Johnnie owned a convenience store. As a cash and carry business and due to his laxadasical bookkeeping and long hours running the store Johnnie was unable to get his taxes done for 2007. Inertia set in and he didn’t get them done for 2008. In early 2009, he got a letter from the IRS asking for his tax return as did his wife Barbara. In order to fund the business, she closed down her 401(k) plan and took out $100,000 from which $20,000 was withheld. She is 35 years old. She also had income from her employer of $100,000 for which she had federal withholdings of $13,000. She and Johnnie had a mortgage on the house for which they paid $15,000 in interest in 2007 and real estate taxes of $3,000. They have a child together, Rhonda, age 10 who lives with them in their home. Johnnie sees the letters from IRS and takes them to his store, not wanting to disturb Barbara. A few months go by and a certified mail notice comes to the house from the IRS. They have computed he amount due from Barbara to be $50,000 and sent her a bill for $17,000 plus interest and non-filing penalties of another $12,000. They computed no tax for Johnnie since he had no income on the books. Barbara was livid. She and Johnnie went to an accountant and the accountant laid out what he needed from Johnnie and Barbara to prepare a return for 2007, knowing that 2008 still needed to be prepared as well. Johnnie pulled all the cash register receipts and pay stubs (luckily he had been paying the payroll and sales taxes) so he had those records to work from. After a couple of weeks a return was prepared. It showed that instead of owing $17,000 that they only owed $15,000, but with penalties and interest it would be another $11,000 or so. Of course they didn’t have the money. A joint amended return was filed for 2007. After a few months a bill was generated by the IRS showing the amount due to be $24,000. Their accountant had at that point prepared a joint 2008 return showing income tax due for them of $12,000 plus interest and late filing penalties of $6,000. So, they owed $42,000 total to IRS. Their house was under water. The got that bill and called IRS to see what they could do.

In a struggling economy it is not surprising that taxpayers get caught short sometimes regarding their taxes. We have already dealt at length in the past with “trust fund” penalties and the problems with those. We are now going to discuss the average taxpayer who finds himself or herself on the short end of straw in collections. The first step should always be to file all returns that are due regardless of whether you can pay. The IRS cannot entertain any collection alternatives until you are compliant. Further, if this gets to bankruptcy, dischargeability may focus on whether a return was filed or not. So, always file the return and then figure out how to pay. This reduces penalties assessed and allows for a meaningful discussion early on. The same goes for state income taxes. Further it is a crime to not file tax returns. If the IRS prepared a return for you (called a substitute for return), you’ll have to file an amended return (Form 1040X). What do you do next? Stay tuned.