Get Square With Federal, State Taxes

PERSONAL FINANCE

August 23, 2009|By EILEEN AMBROSE

You don't have to own a Swiss bank account to evade taxes.

Maybe you purposely underreport your income to the IRS or have gone along for years without filing a tax return. Or, you made a mistake significantly in your favor on the return and never fixed it.

Whatever the case, it's not too late to make it right with the IRS. Uncle Sam prefers that you voluntarily come forward and pay what's due rather than having to track you down or, in serious cases, prosecute you. And while you're at it, you might need to make good on state taxes. Fortunately for Marylanders in tax arrears, the state is launching an amnesty program next month.

About 85 percent of taxpayers voluntarily pay their share of federal taxes each year, according to the IRS. But an estimated $290 billion of taxes go uncollected annually. Some of that revenue is likely in the Alps and might be collected soon. The U.S. struck an unprecedented agreement last week with the super-secretive Swiss to turn over information on about 4,450 UBS accounts suspected of being set up to dodge taxes here.

So how do you get square with taxes?

Basically, you have two options: the quiet way and the noisy way, says George Clarke, a Washington lawyer whose practice focuses on defending clients on tax matters.

The quiet way is where you file back returns or amend returns and pay what you owe without calling attention to yourself, he says.

The noisy way is to approach the IRS and make a voluntary disclosure, where you come clean, pay taxes, interest and penalties and, in return, generally avoid prosecution. The key is to come forward before the IRS has you in its sights.

"If you find us before we find you, typically you won't be prosecuted," says IRS spokesman Eric Smith.

The best option for you will depend on what kind of hot water you're in.

Let's say you haven't reported income from an offshore account, activity that is now the target of the IRS. In this situation, make the voluntary disclosure, experts advise. For six months - ending Sept. 23 - the IRS is offering Americans hiding assets offshore to come clean and potentially avoid prosecution and steep penalties.

How steep? The IRS offers an example: Say you deposited $1 million in a foreign account six years ago and since then earned a total of $300,000 in unreported interest income. Voluntarily fess up, and you would pay $386,000 plus interest. That's high, but if you keep quiet and the IRS catches you, you could end up paying $2.3 million - or more.

Tax dodgers have gotten the message. The IRS said in one week alone in July it received 400 voluntary disclosures, compared with 88 for all of last year.

Chicago lawyer Robert McKenzie says so far this year, more than 50 people have sought his assistance with disclosures about foreign accounts, up from a half-dozen last year. "The handwriting is on the wall that the IRS is coming, and people with accounts [in] Thailand to Israel have come to me," says McKenzie, a tax partner at Arnstein & Lehr.

Voluntary disclosure isn't just for foreign accounts. Some tax evaders choose to make voluntary disclosure just to get assurances from the IRS that the matter is resolved, lawyers say.

For most, though, quietly making good on taxes is the way to go. If you failed to file a return as required - some low-income households don't have to - you can submit tax returns for the years you missed. Tax experts suggest you mail in each return separately to avoid attracting too much attention from the IRS.

(If your spouse doesn't file tax returns, or you suspect he or she is fudging numbers, submit returns under "married filing separately" status to avoid being held liable for your spouse's actions, says Steve Albert, a tax partner at Glass Jacobson in Owings Mills.)

You also can amend returns to correct mistakes by filing a Form 1040X. You'll need to explain why you are correcting the return.

If you're catching up with filing, you will have to pay back taxes, interest and penalties, McKenzie says. When amending returns, you'll owe back taxes and interest, but maybe not a penalty, he says.

Can't pay all at once? The IRS offers payment plans and, under limited situations, might even accept less than owed.

Of course, getting right with the IRS could mean you will have to do the same with the state.

In Maryland, the timing couldn't be better.

Starting next month, the state is launching an amnesty program for those who haven't paid their taxes on returns due last year or earlier. Pay up, and civil penalties plus half of any unpaid interest will be waived. You won't be criminally prosecuted, either, unless you're already under investigation.

If you can't afford to pay immediately, the state will offer a payment plan. You will have to pay 10 percent of what you owe upfront and pay the rest by the end of next year.

Amnesty applications are available online at marylandtaxes.com or by calling 410-260-7951. Your application must be postmarked by Oct. 30, the date the program ends.

Sure, coming clean might be costly, but it has benefits.

"People worry about [unpaid taxes] or their spouses worry about it, and it goes on for years," says Albert. "If they file, they have peace of mind."

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