Every year many taxpayers (individuals and businesses) including contractors prepare for the tax season by having financial statements prepared and filing tax returns to comply with federal, state, and local tax laws. Of equal importance, a business must be prepared to pay any tax liabilities incurred as a result of their filing.
Perhaps ironically, a contractor who experiences a significant financial profit in a given year is likely to expect a tax liability. The ability to pay this tax liability can become a serious burden, especially if the profit has been used for operational purchases or has already been paid out to the owners.
There are several reasons why contractors might not regularly file tax returns. Sometimes it’s down to a lack of knowledge or simply misunderstanding their tax compliance obligations, and/or not having their financial statements in order, but in our experience we’ve met many contractors who say it’s a simple fear of how much tax they might owe. That is, in fact, the biggest reason that contractors often do not file their tax returns on time. We have even dealt with cases in which contractors have not filed taxes for more than five years!
This decision not to file taxes puts contractors in a situation that causes them to incur additional expenses related to taxes, specifically with penalties and fines, such as a Failure to File (FTF) penalty, in addition to a Failure to Pay (FTP) penalty, including interest on the outstanding tax liabilities.
If this sounds familiar, don’t be alarmed. There are several viable options available to help you address your outstanding tax obligations. If you’ve received a “Notice of Tax Due and Demand for Payment”, it is imperative to move quickly to avoid any additional consequences, such as tax liens and levies.
There are several ways to address outstanding tax obligations. Here are the four most common.
Paying Off the Entire Debt
This is obviously the best solution, provided that your business can afford to pay off the debt without stifling cash flow. Not paying the tax debt in its entirety results in much greater costs, including the Failure to Pay penalty plus interest on the outstanding tax liability. The Failure to Pay penalty is 0.5% per month, up to 25% of the outstanding tax liability. In addition, interest is charged on the unpaid tax balance. The interest rate is determined quarterly and compounded daily.
Installment Agreement
If paying off the debt in its entirety in not possible, then an installment agreement may be your best option. Once the tax liability has been assessed the IRS has 10 years to collect the outstanding debt. Because of this collection statute the IRS will most likely accept installment agreements that pay off the debt within the decade. Of course there are instances when it is not possible to pay off the outstanding tax debt within the 10-year period. In such cases, the IRS will accept a Partial Pay Installment Agreement (PPIA). When applying for a PPIA, comprehensive financials are required. The installment agreement is reviewed every two years, at which time updated financial documents will need to be submitted.
Currently Non-Collectible (CNC)
In other circumstances, the taxpayer cannot afford to make any payments. In these conditions, the taxpayer can apply to be put into Currently Non-Collectible (CNC). Taxpayers must provide financial statements and supporting documentation to support their claim of not being able to afford any payments towards their tax liability or demonstrate that making a payment will cause undue hardship. The IRS reviews CNC cases every two years, and will require updated financials at that time. In order to be ready for these bi-annual reviews, it’s a smart practice to consult a professional who can properly prepare the financial statements for submission to the IRS.
Offer in Compromise (OIC)
Perhaps the most popular (and most appealing) option for resolution is the widely-advertised OIC (Offer in Compromise). With this option, the IRS accepts less than the outstanding amount owed as full payment. However, individuals or businesses seeking an OIC must be aware that this potential solution presents the greatest challenges when attempting to get the IRS to accept the terms of the resolution. Once the agreement is made, there is a compliance period implemented and if a violation occurs within that time frame, the decision can be reversed. All that said, once an OIC is accepted it can result in a substantially-reduced tax payment.
Trust the Experts
Whatever route you choose, resolving your tax liabilities reduces stress and provides peace of mind, ensuring that you can concentrate on running your business efficiently without worrying what payments and penalties may be lurking around every corner.
Just as you are an expert in your field, trust the expertise of a financial professional when it comes to tax resolution. An enrolled agent is authorized by the IRS to negotiate on your behalf for an Offer in Compromise or another solution appropriate for your situation. Remember, you don’t have to go it alone.
Founder and CEO of LEK Management Inc., Lynn Karam has two decades of experience in finance, operations, and strategic planning. Karam is an Enrolled Agent authorized by the United States Department of the Treasury to represent clients who are undergoing an audit and to negotiate with the IRS on her clients’ behalf.
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Nancie Michaud