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What Happens If I Don’t Pay My Taxes? Penalties And Solutions

Updated: 02/28/2021 by Financial Samurai 64 Comments

What Happens If I Don't Pay My Taxes? Penalties And Solutions

Have you ever wondered what happens if I don’t pay my taxes? This article will share with you all the possibilities of what might happen.

If you are like me and millions of other screwed Americans, you owe taxes by April 15. I used to think that it was always better to owe taxes each year, but that was when the 10-year yield and CDs were providing a healthy 4% annual return.

Nowadays, you’re lucky to get a 2% return on either instrument. We won’t even talk about the average money market savings rates at 0.1-0.2%. As a result of such low risk-free opportunity costs, I’ve been an advocate of folks getting a small tax refund since 2009 when the world was ending.

After doing my own taxes for the 16th time this year and always getting a small refund, I will finally be sending in a check for a vomit inducing five figure amount on top of an already six figure amount in taxes paid.

So what happened that caused me to make such an erroneous calculation since I should be an expert at doing my own taxes by now? I didn’t make a mistake. Instead, the government and the voters of California got me.

Proposition 30 Passes

California Governor Jerry Brown floated legislation (Proposition 38) where everyone’s income taxes would be raised by 0.4-2.2% for 12 years to help pay for our public schools.

I’m all for everyone pitching in together to help our state, especially if Prop 38 can raise $10 billion dollars per annum for our children. Unfortunately, Prop 38 was shot down because California already has some of the highest income taxes in the country at an average 8% for those making $38,000-$58,000.

What ended up passing was Proposition 30 where income tax rates would increase for seven years for only those making more than $250,000, even if the individual does not have children or does not have kids in public school. Seriously, what’s wrong with having parents pay for their own children? The top marginal state income tax bracket rises by 3% to 13.3% and raises roughly $6 billion extra per annum in tax revenues.

In other words, not everyone was willing to help pitch in to support our state’s youth. This is why Prop 38 was rejected, even though Prop 38 would raise at least $4 billion more a year. Instead, the majority voted to raise taxes on the minority to pay for everything and not pitch in themselves. This is obviously not fair, but everyone needs to accept that the majority will always win in the end. Why work if more than 50% of our income will be taken away?

The worst part about the passing of Prop 30 (raising taxes on the minority) is that the law is retroactive starting January 1, 2012 to collect more taxes. I’ve never heard of a full 1-year retroactive law to claw back income from the public. All this time I’ve been carefully trying to manage my exit from society with the assumption that 2012 would be business as usual. I was wrong, and for my ignorance, I’ve got to pony up thousands of dollars to a state infamous for mismanaging funds.

I usually keep less than $10,000 in a liquid money market account because I hate having cash earn nothing. Furthermore, I have monthly positive cash flow that should continue into perpetuity. With my 2012 tax bill due on April 15 I don’t have enough money to pay my taxes. Perhaps many of you who’ve found this article on search are in a similar dilemma. Here’s what I did to solve my taxation problem.

What Happens If I Don’t Pay My Taxes? Penalties And Solutions

1) There are no penalties for filing late if you have a tax refund. What a surprise! If you don’t want to claim your refund, the IRS has no problems letting you not claim your money. The IRS probably hopes you do your taxes wrong or simply forget to file in order to keep the billions of dollars in unclaimed refunds in their coffers.

2) Failure to file penalty. I guess there are people out there who don’t actually even file their taxes for some reason. If you fail to file, the penalty is 5% for each month the tax return is late, up to a total maximum penalty of 25%. The percentage is of the tax due as shown on the tax return. Let’s say I owe $20,000 in 2012, my penalty would be $1,000 a month up to a $5,000 penalty after five months.

3) Failure to pay penalty. Let’s say you refuse to pay your taxes by April 15. The penalty is 0.5% for each month the tax is not paid in full. There is no maximum limit to the failure-to-pay penalty. The penalty is calculated from the original payment deadline of April 15th until the balance is paid in full. In other words, you can have a failure to file penalty and then a failure to pay penalty which would really screw you over.

4) Interest payments. This is where the IRS really gets you as I’ve written in a previous example. The IRS charges daily interest on the taxes you don’t pay based on a rate of roughly 3-4% per annum. The rate adjusts every 3 months. Even though nobody can get a 3-4% return risk-free, the IRS rakes you over the coals with a super high interest rate.

5) Crushed credit score. If you decide not to file and not pay for over a year, a tax lien will be produced which will destroy your credit score by 100-150 points on average. It will then take anywhere from 2-7 years to get back to your original score.

6) Say hello to jail. Finally, if the IRS catches you evading taxes for much more than a couple years, you could face jail time, depending on how much you owe. You’ve got to evade or cheat on more than the cost it takes for them to prosecute and house you, so this shouldn’t be a problem for the majority of us.

Solutions To Paying Your Taxes When You Don’t Have Enough Money

Now that you know the downside of not paying your taxes, here are some plausible solutions to help feed the government.

1) Ask family or friends for a bridge loan. I hate asking friends or family for money, but when it comes to defending oneself against more government tax penalties, one shouldn’t be too proud to ask. Family and friends should be more understanding that you need to borrow money to pay the IRS vs. borrow money to go buy some extravagant car or purse you don’t need.

2) Adjust your withholding allowances. Check with your company payroll to see what your current withholding allowance is. I usually put 0, which means my employer takes out the most in taxes so I have to pay the least come tax time. Adjust your witholding allowances higher if you need more cash flow, but that might mean a higher tax bill later on.

3) Call the IRS and ask for an extension. You can always call the IRS and ask for an extension by April 15 due to hardship. Depending on how bad your hardship is, a grace period may be granted for a certain period of time. The IRS really are a bunch of nice people contrary to how they are portrayed in the movies. They realize the tax code is ridiculous and the people who work at the IRS are on your side. It’s just the politicians who aren’t because they are being lobbied by tax firms and need a complicated tax system to retain power.

4) Borrow from your 401(k). Borrowing from a 401(k) is discouraged because it takes money out of your investments which may grow. If the world is detonating, then it’s not so bad to pay for a vital liability. However, there are some borrowing fees to pay, and a high interest you pay yourself to pay back your loan.

5) Sell some unnecessary belongings. Here’s a great chance to sell your crap that’s been piling up in your basement. There’s no better feeling than decluttering your house, making money, and using the proceeds to pay off the IRS!

6) Get a temporary second job. If you do your taxes soon enough (Jan), you should be able to work a second part-time job for a month or two to cover your tax liability. This is when you will really start to hate the government for all it taxes you, because you’ll be trying to make more money that’s taxed to pay taxes. Bad jobs develop character, so look on the brightside.

7) Ask your employer for an advance. This is a tricky one because you don’t want to let your employer know you don’t have enough money. They might translate your mismanagement of money as a work flaw which could lead to a lack of promotion and future pay. That said, plenty of people owe taxes every year which they can’t afford. If you have a legitimate excuse, such as the out of the blue retroactive Proposition 30 bill I discussed, then your employer should be understanding. You never know until you ask.

8) Withdraw interest from your CDs or ROTH IRA. The interest you earn from your CDs can be withdrawn penalty free. It’s only the principal that is affected by penalties if you decide to cut the CD duration short. You can also withdraw your original contributions of your ROTH penalty free, but you will have to pay a 10% penalty on earnings before 59.5.

9) Get a personal loan. Getting a personal loan is a private way to borrow money and not get anybody else involved. Personal loans are cheaper than credit card interest rates. Further, getting a personal loan is relatively easy to get.

Check out Credible if you want to get a competitive personal loan. You’ll receive several no-obligation offers from qualified lenders in minutes.

Average Personal Loan Interest Rate

Pay You Taxes On Time

Paying taxes bites the big one. It’s a large part of the reason why I retired early in 2012. There’s too much discrimination, waste, and persecution. Nothing really bad is going to happen if you don’t pay your taxes as you’ve read above. You’ll just have to pay penalties.

It’s only if you try and evade on hundreds of thousands or millions of dollars where you get into big trouble. The IRS goes after big fish and generally leave the rest of us alone.

I am able to pay my five figure tax bill with some fortuitous timing. One tranche of my deferred compensation hit my E*Trade account recently so I liquidated my holdings to pay the IRS.

