After IRS tax resolution: Keep your finances on track

A fact the tax-relief industry leaves out of its commercials: a large share of the people who resolve a tax debt have another one within a few years. Not because the IRS came back for more. Because the thing that created the first debt was never fixed, and it created a second.

The installment agreement that defaults in year three because a new balance appeared. The accepted offer that unwinds in year two because the taxpayer could not pay the following April. The self-employed person who, having finally cleared three years of skipped estimates, skips the next quarter because business is slow again. I have described the IRS as a slow system. It is also a patient one, and it will be there when the pattern repeats.

This chapter is the Endure step. It is the least dramatic chapter in the book and, for the reader who has made it this far, the most important.

The one rule

Everything in this chapter comes down to one rule: from now on, the current year's tax is paid during the current year, as the income is earned, so that April is a reconciliation and not a reckoning.

For an employee, that means withholding that actually covers the tax. For a self-employed person, it means estimated payments that actually get made. For a retiree, it means withholding on Social Security and pension payments, or estimates. For everyone, it means that the money for the tax is never sitting in an account where it looks like it is available for something else.

Every agreement in Part III requires this. An installment agreement defaults if a new balance is not paid in full. An accepted offer defaults if any of the next five years is not paid in full. CNC status is reviewed against the income on each new return. The IRS has built the rule into every exit because the IRS knows the pattern. Build it into your life for the same reason.

One fact makes me believe in withholding more than in any other feature of the tax system. The IRS periodically estimates how much tax goes unpaid and why, and the pattern has held for decades: wages, which are withheld on and reported by the employer, are misreported about one percent of the time. Self-employment and cash income, with no withholding and little or no third-party reporting, is misreported more than half the time. The difference is not that employees are more honest than contractors. It is that the employee never sees the money, so there is nothing to decide. The entire difference between Jennifer's life before her layoff and Michael's life for three years is a mechanism that removes the decision.

Everything in the rest of this chapter is an attempt to build that mechanism for yourself, in whatever form your income takes. If you have withholding available, use it to its limit. If you do not, construct the nearest thing to it, which is an automatic transfer you set up once and do not revisit. The goal is not discipline. Discipline fails on a bad Friday. The goal is to never again be in the room when the decision is made.

If you are an employee

Go to the IRS Tax Withholding Estimator on IRS.gov. It takes fifteen minutes with your most recent pay stub and last year's return, and it tells you what to put on a new Form W-4 so that your withholding matches your actual tax. Do this now, and do it again whenever something changes: a raise, a second job, a spouse starting or stopping work, a child, a marriage, a divorce, a side business.

The second job and the working spouse are the two that catch the most people. Each employer withholds as if their paycheck is your only income, so two paychecks that are each withheld correctly on their own can leave you several thousand dollars short together. The W-4 has a checkbox and a worksheet for exactly this situation. Use them.

If you owe at the end of the year even with corrected withholding, you can have an additional flat amount taken from each paycheck. Line 4(c) on the W-4. Jennifer, who did not want a refund the IRS would take but did not want to owe either, set hers to produce a balance of a few hundred dollars each April and keeps that amount in savings.

Aim to owe a little or to get back a little. A large refund is money you lent the government for free, and if you have any balance from prior years, it is money you will never see.

If you are self-employed

You have no withholding, so you have to create it. The mechanism is quarterly estimated payments, due in mid-April, mid-June, mid-September, and mid-January. The IRS gives you two safe harbors: if your payments for the year total at least 90 percent of this year's tax, or at least 100 percent of last year's tax, 110 percent if your income is above $150,000, you will not owe an estimated tax penalty even if you still have a balance in April.

The safe harbor based on last year's tax is the one to use when your income is unpredictable, because you know the number in January. Divide last year's total tax by four. Pay that amount each quarter. If the year ends up better than last year, you will owe some in April, but you will have paid most of it and there will be no penalty.

The mechanics matter more than the math. Michael's problem was never that he did not know about estimated payments. It was that the money was in the operating account on the due date and the truck payment was also due. Three changes fixed it, and I would recommend all three to anyone with business income.

First, a separate account for taxes, at a different bank if the temptation is strong, into which a fixed percentage of every deposit is transferred the day it arrives. For most self-employed people the right percentage is between 25 and 35 percent of net income, depending on your bracket and state; a preparer can tell you yours. The money in that account is not yours. It is the IRS's money that you are holding, exactly like the trust fund taxes David learned about.

Second, automatic payments. Enroll in EFTPS or use IRS Direct Pay and schedule the four estimated payments for the year in January. Then the decision to pay is never made in the moment, because it was made once, in advance.

Third, monthly bookkeeping, so that you know your profit each month and can adjust the transfer percentage before the year gets away from you. A business that does its books once a year, in March, is a business that discovers its tax problem in March.

If you are retired

Social Security benefits can be taxable depending on your other income, and most people do not have anything withheld from them. Form W-4V lets you have a flat percentage withheld. Pensions and IRA distributions can also have withholding set. Linda's problem was a one-time event, but the fix for the years after was the same: enough withholding on the pension to cover the tax on the Social Security, so that April produces nothing.

