Many taxpayers conclude that if they are going to owe money to the IRS and cannot pay, they are better off just not filing. This is 100% the wrong thought process.
There are a few different reasons why it is very important that a person files each year by the due date regardless of their ability to pay the tax debt. The first major reason it is important to always file is that there is a non-filing penalty. The failure to file penalty is usually five percent of the tax owed for each month or part of the month that your return is late, up to a maximum of 25%. If your return is over 60 days late the minimum failure to file penalty is $425 or 100% of the tax required to be shown on the return, whichever is less.
Another major reason for a taxpayer to make sure that they file every year is because in most cases the IRS will catch up with it and file the taxes on behalf of the taxpayer. When a taxpayer receives their income forms from employers and financial institutions every year, they are also sent to the IRS. If this income has been reported to the IRS and a taxpayer has filing requirements and fails to file, the IRS will do what they call a “Substitute for Return”.
Typically, a Substitute for Return is completed three years after the return was due. The IRS will then send a letter to the taxpayer with a proposed tax debt plus penalties, fees, and interest all accrued since the original filing due date.
Now some may reason, “Why file if the IRS just comes in and does it for you?”. Again, this is a bad way to think. If the IRS files the taxes on behalf of the taxpayer, they will prepare the returns based on only the information that was provided to them from your employer’s banks and other payers. And SFR has a filing status of single or married filing separately. This means you would miss out on any possible deductions, exclusions, or credits that you may have had rights to.
In my time in this industry, I have seen many cases where people come to us with huge tax bills because the IRS has filed unfiled yeas and the taxpayer is in absolute panic mode. This year we have heard this a lot more than other years. A lot of people who had not filed in a long time either did the non-filer tab that was put on the IRS website or filed 2019 or 2020 so they could receive the stimulus checks that were being distributed. When this was done, it also updated their address with the IRS. A lot of people who had thought they were flying under the radar with the IRS or getting away with not filing their taxes were shocked when they received a large tax bill.
It does still happen where somebody can fly under the IRS’ radar but it is very rare. And when the IRS does not update addresses, many people who do not file are left in the dark of what the IRS has been doing since they are unable to receive the IRS letters that have been mailed to an old address.
This past year we took on a client that this happened to. We will call her Mrs. O to respect her privacy.
Mrs. O Gets a $160,000 Tax Bill
Mrs. O is a realtor that had not filed her taxes in almost 8 years. During the beginning of the coronavirus pandemic, her work came to a screeching halt. She was fortunate that the government had made unemployment available to self-employed individuals but with a daughter to support, she needed more income. She admitted that when the government set up the non-filers tab on the IRS website, she submitted as a person not required to file so she could get the benefits of the stimulus checks that were being sent out. In doing so, she also updated her address with the IRS since she had moved a few times over the past 8 years.
The good thing was that she received her stimulus checks and they really helped her and her daughter gets through the tough times. Then earlier this year when the IRS resumed sending notifications and collecting on the debt, she received a bill from the IRS for over $160,000. All this time she had been thinking she was getting away with not filing.
What The Tax Investigation Revealed
We started her case as we do for everybody with a full-on Tax Investigation directly with the IRS. Within 10 days of her signing representation documents, we were able to retrieve all of her records directly from the IRS and show her exactly what had happened.
In the real estate industry, the majority of taxpayers are considered self-employed. Her employers had been providing her and the IRS with 1099’s for all of the 8 years. Her records showed that she hadn’t filed in 8 years as she had informed us and that the IRS had done Substitute for Returns for 4 of these years where she had substantial income reported. She also still had 4 years that were left unfiled that had filing requirements.
Now in cases like this, there are different approaches that can be taken. These different options are really going to be based on her financial situation. At this time in her career, things had started to pick back up again but she was making nowhere close to the money that she made in the past. She also had depleted almost all of her savings during the time she was not working.
Doing a review of her income vs. her expenses we found that she would definitely qualify for some sort of hardship program. Since we would be able to utilize the hardship programs, it would not make sense to go back and redo the tax returns that the IRS had already done. Since there is a ten-year statute of limitations on tax debt in cases of hardship, it does not always make sense to redo the tax returns because there would be more savings by keeping the existing assessment dates then adding expenses to reduce the tax debt. If somebody has a good income and shows the ability to pay the debt back, then you would definitely want to redo the Substitute for Returns with the proper deductions, exclusions, and credits to reduce the tax debt.
The first thing that had to be done to get her into one of these programs was to file all of the unfiled years. Being filed up to date is a requirement for all of the different programs the IRS offers. These years were filed correctly using all of her expenses for those years, keeping the additional debts down as low as possible.
The IRS took a few months to assess the filings. During this time, we monitored collections to make sure that the IRS did not initiate any involuntary collections on the existing tax debt. These four years added an additional $30,000 to her tax debt.
The next step would be to present her financial situation to the IRS. In her case, this was the ideal time to do this because she was definitely living paycheck to paycheck. After a long back and forth with the IRS, approximately 6 months of proving and reproving her financial situation, it was agreed upon that she would only be expected to make a small payment of $100 a month. As long as she did this and did everything right moving forward, she would only end up paying $12,000 on a $190,000 tax debt.
Our job was not done yet. We had to set her up for success with some future tax planning. She had to make sure moving forward that she filed on time every year and she must pay any new taxes on time.
When being paid as a 1099 employee, you are essentially running your own business, so it only makes sense to operate as a true business and get the benefits of operating as a business entity. By setting her up as an S-corporation, we could limit her exposure to self-employment taxes. Operating in this fashion will save her thousands moving forward especially if she starts making a lot of money again.
So, in this case, we not only saved her almost $180,000 on her older tax debt but we also set her up to save thousands moving forward by running her business more effectively. Also, to make sure that she no longer owed the IRS, it was important that estimated tax payments were made quarterly throughout the year so that at the end of the year she didn’t have to worry about any sort of tax debt. As long as she followed through with the established plans, within 10 years she would never owe the IRS again.
If you have not filed taxes out of fear that you will owe the IRS money that you don’t have, contact us for a free tax consultation. Let’s see how we can help you resolve your situation so you can stop worrying about the IRS.