Question: My younger brother didn’t pay his federal income taxes last year because he says he doesn’t have the money. (Nevada doesn’t have state income taxes.) Instead, he paid off one of his high-interest credit cards, because he figures he’ll save more in interest than the IRS would charge in penalties – if the IRS even catches him.
Now he’s planning on doing the same thing this year: Skip his taxes and pay off the other high-interest credit card he has. Once he does that, he says he’ll have the money to pay his back taxes.
So my questions are: How can the IRS not know he hasn’t paid his taxes? How do you know what the penalty is for not paying taxes? (I’m pretty sure my brother hasn’t done the math to figure out if he’s really saving money.) And finally, how much trouble can he be in with the IRS?
– Beth in Las Vegas
Jacob Dayan answers…
First, let’s get this out of the way: Tax debt and credit card debt aren’t the same, so do not treat them as such. Here’s why…
Can I settle my tax debt as easy as I settled my credit card debt? And this is taxing questions. Hi, I am Jacob Dayan, CEO and co-founder of Community Tax.
Sadly, no. Settling tax debt is very different from settling consumer debt like credit cards. If you miss a credit card payment, you get a firm but polite reminder and a late fee. The IRS isn’t so forgiving. The agency will consider a settlement program called an Offer in Compromise if you don’t have enough money to make installment payments or if you don’t have any substantial assets, like equity in a home. Offers in compromise allow you to pay less than you owe to the IRS. But there are steep requirements.
The paperwork is tremendous, and it can take up to a year for the IRS to approve an offer in compromise request. The IRS rejects a majority of the requests. During this waiting period, the IRS will not levy your bank accounts or paycheck, but they could still file a lien. If you think you may qualify for an offer in compromise, I strongly advise you to consult a tax expert. You can call Debt.com to speak with myself or a member of my team.
Now let’s get into the IRS part of the question.
No one really knows the formula for determining when the IRS will enforce collection actions. In general, certain situations are more likely to lead to quicker enforcement. For example, cheating on taxes, higher debt amounts or failure to pay payroll tax — but the reality is that they can only enforce to the extent they have the manpower to do so.
In my experience, I’ve seen clients who were able to get away with cheating on taxes and fly under the radar while others were not so fortunate. I know that isn’t the clearest answer, but there’s no perfect answer to that question.
With respect to penalties, the answer is more clear. The IRS actually published its stance. You can find that information in this report. In short, the IRS charges a number of different penalties. The most significant of them is “failure to file.” If your brother never files a tax return, he will be taxed a 5-percent penalty for each un-filed month, up to a total of five months or 25 percent of the balance.
A failure to pay a penalty of .5 percent will also be payable up to a maximum of 25 percent, as well as interest on the outstanding debt. While in some cases your brother is correct that the penalties and interest owed to the IRS can amount to less than an interest rate on a high-interest credit card, the IRS will always take priority when collecting over other creditors.
Ultimately, there are always some cases where individuals can’t afford to pay the IRS, and that’s why the IRS offers resolution programs, and companies like mine exist. However, if you are in a position to pay the IRS back, I would never advise someone not to do so.
I hope this helps give you a little bit better understanding of your brother’s situation.
Jacob Dayan is co-founder of Community Tax LLC, a full-service tax company helping customers nationwide with tax resolution, tax preparation, bookkeeping, and accounting.