Understanding and Solving Your Tax Problems

Anytime you make a voluntary payment to the IRS, you have the absolute right to tell the IRS how to apply the money.  For most taxpayers, this may never be an issue because they only owe one type of tax for one tax year.  But for some, there may be a number of unpaid tax obligations.  If that is the case, how the money is applied may be important.  For example, if some tax debts are joint obligations with a spouse and others are not, you may want to pay off the joint obligations so your spouse’s assets are no longer exposed to collection efforts.  If you owe money for a number of years and some of the years can be discharged in bankruptcy and some can not (a topic for another day), you will want to pay the taxes that can’t be discharged first. 

You may think this payment strategy could be used when you file a tax return with an overpayment.  If so, you would be wrong.  If you file a tax return that reports an overpayment of tax, you generally lose the right to tell the IRS how to apply that overpayment.   Most people know that if they file a tax return with an overpayment, rather than ask for the money back in a refund they can check a box on the return and apply the overpayment towards their tax liability for the next year.  For individuals that need to make estimated tax payments, this is often a mechanical choice since otherwise they are asking the IRS to send them a check the same time they are mailing in their estimated tax payment.  This is a good system as long as there aren’t other unpaid tax obligations, and sometimes nontax obligations, outstanding. 

If you owe other taxes, whether income tax, employment tax or excise taxes, the IRS is going to override your election to apply an overpayment to the next tax year and, instead, use the money to pay your other outstanding tax obligations. The overpayment will be applied first to the tax, then to penalties and then to interest for the oldest obligation. Certain kinds of other obligations such as child support and student loan payments may also be satisfied with a tax overpayment.  If you have these sorts of obligations, you need to be very careful when doing your estimated tax payment planning for a subsequent year.  If you think your overpayment is going towards your estimated tax payment and it doesn’t, you may now be underpaid in your estimates which will result in penalties. 

A good tax preparer can help you think through this situation, but they need to know that you have these outstanding obligations.  Once a return that reports the overpayment is filed, it is too late.  If you don’t want your overpayment to be used to pay off another tax obligation, then the best advice is to plan in advance not to have the overpayment.

When you owe the IRS money and you can’t pay everything right away,  typically there are three  options:  (1) convince the IRS you can not currently pay anything and have your account marked as “currently not collectible;” (2) set up a payment arrangement; or (3) seek to settle through the offer in compromise program.  Each option has its pros and cons.  The IRS recently announced some helpful changes if you want to pursue the second option of setting up a payment plan.

 Rules for IRS payment plans have always been classified based on how much is owed.  These rules generally address the length of time that can be given for payment, the amount of financial disclosure required before a monthly payment amount will be accepted, and whether a tax lien will be filed.  The significant thresholds of balances owed are $10,000, $25,000, $50,000 and over $100,000.   As you would expect, the more you owe the more involved the rules become.  Therefore, as a threshold consideration,  before approaching the IRS about a payment plan, consider whether a partial payment can be made to move you down a tier or more in the escalating set of rules.   

 The recent changes relate to the “streamline installment agreements” for taxpayers owing less than $25,000 and those owing between $25,000 and $50,000.  In each instance, taxpayers may now be given up to six years to pay an obligation (increased from five years).  Taxpayers owing between $25,000 and $50,000 now need to make monthly payments by direct debit from a bank account.  Also, at this higher level some financial disclosure will be requested but the sole purpose for gathering this information is to ensure that the payments can be maintained for the life of the plan, not to glean the highest monthly payment that can be made.  Generally a tax lien will not be filed at either of these levels under the streamline rules.

 If a payment plan is the best option to resolve a tax debt, all of these changes should make setting up a payment plan easier.

Very recently the IRS Taxpayer Advocate warned Congress that the IRS’s workload continues to increase while its funding is decreasing.  The Taxpayer Advocate is concerned that under these circumstances, the IRS is not able to do the job it is tasked with doing.  While some may smile when hearing such news and think–  “Good, the less IRS the better!”– be careful what you ask for. 

As the funding for IRS operations is reduced, services that we have come to expect from the IRS are vanishing as well.  Reaching a local IRS agent by telephone is fast becoming a thing of the past.  More and more often, matters are being assigned to 800-number call centers where you can be on hold for 30 minutes or more before reaching a live person.  If you need to call back with more information, you endure the same wait and end up with a different person.