If I didn’t get my deferred compensation from my severance package, I would have withdrawn the interest earned from my CDs penalty free. For 2013 and beyond, I shouldn’t have a problem with unexpected tax bills b/c my deductions are the same and my income is much lower.

If you’ve got a tax bill that’s too high to comfortably pay, definitely look into adjusting your withholdings down for the following year.

The easiest tax shield available to everyone who buys a house is mortgage interest. After that, things get much more complicated and you’ll probably want to speak to an accountant to lower your taxes further.

Recommendation To Build Wealth

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Tax Savings Recommendation

Start A Business: A business is one of the best ways to shield your income from more taxes. You can either incorporate as an LLC, S-Corp, or simply be a Sole Proprietor (no incorporating necessary, just be a consultant and file a schedule C). Every business person can start a Self-Employed 401k where you can contribute up to $54,000 ($18,000 from you and ~20% of operating profits). All your business-related expenses are tax deductible as well. Simply launch your own website like this one in under 30 minutes to legitimize your business. Here’s my step-by-step guide to starting your own website.

Start a simple business to pay less taxes and contribute more to pre-tax retirement accounts

When Should You File A Tax Extension? The IRS Recommends Getting Into Debt To Pay On Time

Updated: 06/07/2021 by Financial Samurai 42 Comments

Filing a tax extension buys you time to get your documents in order

Some people have asked me whether they should file a tax extension (tax form 4868) if they can’t afford to pay their tax bill. Unfortunately, being unable to pay your taxes isn’t a reason the government accepts to file an extension. Neither is procrastination.

The only reason I can think of for filing an extension is if there’s a delay in receiving one of your tax documents that will materially alter your taxable income. The most common form that’s sometimes late is the K-1 form from a business partnership, S corp, or trust and estate beneficiary. You should always be able to receive your 1099s and W2s on time.

The K-1 form from my venture debt investment won’t be coming out until the summer. As a result, I’m forced to file an extension because there’s several thousand dollars in pass through income I’ll receive, which requires tax payments. I’m owed refunds of about $1,000 from both Federal and California, so waiting several more months to file isn’t a big deal. If I owed, then I’d still have to pay at least 90% of what I think I owe to avoid penalties. Extension filers have until October 15 to submit their returns. Inline image 1



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The Average Tax Refund And What To Do With It

Updated: 02/10/2019 by Financial Samurai 52 Comments

The average tax refund is around $1,850 in America according to the IRS for 2018. That’s down 8.5% from the year prior due to Trump’s Tax Cuts And Jobs Act which raised taxes on Middle Class Americans.

Since saving, or not spending $154 a month is difficult for many, I’m OK with such a refund.

With basic savings interest rates around 2.4%, your opportunity cost is not huge.

If we are to compare the average tax refund to the average per capita income in America of $61,000 (~$40,000 after tax), $1,850, or roughly 3% of income is a pretty meaningful number.

Your goal should be to not only max out all your retirement plans (401K/IRA), but to also then save another 20%+ if you’ve been a long time reader of this site.  With 7% out of 20% down, you’ve only got to find a way to save 13% more!  Not bad at all.

There’s a big debate on whether you should have a tax refund at all, given that simply means you overpaid our incredibly inefficient and wasteful government.

Since most people can’t save for cookies, I’m of the opinion that a tax refund is good for most people.

A QUICK MENTAL EXERCISE ON YOUR TAX REFUND

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The Marriage Penalty Tax Has Been Abolished, Hooray!

Updated: 07/09/2022 by Financial Samurai 77 Comments

Marriage Penalty Tax Disappears

The marriage penalty tax is discrimination. But given the marriage penalty tax doesn’t hit everybody, there hasn’t been enough uproar to make it go away. Thankfully, the marriage penalty tax has been abolished for 98% of households.

In the past, I used to wonder why two individuals with high incomes or two individuals with a large income differences would ever want to get married. Paying thousands of dollars in marriage penalty taxes didn’t make sense. It seemed obvious that the government wanted one spouse to give up his or her career to stay at home, even if there were no children to raise.

