties. The IRS calculates interest using the federal short-term rate plus 3%, adjusted quarterly. If the federal short-term rate is 5%, the total interest rate applied would be 8%. This compounding effect can turn a manageable debt into a larger financial burden over time.

State tax agencies impose their own penalties and interest, which vary by state. Some states charge a flat penalty, while others use a percentage-based system. State interest rates can sometimes exceed federal rates, further increasing the total owed.

Possible Liens and Garnishments

If tax debt remains unpaid, the IRS and state agencies may take aggressive collection actions, including filing a federal tax lien or initiating wage garnishments. A federal tax lien is a legal claim against a taxpayer’s property, including real estate, personal assets, and financial accounts. While it does not immediately seize property, it establishes the government’s priority over other creditors, making it difficult to sell or refinance assets without first addressing the debt.

Though the IRS no longer reports tax liens to major credit bureaus, lenders may still discover them through public records, affecting loan approvals and interest rates. Some states also impose their own tax liens, which can carry additional consequences.

If a tax balance remains unpaid, the IRS may issue a wage garnishment, instructing an employer to withhold a portion of a taxpayer’s paycheck. Unlike other creditors that require a court order, the IRS can do this directly. The amount deducted depends on income level and filing status, with only a minimal portion of wages exempt. This continues until the debt is paid or an alternative arrangement is made.

The IRS may also levy bank accounts, seizing funds to satisfy outstanding tax obligations. This typically occurs after multiple ignored notices, leaving taxpayers with limited time to dispute or negotiate a resolution before funds are withdrawn. Business owners with unpaid payroll taxes face stricter enforcement, as the IRS can hold individuals personally responsible under the Trust Fund Recovery Penalty.

Refund Offsets

If a taxpayer has an outstanding tax debt, the IRS can seize future refunds to apply toward the balance. This process, known as a refund offset, occurs automatically under the Treasury Offset Program. If a refund is available in a subsequent year, the IRS will redirect the funds before issuing any remaining amount to the taxpayer.

Federal tax debts take priority in the offset process, but unpaid state income taxes, child support arrears, and certain federal debts like defaulted student loans may also be deducted. The Bureau of the Fiscal Service oversees this system and notifies taxpayers when an offset occurs through a mailed notice explaining where the funds were applied.

For those who rely on tax refunds to cover expenses, an offset can create financial strain. To avoid an unexpected loss, taxpayers with ongoing liabilities should adjust their tax withholding or estimated payments. Reducing withholding amounts on Form W-4 or making smaller estimated tax payments can limit the size of a refund while still meeting tax obligations.

Credit Impact

While the IRS no longer reports tax liens to major credit bureaus, unpaid tax debt can still affect creditworthiness. One risk comes from third-party collections if the IRS assigns the debt to a private collection agency. Agencies like CBE Group or Coast Professional may report the debt, negatively impacting credit scores.

Tax debt also affects debt-to-income ratios, a key factor lenders evaluate when assessing loan applications. Mortgage lenders, in particular, scrutinize outstanding obligations, including tax liabilities. If a significant balance is owed without an active installment agreement, it may be viewed as a financial risk, leading to loan denials or higher borrowing costs. Fannie Mae and Freddie Mac guidelines require applicants with tax debt to provide proof of a payment plan and a history of timely payments before approving a mortgage.

Payment Arrangement Options

For taxpayers unable to pay in full, the IRS and state tax agencies offer options to manage debt. Setting up a formal payment arrangement can prevent aggressive collection actions while allowing individuals to pay over time. The most common option is an installment agreement, which enables taxpayers to make monthly payments until the balance is cleared. The IRS offers streamlined installment agreements for those owing $50,000 or less, requiring minimal paperwork. Larger debts require a more detailed application, including submitting Form 433-A or 433-F to demonstrate financial hardship.

Another option is an Offer in Compromise, which allows taxpayers to settle their debt for less than the full amount owed if they can prove that full payment would create financial hardship. The IRS evaluates applications based on income, expenses, asset equity, and future earning potential. While this can provide relief, approval rates are low, and applicants must meet strict eligibility requirements, including being current on all tax filings. Those who do not qualify may request a temporary delay in collection, which the IRS grants in cases of severe financial distress. This status, known as “Currently Not Collectible,” does not eliminate the debt but temporarily halts enforcement actions.

Communication with Tax Authorities

Engaging with tax authorities can prevent escalating consequences and provide access to resolution options. The IRS and state agencies send multiple notices before taking enforcement actions, and responding promptly can prevent additional penalties or collection measures. Taxpayers who receive a notice should review it carefully, as some letters provide opportunities to dispute amounts owed or request additional time to pay.

For those unable to pay immediately, contacting the IRS or state tax agency directly can lead to more flexible arrangements. The IRS provides an online payment agreement tool for setting up installment plans, while phone support and local taxpayer assistance centers offer additional guidance. In cases where a taxpayer disagrees with the assessed liability, filing an appeal through the IRS Office of Appeals may be an option. Seeking assistance from a tax professional, such as an enrolled agent or tax attorney, can also help navigate complex situations, especially when dealing with liens, levies, or disputed amounts.