Archive for the ‘ Procedure ’ Category

IRS Delays Benefit my Clients

The IRS is woefully understaffed: in IRS offices across the country staffing is down 7 to 41% and not one office has seen an increase.

Complicated correspondence is not answered timely, or sometimes at all. I have a large collection of letters from the IRS saying that it received my inquiry some time ago, that it strives to answer inquiries within 45 days, but that it needs another 45 days to respond. But the understaffing and the resultant delays often work to my clients’ advantage. Here’s two examples.

Audit Reconsideration Example. A client’s CPA said she’d handle the client’s audit, but the CPA went out of business mid-audit and didn’t tell my client or the IRS.  The IRS continued with the audit and presented my client with a $50,000 tax bill. My client owes nothing if her expenses are presented correctly, which they weren’t. There’s a process to address this problem: the audit reconsideration which I promptly applied for once my client came to me. It’s now fifteen months later, and we still have not heard back from the IRS. However, collection notices for the $50,000 the IRS thinks it’s due have stop being sent to my client. Indeed, when looking at her account, I see that the IRS has flagged it as “claim pending,” an internal IRS code that prevents its personnel from issuing further collection notices. I have no idea when IRS will finally pick up my client’s file and grant the audit reconsideration. Frustrating but my client isn’t hurt.

Collection Due Process Example. Another client didn’t file tax returns and eventually an IRS collection agent called and said he was preparing and filing returns on her behalf (yes, the IRS can do this). This is always a bad thing because the IRS will make the most conservative guesses on filing status and deductions, so the total tax owed is always higher when the IRS prepares a taxpayer’s return, than when the taxpayer does. At this point my client hired an accountant, who worked up actual tax returns and sent them to the collection agent.

Six months later my client still hadn’t heard about her filed returns, but did start receiving collection notices on IRS-prepared tax returns. My client hired me at this point in the story, and I filed a collection due process hearing since the IRS clearly had not processed the returns she’d send. Collection due process stops the IRS collection, but only when the IRS has sent the last collection notice. It hadn’t, so the collection due process hearing request was denied. Almost exactly a year ago, I sent a request for an audit reconsideration and attached copies of the previously-filed returns and asked that they be processed finally. We still haven’t heard from the IRS. However, after I filed for an audit reconsideration, the IRS added the “claim pending” notation to my client’s account, thus ending all collection processes. We don’t know when or if the IRS will grant an audit reconsideration but, again, my client is not harmed by the delay – only irritated by the IRS’ glacial pace.

In both cases, I could call the IRS to see what’s happening and if there’s any way to speed up the process. However, such a call likely won’t get my clients’ cases unstuck, and it will end up in another bill from me: I have sometimes been on hold with the
IRS for over 6 hours, and the average time I wait is approximately 90 minutes.

Even though interest accrues on my clients’ unpaid liabilities at 4 to 10 percent per year, delay works to their advantage. They are likely to owe a lot less tax in the end than the IRS assessments on the books, and the 10-year collection statute of limitations is running. If the IRS never gets around to opening their files, then the tax assessments will disappear without being collected. If the IRS finally does deal with these situations, the taxpayer will have been able to postpone paying the IRS for a long time.

That’s good for my clients. It’s bad for the country; the tax system is at the heart of how our government functions. Good administration of the tax laws breeds respect for the rule of law in this country.

IRS Tax Debt Ten-Year Clock

Most people don’t know that the IRS stops trying to collect on tax debt after 10 years. This 10-year clock can be valuable to people who owe back taxes from several years ago.

The statute of limitation on collecting tax owed is at 26 U.S.Code § 6502(a)(1): the IRS may start a collection proceeding only within 10 years after the assessment of the tax. The “assessment” date is determined as follows: (1) if the tax return was filed before the due date for that year, then the assessment date is the due date for that year (for example, 2016 tax returns are due by April 17, 2017). Thus, a 2016 return filed on March 13, 2017, will have an assessment date of April 17, 2017. (2) If the tax return is late-filed after the due date for that year, then the assessment date is the date the return arrives at the IRS. The assessment date starts the clock, and the IRS tries to beat the clock by collecting all taxes owed before the 10 years run out.

