Where do IRS nightmares come from?

If TV commercials here in the US have taught me anything, it’s that there are lots of people out there in TV land that are destitute but owe big bucks to the Internal Revenue Service (Federal tax agency), ripe pickings for tax settlement companies that are more than willing to step in and help you negotiate your back taxes for pennies on the dollar. Where do these nightmares generally come from?

Considering my personal experiences, it seems difficult to understand how Joe Timeclock, subject as he is to mandatory withholding of a major portion of his paycheck before he even gets his hands on it, is going to be able to reasonably get himself that much in the hole such that by filing time, his tax owed is greatly above the amount that was withheld.

Where do these nightmares come from? Are these from 80 year olds who sell their house of 50 years (capital gains $$$$$) and then blow all the money in Vegas only to realize in horror that they can’t deduct all their gambling losses and they accidentally spent the money they needed to pay tax?

I believe independent contractors are a pretty common IRS target - since they’re often paid on a pre-tax basis and the onus is on them to report everything to the IRS.

I suspect there’s also a good deal of small-business owners who run into similar issues.

Business owners and independent contractors are MUCH more likely to be the ones with problems. If you take a person making $30,000 salary, it’s likely that $10,000 was withheld for income and payroll taxes. A self-employed person who makes $30,000 net income has to pay that $10,000 himself - and most don’t.

Then you have the problem that they can (and do) put off filing for years. So take that 10,000. Add 25% (late filing penalties). Add 12% (estimated interest and late paying penalties). Multiply by 3 years of doing this. Now this schmuck owes $40,000.

Of course, it isn’t just the self-employed. Let’s say you take $100,000 out of your 401k and have NO taxes withheld. 10% penalty. 25% income tax. You owe $35,000 more in taxes than you’re used to. And when you figure that out, you freak out and decide to bury your head in the sand. Fine with the IRS - they have 3 years to audit you, and they’ll wait 2.5 years before sending a letter asking you why you never filed. So 25% penalties. 12% interest. Now you owe $48,000 in back taxes.

These are the two most common scenarios in my practice.

By the way, those commercials are highly misleading. Some of the “pennies-on-the-dollar” settlements simply result from correctly filing a return that the taxpayer hasn’t ever filed (and therefore, finally claiming expenses and deductions that the IRS didn’t know about until the filing happened).

I realize that was meant to be a rounded estimate and is sort of inconsequential, but your figures are way, way off. Assuming most basic possible case (person is single, no kids, and taking the standard deduction + personal exemption) a salary of $30k (regular worker, not IC) would equate to a federal income tax burden of $2,661. Their employer will withhold a little more, so maybe $3k or so.

My business grossed around $120K last year. Problem is, the vast majority of that did not go into my pocket, (more like $20K) but if I fail to file for some reason or screw it up royally, there could easily be $20K-$30K in taxes due between state and federal + penalties + interest.

But when you do assume an IC, they have to withhold even more for the employer portion of the payroll tax, so it would be around $5K, which granted is still not very close to $10K.

The W-4 form that an employee fills out to determine how much tax should be withheld from Joe’s paycheck is not sent to the IRS, and even the employer does not control what the employee enters for deductions. This is just a tool to help the worker determine if enough tax is being withheld to cover the end of year tax filing.

An unmarried person who has no other deductions should claim one dependant on his W-4. He can claim zero deductions and have tax over-withheld, he can claim nine deductions (I think that is the max) and have no taxes withheld.

Some employers make it very easy to change your W-4. Many of the Joe Timeclocks at my wife’s job routinely change to 9 deductions for pay periods where they have worked a lot of overtime to keep from losing a big chunk in taxes, then they change back to their regular deductions.

This is foolish, but is often done. In spite of the statement in the OP, there really isn’t any mandatory withholding of a major part of the pacheck.

http://en.wikipedia.org/wiki/Tax_forms_in_the_United_States#W-4

Yeah, it was meant to be rounded. But you are missing the FICA tax component.

In the employee scenario, 7.65% would be withheld from pay, and 7.65% would be paid by the employer, for $4590 in additional taxes. In the independent contractor scenario, they pay both amounts.

So total tax due on the 1040 is more like $7,200 for this independent contractor, which is certainly closer to the $10,000.

I don’t want to recount my own IRS disaster story right now, but sometimes IRS employees steal tax money paid, and many other IRS employees will cooperate in a cover-up of the theft. I came out of it OK, losing only $10,000, which seemed to be the minimum cost of engaging a tax lawyer to fight it. Only after paying them off was I able to find out the circumstances in which the money was stolen, and to my knowledge there have never been any prosecutions.

