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With the end of tax season fast approaching, millions of taxpayers are scurrying to finish their 2012 tax returns. But if you haven't filed taxes for past years, you may well be completely clueless about how to get caught up. Fortunately, to give you some help with back taxes, we've put together a quick primer on what you need to know about late returns and the potential problems they can cause.
What back taxes can cost you
The most important thing to understand about owing back taxes is that it almost always makes sense to get the issue out into the open as quickly as possible. Many taxpayers mistakenly believe that if they haven't heard from the IRS about their back taxes, then letting sleeping dogs lie by doing nothing is the wisest course.
But the reason doing nothing doesn't work is that in the vast majority of situations, the IRS already knows about your back-tax problem. If you had a job in a given year, then your employer sent a copy of the W-2 reflecting your wages to the IRS. Similarly, if you have any other type of reportable income, such as business or investment income that gets reported on a 1099, then again, IRS computers have a record that will trigger alarm bells if you go too long without filing.
Moreover, the longer you go without getting help with back taxes, the worse the consequences can be. If you don't file your return, then the penalties amount to 5% of the tax you owe for every month that you're late, up to a maximum of 25%. Beyond that, though, if you still have unpaid taxes, then the IRS gets to add another 0.5% penalty per month for as long as four years after your original return was due.
On the other hand, many people who don't file back-tax returns miss out on lucrative refunds. You only have three years beyond the original due date to file a return and receive a refund back; after that, the refund is lost forever. The IRS recently estimated that taxpayers are set to forfeit nearly $1 billion in refunds for the 2009 tax year if they don't file to receive a refund by April 15.
The right help and the wrong
Unfortunately, many companies prey on those who need help with back taxes, promising to resolve disputes with the IRS for pennies on the dollar. In reality, many people have reported horror stories about companies collecting up-front fees and then never doing anything to relieve their clients' tax burdens.
Instead of hiring a professional, going directly to the IRS can be your best move. On its website, the IRS gives details about its Fresh Start initiative. which changes the way the IRS has handled back taxes in the past and provides some useful guidelines for how to deal with back-tax issues.
For instance, you may be eligible to set up a payment plan or installment agreement with the IRS. To do so, visit this page on the IRS website to find out which form you need to file and what the fees will be. Doing so won't necessarily reduce your interest and penalties, but you will be able to avoid more severe collection activity such as tax liens or garnishment of your wages.
For more serious tax problems, the IRS Offer in Compromise program can actually reduce your outstanding tax debt. By looking at your financial resources and income, as well as your living expenses, the IRS establishes what you can afford to pay, and can then evaluate the offer you make to settle your outstanding tax debt. In some cases, a discounted up-front cash lump-sum payment will settle your tax bill, while under other circumstances, the IRS will accept monthly payments.
The key to getting help with back taxes is not procrastinating. The sooner you get the help you need, the sooner you'll be on the road to resolving your back-tax problems once and for all.
Meanwhile, once you have your back-tax situation resolved, take a step toward getting your investments in order. To learn more about a few ETFs that have great promise for delivering profits to shareholders in a recovering global economy, check out The Motley Fool's special free report " 3 ETFs Set to Soar During the Recovery ." Just click here to access it now.
Fool contributor Dan Caplinger appreciates your comments. You can follow him on Twitter @DanCaplinger. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .