Dealing with Tax Debts? Here are some tips to get things right with the IRS
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A large bundle of debt to the IRS can be a soul-shattering burden, but the worst thing you can do is ignore the problem. It won’t go away.
“It depends on the size of your debt, but it can be overwhelming,” said Beverly Winstead, a tax attorney based in Laurel, Maryland.
“To some people, $ 10,000 IRS debt may seem like $ 100,000 to someone in my private practice, but you can’t bury your head in the sand,” she said. “There are ways to move you in the right direction.”
The right direction is to solve the problem by filing up-to-date tax returns and creating a potentially longer-term plan to pay off any after-tax owed.
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The IRS will continue to impose penalties and charge interest on unpaid tax credits until they are paid. In 2019, the service issued nearly 543,604 tax liens on real estate and issued 782,735 tax receipts to third parties generating income from criminal taxpayers.
The longer you leave behind a tax debt problem, the deeper the hole becomes.
“Taxpayers with IRS debt will have to deal with it sooner rather than later as it can take years,” said Tom Gibson, CPA at Tax Saving Professionals in Vero Beach, Florida. “If you put it off, it will only get worse.”
Gibson suggests that taxpayers make resolving tax debts a top priority in managing their obligations – even topping a mortgage. “The IRS can seize your home or business assets,” he says.
What do you do when you can’t pay
A first option – especially for business owners – is to take out a bank loan or line of credit to cover your debt. The interest may not be deductible, but it will almost certainly be less than the effective interest rate calculated by the IRS.
There are penalties of 0.5% per month for unpaid tax credits. The IRS also charges interest on the balance equal to the federal short-term interest rate – currently 0% – plus 3%. All of this equates to an obligation of 9%, which increases further as interest rates rise.
A second alternative is to take out a loan from a qualified retirement plan like a 401 (k) or an individual retirement account that you can repay over time. You will miss out on the potential investment returns on the money and there will be some interest in replacing the funds, but again this will be well below the book cost of debt with the IRS.
Don’t just pull the money out of your plan. “I think a lot of people pull it out as a taxable distribution, and that makes matters a lot worse,” Gibson said.
If you have unresolved issues with the IRS, now is the time to take a step in the right direction.
If immediate debt settlement isn’t a viable option, taxpayers can work with the IRS to devise an installment payment plan of up to 72 months to resolve the issue. For funds less than $ 10,000, you can set it up yourself on the irs.gov website without disclosing any financial information. If the debt is higher, you will need to provide the IRS with information about your monthly income and expenses.
“In many cases, the people on the IRS website can just deal with this themselves,” said Winstead. “But if it’s too overwhelming, at least talk to a lawyer or tax representative about it.”
People who cannot afford counseling can seek free counseling from organizations such as the low-income Winstead Taxpayers Clinic, which the University of Maryland supports.
Taxpayers in really difficult financial circumstances who feel they cannot cope with a tax debt can submit a “compromise” offer to the IRS. It is essentially a plea for a reduction in the amount owed. Beware of companies that promise to pay off the tax bill for pennies on the dollar. It will take fairly serious circumstances for the IRS to agree to a tax debt haircut.
Things like catastrophic medical expenses, a lost job, or unemployed family members relying on you can qualify. However, if you still have a good income, your chances are probably slim. “The IRS is unlikely to compromise with a high-paying doctor or dentist,” Gibson said.
In 2019, the IRS received 54,225 compromise offers from taxpayers and accepted 17,890 of them according to IRS data. To submit a quote, you must be up to date on your tax returns and have paid the estimated taxes for the current year.
The IRS is not heartless, but its decision is based on how collectable it holds your debt and how exceptional your circumstances are. “Ultimately, it depends on how much disposable income you have and how much equity and assets you have to pay off the debt,” Winstead said.
She suggested that now is the time to address the issue as the IRS has been more lenient with taxpayers during the pandemic. That can’t last.
“When we get out of this, they’ll likely revert to a more normal collecting tactic,” said Winstead. “If you have unresolved issues with the IRS, now is the time to take a step in the right direction.”