Both tax and debt are very common financial terms in our daily life. Tax is a mandatory financial charge that you have to pay to the government every year. On the other hand, debt is the amount that you have borrowed from a bank, financial institute, or individual borrower. Tax debt is another important term and is usually incurred if you forget to file your taxes. In this type of situation, you owe money to the IRS.

Definition of Tax Debt

If you forget to pay or file the tax on your federal income tax return by the due date then it will create a tax debt. The due balance is subject to interest and the IRS can also charge penalties on that debt. So, whenever, you don’t pay the tax amount shown on your federal income tax return you create a tax debt. If there is any tax debt on your behalf then the IRS will send you urgent notices to pay the tax debt to avoid any future problems.

Tax debt is very common in the USA so if you have a tax debt then there is not much to worry about. The good news is IRS offers various facilities to taxpayers who have tax debt. So, it means you can easily resolve the tax debt issue.

How Tax Debt Works

Now that we know why tax debt occurs, let’s see how tax debt works and increases with time. If you miss your tax payment then it will result in penalties. You should know that the IRS charges a 0.5% penalty on the total tax debt amount. However, in some cases, the IRS could charge a 25% penalty on the total tax debt amount.

Moreover, every month, the IRS will charge a penalty as well as interest on the total tax debt. So, your total due amount will increase every month and if you don’t clear your tax debt quickly then the amount can grow significantly. If you have a valid reason to not pay the tax then the IRS could reduce the number of penalties on tax debt but they will never reduce the interest from tax debt.

What IRS will the Do If you have Tax Debt?

When IRS realizes that you have tax debt, they will file a substitute tax return on your behalf and find out the liability. Then the IRS will calculate your total tax debt. After that, the IRS will send you a notice regarding how much you owe to IRS and how you can pay. You should keep in mind that the notice won’t contain any information regarding debt reduction, penalty reduction, etc.

So, when you receive a notice, you should consult a tax professional and then prepare a response to the IRS notice. You should keep in mind that if you don’t pay your tax debt then the IRS has the power to block your wages and all your financial accounts up to the total tax debt amount.

Definition of Tax

Tax is a type of mandatory charge that is imposed by the authority on individuals, businesses, and properties. The tax revenue is one of the main sources of income for the government. Every country has a tax system with its own rules and regulations. The funds collected from the taxation are used for the betterment of the economy as well as for maintaining the infrastructure of the country.

Depending on the country where you live, you might have to pay tax on income earned from salary, profits from business, or payments from services.

Different Types of Taxes

There are 7 common types of taxes available. They are –

1. Income Tax: You have to pay a percentage of your income to the state or federal government
2. Payroll Tax: If you are an employee then the employer will withhold a certain percentage from your payroll and then the employer will pay the amount to the government on behalf of the employee.
3. Corporate Tax: Every corporation has to pay the corporate tax on the profits that they make. The corporate tax has to be paid to the state or federal government.
4. Sales Tax: This type of tax is mandatory for different types of goods and services.
5. Property Tax: You have to pay property tax depending on the value of the land and the property.
6. Tariff: This is a type of tax that is imposed on various imported goods. The main purpose of this type of tax is to strengthen the domestic business.
7. Estate Tax: The rate of the estate tax depends on the state where you live.

Definition of Debt

Debt is a type of obligation where the borrower has to pay the money that he/she took from the lender with an agreed interest rate. Individuals and corporations take debt to purchase something or expand the business with a large amount of money that they won’t be able to afford in normal circumstances. Some common examples of debt are loans, car loans, property loans personal loans, etc.

Different Types of Debts

The 4 main types of debts are –

• Secured Debt: This type of debt is always backed by collateral. Here the collateral could be property, car, house, etc. If the borrower fails to repay the debt amount then the lender will take the collateral and sell it to get back his money.
• Unsecured Debt: This type of debt doesn’t backed by any collateral. So, if the borrower fails to repay the debt amount then there is a chance that the lender will lose his investment. Another key aspect of unsecured debt is, that the interest rate of unsecured debt is higher than that of secured debt.
• Revolving Debt: This is a type of debt that the borrower carries from any revolving credit. The most common type of revolving debt is credit card debt. In most cases, revolving debt has a fixed limit that the borrower won’t be able to cross.
• Installment Debt: This is a closed-ended type of debt and it is quite different from revolving debt. In this type of debt, the borrower has to pay a fixed monthly installment. Moreover, this type of debt could be secured or unsecured.

Difference between Tax and Debt

FAQs about the Difference between Tax and Debt

Does tax debt have a statute of limitations?

Yes, tax debt has a statute of limitations. Usually, the statute of limitations for tax debt is 10 years from when the penalty was assessed. This time frame is known as a Collection Statute Expiration Date (CSED).

What are the common causes for penalty abatement of Tax debt?

Some common causes for penalty abatement of tax debt are –

• Natural disaster
• Fire, accident
• Serious illness
• Death
• Erroneous IRS advice
• Unavoidable absence, etc.

What types of debts won’t go away with bankruptcy?

Below is a list of debts that won’t go away with bankruptcy –

1. Credit card debt
2. Medical bills
3. Personal loans.
4. Utility bills.
5. Business debts
6. Unpaid/overdue taxes
7. Secured debt, etc.

How do you know if you have a tax debt?

There are many ways you can check/know whether you have a tax debt or not. The simplest way is to check online. There are various online tools available that you can use to check whether you have tax debt or not. You can also call IRS at 800-829-1040 and check if you have tax debt. You can also visit the IRS office in person and find out about the tax debt. 

Last Updated on July 10, 2022 by William A. Leong