Q&A; : ‘Offer in Compromise’ May End an Obligation to Make Payments for Back Taxes

Q. Because of a severe financial hardship, I didn’t file my 1987, 1988 and 1989 tax returns until 1990. Naturally, I was hit with some pretty stiff penalties and interest charges, raising my total obligations to $32,000 to the state and $50,000 to the federal government. I have been paying down these balances with monthly payments of $150 to the state and $230 to the IRS, but I have barely made a dent in the total. How long must I keep at this? Is there a statute of limitations on the length of time the government can collect delinquent tax obligations?

--R.L.H.

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A. Once the taxes have been assessed, as in your case, the government has 10 years in which to collect its due. And presumably collection agreements such as the one you are operating under are structured so as not to exceed that limit. In your case, 10 years of paying the federal government $230 a month will result in payments of $27,600; your payments to the state will be $18,000 at that rate.

Perhaps you can get out from under this payment program. How? If you can demonstrate that you are unable to pay your tax bill, you should consider filing an “offer in compromise” with the IRS. This process is designed toallow taxpayers who are either contesting their tax obligations or financially unable to meet them to negotiate a tax settlement with the IRS that will erase the taxpayer’s bill. Eachnegotiation is separate, and it is by no means an easy process to complete successfully. But if you are truly unable to pay your outstanding obligations, the government feels it is better off getting what it can rather than nothing at all.

For more information, see IRS Form 656. You can order it by calling the IRS tax form hotline at (800) 829-3676.

Avoiding Withdrawal Penalties on 401(k)

Q. I read somewhere that at age 55 you can withdraw your funds from a 401(k) plan without any penalty. I am 54 now and am scheduled to be laid off next month. Can I use my 401(k) money to launch a new business without paying early-withdrawal penalties once I turn age 55?

--K.H.L.

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A. The 401(k) plans at many companies do allow employees to withdraw funds from their 401(k) plans at age 55. However, these plans cannot and do not in any way change or waive the normal federal and state regulations governing withdrawals from these tax-deferred accounts.

What does this mean? There are three major options, only two of any use to you.

First, you could transfer your 401(k) funds to another tax-deferred account, most probably an individual retirement account, until you reach age 59 1/2, when you could begin withdrawing without penalty. The most likely reason for making such a move would be that you think you can do a better job investing your funds than your company has been doing.

Second, taxpayers under age 59 1/2 may dip into their 401(k) accounts without penalty if they take their distributions in equal annual payments over their life expectancies for at least five years or until they turn 59 1/2, whichever takes longer.

In your case, at age 55, you could withdraw somewhere between 3% and 5% of your account during each of the five years you would have to follow the annuity schedule. Unless your 401(k) account is large, this amount isn’t likely to provide much in the way of funds for you to start a business.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053 Or send e-mail to carla.lazzareschi@latimes.com