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What happens when you can’t pay your taxes?

In the wake of a serious economic recession, an ever-increasing number of taxpayers have found themselves in a situation where they are unable to pay their taxes. Often these individuals have never before found themselves in such a predicament; the vast majority of people pay their taxes on time and in full. However, desperate times call for desperate measures to survive: Some people may have had to cash in retirement plans because of extended periods of unemployment of underemployment. While sacrificing long-term financial security is painful enough, many are unaware that there are immediate tax consequences to taking early distributions. Often, at the end of the year when they file their return, they realize that they are stuck with a bill they cannot pay. Some taxpayers were unaware that foreclosing on their home, settling their credit cards, or participating in a short-sale would leave them with a tax bill. Other taxpayers are self-employed, and they are responsible for making quarterly estimated tax payments, or subject to paying their own tax and self-employment tax out of the money they take in. Because they may later be unemployed, they may have been unable to make those payments. Some taxpayers may have filed a return, received a refund (which has been long spent), and received a letter from the IRS disallowing a deduction or credit. If you find yourself in a situation like this, the first thing you should do is to consult a qualified tax attorney to evaluate your options.

I got a letter from the IRS! What do I do?

Regardless of the circumstances that led to a balance due, it is important not to ignore correspondence from the IRS. Even if it refers to a previous year’s tax, it needs to be addressed head on: the IRS generally has 3 years from when a return was filed (or due, if you filed it early) to reexamine the return and asses any additional tax due. (They may have longer under certain circumstances: if the amount is large enough or if they allege fraud). Ignoring it WILL NOT make it go away, it will only exacerbate the situation. If you refuse to respond to the correspondence, eventually the IRS will assume that their assessment is correct and will go into collections procedures. Furthermore, with a professional evaluation and assistance from a tax professional, many tax disputes can be resolved early on: perhaps the return was improperly filled out, maybe you had a questionable deduction that requires additional documentation, or you were entitled to deductions and credits you did not claim. If the IRS has sent correspondence requesting a “proposed adjustment to tax,” an examination, or an “audit,” the safest course of action is to contact a tax professional immediately to evaluate any potential course of action. Ignoring the inquiry will only result in an automatic “win” for the IRS.

If you have already been through the audit process, and have received a “proposed adjustment,” indicating you owe tax, you still have options left to dispute it. Again, consulting with a tax professional is crucial to determine how to proceed. Appealing the decision may be an option, or waiting for the issuance of a Notice of Deficiency (90-day letter) and petitioning the US Tax Court for review.

If you received a Notice of Deficiency, you must act IMMEDIATELY. This is what is commonly referred to as a “90-day letter.” In order to dispute the tax due without first paying in full, you must petition the United States Tax Court within 90 days of the date on the letter. There are no exceptions, no excuses for reasonable delay: 90 days IS 90 days. If a petition is filed on day 91, it is too late. It is crucial to speak with a tax professional as soon as possible, so that he or she can assist you in responding timely and if necessary, in handling the case before the United States Tax Court. If you do not file a petition on time, but still dispute the amount of tax, your only option is to pay the full amount due and sue for a refund in Federal court.

If you have already had a final determination of the tax due, and are still unable to pay it, again, consultation with a tax professional is of the utmost importance. Simply ignoring the IRS will not make them go away; the persistence of the agency is unparalleled, as is its authority. If you refuse to pay, the IRS will just TAKE. The IRS can place a lien on property. The IRS can levy bank accounts, garnish wages, garnish social security, and seize your property.

What if I owe the tax, but I just can’t pay?

If the tax IS due, and you simply cannot pay it, you still have options. Again, consulting with someone experienced in this area is of the utmost importance: There are several options that may be open to you: First, you may qualify to have collections proceedings abated against you until you are able to pay (Placed on Currently Non-Collectible status). While this will not resolve a tax debt, it will provide relief from collection proceedings like wage garnishment and levies, if the proper procedures are completed. Second, you may qualify to pay the tax on an installment agreement. Even the IRS may accept a payment plan, and with the help of a professional, monthly payments may be less than you expect. A third option may be to attempt to settle the tax debt, by making an Offer In Compromise.

Offers in Compromise have had a top spot in television and radio advertisements lately; there are numerous companies that promise to settle tax debt for “pennies on the dollar.” An offer in compromise, as authorized by IRC 7122, is certainly a valid option for a taxpayer who qualifies for it. However, the rules are complex, and while success is never a guarantee, having representation is very important: proper evaluation to determine if it is an appropriate avenue of relief and assistance in preparing one helps to ensure that the facts that are most relevant come to the reviewer’s attention. This can make all the difference. For additional information on Offers in Compromise, please see “What is an Offer In Compromise?”

If I know I can’t pay, should I just not file?

NO! Generally, (though there are very limited exceptions) you are legally required to file a return. Under Internal Revenue Code, Section 7203, willfully failing to file a tax return when you are required to is a crime. Furthermore, there are separate penalties for not filing and for not paying. If you know you are not going to be able to pay your taxes, it is still generally better to file timely for several reasons. First, it starts the statute of limitation (both the amount of time the IRS has to open up your return for examination and the total amount of time the IRS has to collect any tax due) running. Second, late-filing penalties will not attach if you file on time, even if you did not pay your tax due. If you file but have not paid, you will have late-paying penalties and you will accrue interest, but it will be less than if you did not file at all. Third, if you do not file, eventually the IRS will probably file a substitute return for you. Generally, the return the IRS files will not take into account exemptions, deductions, and credits you may be entitled to, so the amount you owe will be even greater than if you prepared the return yourself. Even if you cannot pay the amount in full, it is better to file; in consultation with a tax professional you will be able to come up with a solution for the tax amount due.