IRS Tax Debt: Free Money Isn’t Free!

I receive letters and e-mails from people asking about their tax debt issues. I received this e-mail regarding money from a lawsuit not being taxed, and now the person is in debt to the IRS because of some bad advice. In the e-mail, they're asking if they can settle the debt for a lower amount.

Dear Sir:
Do you defend people and help to get the amount lowered which is owed to the IRS? How do you help? I am interested in someone working with the IRS on our behalf to get the amount we owe down? Is this what you do? Ours was a mistake our tax guy made on money we received from a lawsuit. He said that this money didn't have to be taxed like income. Long story short, he couldn't have been more wrong. Now the IRS is wanting much more than we can pay. Sound familiar?

The same old song and dance... Their situation is pretty familiar. I've lost count of how many people think that when they receive a lump sum of money, or if they withdraw money from an investment account, that taxes have already been taken out. This misconception has forced too many people into serious tax debt.

In a nutshell... In brief, you have to pay taxes on any and all lump sum payments or investment withdrawals. In fact, you should figure that you will have to pay the IRS around 30% of the total amount. In addition, the lump sum or investment counts as income for that year, so you'll likely be bumped into a higher tax bracket and may even owe additional funds on your taxes for that year. This also applies to lottery or gambling winnings as well.

Can you settle for less... The person from the letter also asked about lowering their total debt owed. Since they received a lump sum payment from a lawsuit, they're not very good candidates for a settlement known as an Offer in Compromise.

What can be done? This person is in a pretty tight situation. There are two options available: They can enter into a monthly payment plan with the IRS. They will need to pay off the debt in installments over time, and the interest and penalties will continue to add on to the debt.

Since they received bad tax advice, they can also try to file an amended return. If they can prove that they didn't know taxes weren't taken out, then they would be able to re-file the return. Because the income from the lawsuit will put them into a higher tax bracket, they will probably still owe money to the IRS. However, it will be much less than the taxes owed on the lawsuit money and the money due from the tax return.

If you can take anything away from this, it is that you have to pay taxes on any money you receive.

Now they have the smoking gun... and so do you.