Four actions will stop the 10-year clock and add to the time the IRS has to collect back taxes. First, filing for bankruptcy protection stops the clock until the bankruptcy court discharges the debt/case. Since it typically takes 4-6 months from the filing to the discharge of a bankruptcy case, a bankruptcy generally adds 4-6 months (and then another 60 days) to the 10-year clock. Second, filing a request with the IRS for a Collection Due Process hearing under 26 U.S. Code § 6330 stops the clock until the hearing occurs; it is currently takes an average of six months to get a hearing result. Third, submitting an Offer in Compromise to the IRS stops the clock until the offer is rejected or accepted, plus 30 days); it currently takes an average of two years to get an IRS decision on an Offer in Compromise. Finally, submitting a request for an installment agreement with the IRS stops the clock from the date the request is submitted until the IRS acts on the request, plus 30 days; it currently takes an average of two months for the IRS approve installment agreements.

Ten years is a long time. I rarely advise clients to try to run out the clock: anyone trying to avoid paying the IRS would need to join the underground economy, and, as a citizen of the United States, I have an interest in seeing to it that my neighbor pays the same tax that I do. But sometimes a client will come to me with a situation where the IRS has just figured out where he is, and there are only nine months left until the Collection Statute Expiration Date (CSED, for those of us in the know). In this situation, I might advise the client to just not contact the IRS, and attempt to get by without putting money in a bank account.

I feel much better about putting clients into installment agreements. Here, the IRS investigates the taxpayer’s financial situation, and agrees to accept a monthly payment in exchange for not levying on the taxpayer. It is a way to reach a truce with a most powerful government agency, an agency that can create chaos in one’s life. Sometimes, the taxpayer’s situation prevents him from paying more than a small token toward his large tax debt. During the time the installment agreement is in effect, the 10-year clock continues to run. When well-managed, this process may allow a portion of a taxpayer’s liability to die a natural death while he is still paying it off.

Note that this article speaks only of the IRS. California income tax is collected by the Franchise Tax Board, under California statutes. Until 2006, the FTB had no statute of limitations on collection; in that year, the legislature passed a law providing for a 20-year collection statute. Rev. & Tax Code § 19255. The statute provides for the FTB to collect a liability for 20 years after the latest tax liability becomes due and payable. Let’s say that 16 years after the assessment, the FTB files a notice of tax lien and charges a $35 lien filing fee. That action, according to the FTB, starts the 20-year clock all over again.

Conclusion: you can sometimes get out of paying federal income tax by being clever, but you can’t get out of the state tax so easily.

A Dream Job

A Dream Job

 

I love what I do. Intervening on behalf of my clients in tax audits, or helping people shed crippling debt, allows me to (1) draw on prior professional experience at the IRS and elsewhere, (2) use my detective and people skills in finding and negotiating with the right auditors and revenue officers, and (3) helps me solve people’s problems and move them forward in their lives.  As a small business owner, I also get complete discretion over my time and, of course, full responsibility for all my successes and failures. I’m sure I’ll be doing this for another 20 years, at least.

 

However, every now and then, I daydream about alternative careers. I recently read an article about the razor manufacturer, Gillette, and how it has half a dozen highly-trained men who have a gig testing razors and shaving techniques. http://www.wsj.com/articles/for-cutting-edge-analysis-few-come-closer-than-this-elite-shaving-squad-1460323470  They leave home and stop at Gillette headquarters on their way to work, where they shave. Their daily shave is done according to a strict protocol; they are testing different shaving creams and razors against each other, so every shave has to be done exactly the same way. These guys know about shaving. “Way cool,” I announced to the wife and daughter, both of whom dismissed my excitement with barely-concealed eye-rolling.

 

But I was serious. About a decade ago, I started using shaving soap, rather than canned lather. I like the closer shave, and the soaps generally smell better and feel somehow richer. As I read about the Gillette shavers, I envied that they get to try new soaps and razors on a daily basis. They get to be experts in shaving. Me – I invest in one cake of shaving soap, and it lasts 18 months. Neither my wife nor daughters appreciate how silky smooth I get my face – it’s always too bristly for them, no matter what I do. I suspect at Gillette, the shave scientists get well-deserved praise.

 

Another thing I like about the job is the attention to process. At the IRS, I learned the importance of process: thinking about the steps toward getting a job done. In my law firm, even though each case is different, I always look for the uniform elements so that I can create a check list and get all the steps done.

