If You Can't Pay Taxes, Not Filing Is the Worst Option

I've counseled a number of people lately who, suspecting that they had to pay taxes, didn't file their returns -- for years.

The Internal Revenue Service has finally caught up with them, and now they are facing possible tax liens. They never attempted to contact the IRS or a professional to discuss their options. They just didn't file.

"Why?" I asked.

"Because I was afraid," was the usual answer.

If you've done your tax return and realize you owe but can't pay, the worst thing to do is nothing. You may be fearful of what lies ahead, but if you don't do anything, eventually the IRS will track you down, and by then, the penalties and late fees will make your debt that much larger.

In fact, the interest on unpaid tax debts is compounded daily and is charged from the due date of the return until the date of payment. The interest rate the IRS charges is the Federal Reserve's benchmark short-term rate plus 3 percent, which these days means 8.25 percent.

Although the IRS doesn't have the storm-trooper reputation it once did, it hasn't gone SpongeBob SquarePants soft. Agents won't giggle and forgive your transgression like the sweet sea creature in the Nickelodeon cartoon. They will come after you hard.

If nothing else, at least file your tax return even if you can't pay the full or even a partial amount. The total penalty for failure to file and pay can be 47.5 percent (22.5 percent for late filing, 25 percent for late payment) of the tax owed. Filing would save you the 22.5 percent portion of the penalty.

This time of year, companies prey on individuals who either have not filed and owe, or have filed and can't pay. These firms promise they can get the IRS to settle your tax debt for a fraction of what you owe.

In the majority of the cases, this is just a deception. Essentially, these promoters have you apply for what's called an offer in compromise, or OIC. This allows the IRS, under certain circumstances, to accept less than the full tax payment.

An OIC is tough to get. Last year, the IRS received 59,000 requests for offers in compromise but only 15,000 were granted -- resulting in a tax collection of more than $283.7 million.

You have to be experiencing unusual economic hardship to qualify for an offer in compromise. The IRS will not accept an OIC unless the amount you offer to pay in lieu of your full tax obligation is equal to or greater than what the agency thinks it can reasonably collect from you.