WHEN THE IRS says you owe money, don't panic. Take one step at a time. Remember, you have rights.
First, review the interest charge: It is estimated the IRS miscalculates interest charges 25 percent of the time. Determine whether interest is based on the correct year; then, check the amount. Calculate a rough estimate of interest at 1 percent per month. If you owe interest on $1,000 for two years, the notice should say you owe about $240 in interest.
Then check the penalties: An IRS computer often generates penalties that can be fully abated. A negligence penalty, for instance, does not automatically apply if the taxpayer is wrong - the taxpayer must be negligent. Penalties are negotiable, so always try to get penalty charges excused. You may now abate interest when IRS, through ministerial or managerial acts (loss of records, agent training or personnel transfers), causes unreasonable errors or delays.
Don't pay until you are certain the IRS is correct. Once you pay an erroneous amount, it is difficult to get a refund. As long as the IRS expects money from you, your bargaining position is stronger.
However, once you concede taxes are owed and that the interest is calculated correctly - and you cannot reduce or eliminate the penalties - send the IRS a check (marked with the tax year and your Social Security number). Keep copies.
If you owe the IRS but cannot pay, generally there are three alternatives:
One is to enter into an installment arrangement to pay the IRS the full taxes owed, plus interest, usually in equal monthly installments. The IRS will not take collection action while the agreement is in force. You must provide financial information so that the IRS can determine if you can afford to pay the tax immediately.
Installment arrangements work best when the taxpayer has a steady income. People on commissions or working for themselves often have difficulty maintaining monthly payments.
Unfortunately, the IRS is notorious for canceling installment arrangements without warning and then levying bank accounts or paychecks. In response, Congress enacted new rules to make the IRS comply with installment arrangements once in effect.
Offer in compromise<
The second alternative is an offer in compromise, an agreement to pay less than the taxes owed. The IRS will compromise taxes based on its doubt about liability (you might not owe the tax; no financials are necessary) or collectibility (if the IRS cannot collect in full from you).
If your offer is based on doubt about collectibility, you submit financial statements showing your assets and monthly income. Your offer must exceed the larger of either the quick sale value of your assets (generally 80 percent of fair market value) or 60 months' worth of your so-called "excess income" (income that exceeds your necessary living expenses). You submit your offer on Form 656, but read the fine print on the back.
For example: If you owe $100,000 in taxes, have $10,000 in assets and have $100 a
month in excess income, your offer must exceed $10,000 (your assets are worth more than your income stream). If you have $5,000 in assets, your offer must exceed $6,000 ($100 a month times 60 months) since your income stream is higher than your assets.
Note: Your offer is based on the IRS's ability to collect, not on the amount of taxes you owe. Generally, you should offer at least $5,000, even when you have no excess monthly income. An unrealistically low offer is a waste of time.
There are two drawbacks to the offer process: First, you cannot offer the IRS assets already available for collection. For instance, if you have $10,000 in savings, you cannot offer the IRS that asset since it can take it anyway. You usually need a financial angel (someone to gift or lend you the money).
Second, you must file and pay all taxes owing for the next five years in a timely matter. Watch out: the IRS erroneously believes that using extensions to file causes those returns to become untimely and could void your offer.
In addition, the IRS will keep your tax refund in the year the offer was accepted - a nasty surprise. If your offer is accepted in 1997 and you file for a refund during 1998, for example, the IRS will keep that refund. Further, it will not be applied toward your offer balance. Plan ahead: Make sure your refund is as small as possible.
If all else fails, the third alternative is to consider filing bankruptcy on your income taxes. Bankruptcy can eliminate your liability for income taxes that are more than 3 years old, provided you have filed non-fraudulent tax returns (fraud is usually court-determined) at least two years before declaring bankruptcy. If the IRS has assessed you additional taxes, you must wait 240 days from the date of assessment before filing bankruptcy.
For example: If you incurred a $100,000 capital gain in 1996, the due date for that return was April 15, 1997. If you filed a non-fraudulent tax return by that due date, you must wait until April 16, 2000, to eliminate your tax liability in bankruptcy.
Trust fund taxes (i.e. payroll taxes or other payments held in trust for the government) are not dischargable in bankruptcy. Also, there is a trap lurking for taxpayers who sold a principal residence for a taxable gain but did not replace it within the two-year period under old Section 1034 (the principal residence rollover rules). The IRS has argued, and one court has agreed, that you cannot discharge these taxes in bankruptcy until three years after you file an amended tax return reporting the gain from the sale.
Tax attorney Robert L. Sommers is the Tax Prophet. Send questions to "Tax Prophet," c / o Business Editor, San Francisco Examiner, 110 Fifth St. San Francisco, CA 94103. Or send them by e-mail to firstname.lastname@example.org or by fax to (415) 957-9428. Sommers' award-winning Web page can be found at www.taxprophet.com .<