Dear Penny: I Didn’t Pay Taxes in 2020. How Do I Deal With Monster Bill?

Dear T.,

You didn’t commit tax evasion. You didn’t file a fraudulent return. At this point, you haven’t even failed to file a tax return. So I hope what I’m about to say will help you breathe easier. This is probably going to be an extraordinarily common problem for tax year 2020, given how many people have relied on unemployment and freelance work to survive.

Yes, technically, you should have been paying taxes on your unemployment and your freelance income. The U.S. tax system is “pay as you go,” meaning you’re supposed to make tax payments as you earn money, rather than saving it all for the end of the year. For taxes on unemployment benefits, if you don’t have the state withhold money, you’re supposed to make quarterly tax payments, just as you do with freelance income.

The consequences for not doing so aren’t too painful, though. Without getting too deep into the rabbit hole of IRS rules, the penalty for paying late is generally 0.5% of what you owe per month, provided that you file your tax return on time. You can avoid the penalty altogether if you owe less than $1,000. If you can’t afford to pay the bill, you can easily set up a payment plan through the IRS, but we’ll get to that shortly.

But I’m less worried about your 2020 tax bill than I am about your tax bill for 2021 and beyond. You don’t say whether you plan to make freelancing your permanent job or if it’s a stopgap to pay the bills until you find full-time work.

Regardless, as long as you’re freelancing full time, you need to find some way to budget for the taxes. Whether that means taking extreme cost-cutting measures or earning more by getting a side job, finding new clients or raising your rates is up to you to determine. The fact that you managed to rev up your freelance work to full-time status in just 11 weeks tells me that you’re resourceful.

Your first step is to estimate how much you’ll owe. You can easily do this by using the tax withholding estimator at IRS.gov. Obviously, you need to know this number for practical reasons. But understanding what you’re dealing with will also give you some peace of mind. When we’re dealing with the unknown, we often imagine the most catastrophic scenario possible. The reality may not be as bad as you envision.

You’re actually not as behind as you think you are. Quarterly taxes aren’t due in even increments. Taxes for the four-month period from September to December aren’t due until Jan.15, 2020, so you’re really only behind on taxes for your unemployment benefits, plus two months’ worth of freelance income. If it’s possible for you to cut expenses or take on extra work, try to set money aside so that you can at least make a partial payment in January.

Your tax situation is probably simple enough that you can set up a payment plan at IRS.gov/payments without speaking to a human. Whatever you do, though, please don’t charge that tax bill to your credit card. That 0.5% monthly fee works out to 6% per year, which is no doubt better than your credit card’s interest rate.

Even if you can’t afford to pay a dime, make sure you file your tax return on time by April 15. The penalty for failing to file is 5% per month of what you owe, rather than the 0.5% if you file but can’t pay. The lesson here is don’t be afraid if you can’t afford to pay. And whatever you do, don’t try to hide from the IRS.

Robin Hartill is a certified financial planner and a senior editor at The Penny Hoarder. Send your tricky money questions to [email protected].