Delays are part of the process when dealing with a tax problem but now those delays seem longer than ever.  With outstanding obligations accruing interest and sometimes penalties, delay can be costly.  The IRS always encourages voluntary payments while an issue is being reviewed and given these delays, sometimes that can make  sense.

As the IRS faces the same economic challenges of any other business, having an experienced advocate that knows where to go, knows how to streamline the process, and knows how to manage the ever changing bureaucratic landscape is important.   

              I am often asked:  “If I can’t pay the tax due with my return, am I better off not filing until I have the money to pay?”  While the situation presents some complexities, the advice is simple:  it is always best to file your tax returns on time even if you can’t pay.  Such filing eliminates the failure to file penalty (which, along with the failure to pay penalty, can grow to as much as 25% of the tax due) and the possibility of the much more serious criminal consequences for not filing.  (These are the IRS consequences; each state has similar rules for their returns as well.)

            But what happens if I didn’t file a tax return, or worse yet, several returns?  Here’s the good news, it’s not hopeless.  Many people don’t file their tax returns.  The reasons for non-filing can run the gamut from serious medical or personal issues, natural disaster, economic reversal, business failure, and so on.  (I intentionally exclude illegitimate reasons for non-filing as the consequences for those are much different.)  In my experience, if someone hasn’t filed for one year, typically they haven’t filed for several years.  This prolonged period of non-filing typically starts with one of the reasons listed above, but the repeated failure to file results from the uncertainty – - really the fear — that “coming back into the system” will be too costly and potentially devastating.  Those that do not file one or more returns very often find themselves in what seems an inescapable and unsolvable predicament. 

            Fixing a non-filing situation is not always pain-free but there are options for non-filers and certain choices are much better than others.   Most importantly, for at least 25 years it has been the IRS’ policy not to press criminal charges for non-filers who voluntarily file their past due returns.  Returns are considered filed “voluntarily” as long as the IRS hasn’t commenced any investigation or contacted the non-filer before the returns are filed.  So the best option for the non-filer is to get the returns filed – before the IRS asks you to file them.  (Even when the IRS asks for unfiled returns, it is not automatic that criminal charges will be asserted.)

            What if you haven’t kept your records (W-2s, 1099s, etc.) to prepare your returns?  Don’t let that be an excuse.  All of that information is available from the IRS.  In fact, if you plan to file returns for the past several years it is a good idea to request that information before filing just to be sure you report everything that the IRS already knows about.   Once the return(s) have been filed, there are three basic options to then consider in dealing with the amount due:  full payment (all at once or over time), settlement through an offer in compromise, or having the debt found to be “currently not collectible.”     If penalties are been imposed after the return is filed, which is very likely to be the case, those additional charges may be removed if the taxpayer can demonstrate that the late filing was due to reasonable cause and not willful neglect.

            Nonfilers that I have worked with are almost universally relieved to learn that the heavy burden of not being in noncompliance can be resolved, often with consequences much less severe than ever envisioned.

Ever hear the expression, “If you find yourself in a hole, stop digging.” That is as good a place to start when someone has fallen behind in their obligation to pay their taxes. So often when someone has a tax problem I see that they are always playing catch up.

A typical scenario may be: Bob files his 2009 return late with a big balance due. Determined to fix the problem, he stops his withholding for 2010 and he starts paying all of his 2010 tax money over to the IRS to pay off the 2009 bill. Or if Bob is self-employed, he commits to pay over a lump sum payment (when his next deal closes) and neglects to make his estimated tax payments for the 2010 income. So now, when the 2009 debt is satisfied, the 2010 return comes now due and Bob realizes he is going to owe about as much again for 2010. My advice: stop digging Bob. What Bob is doing is running up more penalties and interest than is necessary.

A better approach would be to contact the IRS and come up with a payment plan to pay off 2009 which allows Bob to stay current on his obligation for 2010, and beyond. Yes, penalties and interest will continue to accrue on the 2009 balance until it is paid off, but failure to file and failure to pay penalties max out at 25% of the tax for each year. Consider that the cost of needing more time to pay the 2009 debt. Using the “catch-up” approach, Bob is now likely to face that 25% penalty for each year he owes. In the long run, he will pay a lot more than he should have to.

If you fall behind for one year, work out a plan for that year that allows you to stay current for subsequent years. Now you have minimized the cost of having fallen behind.