Back Taxes – What Do You Do?

You’ve had a great day. Everything went right at work. You finally landed that new account you’ve been chasing, and you found $20 in an old pair of pants. Things have certainly gone your way; until you get home, look through your mail and find a letter from the Internal Revenue Service. When you open it, you find a bill for $24,713.65 in back taxes, penalties and interest. What do you do now?

First Things First

When you receive an unwanted letter from the IRS, try not to panic and don’t assume anything yet. While some taxpayers who get such a notice really do owe back taxes, the amount assessed is often incorrect. Many times the amount on the notice is far too high. Sometimes, when all is said and done, the IRS might even owe you something.

With the advent of computers and the requirement for many businesses to send both you and the IRS information on your interest, dividends, stock and other transactions, the IRS initiated a matching program. This program compares the information sent in by a third party with the information you report on your tax return. If you fail to include all of this information, the IRS assumes you understated what you received and sends you a bill – without taking into account any possible deductions that would reduce your taxable income.

For example, you started a new lawn care business two years ago. Since you only received $1,000 from ABC Enterprises Inc. that year and you had some expenses, you decide there is no real need to include the $1,000 on your return. Unfortunately, the tax law says that ABC Enterprises Inc. was required to send you a Form 1099-Misc. to report what it paid you. The IRS also receives a copy of that form. If your tax return has less than the total of all the payments reported and you are in the 20 percent tax bracket, you will receive a bill for $200 in taxes plus penalties plus interest.

While receiving a tax bill in the mail is unwelcome news, remember the reason you didn’t file in the first place – you figured you had enough deductions that you wouldn’t owe any taxes. There was the gasoline you used, the transportation to and from ABC’s offices, and a host of supplies. Oh, and don’t forget the $4,000 lawnmower you bought along with the $3,500 trailer to haul it in. By the time you add it all up, you actually lost money in the first year.

Assuming you reported income correctly in the following years, you might actually have a refund coming. So don’t panic when you receive the IRS notice – just take a deep breath and read it carefully.

Step Two

One big mistake we see from taxpayers is failure to acknowledge a problem. In the case of the IRS, any bill you receive is a problem – whether you actually owe money or not.
All too often, a taxpayer will receive a notice claiming taxes are due and, if the amount is small, they will throw it in the trash and forget about the letter. If the amount is large, the taxpayer might assume the IRS is correct and go into denial. Either way, failure to follow up and communicate with the IRS can spell trouble. At the very least, the notices will continue. Assuming there is no fraud, notices will continue until the IRS finally places a lien on the taxpayer’s assets or levies their bank account. This tends to prolong the agony and might end up costing more to correct. The longer a taxpayer ignores the IRS, the less inclined collections will be to work with them.

Step two, then, is to immediately work to address your problem with the IRS. This could be as simple as making a phone call or writing a letter. In a more complex case, you might need to engage a tax professional to help you correct any errors or file any income tax returns you have not filed.

Step Three

Once you have corrected your tax return or filed any delinquent returns, step three is a simple matter of paying any taxes due or waiting for the IRS to send you the refund. If, however, you owe a significant amount, you might need to work out a payment plan with the IRS. In that case, the IRS will require a substantial amount of information to determine your payment plan.

This is when a tax professional experienced with IRS collection laws and procedures is invaluable. They will look at your overall financial picture and help you present your case to the Internal Revenue Service. Your situation will dictate what you pay and whether you pay it in installments or in one lump sum. An experienced professional will be able to help you get the best deal possible.

The United States’ tax system is a voluntary one. That means the IRS first relies on you to compute your income and pay the taxes due. If you don’t, they have at their disposal some of the information necessary to file a substitute return for you – a return that is rarely correct and almost certainly does not take into account all legal deductions to which you are entitled. If you receive an IRS notice, especially one claiming you owe a substantial amount in taxes, give us a call. We are here to help.

Have a great month.

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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