Meet the IRS halfway when trouble's afoot

Here's some comforting news if you're in hot water with the IRS: not all transgressions are treated equally. For those entrepreneurs who face hefty tax bills for denied deductions, back-interest charges, financial penalties, and the like, there may be room to negotiate a reduced settlement -- if they handle matters the right way.

There are two kinds of troubles a business owner can have with the IRS: criminal (when the risk may be jail time as well as financial penalties) or civil (when the downside is purely financial). "What I try to emphasize to my clients is that I've never seen any business owner face a criminal charge for being too aggressive about deductions. But if you 'forget' to report income, that could be criminal," notes Richard M. Colombik, a tax lawyer and certified public accountant whose firm, International Tax Associates, is based in Schaumburg, Ill. "There just aren't any formal guidelines that say, 'You probably won't face jail time below a certain dollar amount.' What the IRS will be looking for is a pattern of intent."

Here's what "intent" might look like: A struggling young company is so strapped for cash that its owner overlooks payroll taxes. IRS officials repeatedly contact the owner, first with fairly gentle reminders, then with offers to help calculate the tax bill. Eventually, ominous warnings follow. "In a case like that, it's very hard to go to the government and try to argue you didn't know there was a problem," explains Colombik. "So you might well wind up facing an overdue tax bill, penalties, and even the prospect of jail time. And there's no way to escape that -- even if you go bankrupt -- because payroll-tax liabilities are not dischargeable in a bankruptcy court."

The good news is, there's usually some more wiggle room with civil matters (that is, when they don't accompany criminal charges). Let's say that a business owner owes a big tax bill because of the disallowance of a key deduction or the improper structuring of a retirement plan. "Even though you're sitting across the desk from a revenue agent who's shaking his head and saying, 'No, no, no,' you can always try," Colombik explains. "Your records may not be perfect, but you may be able to explain why you made a mistake. It happens all the time that people say, 'Let's split the difference,' or, 'I won't challenge the audit if you forgo the penalties."

If a revenue agent refuses to budge, you can always request a meeting with his or her supervisor (who may have greater authority to cut a deal). But if that effort fails, taxpayers have the right to request an appellate conference.

"At the appellate level, tax officials have the responsibility of not only reviewing your case's records but also evaluating the hazards of going to trial," says Colombik. "If they figure that there's a 20% chance of losing, they may be more willing to offer to discount your tax bill. That's something that revenue agents and supervisors are prohibited from considering when making their decisions."

If you're trying to make a deal, the most important point to keep in mind is that it never, ever pays to represent yourself with IRS officials. "People can end up creating new problems for themselves, just through idle conversation with an agent," explains Colombik. So don't try any of this without some expert guidance.