What to do if you have an ATO tax debt?

This year it’s highly likely that my husband and I will have a reasonably large tax debt due to the growing dividend income from investments. I have had large tax bills in the past and so I thought I would share what we’ve learnt from our past experiences with Australian Tax Office (ATO) debts.

Don’t Panic (or at least try not to)

The first time I received a tax bill I was immediately sick, stressed and terrified at the unknown. The feelings I felt at the time were a completely natural response (especially for someone with anxiety), but I want to reassure you that getting a tax bill isn’t the end of the world (although it does feel like that at the time). Make yourself a cup of tea, take a few breaths, and phone a support person if you need to.

Note: If you are feeling so overwhelmed or anxious by a debt to a point where you are unable to cope then please seek mental health assistance to complement the steps below.

Don’t bury your head in the sand

The worst thing you can do with a tax debt is to ignore it. It won’t magically go away, and the longer you delay dealing with it the more difficult it can be. The most important thing to do is to read your ATO Tax Assessment letters or any other correspondence you’ve received regarding this debt (you will receive this information via mail or the online ATO portal). The ATO correspondence will provide you with dates as to when the tax bill is due, where to make a payment, and what your options are if you can’t pay the full bill by the due date (eg. payment plan).

Emergency Fund

If you have a fully funded emergency fund or the money in savings to pay for your tax bill outright then you can pay it off by phone or online via the MyGov ATO portal. If you don’t have the money to pay it off that’s okay you can organise to pay via payment plan. The benefit of paying it off in full is that you will avoid any interest that a payment plan from the ATO may incur.

Payment Plan

If you don’t have enough money to pay your tax debt the ATO allows you to enter into a payment plan. ATO Payment Plans are designed to allow you to pay off your tax debt and any interest in a time frame that suits your financial situation. Be aware that ATO Payment Plans do attract interest so the longer you take to pay off the debt the more interest you pay.

If your debt is $100,000 or less then you can set up your payment plan online without even talking to someone (which can take a lot of the anxiety and even shame out of it). You can also call the ATO directly or have your tax agent negotiate your payment plan on your behalf.

Calculating your Payment Plan repayments and term

The ATO offer a Payment Plan Estimator here that allows you to run your own scenarios anonymously.

Additional Notes:

  • In order to set up your payment plan online you need to agree to an upfront 10% repayment within 7 business days of agreeing to the payment plan.
  • You also need to set up your repayments to pay the debt and interest off within 2 years.
  • Interest is currently charged at 7.04% (current rate Aug 2021)
  • You can make additional payments at anytime after you sign up to a payment plan.
  • You can opt to pay it off as quickly as you can afford to.
  • You can make payments weekly, fortnightly or monthly.
  • It’s important that you stick to the plan you’ve agreed to once set. If something changes and you can no longer pay you will need to call the ATO immediately to let them know your change in circumstances.

Example ATO Payment Plan: If you used the online payment plan estimator and had a $5000 debt you would need to agree to pay $500 within the first 7 days of starting the plan. After this you would need to pay $50 a week for 96 weeks (plus one additional part payment of $11.03) to pay the loan off within the maximum 2 year repayment period. This would incur $311.03 in interest over this period. If you opted to pay it off sooner the interest would be reduced.

What if you can’t pay a 10% upfront payment? or afford to pay the debt off within 2 years?

If you are in serious hardship, need a little more time to pay, or can’t afford the upfront payment then call the ATO directly. They have additional supports available to those in serious hardship. By calling the ATO directly you can negotiate more time on your payment plan, or negotiate a reduced upfront payment.

So as you can see getting a tax debt isn’t fun, but it also isn’t the end of the world. If you take steps early you can sort out a payment plan that suits your financial needs without completely ruining your future financial plans.

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Should I pay off debt first or focus on building an Emergency Fund?

This post is a part of a new tagged series of posts that give my perspective on a number of common budget, debt or finances questions. I find these questions in several ways including Reddit and Facebook Groups.

Today I’m tackling a common question I see from people at the start of their debt free and financial independence journey’s.

Focus on first getting a starter Emergency Fund

A fully funded Emergency Funds generally should cover 3-6 months worth of expenses, however this may be different for each individual. Regardless of the amount a fully funded Emergency Fund typically represents a substantial amount of money for someone to come up with, and it will take significant time to complete. If the person saving for the Emergency Fund has consumer debt they will likely be incurring interest during this time. Its for this reason why building a starter Emergency Fund first, and then prioritising consumer debt payment sooner over a fully funded emergency fund may be a better option.

How much should my Starter Emergency Fund be?

There are a number of different school’s of thought on how much your starter emergency fund should be. For example:

  • The Barefoot Investor recommends that your starter Emergency Fund should contain a minimum of $2000 before tackling debt.
  • Dave Ramsey recommends a starter Emergency Fund of $1000 as part of his baby step method before tackling deb.

What amount you choose to go with for your starter Emergency Fund is ultimately up to you as this will be different for everyone.

Prioritise getting your Starter Emergency Fund fully funded

Once you’ve settled on your starter emergency fund amount its time to pay minimums on all your debt payments temporarily. That way you can prioritise all additional funds to your starter emergency fund, and knock it off as quickly as possible. If you are going to struggle to get your starter Emergency Fund completed in less than a month think about some ways you could speed up the process. This could be selling items you no longer need or use, side hustling, or some other creative way to raise the funds.

Prioritising consumer debt

Once you’ve got your starter Emergency Fund in place its time to prioritise your consumer debt (excluding mortgage debt). By consumer debt I mean debt such as credit card, student loans, car loans, and short term loans (like payday loans).

There are two approaches to prioritising debt:

Debt Snowball: You list and prioritise paying off your debts from lowest balance to highest balance, and you focus on paying off the smallest one first (regardless of the interest rate). On this method you only pay minimum repayments on your other debts, and put all additional funds to the smallest debt. Once the smallest debt is paid off you then focus on the next smallest debt, and so on and so forth until all your debts are paid off.

Debt Avalanche: You list and prioritise your debts by highest interest rate to lowest interest rate, and focus on paying the debt with the highest interest rate off first. With this method you only pay minimums on the lower interest debts, and put all additional funds to the debt with the highest interest rate. Once the debt with the highest interest rate is paid off you then focus on the debt with the next highest interest rate, and so on and so forth until all your debts are paid off.

Which option is best?

The simple answer is the one that works for you, and you may start a method and switch to the other during your debt payoff. As long as the method works for you who really cares which one is best.

That said the Debt Snowball method has the greatest chance of success from a psychology stand point, and the Debt Avalanche method will result in less interest being paid overall.

It may be worth using a calculator to enter in your debts and compare your options against the methods. I have created one for this purpose (link here) or you could create your own.

Track your progress

Regardless of where you are with in reaching your financial goals whether that be paying down debt, saving or investing I recommend tracking your progress. All debt free journey’s feel slow at times so tracking your progress via a visual chart can really keep you inspired to keep going (its a marathon not a sprint remember).

You can find visual charts easily available online and there are a tonne of free ones click here for a link to my favourite ones from Debt Free Charts.

I also have a free investing printable available here or a free savings printable here.

If you’ve got a question you would like me to cover feel free to complete my contact form. If you would like to have articles like this delivered to your inbox subscribe below.

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