A client recently had the FTB, Franchise Tax Board, garnish his son’s bank account.  His son didn’t owe the tax money; my adult client did.  But the FTB didn’t care; it took the kid’s money – $14,000 – and paid it to the father’s tax liability.

The child had just turned 21.  His parents set up the bank account when their son was 10.  Because he was a minor at the time, the parents needed to sign on their son’s account and present one of their social security numbers.  So far as the FTB was concerned, this was the father’s money.  Presenting the signature card, with the boy’s uncoordinated 10-year signature, did not soften the hard hearts of the FTB.

The father could have sued the FTB in state court to return the money to his son.  That would have taken hours of attorney time, and it was the father’s burden to prove that the money didn’t belong to him.  If he succeeded, (more likely than not) he would have owed $14,000 to the FTB, because his son had effectively paid his tax debt for him.

I thought this would have ended the matter for the FTB.  It did not.  Not only did the FTB seize the son’s money, the seizure created a new debt.  The FTB assessed a $150 seizure fee that was not taken during the original raid on the son’s account, so the FTB threatened to levy on the father’s accounts again to satisfy the $150 still owing.

A few lessons here: first, the FTB is a harsher agency than the IRS.  After having worked at IRS, I believe it is more likely that the IRS would have returned the son’s money.  The FTB is harsher on collection matters because it has a different relationship to citizens than the IRS.  The IRS feeds the world’s largest pot of money; it’s also part of the Treasury, an agency that can just print more dollars. Dollars going back to the Treasury are like pouring water into the ocean, or electricity going to ground.  If someone doesn’t pay his taxes, the Treasury won’t miss it.  The state treasury will miss it much more immediately.  To make up any budget shortfalls, the state needs to issue new bonds, or declare bankruptcy (can a state declare bankruptcy?  Probably not; that discussion is worth another article).  In short, the FTB doesn’t have the fiscal flexibility to be nice; it must take such dramatic measures as it did against my client – whether it was ethical or not.

Second lesson: to avoid a similar incident, parents should set up an account under the Uniform Transfer to Minors Act (Cal. Probate Code § 3900 et seq.). The account needs specific language in the name.  If the proper procedural steps are followed, the state is bound to respect the ownership of the account.

A note that interests lawyers, though not laypeople: even though it’s called a “uniform” law, meaning that the language is the same in every state that adopts it, the actual provisions may not necessarily be the same in each state.  Courts in different states may interpret the same phrase in the Uniform Transfers to Minors Act differently.  The California legislature may have decided that the model statute needed to be improved in some way, so the California version may read differently than the Nevada version. When you set up an account like this, there are pitfalls.  Talk to a lawyer.  We can help.

Declaratory Judgments for Dischargeability

When discharging taxes, I have always thought that it was the best practice to seek a judgment from the bankruptcy judge that the taxes are discharged. That’s because unlike many other nondischargeable debts (fraud, malicious tort, etc.), the debt may remain in force with no further word from the court. The IRS or the FTB could come back five years after the discharge and just start collecting on taxes where it wasn’t made explicitly clear that the tax was discharged. A declaratory judgment gets rid of this ambiguity.
I’m changing that stance now.
Up until now, I have operated on a simple procedure: I file an adversary proceeding for a declaratory judgment stating that the taxes are discharged, the IRS either stipulates that they are, thereby ending the issue, or it doesn’t stipulate and the parties go through a trial to determine dischargeability. Section 523 gives six exceptions to dischargeability: the assessment is from a tax return due less than three years before the bankruptcy petition; the assessment is from a tax return actually filed less than two years before the bankruptcy petition; the assessment occurred less than 240 days before the bankruptcy petition (think of an audit assessment); the tax return was never filed; the assessment is from a fraudulent return; or the taxpayer willfully attempted to “evade or defeat” the tax (some of these clocks can be tolled under circumstances such as offers in compromise or prior bankruptcies, but that’s a discussion for another day).
The first five exceptions are very easily determinable: either the number of days or the filing exist, or they don’t.
It is not always so easy to determine whether the taxpayer “evaded” tax. The tax authority merely needs to prove that the taxpayer knew about the tax liability and did something (or failed to do something) to avoid paying the tax. This could be as small as paying $3,000 for a kid’s tuition, or a trip to Las Vegas with a fine dinner and some casino time, during a period when tax was owed.

