What should you do if it turns out that you do owe money and you haven't saved any funds in anticipation? In general, assuming there is no one available to assist you with the debt, you have two options. You can arrange a payment plan with the taxing entity (your state or the IRS) or, usually, you can have the debt transferred to credit cards.
To learn about your credit card options, go to the Internal Revenue Service website (www.irs.gov) and search for "credit card payments." The IRS has chosen to stay out of the credit card collection process by establishing relationships with several service providers, which offer various rates: just $3.95 if you use a debit card or, if you're using a credit card, between 1.9 percent and 3.89 percent of the amount you're placing on the card.
For example, if you owe $2,000 and use a credit card, you would be asked to pay from $38 to $79 by the service provider. This is on top of the yearly interest rate that your credit card charges you. You should also consult your credit card company to learn whether it considers these charges to be cash transactions, which could result in a higher interest rate.
According to CreditCards.com, the average national interest rate is close to 15 percent for those with "normal" credit and 24 percent for those with "bad" credit. Paying off that $2,000 debt over a single year would cost you an additional $166 at 15 percent interest and as much as $269 at 24 percent interest (these are approximate figures based on average payments), plus the service provider fee.
If using a credit card is not an option, then the IRS and most states will permit you to sign up for an installment payment plan. Depending on your credit rating, you may find that the IRS plan is actually a better deal. Although the IRS reserves the right to decide who it allows on its plan, usually you have to be way behind on your taxes to be declined.
If the installment agreement is approved, the normal cost is $105, but if you allow the IRS to withdraw the payments electronically from your bank account, that fee is reduced to $52. On top of the fee, the IRS charges both late-payment penalties and interest, currently at about 9 percent per year, based upon the amount you owe each month.
In some cases, you may be able to avoid requesting an installment agreement, if the amount you owe is not considerable or if you have the resources to pay the debt within a few months. The IRS will generally allow you up to 120 days to pay your outstanding debt without the need for an installment agreement, although the agency will still charge you late-payment penalties and interest on the outstanding amount during that time.
Always try to file your tax return on time in order to avoid a late-filing penalty, and if possible, pay the full amounts you owe. If you have to choose between paying state and federal taxes, we suggest that you pay off your state debt first, as the states seem to be more aggressive in collecting debt and they may charge more in fines and/or interest for late payments.
Something important to keep in mind is that filing for an extension will not let you avoid these fees. You probably won't have to pay the late-filing fee (although the IRS may invalidate an extension if the amount due is significantly greater than you state on your extension form), but penalties and interest on any outstanding debt will still accrue from April 18, 2011. In other words, the extension won't save you any money. If you owe money, you may be able to put off making your payments for a few months, but it will cost you more to do so.