Here’s how to manage outstanding federal bonds
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A big bundle of IRS debt can be an overwhelming burden, but the worst thing you can do is ignore the problem. It will not go away.
“It depends on how much debt you have, but it can be overwhelming,” said Beverly Winstead, a tax lawyer based in Laurel, Md..
“To some people, $ 10,000 in IRS debt may seem like $ 100,000 for someone in my private practice, but you can’t bury your head in the sand,” she says. “There are options to move you in the right direction.”
The right direction is to fix the problem by completing the current tax returns and putting in place a potentially longer term plan to pay off the arrears owed.
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The IRS will continue to collect penalties and charge interest on unpaid tax balances until they are paid. In 2019, the service placed nearly 543,604 tax liens on property and issued 782,735 debit notices to third parties seizing overdue taxpayer income.
The longer you leave a tax debt problem, the deeper the hole will get.
“Taxpayers with IRS debt should deal with it as soon as possible because it can go on for years,” said Tom Gibson, a CPA with tax savings professionals in Vero Beach, Florida. “Putting it off will only make things worse.
Gibson suggests that taxpayers make tax debt resolution their top priority when it comes to managing their obligations – even surpassing a residential mortgage. “The IRS can seize your house or your business assets,” he points out.
What do you do if you can’t pay?
A first option – especially for business owners – is to take out a bank loan or line of credit to cover what you owe. The interest may not be deductible, but it will almost certainly be lower than the effective rate charged by the IRS.
Penalties on unpaid tax balances accumulate at the rate of 0.5% per month. The IRS also charges interest on the balance at the rate of the federal short-term interest rate – currently 0% – plus 3%. All of this equates to a 9% bond that will rise further if interest rates rise.
A second alternative is to take out a loan from a qualified retirement plan like a 401 (k) or individual retirement account that you can pay off over time. You will miss out on the potential returns of investing the money and there will be interest due in replacing the funds, but again, this will be much less than the cost of holding the debt with the IRS.
Don’t just take the money out of your plan. “I think a lot of people are pulling it off as a taxable distribution and that makes it worse,” Gibson said.
If immediate debt repayment isn’t a viable option, taxpayers can set up a installment payment plan with the IRS for up to 72 months to tackle the problem. For balances less than $ 10,000, you can set it up yourself on the irs.gov website without having to disclose any financial data. If the debt is more than that, you will need to submit information about your monthly income and expenses to the IRS.
“In many cases, people can manage it on their own on the IRS website,” Winstead said. “But if it’s too overwhelming, they should at least talk to a lawyer or a tax representative.”
People who cannot afford counseling can get a free consultation through organizations like the Low Income Taxpayer Clinic that Winstead helps run at the University of Maryland.
Taxpayers in truly dire financial distress, who feel they cannot meet a tax debt, may present an “offer in compromise” to the IRS. It is essentially a plea for a reduction in the amount owed. Beware of companies that promise to pay off tax debt for pennies on the dollar. It will take some pretty serious circumstances for the IRS to agree to a haircut on the tax debt.
Things like catastrophic medical expenses, a lost job, or unemployed family members who are relying on you may be eligible. However, if you still have a good income, your chances are probably slim. “The IRS probably won’t compromise with a well-paid doctor or dentist,” Gibson said.
In 2019, the IRS received 54,225 offers in compromise from taxpayers and accepted 17,890, according to IRS data. To bid you will need to 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 will be based on how it thinks your debt is collectable and how exceptional your situation is. “Ultimately, it will depend on how much disposable income you have and how much equity and assets you have to pay off the debt,” Winstead said.
She suggested now is the time to tackle the problem, as the IRS has been more lenient with taxpayers during the pandemic. It may not last.
“As we get out of this, I think they’ll go back to more normal collection tactics,” Winstead said. “If you have unresolved issues with the IRS, now is the time to take a step in the right direction.”