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What Happens If You Owe the IRS?

written by: Dave Guilford•edited by: Donna Cosmato•updated: 6/28/2010

So you owe the IRS. Join the club. Here is what happens and what you can do about it.

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    As sure as death and taxes...

    Once an American takes that first job flipping burgers as a teenager, he begins a perpetual cycle of owing money to the IRS that continues until the day he dies, and sometimes beyond. Ask the average American adult what his single largest expense in life is, and he'll probably tell you it is either his home or his children's college tuition. He's dead wrong. Taxation is the single largest expense the average American will pay in his life.

    Every April 15th, or quarterly in the case of businesses and individuals the IRS considers wealthy, Americans tally what they owe to the IRS. Most people have taxes automatically deducted from their paychecks so, depending upon the number of deductions they claim, the annual tax bill may not amount to much. They may have even overpaid during the year, in which case they'll receive a refund.

    For those unfortunate souls who didn't have enough taken out over the course of the year, or who had significant outside income or capital gains, a very large amount may be due to the IRS. This is not a favorable situation, for the taxpayer or the IRS.

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    The taxman cometh...

    It is a little known fact that the IRS would much rather send every taxpayer a refund check than to collect taxes from them. That is because, in order to be due a refund, the IRS must have overcharged the taxpayer during the year and got to use that money interest-free. It also eliminates the sometimes difficult task of collecting those taxes.

    This is why, if a taxpayer has significant outside income and owes a large amount of taxes, the IRS will insist the taxpayer begin paying his taxes quarterly. The thinking is that a smaller amount due will accumulate over the course of three months than it would over a year, thus reducing the chance that the taxpayer will refuse to pay. If a taxpayer has been ordered to file quarterly and refuses, he will be charged a penalty when he files on April 15th.

    Taxpayers that do not file and pay the amount they owe on or before April 15th are penalized, and the amount due begins to increase with interest. While the IRS pays no interest on the overpaid funds they've held all year when they issue a refund check, they expect to be paid interest on the money taxpayers owe beginning at 12:01 on April 16th. Taxpayers who file by April 15th, but do not pay what they owe, avoid the penalty but not the interest.

    Once a tax debt has become seriously past due, the taxpayer will be contacted directly by the IRS. The first contact will most likely be by mail, and the letter will outline what total amount is due, inclusive of penalties and interest to that point. It will also include remittance instructions and threats of further action if the warning letter is ignored. Finally, it will include contact info for the collection agent assigned to the account.

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    Taxpayer Options

    At this point, the taxpayer has three options: contact the IRS and arrange to make payment, contact a tax attorney and prepare to fight the IRS, or ignore the payment demand. The first option is probably the easiest long term, but not necessarily the most advantageous.

    When a taxpayer contacts the IRS to make payment on a tax debt, he may find that they are quite helpful and willing to make many different payment arrangements to accommodate his budget and present circumstances. They will not, as a rule, reduce the amount owed or the interest or penalties, however. For that kind of consideration, a tax lawyer must get involved.

    Hiring a tax attorney is expensive but, in the long run, may be worth it. Many tax attorneys are former IRS agents and know the internal workings of the IRS. They are adept at negotiating settlements for a fraction of the amount owed, and they can have penalties and interest waived altogether in some circumstances. If a taxpayer owes any amount over $15,000, he should consider hiring a tax attorney.

    Ignoring the collection letter is generally a bad idea, unless the taxpayer in question likes moving frequently and changing employers even more frequently. Once the IRS has determined that a taxpayer will not pay his debt willingly, they will obtain a judgment against the taxpayer and take the money. They do this by freezing bank accounts, garnishing wages, and seizing assets. Employers are required by law to comply with a garnishment order, so once the IRS finds out where an errant taxpayer works, he must find a new employer. With the new databases that are in place, it is reasonable to expect that the IRS will find the taxpayer's new employer within two or three pay periods.