If you find yourself in a hole, stop digging…

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.

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