The IRS may be ridiculed, and it may be railed on. But it is still one of the most effective collection agencies in the world.
In 2011, the agency claims to have processed 234 million Federal returns (including supplemental documentation). Of these, 143 million were individual income returns. Roughly $2.4 trillion was collected in gross, with $1.3 trillion coming from individuals.
By comparison, Exxon Mobile pulled in $453 billion last year, less than one-quarter that amount.
The IRS is also one of the most powerful collection agencies because of its special powers and access to your sensitive information.
Through your social security number, the organization can find bank accounts, employers, estates, and special funds. This information empowers the organization to lien property, garnish wages directly from employers, levy bank accounts and automatically take tax refunds.
What is the difference between a tax lien and levy?
A federal tax lien is a claim to your property, which can lead to the liquidation of the asset to satisfy the overdue tax obligation. If enacted, the lien also sends a direct notification to creditors that a federal lien has been served to you, and the mark against your record lasts 7 years before it will be removed.
Once a lien is enacted, it typically cannot be removed until the full balance has been paid in full, but filing for bankruptcy can put lien proceedings on hold temporarily.
A levy gathers funds from your sources of income or your assets, such as real estate, bank accounts and wages, even Social Security benefits and retirement funds. These methods of collection limit your ability to live until you can meet the obligation.
Cost of non-payment and how to reduce your back taxes ahead of time
If you are unable to fulfill your tax obligation, then the IRS’ penalty system makes it in your best interest to at least file your tax return. The penalty for not filing is twofold.
Firstly, the IRS will file your return for you (typically resulting in unfavorable representation). Secondly, the rate of interest is 4.5% of the amount you owe, per month. Not paying your full monetary obligation accrues at 0.5% per month, or one-ninth the interest rate of failing to file.
That gives you an annual interest rate of 6.17%, compounded, if you file and do not pay, versus 79.59% interest if you do not file at all. The penalty is capped at 47.5%, with 22.5% maximum for not filing, and 25% for not paying.
So, if you do not file, your penalty will rise to over 23% within five months – a larger penalty than any credit card or legal short-term loan.
If you cannot pay, then you might also pursue a payment plan option, or an Offer in Compromise (OIC) to reduce what you owe. The catch is: you can typically only ask for an OIC as long as you are fully up-to-date on past tax years.