If you are taking large or irregular distributions from retirement accounts, for a medical expense, a home repair, or to help a family member, understand before you take the money that the distribution is income and the default withholding is often not enough to cover the tax on it. Ask the custodian to withhold more, or make an estimated payment the same month.

If you are in an installment agreement

The IRS will send an annual statement showing payments received and the remaining balance. Read it. Compare it to your own records.

Make every payment. If something happens that makes a payment impossible, call before the due date. The IRS can sometimes skip a payment without defaulting the plan if asked in advance. It cannot undo a default after the fact without a reinstatement process and a fee.

If your financial situation improves, consider raising the payment to finish sooner. The interest savings are real.

If it gets worse, call and ask for a modification with an updated financial statement. Do not simply stop paying.

If the IRS asks for updated financials, which it may on larger plans every couple of years, respond by the deadline. Silence is a default.

When the balance drops below $25,000 on a direct-debit plan that will pay within sixty months, request lien withdrawal on Form 12277 if a lien was filed. When the plan is complete, request withdrawal regardless.

If you have an accepted offer

Five years. Every return filed on time. Every balance paid in full by the due date. This includes extensions: filing on extension is fine, but the tax is still due in April, and an extension to file is not an extension to pay. If the offer had payment terms extending past acceptance, make every one.

If you cannot pay a balance in one of those five years, call before April 15, not after. The IRS can sometimes work with a taxpayer in offer compliance who is briefly short, but the window closes the day the balance goes unpaid.

Keep the acceptance letter forever. If a question ever arises about the compromised years, it is the document that ends the question.

If you are in Currently Not Collectible status

Read each annual balance reminder promptly. CP71 concerns an unpaid balance requiring attention; compare the amount and instructions with your account and payment records, and contact the IRS about discrepancies. Continue scheduled payments under an approved agreement. If hardship CNC status is confirmed, remember that it temporarily suspends most collection but does not cancel the balance, prevent refund offsets or guarantee that collection cannot resume. Keep the notice after checking it; do not simply file it away unread.

Know the income threshold the IRS recorded when it placed you in the status; if you do not, call and ask. Understand that income above it on a future return can reopen the account. Plan large one-time income events, such as a retirement distribution or the sale of something, with that in mind, and if one is unavoidable, be prepared to provide an updated financial statement showing that your ongoing situation has not changed.

Pull your transcript after each collection deadline passes and confirm the balance is zero. Robert's three dates are on his refrigerator for this purpose.

Records

Keep your returns and supporting documents for at least three years from filing, six if you have significant self-employment or investment income, and seven if you have claimed a bad debt or worthless security. Keep records of anything you own, especially real estate and investments, for as long as you own it plus three years, because you will need the cost basis when you sell.

Keep your communication log, your copies of every form you submitted to the IRS, every notice you received, and every agreement or determination letter, for ten years. Anthony's storage unit is the counterexample.

Keep your IRS Online Account active and check it twice a year. It shows balances, notices, and payment history, and it will tell you about a problem before the mail does.

Consider an Identity Protection PIN, which you can request through your online account. It prevents anyone else from filing a return under your Social Security number, which is a growing source of surprise balances.

The events that start the cycle again

I will list them because the list is short and the pattern is strong.

A new job without a corrected W-4. A second job or a working spouse. A side business with 1099 income. A retirement account withdrawal. A divorce, especially one in which the returns were handled by the other spouse. The sale of a house, a rental property, or investments, where the gain is not what you expected or the basis records are missing. The start of a business with employees. A year of unusually good income with no corresponding increase in estimates. A year of unusually bad income in which the estimates were the thing that got cut.

Each of these is foreseeable. Each has a fifteen-minute fix in the month it happens. Each, left alone, produces a letter in eleven months.

What the year after looked like for the seven

Michael's business now transfers 30 percent of every deposit to a tax account at a different bank, and the quarterly estimates are scheduled in January. His bookkeeper closes the books monthly. He has not missed a quarter in four years.

Sarah reads every line of her return before she signs it, files separately from her new partner, and keeps her own copies.

Robert files on time, keeps his part-time income steady, and has not touched the IRA.

Jennifer's W-4 produces a small April balance that her savings account covers. Her direct debit has never bounced.

David's deposits are automated through EFTPS and he reviews the deposit history on the first of every month. The restaurant has a credit line for slow seasons so that the deposit is never the lever.

Linda has withholding on her pension that covers the tax on her Social Security. Her daughter checks the online account every spring.

Anthony's estimated payments are automatic, his receipts go into a folder every week, and his returns are filed in February.

None of that is remarkable. All of it is the difference between resolving a tax debt once and resolving it every few years for the rest of your life. The programs in this book are there if you need them again. This chapter exists so that you will not.

Official notice sources

IRS CP71 instructions and IRS hardship collection guidance. Follow current instructions and the deadline on your actual notice.