Did you pay your taxes with cash? Otherwise I’d think you had a canceled check or credit card proof you paid.

I was trying to “beat the system” cut back on my witholding, sock it into savings and pay the taxes from the savings accounts. It takes discipline I didnt have at the time.

I had checks, and letters from the IRS saying I had paid. But the funds were stolen and never recorded on the tax rolls. These were FICA taxes from a business I owned, and those can’t be discharged by the IRS. They had to make up the money somehow, and I was a vulnerable target. I’m sure many others were ripped off as well. As I said, there was a major coverup of the illegal activity, and it was not an isolated case.

This is a good example for the OP.
A real world example is the bone headed mistake I made this year. I’m not claiming my daughter and forgot to change my deductions from 2 to 1 (or whatever I had it set to to whatever I had it set to minus 1). Luckily it’s not a big deal since I A)socked away a ton of money into savings and B)have a mortgage so all the deductible interest keeps my refund pretty high in spite of what I might owe the government (IOW, I always get a refund). Either way, I was pretty surprised to see that I owed (for the first time ever) this year until I put my 1098 from my mortgage in. It took me a while of starting at my tax forms to realize that I never changed my deductions.

Also, not that it matters, but I’m one of those employers that make it easy to change your deductions. You can change it 30 times a year if you want to, all I have to do is go into QuickBooks and change one number. I usually ask you to fill out and sign a new Form W-4 and WT-4 (Wisconsin’s version of the W-4). But only because I’ve had people (or rather, people’s accountants) call me up and ask why I changed their deduction or put in odd numbers. It’s nice to be able to pull out that form and ‘remind’ them that I didn’t randomly change it, I did it at their request…the fallout from that is their problem, not mine.

Also, to get back to the OP, another way you can find yourself in the hole is doing 1099 work. Especially if you don’t realize you’re doing it. That can happen in a few ways…
A)You did a few odd jobs for a business owner for what you thought was cash under the table then at the end of the year he sends you a 1099.
B)You did a few odd jobs for a business owner, got paid by check and just assumed he was paying you like a regular employee and was taking taxes out…but he wasn’t (which can sometimes just be a miscommunication, but that’s not the point)

Also, sometimes it’s just plain irresponsibility. You’re really bad with money, you take a 2nd or 3rd job and because you need the money so bad you ask if you can be a 1099er…the employer decided to do it (right or wrong, not the point). Since you need the money, you spend it all right away and at the end of the year, of the 10K you made, you suddenly have to cough up 3K which you don’t have. What you should have done was put 30% of each check away, but if you could have done that, you might as well have just been a regular employee.

To be honest, i have a lot of trouble believing this.

Any evidence you can point to regarding such illegal activity, and subsequent coverup?

Look it up yourself. I don’t feel like reliving this experience. You’ll find there were congressional investigations into this kind of activity.

Sorry, I was rude in responding. This is a sensitive subject for me. I don’t want to go through it all, but here’s one websitethat documents recent cases. Mine started in 1984. They refence the US Treasury site where you can find more details.

I haven’t filed for 4 years and I claim 0 on W2…

I pay 10k per year Tax…

Will they give me my overage or just “Fine’s” it all away, back to them? :dubious:

By “I claim 0 on W2” do you mean no with holding exemptions or you have nothing withheld?:confused:

In any case go hire a competent Tax Pro now. CPA or Enrolled Agent.

The IRS is likely the cleanest agency in the government. Mind you, of course it has (like any other civil service) a bunch of dudes putting in minimum work, waiting for retirement, but actually likely less than most agencies.

Although I could certainly believe some IRS agent accidentally losing a payment, stealing it would be nearly unheard of. They don’t call those guys “the Untouchables” for nothing. Uncaring bureaucrats? Sure. Crooks, no.

But as has been said here, most dues that end up owning the iRS big bux are either self-employed, or a business that is stealing the withholding (aka Payroll taxes) from their employees. The IRS really doesn’t like this.

Are you joking?! Here’s anothercite.

1991? :eek: That’s the best you can come up with? The IRS has 60000 employees, far more than any other similar agency.

Look, any agency has a few bad apples, but compared to others, the IRS is known to be squeaky clean. A few articles about a few arrests mean nothing, no one there’s never been a crooked agent, it’s just that compared to other agencies the IRS is pretty damn clean.