Woe to Those Who Owe, but Find a Way to Pay

By Nancy Trejos
Washington Post Staff Writer
Sunday, March 9, 2008

Lee Tanner's troubles with the Internal Revenue Service began with a common mistake. While working for a dot-com, he earned money from the sale of stock options in addition to his salary and didn't have the proper amount of taxes taken out.

"I didn't know any better to correct the problem," said Tanner, 40, who lives in Ashburn.

After three years of not paying enough in taxes, in June 2004 he received a bill from the IRS for $764,000, swollen by interest and penalties. He didn't have the money. His accountant urged him to fight the bill. He did for more than two years, during which the penalties and interest kept adding up. "I was just completely lost," he said.

Most Americans will receive tax refunds this year. But for those who get tax bills instead, figuring out how to deal with the IRS can be stressful and sometimes downright scary.

Local tax lawyers, accountants and financial planners said avoidance is a common reaction among people who owe the IRS and don't have the cash to pay.

"If you don't file, a number of things can happen, and all of them are bad, and often we see clients who don't file because they don't have the money to pay what they owe, " said Burton J. Haynes, a tax attorney in Burke.

For one thing, you incur penalties for not filing a return, anywhere from 5 percent per month of lateness to 25 percent of the amount due.

The IRS can also determine your tax liability on its own in what is called a "substitute for return." You certainly don't want that to happen, Haynes said, because "their estimates of what you owe are almost always way too high."

Even worse, you can actually be prosecuted for willful failure to file.

If you do file a return and have a tax liability, financial planners and other experts said you should do what you can to cobble together the money. Raid your bank accounts and sofa cushions. Cash in those IOUs. Beg relatives for loans.

"Clearly, you find a way to pay the IRS and to pay the state because they're not your favorite creditors," said Barbara Ames, a certified public accountant in Rockville. "Before you deal with the IRS or states, you get a third or second mortgage on your home or ask Mom and Dad for the money."

If you own a home, you can also try to get a home equity line of credit. Or you can apply for some other kind of consumer loan. But planners and tax attorneys said the credit crunch has made this a less viable option as banks tighten their lending standards.

Gerald W. Kelly, a tax attorney in Columbia, has two clients, a married Maryland couple in their 50s, who have been battling the IRS for 14 years. They originally owed less than $10,000 after the husband borrowed money from his 401(k) to pay for their son to attend a special-education school.

The couple's tax liability has ballooned to almost $40,000 with interest and penalties. They refinanced their house and gave the IRS a portion of what they owe. But the IRS wants more and asked them to take out a home equity line of credit. They applied but were rejected.

"We're not making enough money to pay for basic living expenses," said the wife, a health-care worker who spoke on condition of anonymity out of fear of damaging negotiations with the IRS. "Can it just be over?"

Many other taxpayers end up using their credit cards to pay their tax bills. The IRS will accept payments through third-party credit-card processors that it has designated, but that mode of payment typically comes with a 2.5 percent service fee.

Over the years, credit card companies have aggressively marketed this as an option, even pointing out that customers can get cash back if they use a card with a rewards program. But if you're not disciplined enough to pay off your balance each month, that tax bill could end up multiplying rapidly, as credit card interest rates can be higher than the IRS's penalties and rates.

"The company you're going to go through is going to bang you on that," said Arthur J. Williams, a certified public accountant in the District. "For someone who can't pay, you wind up getting banged left and right."

Ames said getting a cash advance from your credit card might be a better option than directly using the card to pay the IRS because you can typically get the money at a lower rate. When it comes down to it, Ames said, it is better to owe your credit card company than the IRS. "The IRS, they can come after you or come after your wages if you don't fulfill an agreement, versus dealing with Visa, where all you have to do is make a minimum payment."

You might also consider borrowing against your 401(k) retirement plan, but that too can come with tax liabilities and other fees. "I always kind of recommend that as one of those last resort items," said Dave Strege, a certified financial planner at Syverson Strege in Des Moines.

If none of these options works and you can't pay the full amount you owe the IRS, financial advisers and accountants said you should offer the IRS a portion of it. That would also save you in penalties and interest because those are based on your balance.

From there, you can try to work out an installment agreement.

"The next step is really on you as the taxpayer," said Mark Johannessen, a certified financial planner at Harris SBSB in McLean and president of the Financial Planning Association. "The burden is on you to be proactive and communicate with the IRS. Don't wait on them because they will find you."

If you owe less than $25,000 in taxes, penalties and interest, you can apply for an installment plan online. If you owe more than that, it can get more complicated, as the IRS will demand a lot of documentation to come up with your monthly payment. The agency will take into account your income, living expenses, transportation costs and other necessary monthly payments.

"They have their own standards in terms of what they allow for living expenses," Haynes said. "Unfortunately, their ideas of what it costs to live come straight out of Charles Dickens. It's a miserly existence."

Don't even think about paying off that credit card or any other financial obligation before taking care of the IRS. "They basically say they're more important than Visa, your child, school or other things," said Ames, the accountant in Rockville.

Even if you're making your monthly payments on time, the IRS can file a notice of tax lien, which could damage your credit and even affect your employment.

Sometimes, though, the IRS will determine that you simply cannot afford to pay the bill. Once the IRS declares a taxpayer "currently not collectible," all wage garnishments are suspended, but a reminder will be sent every year that the debt is still there. "It's a good place to be for a lot of taxpayers," said Kelly, the Columbia tax attorney.

The agency will periodically review your financial condition, and if your income increases or you come into money some other way, you could once again end up with a bill.

If the agency cannot collect on a bill within a 10-year statute of limitations, the debt will most likely expire, experts said. Often this happens simply because the IRS does not have the staff to continuously pursue a taxpayer, Kelly said.

Finally, you can try to get the IRS to accept what is known as an "offer in compromise," under which the agency agrees to take less that what it is owed. That can take a lot of time and effort, as the IRS will often reject your first offer and counter. Very few offers are accepted, Haynes and other attorneys and accountants said.

Tanner was one of the few whose offer was accepted.

In December 2005, he decided to seek help elsewhere after deciding his accountant was giving him bad advice. That's when he turned to Haynes.

Haynes drew up the offer in compromise, which they submitted in August 2006. The IRS rejected it twice but eventually agreed to take about 10 cents on the dollar last March. Haynes is still negotiating an agreement with the Virginia Department of Taxation, but as far as Tanner is concerned, the worst is over.

"I consider it a new lease on life," he said.

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