Otherwise, before the Tax Cuts And Jobs Act Was passed in 2017, why would the top tax rate of 39.6% for a married couple not kick in starting at a combined income of $836,802+? Back in 2017, married folks begin paying at the 39.6% tax rate once their combined income surpasses only $470,701.

In the eyes of the government, 1 + 1 literally only equaled 1.12. This is blatant anti-marriage discrimination. Discrimination is not OK even if you aren’t being discriminated against. Below are examples that demonstrate the marriage penalty tax that used to occur under the old tax structure. I used the Tax Policy Center Calculator.



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How To Save More Than $100,000 A Year Pre-Tax: Open A SEP-IRA Or Solo 401k

Updated: 12/10/2021 by Financial Samurai 146 Comments

How to save a lot of money in your pre-tax 401k or SEP IRA

One big goal on Financial Samurai is to highlight to readers what is financially possible. Once you know what is possible, you minimize your limiting beliefs and tend to strive much farther. You can actually save more than $100,000 in your pre-tax retirement accounts per year! Let me explain with some basics first.

The 401k maximum contribution for 2021 is $19,500 and $20,500 for 2022. The increases will likely continue by $500 increments every year or two to keep up with inflation. Contributing the maximum pre-tax a year for 30+ years will most likely make you a 401k millionaire by the time you retire.

Unfortunately, $3 million is the new $1 million, and in 30 years, $7 million will likely be the new $1 million if we assume a 3% annual inflation rate!

The 401k is not enough for most people to retire on. Sure, we potentially have Social Security to help us when we reach, at the earliest, 62 years of age. But I wouldn’t count on the government to properly manage our money until then. Beyond maxing out a 401k every year, I encourage everyone to also invest at least 20% of their after-tax, after-401k money into a diversified investment portfolio.

As a contractor over the past year, I’ve discovered something that will really supercharge one’s pre-tax retirement savings. The discovery still seems too good to be true, but it is true. The research I’ve done is based off the IRS website, my own experience, and speaking to Fidelity’s small business retirement department where I have a rollover IRA, SEP-IRA, and Solo 401k.



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How The New Tax Plan Will Ruin Your Life If You’re Not Careful

Updated: 02/20/2018 by Financial Samurai 140 Comments

How the new republican tax plan will ruin your lifeI firmly believe tax policy changes behavior. The higher your taxes go, the BETTER your life becomes! Why? Because at the margin, the less money you keep, the less motivated you’ll be to work. Since the love of money is the root of all evil, the less time you spend chasing money, the happier you will be.

One of my catalysts for leaving work in 2012 was because the finance industry was in a structural decline. We were working longer hours for less pay. At the same time, we faced a progressive tax system where we had to pay a 39.6% Federal tax rate plus a 3.8% Net Investment Income tax plus a 0.9% Medicare tax plus an Alternative Minimum tax plus a 13% State tax plus Social Security tax plus Sales tax plus retroactive State taxes to pay for government overspending. Instead of complaining about paying a 60%+ marginal tax rate, I just negotiated a severance to make no money as a writer.

My life since leaving work has never been better, all because I decided to focus on maximizing freedom instead of maximizing net worth. When you’re in the grind, it’s hard to fathom the benefits of giving up a steady paycheck. But the benefits truly are incredible.

For those of you who naturally like to work more when you can keep more of your money, here are three items from the new tax plan that will ruin your life or your family if you are not careful.

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Tax-Deductible Job Hunting Expenses – Finding Work Is Expensive!

Updated: 07/06/2020 by Financial Samurai 40 Comments

Job Hunting Expenses Duck Hunt

Recently, I discovered that finding work is expensive. Fortunately there are tax-deductible job hunting expenses that make it less painful. Thanks to 33% of you voting that I should go back to work full-time, I decided to rev up the rusty job search engine after 3.5 years of inactivity.

And boy, what a waste of time and money it has been! Thanks for nothing everyone! If the percentage of you saying “yes” was 25% or less, I wouldn’t have bothered. See how much y’all mean to me?

Let me share with you how much job hunting cost me with this one firm. It’s a fintech company in the robust personal lending space where SoFi and their recent $1 billion in funding from Softbank is dominant.