Here are some cases on evasion:
Dalton v. IRS, 77 F.3d 1297 (10th Cir. 1996)
In re Fegeley, 118 F.3d 979 (3rd Cir. 1997)
U.S. v. Jacobs, 490 F.3d 913 (11th Cir. 2007)

While the burden is on IRS to prove evasion, the evidentiary standard is low, and yet the IRS very rarely asserts this exception. In 10 years as an attorney practicing bankruptcy law within the IRS, I never saw this exception asserted.
Recently, the Department of Justice changed its policies on stipulating to dischargeability of tax. The local US Attorney’s Office no longer stipulates to dischargeability across the board. It requires the taxpayer-debtor to stipulate that the United States may later rely on the evasion exception if it uncovers evidence. That somewhat defeats the point of the stipulation: the IRS could administratively determine, five years after the discharge, that the debtor had actually evaded the payment of tax, and open collection proceedings. Our clients could first learn about this when the IRS files a notice of federal tax lien against them. The client’s recourse is to then re-open the bankruptcy case and prosecute another adversary proceeding against the IRS.
In other jurisdictions, the United States has started to move to dismiss these declaratory adversary proceedings on grounds of ripeness or nonjusticiability. The IRS argues that there is no controversy: it will admit that the tax is dischargeable under five out of the six tests, that it has administratively abated the tax, and that it is not threatening to collect the tax. No controversy, no need for a judicial decision. Midwestern courts agree. See, for instance, In re Mlincek, 350 B.R. 764 (Bankr. N.D. Ohio 2006), or In re Erickson, Case No. 12-59165, Adv. Pro. No. 12-05546 (Bankr. E.D. Michigan 2013). (The IRS hasn’t yet succeeded in dismissing these cases in California).
So what do I advise now? Today, I cooperate with what the IRS wants us to do here: get your discharge, then call the bankruptcy specialist to ask what tax years are discharged. If you agree with the IRS’s answer, leave it alone. If you disagree, ask why the IRS analyzes it differently than you, and take a deep breath before filing suit to get a declaration of dischargeability.
Why the deep breath? Because the lawsuit may well become more expensive than the taxes being discharged. Your adversary in bankruptcy court will be a Special Assistant U.S. Attorney, directed by the Tax Division of the Department of Justice in Washington, DC, answering to Eric Holder. My experience of the Tax Division is that it is staffed by very intense and driven attorneys living in a cocoon who see their patriotic duty as expanding the law in favor of the government; it will often require its attorneys to argue cases that the IRS itself (answering to Jack Lew) is willing to concede.
This strikes me as unsatisfactory, but I must defer to practicality. We represent taxpayer debtors. At the moment when they get their discharge, they have, by definition, few assets. They cannot bankroll a lawsuit against the Department of Justice when it is willing to throw highly-trained bodies from across the country in the service of vindication of a highly esoteric point of law.

Business owners owing back payroll taxes often ask me why the IRS won’t lift its levy. After all, these clients argue, I just need a bit of free cash to invest back into my business and then I’ll make enough money to pay what I owe the IRS. Why can’t the IRS act more like my business partner – if I make more money, than we’ll both be better off?

While this reasoning is intuitively appealing – after all, isn’t payment of taxes what the IRS seeks? – it also overlooks how the IRS fundamentally differs from a business partner, and thus overlooks the incentives that IRS agents face and that result in the enforcement of levies for payroll taxes even if that enforcement bankrupts a business.

First, the IRS has no assurance that a faltering business that was unable or unwilling to make payroll tax payments in the past will do so in the future. Think about it: the only evidence the IRS has of the business’ future reliability to grow its business is the past failure to make required payroll tax payments. This is what’s known as negotiating from a position of weakness, and is highly unlikely to persuade a revenue officer to cut you slack.

Relatedly, the IRS is not a bank and revenue agents are not loan officers. The IRS has neither the mandate nor the expertise to decide on a business’s creditworthiness. After all, asking the IRS to lift a levy is like asking it to loan money to the business. Making such financial decisions, or even analyzing the documents on which such loan decisions are made, isn’t part of revenue agents training or skill set.

