What Is a Tax Debt & What Happens If You Have One?
Discover what tax debt truly entails, how it accumulates, and the potential actions taken by tax authorities.
A tax debt represents an amount of money a taxpayer owes to a government tax authority, such as the Internal Revenue Service (IRS) at the federal level. This obligation arises when taxes legally due are not paid in full by their designated due date. It signifies an outstanding financial liability that can accumulate if left unaddressed.
Tax debt is a formal obligation that carries specific consequences. This financial burden can occur at various governmental levels, including federal, state, and local jurisdictions, each with its own set of rules and enforcement mechanisms.
How Tax Debt Originates
Tax debt originates from a taxpayer’s actions or inactions. One common scenario is underpayment of taxes throughout the year, occurring when insufficient income tax is withheld from wages or estimated tax payments are not made adequately or on time.
Another cause of tax debt is failure to file a tax return by the due date. Even if no tax is initially owed, neglecting to file can lead to an assessment of taxes due by the tax authority, often with penalties. Errors or miscalculations during tax return preparation can also result in a lower reported tax liability than what is actually due.
Tax debt can also arise from adjustments made by the tax authority following an audit. If a review uncovers discrepancies or unreported income, the tax liability may increase, leading to an additional amount owed. This can also stem from underreporting income or claiming unqualified deductions.
Elements of Tax Debt
Tax debt includes the original unpaid tax amount, known as the principal. Additional charges are often assessed, significantly increasing the total liability.
Penalties are a common element, imposed by the tax authority for various types of non-compliance. These include a failure-to-file penalty (5% of unpaid tax per month, up to 25%) and a failure-to-pay penalty (0.5% of unpaid taxes per month, capped at 25%). Accuracy-related penalties, such as those for negligence or substantial understatement of tax, can also add 20% of the underpayment amount.
Interest also accrues on the unpaid tax and any penalties from the original due date until the debt is fully paid. This interest is compounded daily, meaning it is calculated on the previous day’s balance. For individuals, the interest rate on underpayments is currently 7% per year, though rates are adjusted quarterly. This ongoing accumulation of interest further inflates the total tax debt.
IRS Actions Regarding Unpaid Tax Debt
When a tax debt remains unpaid, the IRS initiates actions to collect the outstanding amount. The process begins with notices and demands for payment, informing the taxpayer of the debt and requesting resolution. These communications serve as formal notifications of the IRS’s intent to collect.
Should the debt remain unresolved, the IRS may file a tax lien. A federal tax lien is a legal claim against a taxpayer’s property, including real estate, personal property, and financial assets, to secure the debt. This lien is a public record, alerting other creditors to the government’s priority claim on the taxpayer’s assets, and attaches to current and future property.
If the tax debt is not satisfied, the IRS can proceed with a tax levy. A levy is the legal seizure of a taxpayer’s property to satisfy the unpaid tax debt. Examples of assets that can be levied include wages, funds in bank accounts, and other financial assets. The IRS must provide a Final Notice of Intent to Levy at least 30 days before the actual seizure of property.