IRS debt kills businesses. Real estate investors are in a particular danger. How so?

Digging your own grave slowly

Let’s take an example. Last year, you decided to go full-time into real estate. Without savings, your immediate goal was to generate some cash, so you naturally started with wholesaling. You hit it hard, and it paid off: by the end of last year, you made a very respectable $100,000 from assignment fees. Of course, you had to pay for your mailouts, and split some deals with the guys who helped you, and subscribe to some lists, not to mention all the gas you pumped into your trusted truck. Still, after paying everyone, you put in your pocket around $70,000. Not too shabby for the first year in business. Certainly beats sitting in a windowless cubicle for 8 hours or serving tables. Congrats!

But – here is the problem. While you put $70,000 in your pocket, you did not put anything in Uncle Sam’s. And he is going to be unhappy. How unhappy? $20,028 unhappy. Because this is how much taxes a single person will owe on $70,000 self-employment income earned in 2014. Yes, between Federal income tax, Social Security tax and Medicare tax (the last two jointly known as Self-Employment tax) it will be a whooping $20k bill. If you live in a state with a state income tax – it will be worse.

I have not met many people who will look at their $20k bill and say – fine, who do I write this check to? You write this check to “The United States Treasury” – assuming you have the money. Unfortunately, almost nobody does.

Well, the IRS will understand, right? Kind of. The nice folks at the IRS will not force you to pay the entire $20k at once. They will give you up to 6 years to pay it off. With significant interest and penalties added, of course, but you will be able to pay it off slowly.

So, what’s the big deal?

Your business keeps getting better, so you can make those monthly payments. The big deal is that your business keeps getting better. It means that this year, which will soon be over, a brand new second tax bill is growing. And it’s going to be more than last year’s.

You are only starting to pay last year’s $20k, and now you have another $25k for this year on TOP of it, plus penalties and interest. We are looking at a $50k IRS debt. Can you still get a 6-yr payment plan? Possibly. But the party is ending here.

Another successful year, and your payment plan option will collapse, and you will be dealing with the IRS collectors. Hint: they are not your friends. They can take your bank account, your IRA accounts and even your house if you try to test their powers. I would not.

Before long, you will be asking me if I know a good bankruptcy attorney. Actually, I do. Should I give you his name already, because this is where you’re surely heading?

How about not getting in trouble?

Let’s see if we can maybe prevent the IRS from ruining your business. No, there is no restraining order. No, those TV commercials for “IRS relief” are no different from weight-loss TV commercials. And no, our next President is not going to abolish the IRS. You have to pay.

How do you pay the IRS, then? As a wholesaler, you cannot have IRS taxes taken directly out of your title company checks, the way they do it with payroll checks. Hoping that you will save up $20k to pay the entire tax bill on April 15 is naive. It will not happen, don’t fool yourself.

Even the IRS realizes that they will not receive a $20,000 check from you on April 15. So, the government solution is to make you pay your annual bill in 4 quarterly installments that they call estimated payments.

If you estimate your current year’s tax bill to be around $20,000 again, then you divide it into four $5,000 payments and send the IRS four $5,000 checks according to the IRS schedule: April 15, June 15, September 15, January 15. If you noticed, this is NOT “every 3 month” schedule, as any normal person would expect. News flash: the IRS rules are nor created by normal persons. They are created by Congress and the IRS.

Whatever the schedule, the concept of four $5,000 checks will not work, either. Wonder why?

1. $5,000 is still a huge check to write at one time
2. You pay nothing else quarterly, and we are creatures of habit

Here is my solution: make IRS payments monthly.

Set up a monthly payment to the IRS

How exactly do you set it up?

Step 1. Figure out how much.

If you expect to make about the same as last year, you’re looking at $20,000 (per my example, use yours instead!) divided by 12 = $1,700 per month. If you expect this year to be better, as I hope is the case, adjust this number up. Make it $2,000 or more.

Step 2. Pick a day of the month.

If you pay all bills on the same day of the month – then this will also be your IRS payment date. If you like to spread those bills around the month – then pick a day far away from other bills, when you’re less likely to run short. And then put this day on your monthly calendar.

Step 3. Set the payment system.

You cannot make the IRS draw it from your account monthly, they are not set up for it. You have 4 options for monthly payments, listed in order of my preference, starting from the best.

1. Auto-pay via your bank bill payment system. It will be on auto-pilot, which is the most reliable system for most people. Drawback: your bank will be mailing paper checks to the IRS, and occasionally those get misplaced by the IRS or lost in the mail.
2. Sign up for the Federal government EFTPS system that can accommodate electronic transfers from your bank to the IRS. Drawback: you will have to remember to log in monthly and initiate each payment manually. Also, you have to do it 2 days ahead of the deadline.
3. Make monthly electronic payments via the IRS website. Direct bank drafts are free, but credit card payments have a significant transaction fee charged by 3rd party vendors. Drawback: also requires manual initiation every month.
4. Mail old-fashioned paper checks every month.

Step 4. Reminders.

If you’re doing anything except automatic bank pay – set up monthly reminders on your smart phone. Otherwise, you will forget. The IRS won’t.

Deadline Alert!

And, while talking about staying in business and running it professionally – check out the new REI Pro Guard professional guidance program that I run jointly with real estate attorney Steven Newsom.