Second, even if revenue agents had the discretion to lift the levies on some businesses, do we want that? What if your business got the “hard-nosed” revenue agent, while a competitor of yours in a similarly-bad financial position was assigned an “easy” revenue agent: your levy is enforced and kills your company, while your competitor’s levy is lifted, giving them the chance to remain in business for at least a while longer, simply because you were unlucky on which revenue was assigned to your case. Unfair? You’d have a right to be steamed.

Please understand, I used to counsel collection officers at the IRS. They were conscientious, surprisingly kind people. Many were military veterans. And they all saw their job as making sure that everyone felt the same pain from the enforcement of tax laws. This meant that taxpayers couldn’t “buy” laxer enforcement with a promise of making more money if they could just use the taxes owed as a temporary loan.

Finally, the collection officers’ commitment to the consistent enforcement of the tax laws underscores that the IRS is first and foremost a law enforcement agency. As such, it views a business owing payroll taxes as having committed a criminal act, namely stealing employees’ tax payments for private and unauthorized use. For this reason, revenue agents are rewarded for closing cases, not for the amount of back taxes collected. The IRS is in the business of tax compliance – a mandate that needs to be carried out as consistently and fairly as is humanly possible in order to preserve the credibility of the agency and government (just think about the recent brouhaha over “tea-party” scrutiny).

So, the bottom line for business owners facing levies for back payroll taxes: the IRS never has and never will be your banker, no matter how convenient it would be for you if it were.

What happens when I meet the trustee?

Every bankruptcy case has a Meeting of Creditors, often called the “341 meeting.”  It occurs about 30 to 45 days after the petition is filed.  My clients often tell me that they are scared of the meeting: will they need to explain why they filed bankruptcy?  What if they say the wrong thing?  What if the trustee decides not to approve their bankruptcy?

The hearing takes place in front of the trustee.  It’s in a separate office from the courthouse.  In chapter 7 cases, trustees spend the whole day questioning debtors, who wait and watch the other debtors.  When it’s well-run, the 341 meeting lasts about five minutes; a debtor can expect to be at the office for an hour, waiting for his case to be called.

Some trustees require a debtor to complete a questionnaire, others don’t.  All trustees require the debtor to read a pamphlet with information on the bankruptcy process.

Each debtor has to produce identification (driver’s license, passport, military id) and proof of social security number (original card is best, but an original W-2 or health insurance card with the entire number will work).  The trustee’s assistant verifies the numbers and identification.

The debtor is put under oath, and the trustee records the proceedings.  So it’s natural to be a bit nervous about it.  The trustee has a standard patter of questions:   Are you who you say you are?  Did you intend to file bankruptcy?  Is that your signature on the petition?  Does your petition list everyone you owe and everything you own?  Are there any mistakes on it?  Did you read the green pamphlet Here’s a more complete list of questions from another district.

If the trustee is interested in any particular item on the petition, he’ll ask questions about it.  But because he has dozens if not hundreds of other debtors to question that day, he doesn’t want to spend much time on a single person.

My advice to debtors facing a 341 hearing: listen to the trustee’s question, answer only the question asked, and tell the truth when doing so.

The meeting usually goes very easily, and my clients tend to wonder what they were so worried about before the meeting.

Bankruptcy: Redemption, not Failure

I like to say that I am involved in “capitalist recycling.” In a capitalist, free-market society, there are people who win and there are people who lose. Those people who do not win and cannot function economically because of crushing debt need to come back into the system and function again. By helping them through bankruptcy, I provide redemption; I like to say that capitalism without bankruptcy is like Christianity without forgiveness.
I recently read “The Antidote: Happiness for People Who Can’t Stand Positive Thinking,” by Oliver Burkeman. He devotes a chapter to embracing failure as a way to live a fuller and ultimately happier life. And he ties our current notion of failure to our ties to the economic system (at page 176, quoting from “Born Losers”, by Scott Sandage):

“ . . . the idea that a person could be ‘a failure’ [sprang] directly from the growth of entrepreneurial capitalism . . . One crucial development was the emergence of credit rating agencies, whose role was to sit in judgment upon individuals seeking loans from banks, helping the banks determine the risk they would be taking by making a loan. In a society increasingly dominated by business, a bad credit rating could all too easily come to be seen as a verdict condemning a whole person – and it is from the language of credit rating that we take several modern idioms for describing someone’s moral worth, such as ‘good-for-nothing’ and ‘first-rate.’ . . . From the middle of the nineteenth century onwards, failure started to be thought of ‘not merely as a cataclysm that adds to the plot of your life, but as something that stops your life cold . . . Failure, in short, came to be seen as a kind of death.”

