How to Deal With an Unexpected Tax Bill

In an ideal world, you'd never find yourself fielding a surprise bill from the IRS—but it does happen. Just to be clear: A bill isn't a moral judgment. You don't have to be a sneak to end up in this situation. Maybe you just didn't withhold enough during the prior year, pulled in a bit more income than you realized from a side hustle, or picked the wrong stocks to sell while tidying up your investment portfolio.

In short, there are numerous ways to generate an unexpected tax bill. Fortunately, there are also numerous ways to deal with one. Here are a few to consider:

• Tap your emergency fund. We generally recommend investors maintain an emergency fund holding three to six months of essential expenses for situations exactly like this. With luck, you'll have more than enough on hand to cover your bill, and then you can just plan to replenish your reserve as soon as you're able. As a reminder, consider keeping a decent chunk of your reserve in a yield-bearing savings account. Returns may be low, but liquidity is key. Savings accounts are insured by the FDIC against the loss of your money up to $250,000 per depositor, per FDIC-insured bank, based on account ownership type.
• Consider selling losing investments. You might think your winning investments are the first place to go for cash, but offloading losers might actually make more sense in certain situations. In fact, selling a losing investment could help raise the needed funds to pay your current tax bill and reduce your future tax liability, through the power of tax-loss harvesting. If you sold an appreciated investment, on the other hand, you'd have your cash, but you'd also trigger a future tax liability. (If you've held the investment for less than a year, you'd have to pay ordinary income tax rates on any gains, though if you've held it for a year or more, capital gains rates would apply. Those tend to be lower.) 
• Approach debt carefully. What about taking out a loan? This may seem like a simple solution—you get your money, pay your bill, and call it a day—but borrowing should probably be avoided if you have other options. First of all, you'd just be substituting one debt for another, potentially with significantly higher interest rates (especially if you use a credit card). And second, if you've put up collateral by securing your loan against the value of your home or your investments, you could risk losing your assets if you were ultimately unable to repay the loan.

What if the options above aren't for you? The IRS does offer some solutions. For example:

• Short-term payment plans (up to 180 days). These are for cases where you can't pay your bill on time but expect to be able to do so within the next 180 days. There's no fee to participate, but late payment penalties and interest will accrue until you've paid off your obligation.
• Regular payment plans (longer than 180 days). This is basically an installment plan, where you make monthly payments directly, say through your bank account or payroll or even by sending in a check. Note that you may have to pay a fee and meet other eligibility criteria to participate in this program. 
• Offer in compromise. In some cases, it may be possible to reach an agreement with the IRS to pay less than the full amount owed. However, this could also involve fees and particular eligibility criteria. 
   

If an unexpected tax bill temporarily scrambles your plans, consider using it as a prompt to set up a more detailed financial plan. If you need help getting a handle on your money, talk with a financial or tax planner. Careful budgeting, tax planning, and goal setting can help you lower the chances of a surprise bill landing in your box.