Tax debt is becoming a severe problem for the IRS. In the IRS’s lasted published estimation, they believe that the difference between what is owed by taxpayers and what is collected by the IRS is greater than $450 billion dollars. As the amount of uncollected tax debt continues to increase, the IRS continues to take steps to attempt to collect this debt. One of the IRS’s most recent attempts to collect even involves looking to private collection agencies.
Tax debt is also a huge problem for the taxpayers causing this tax debt. Your tax debt can be reported to credit agencies. This will significantly lower your credit score and can prevent you from getting financing for a loan. Tax debt may also cause issues for professional licenses or prevent you from travelling outside of the country. Taxpayers with unresolved tax debt may be subject to IRS enforcement action, such as bank levies and wage garnishments. In certain cases, the IRS may assign a Revenue Officer to your account. Revenue Officers may show up at your home or place of business. They also may subpoena your bank statements or other personal information.
There are many ways that a taxpayer can acquire a tax debt. Here are some of the ways in which tax debts come about:
- Taxpayer does not pay enough taxes during the year. If a taxpayer does not have proper withholding or if they do not pay enough in quarterly estimates throughout the year.
- If there is an error on the return, unreported income, or an improper deduction. The IRS will adjust the return and send a notice to the taxpayer regarding the change.
- Audit adjustment. The IRS may adjust your return if there are changes based on an IRS audit.
- Substitute for Return (SFR). If you do not file a return, the IRS may prepare a return on your behalf. This return will not include any deductions and will generally result in a larger tax debt than you would owe if you filed on your own.
- Identity theft is a huge issue. People will go to file their return only to find that someone has already filed under their Social Security Number and name in order to receive a refund. In this situation, the IRS will then adjust the return, leaving a large tax debt on the taxpayer’s account.
- Various taxable events. Often people will have an event happen throughout the year that will result in an unforeseen tax debt. Some of these events may include sale of real property, court proceeds, cashing out of a 401(k), or various other taxable events.
Once you have a tax debt, the next question becomes, how to deal with it. The first question you have to ask is, “Is the current tax debt correct?” In the above examples, many of the taxpayers may not have the correct tax debt. For instance, the fraud, the SFR, and even the audit or IRS adjustments may not accurately reflect the correct tax debt.
If you do not believe that the current tax debt is correct, the IRS puts the burden on the taxpayer to prove why the debt is incorrect. Many taxpayers will come out of an audit not believing that they owe the tax debt that the IRS adjusted the return to. However, they must be able to prove to the IRS that they are entitled to the deductions. For instance, if you do not have receipts or records, you are going to have a much more challenging time getting the balance adjusted. If you went through an audit and later find additional support, there are avenues available to further contest the tax debt.
For situations where the IRS has assessed an SFR because an original return was not filed, the taxpayer needs to file an original return to replace the SFR. Especially for taxpayers with business income and expenses, replacing this SFR can greatly reduce, if not eliminate, your tax debt.
One thing to think about before you proceed forward with correcting your tax debt is what type of resolution that you are going to qualify for. For instance, if you have no ability to pay your tax debt, does it really matter if you reduce it from $50,000 down to $40,000? Wouldn’t your time, energy, and money be better spent working to resolve the tax debt, instead of trying to adjust it to an amount that you still will not be able to pay? On the flip side of that, if you can contest the tax debt and eliminate it, or get it to an amount you can pay, it is worth it to contest.
Take the following two examples of two taxpayers. Both are under audit by the IRS for three years of tax returns. In the first situation, the taxpayer has a construction company. He filed original returns with a tax debt of $35,000 that he has not paid. The IRS wants to assess an additional $20,000 to the tax debt owed. The taxpayer has no additional receipts to support the items that the IRS is adjusting.
In the second situation, the taxpayers own a motel. They filed and paid the tax debt due on their returns. They have all their receipts to support their claimed deductions. The IRS wants to assess an additional $10,000 of tax debt owed.
In the first example, the taxpayer has limited receipts and a tax debt that he can already not pay. In this example, the taxpayer should look at the cost vs. the benefit to continue to contest the audit. We have had taxpayers come to us from previous accounting firms who had spent thousands of dollars to contest an audit when they did not have records and were not able to pay the tax debt regardless of what it was reduced to. In this situation, the taxpayer may have been better off to spend that money towards resolving the tax debt instead of attempting to contest it.
In the second example, there is an entirely different scenario. These taxpayers have their documentation to support their deductions. They also have the ability to pay their tax debt. Therefore, they need to do a cost/benefit analysis to determine whether it is more beneficial to contest the tax debt or to pay the tax debt owed. In this situation, it is likely worth it to continue to contest the auditor’s determination and work to eliminate any additional assessment.
A qualified representative should be able to help you to determine what your resolution options are and what is the best course of action for resolving your tax debt.