Many Americans are used to getting a refund during tax season. But what if the opposite holds true for you this year? What if you find out you underpaid your taxes and now have an IRS bill on your hands? Would you simply dip into your savings to pay it off? Or would your finances be pretty upended?
If you're in the latter category, you're not alone. An estimated 44% of Americans say that owing the IRS money this year would derail their 2020 budget, revealed financial company Self in a recent survey. And that's not a good spot to be in.
You can't count on a refund
It's easy to assume that you'll get a refund during tax season. But here are a few reasons that might not happen this year.
First, if you worked a side hustle in 2019 and didn't pay taxes on that added income as you earned it, then you could have a significant tax bill on your hands this April. The same holds true if you took in a large amount of capital gains in a traditional brokerage account or if you earned a lot of interest in a savings account or certificate of deposit.
Furthermore, if you never adjusted your withholding following the massive 2018 tax code overhaul, you might owe the IRS some money this year. As part of the tax changes, the IRS issued new withholding tables to help ensure that workers would receive more money in their paychecks. The problem is that some people collected too much extra income, and those who never adjusted their withholding are at particular risk for this scenario.
The point? Even if you're used to getting a refund during tax season, you might not be entitled to one this year. And if you owe the IRS money, it's important to pay your tax bill on time. If you're late with that payment, you'll risk interest and penalties, thereby adding to your costs and increasing that unwanted strain on your budget.
Prepare for a tax bill
The best way to ensure that you're able to cover an IRS bill is to have an emergency fund. Tax issues aside, you should always have three to six months' worth of living expenses tucked away in the bank. That way, if you lose your job or encounter any type of unplanned bill, you'll have the money on hand to cover your costs without having to resort to debt.
If you're without emergency savings at present, make an effort to ramp them up in the next year. Cut back on spending, or get a second job and bank your earnings. That way, if you owe the IRS money in the future, it won't wreck your budget, and you won't find yourself stressed and scrambling to come up with that cash.
Owing the IRS money is never fun, but think of it this way: Instead of giving the government an interest-free loan, you got advanced access to some money that you're simply being asked to repay. If you don't have savings on hand this year to pay that debt, contact the IRS to set up an installment plan. That way, you can pay off your tax bill over time without having to strain your finances too badly.