So another tax deadline has come and gone, and you still haven’t come clean about that little “problem” you had a few years ago.
Maybe you were short on cash at the time, or going through a divorce or just couldn’t face the paperwork. So you fudged a couple of numbers, or decided not to report some income or just didn’t file. Or maybe the problem isn’t yours but an aging parent’s–something that slipped Mom’s mind that you have discovered while helping sort out years of neglected paperwork.
“It happens in the best families,” says Terrence G. Perris, a Cleveland tax attorney. “I’ve seen it with doctors, lawyers and even accountants.”
No matter what the reason, people who haven’t told the Internal Revenue Service the whole story can find that the problem quickly compounds. Those who don’t file soon, for example, find they can’t file for fear of getting caught.
“The longer you keep it going, the worse it gets,” Perris says. “You might as well face the music.”
There is good reason not to dawdle. Under the IRS’ voluntary disclosure policy, people who turn themselves in before discovery generally won’t be prosecuted. If the IRS uncovers the problem, you lose that protection and can face jail time if convicted.
“Our goal is to get non-filers back in the system,” says IRS spokesman Steven J. Pyrek. The IRS tends to view most non-filers as procrastinators rather than criminals, he says. “But once we discover a non-filer, the non-filer protections may not apply.” The same rules generally apply for those who need to amend a return, he says.
The threat of penalties–which can total 47.5 percent of back taxes or more if fraud is a factor–is another incentive to fess up. “If they call you first, they are almost certain to assess penalties,” says Thomas Ochsenschlager, a partner in the accounting firm Grant Thornton in Washington.
But that doesn’t mean tax sinners should simply throw themselves on Uncle Sam’s mercy. You need to pull together your paperwork, prepare your returns and figure out the bottom line. That job will be much easier with help from a knowledgeable accountant or tax attorney.
If what you did–or didn’t do–might be seen as fraud, you probably want to start with a lawyer, who in turn will hire an accountant. That’s because lawyers, unlike accountants, can claim client privilege if asked to testify.
People should be realistic, though. Just hiring a skilled lawyer or accountant won’t erase a tax debt. Nor will the IRS waive interest, currently set at 9 percent and compounded daily.
“The interest alone can be enormous,” says Stuart Kessler, senior partner with Goldstein Golub Kessler & Co. in New York. Ten years of non-payment, he says, could result in interest equaling 100 percent of the original tax liability–“and that is not deductible.”
Then there are penalties and interest on penalties. Once you are done with the feds, you also need to calculate state back taxes, penalties and interest, since Uncle Sam shares tax information with the states.
When everything is added up, the bottom line can be several times the actual tax liability. Back taxes of $15,000, for example, could easily end up costing someone $50,000 by the time all of the penalties and interest are added in, Kessler says.
The outcome of negotiations with the IRS hinges on a variety of factors. “It will depend on how big the number is and how good the reason is,” says Don Alexander, former IRS commissioner and now a Washington tax attorney.
It also will depend on who you are. Tax experts say the IRS not only likes to make examples of prominent citizens but also takes a tough stance with lawyers and accountants, believing they should know better.
Still, some tax slackers may be pleasantly surprised, even in cases in which the tax omission has stretched for years. They may find, for example, that the three-year civil statute of limitations–six years in cases in which gross income is misstated by 25 percent or more–has already run, making any payments moot. But the clock never starts to run on some civil charges. On the criminal front, there is a six-year statute of limitations.
Others may find that they actually owe less than anticipated. Ochsenschlager points to the case of a man who failed to file tax returns for 10 years while he was overseas working on major construction projects. When he finally did file, Ochsenschlager says, it turned out that there had been virtually no tax liability because the client had been overwithheld for most of those years.
Did he get any of that money back? Not a chance. That’s because statutes of limitations cut both ways, and often favor Uncle Sam. By not filing a return within two years–the time limit for someone who fails to file but wants money back from the IRS–the client had waived his right to any money.
For many, however, coming up with the cash to pay those IRS settlements is a real problem. “Most people end up not being able to pay,” says New York tax attorney Robert S. Fink. “That’s the reason they got into the problem in the first place.”
These folks can request an installment plan, paying Uncle Sam off over time at the cost of additional interest. Or if the bill is so big that there’s no chance they will ever be able to pay, the IRS may agree to something called an “offer in compromise.” That’s an arrangement in which the government agrees to take less than the full amount owed in order to get something.
To get an offer in compromise, the taxpayer must prove his inability to pay with detailed net-worth statements and other documentation. And the IRS is far more likely to agree to such an arrangement with a retired person on a fixed income than with a 35-year-old stockbroker whose annual earnings are continuing to grow, says Fink.
Whether or not you can pay the full amount, it makes sense to file a return, says Linda R. Martin, senior manager at Deloitte & Touche in Washington and former national director of the IRS’ problem-resolution program.
“Pay whatever you can, and indicate that you want to work out an agreement,” she says. “That fixes the filing, the date upon which certain penalties run.”
And that, in the long run, she says, may end up saving you money.
