Whenever you call the IRS about a past due tax bill or a Revenue Officer makes "first contact" with you, one of the first things that they will ask you to do is pay your past due IRS tax bill in full. Once you tell them that you are unable to pay your debt in full, the next thing they will ask you is "can you borrow money to pay off your tax bill?" Before you go ask for money from a bank, your parents, or a rich uncle, first read this article on why borrowing money to pay the IRS off in full can be the worst possible idea.
Why it may be a good idea to borrow money to pay off the IRS
Don't get me wrong, there are some great reasons to pay off an IRS tax bill. The IRS is unlike any tax collector in the world.
- They can levy your bank accounts and wages without a court order.
- A notice of federal tax lien filed against you? Your credit score is reduced by 100 points. Pay a lien in full and you can request a lien withdrawal, which is as good a never having had a lien in the first place.
- If you ignore them and don't pay your bill, the IRS may come to your house or place of business.
- Penalties for non-payment can really add up.
- Interest charges will also pile up.
Why it may be a horrible idea to borrow money pay off the IRS
So, how could it be a horrible idea? Well, let me tell you a true story (names have been changed).
Bruce Banner came to my office in 2005. He owed the IRS about $200,000 in payroll taxes. We talked and it looked like he may qualify for an Offer in Compromise. Bruce said he would borrow money from his parents to pay our fee and we would get started the following week. But he never came back, so I called him. I said Bruce, what's going on? He said "Great news! When I asked my parents for your fee they said 'why don't we just give you money to pay the IRS off?' So they are taking money from their savings so and I'm finally getting rid of my tax problem. I feel great!"
So I congratulated Bruce and wished him well. Now, why does this story not end happily ever after? For the clue, I will point to this statement of Bruce's: "I'm finally getting rid of my tax problem".
Because guess what, Bruce did not get rid of his tax problem. Why? Two reasons. First, The IRS did not go away. IRS taxes are on-going, and Bruce seemed to forget about that. Fixing an old problem may not stop a new problem from happening. Which leads us to the next problem.
The next year, in 2006, Bruce ran up a new tax debt. He never fixed the bad habits that caused the tax problem in the first place, and now he had the additional burden of having to repay his parents each month. Bruce had a hard time paying his parents back so he shorted his payroll taxes again from 2006-2010.
Bruce never solved the underlying problem that was the root cause of his tax problem. The root causes of his tax problem was that he had bloated payroll expenses, a business that needed serious restructuring, and personal expenses way out of control. Instead of addressing these issues in 2005 when I first met him, Bruce just "threw money" at his tax problem and hoped it would go away.
He came back to see me in 2010, now $300,000 in debt with the IRS in on his back. His parents were furious at him. He wasn't repaying them on schedule and now he had another tax problem that was even bigger! Bruce called me again so I sat down with he and his parents and explained what happened, and that Bruce's case is rather common. I explained how paying off an IRS bill without solving the underlying problem is a horrible idea. I explained that the IRS is more than happy to take as much money as they can today, regardless if there is an actual exit plan from a tax problem.
Bruce's first priority should have been to fix his business.
The money Bruce borrowed from his parents to pay off his federal tax liens was really a band-aid. The truth was that Bruce's business was failing and he didn't want to have to face that reality. He hoped things would turn around, but this recession was unlike any other.
Bruce needed a recovery plan.
The first time Bruce came to us, we explained that he shouldn't pay off the IRS but rather, have someone take a look at what was going on and get an independent adviser to tell him what to do and develop a real recovery plan. At the time, he just wanted to get the tax problem behind him.
The good news is that the second time around in 2010, his parents agreed to pay our fee and no longer just give Bruce money to throw to the IRS. He agreed to try it our way. Among other things, we secured the loan to his parents against Bruce's house; now that was an allowable business expense on his 433b, lowering his "collection potential."
I'd like to say the Bruce didn't have to make any uncomfortable changes. He had to find a new lease, he had to fire his old bookkeeper, and his wife had to cut down on her discretionary spending. But after we prioritized Bruce's goals, we were able to get a real plan together that permanently ended his tax problems. Additionally, we were able to use our plan to demonstrate to the IRS that the amount we offered to settle Bruce's taxes was fair. If you need assistance with a tax issue, contact us. We can help.
