Tips to avoid tax troubles

Learn how to avoid heavy penalties and interest

Entrepreneurs who are behind with the IRS shouldn't be fooled by the agency's new taxpayer-friendly approach. Although legislative reforms were passed in 1998 to help protect taxpayers from overzealous collection agents, the IRS hasn't forgotten its job--to collect what it thinks taxpayers owe. Since interest and penalties on back taxes can run as high as 24% a year, it's a good idea to get caught up as soon as possible.

Typically, two types of businesses find themselves in tax trouble? The first type are independent contractors who get 1099s and don't make arrangements to pay in quarterly installments or set up a savings account to hold their taxes separate from their regular checking account. The second type are small to midsize companies that are growing quickly and suddenly find themselves strapped for cash. These businesses borrow from their employee withholding account with the expectation that they will be able to pay the money back in a few months. But when the time comes to pay that quarterly installment, they still don't have the cash.

If you find yourself in arrears with the IRS, follow these tips for turning things around:

* Work out the best deal up front. When extenuating circumstances such as job loss or illness contribute to tax delinquency, it's sometimes possible to get the penalties and interest associated with them removed. In order to arrange this type of settlement, you have to know the pertinent laws and regulations. But don't expect the government to point out the angles that work in your favor.

* Seek an effective remedy. The Offer in Compromise is a settlement program designed for the person who has amassed a large tax debt that they aren't realistically able to pay off. It is a formula-driven program that is based on a delinquent taxpayer's net worth and future income stream. The Offer in Compromise is for people who truly cannot pay their back taxes and wish to settle the matter. You should seek an Offer in Compromise when you are still in financial trouble.

A Penalty Abatement is a request by someone who has been paying his or her tax debt to have the penalty excused because of the special circumstances (death in the family, divorce, natural disaster, etc.) that prevented them from paying their taxes in the first place. Quite often, the amount excused equals the amount of the original tax debt.

Another program, tax resolution, helps you reduce the amount you owe. Often tax debt can be reduced to a payment of pennies on the dollar.

* Don't enter into long-term installment agreements. If you can't pay your tax bill, be careful about entering into installment deals that sound too easy. In some cases, IRS agents agree to let taxpayers make small monthly payments. But interest and penalties accrue rapidly, so the debt is chipped away very slowly. In the worst cases, the debt even increases over time. Some people eventually pay three or four times the original debt. Meanwhile, the IRS may file a tax lien against you that ruins your credit rating and makes it impossible to get a loan. This situation can stretch out indefinitely, because as part of the arrangement, the IRS often asks you to waive the statute of limitations.

* Get current and stay current. As part of the IRS's "Fresh Start" deal, you can negotiate tax relief, but this includes staying in compliance for five years. Compliance means that you must file your quarterly payroll taxes; you must file your taxes on April 15; you must file all estimated quarterly payments; and you must lower the number of exemptions you claim so that you don't owe taxes on April 15.

* Be proactive. The IRS looks more favorably on people who take responsibility for their tax troubles. If you have a tax problem, it won't go away by ignoring it. Deal with it as soon as possible. Increasing interest and penalties alone are good reasons for handling the problem immediately. Nothing impacts your credit record quite like a tax lien.

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