Taxation & Estate Planning

3 Ways to Rid Yourself of IRS Debt and Its Accruing Interest and Penalties

By Darrin Mish

If you owe back taxes the IRS is constantly adding on interest and penalties to your balance. Your debt will grow about 2% per month in combined interest and penalties, adding nearly 24-25% to your balance every year. If you owe $10,000, after one year your debt grows to $12,400. Worsening your plight is that the IRS applies any payments or refunds to interest and penalties first, causing the "principle" of your tax debt to be reduced more slowly. This is one reason installment agreements are so expensive. Your payments are applied to principle and interest first, but the principle and interest continues to compound each month you are in the installment agreement. Consider these possible solutions:

First, a loan. If you're able to get a bank loan that can be a great help. Even with bad credit a bank's interest is lower, allowing you to chip away the principle more quickly. Try friends and family if you get no where with the bank. Paying the tax debt in full will allow you to keep your refunds each year, giving you additional funds to apply toward your principle. Second, if you can't get a loan hire a qualified professional to negotiate with the IRS on your behalf. Attorneys, CPAs and Enrolled Agents are admitted to represent taxpayers before the IRS. They can work to make sure your payments are applied to your tax debt, and limit the interest and penalties you end up paying. Lowering the principle will also lower the interest and penalties.

Third, if you have no other choice you can wait until your circumstances change. Worst case scenario is that you may have to wait for the Statute of Limitations to run out on your debt. The IRS has 10 years to collect tax from the date it is assessed. There are several things that can extend this collection period, educating yourself to avoid these actions will minimize any inadvertent extensions in the collection period. Of course this last option may not really be an option if you are faced with imminent collection activity like a tax lien, wage levy or property seizure. Truly your best option at preserving your rights and protecting your hard earned income is to hire a professional. If you're able to scrape up a few thousand dollars, hiring a professional is likely to yield better results than throwing that money at interest and penalties that accrue faster than your principle can be reduced.

Full post as published by IRS Problem Solver Blog on August 25, 2008 (boomark / email).