I’ve already exhausted my learning curve in the the digital wealth management space so I thought it would be a good idea to expand my understanding in the payment or consumer lending niche. 



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How To Win Under The Proposed Republican Tax Plan

Updated: 12/26/2017 by Financial Samurai 149 Comments

How to win under the new GOP tax planHere are the key points from the now passed Trump administration’s tax plan for 2018 and beyond.

After reviewing the key points, I share my thoughts on how to win under this possibly new tax environment. The audio version is at the end of the post.

Republican Tax Plan Highlights

* No change to existing rules on 401k retirement accounts and the ability to contribute the current $18,000 into the accounts tax-free, and $18,500 for 2018 and beyond.

* Lowers the deduction for mortgage interest for new home loans of $7500,000 or less from the current $1,000,000 cap. Old loans up to $1,000,000 are grandfathered in.

* Limits the deductibility of local property taxes and state income taxes to only $10,000.

* Lowers the top marginal tax rate from 39.6% to 37%.

* The long-term capital gains and qualified dividend thresholds will remain as they are under the current system e.g. those in the bottom two tax brackets are eligible for 0% capital gains and dividend tax rates, those in the middle get a 15% tax rate, and those in the top pay a 20% tax rate.

* No repeal of the 3.8% Medicare surtax on net investment income over $200,000 per person.

* Individuals making over $500,000 and couples earning over $1 million may still pay 39.6 percent

* Reduce the corporate tax rate from 35 percent to 21 percent.

* Doubles the estate tax limit to $11M for individuals, and $22M for married couples.

*  Increase child tax credit from $1,000 to $2,000.

* Nearly double the standard deduction used by most average Americans to $12,000 for individuals and $24,000 for families

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The Best Thing About Trump’s Tax Plan: Earning Business Income!

Updated: 11/07/2018 by Financial Samurai 132 Comments

The best thing about President Trump's tax plan is earning business income due to the 15% corporate tax rate.On Wednesday, April 26, 2017, Treasury Secretary Steven Mnuchin and National Economic Council director Gary Cohn announced President Trump’s latest tax plan that proposes to cut corporate taxes and lower personal tax rates.

For anybody who has ever made money, you know that paying tax on your income is one of your largest ongoing lifetime expenses. A progressive tax system that taxed my income at a Federal + State marginal rate of over 50% during the Obama years was one of the catalysts for negotiating my severance and leaving the workforce for good in 2012. It didn’t feel worthwhile anymore to work 60-70 hours a week and go through so much stress for the privilege of paying the government more than I kept.

What’s even more amazing is that the vast majority of Americans save LESS than their effective tax rate! Can you imagine being taxed at a 20% effective rate when you can only save 6% of your after tax income? No wonder why so many people can’t escape the Matrix. There are government officials who are laughing behind closed doors at the masses for saving so little and paying so much to the government.

US personal savings rate historical and up to 2017

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The Average Tax Refund And How To Spend It

Updated: 04/14/2019 by Financial Samurai 36 Comments

The average tax refund is roughly $2,750 for the 2018 tax year. With the US household income at around $62,000, that’s 5% of one’s income they’ve overpaid to the evil empire. Everybody knows that getting a refund is like giving the government an interest free loan.  But, with interest rates the way they are, who cares?!

If you were to ask people to put aside $230 a month to save $2,750 a year, I bet most would fail due to the lack of discipline. As a result, I think it’s fantastic most people are getting refunds. The key is not blowing your refund on some splurge you wouldn’t otherwise spend money on if you didn’t get a refund.

In 2014, I had to pay about $1,000 more in Federal taxes, but I got several thousand back from the state of California. For the past 10 years, I’ve saved or invested every single refund I’ve received, and this year was no different. Boring! At least a philosophical post came out of it entitled, “Is Paying Taxes A Form Of Charity?”

Here’s a neat infochart with more ideas of what to do with your refund. I like the rocket ship chart of investing your refund every year until you retire with a 7.5% return. Buying a nice Macbook Pro would be sweet too, however, that’s a corporate expense, baby!

If you are like me, you should be motivated to invest and pay down more debt with your refund, rather than spend it on superfluous things. Although buying 1,000 lottery tickets sure sounds like way more fun!

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