I try to encourage my clients to see their identity as being more than their level of functionality in the economic system, and I try to redeem their status so that they may function in that system. I think the Stoics, Buddhists, and others quoted by Burkeman would do the same in my shoes.

34 Things Not to Do before Filing Bankruptcy

1. Do not leave out any Bank, Checking, Savings, Brokerage, Credit Union accounts from your schedules.

2. Do not file if your income is greater than your expenses.

3. Do not use your credit cards.

4. Do not take Credit Card Cash Advances.

5. Do not use convenience checks offered from any credit cards.

6. Do not do balance transfers between credit cards.

7. Do not pay money owed to Family Members.

8. Do not pay money owed to Friends.

9. Do not tell a creditor that you intend to pay.

10. Do not leave assets off of your paperwork.

11. Do not file if you are about to receive a tax return or an inheritance. Discuss the timing with your attorney.

12. Do not fail to tell your attorney about your small business, sole proprietorship, partnership, LLC, LLP, LC, corporation, or hobby.

13. Do not purchase a home shortly before filing bankruptcy without consulting your attorney.

14. Do not give away or gift any property to anyone.

15. Do not pay more than $600 on any past due bill without first consulting your attorney.

16. Do not transfer (title or deed) property to anyone.

17. Do not cash out retirement plans or 401k’s.

18. Do not take out a second mortgage.

19. Do not gamble.

20. Do not hide your assets or debts.

21. Do not take out “payday loans.”

22. Do not put your money in your kids’ bank accounts.

23. Do not omit or ‘save’ a credit card for you to use after your bankruptcy.

24. Do not fail to list debt to family or other “insiders.”

25. Do not write bad checks.

26. Do not borrow money.

27. Do not forget to tell your attorney about liens you may have on your home or unpaid judgments. They may be avoided.

28. Do not make major financial decisions without talking to your attorney.

29. Do not get married before filing if your spouse has a high income.

30. Do not misrepresent facts to your attorney.

31. Do not run up your credit cards in advance of filing bankruptcy.

32. Do not fail to appear at State court hearings, trial or proceedings; coordinate this with your attorney.

33. Do not hide from your attorney. Keep them up-to-date with your address, phone number and email address.

34. Do not bank where you owe money. Close the account and reestablish an account somewhere else. Social Security debtors who do this have a lag time of a few months because it sometimes takes that long for SS to get it done. If you are pressed to file then clear out the account as soon as the deposit hits the bank. This also happens with payday loans. Many of these companies will have a debtor sign a form to permit them to withdraw money from the account on a regular basis and these are nearly impossible to stop.

Note: Ask your attorney about accounts that might get frozen whether or not you owe that institution money or not.

Credit: National Association of Consumer Bankruptcy Attorneys

Statutes of Limitation, the IRS, and the FTB

A potential client called me last week for help in dealing with the IRS.

It seems he owed a lot of taxes for tax years from 1992 to 1996. Had he filed the returns on time? Yes. Had he filed bankruptcy in the meantime? No. Had he filed an offer in compromise? No. Has he heard anything from the IRS in the last three years? No, but he thought that was because he had moved and not written to the IRS collection department to tell them about the move. Has he filed a tax return from his new address? Yes.

I told him not to worry, that he probably didn’t owe the taxes anymore because it took more than 10 years for the IRS to collect those taxes. And it occurred to me that I should explain how statutes of limitation can work to the taxpayer’s advantage.

Audit and Assessment – Three Years IRS, Four Years FTB

The IRS has a three-year limitation period on assessment from the time of the return’s filing. That means that if three years pass from the time you, the taxpayer, filed your return, the IRS can no longer audit you for that tax year.

Sounds simple, right? But when did you actually “file the return?” Let’s take a return for the 2011 tax year. If you filed it before April 15, 2012, the law says that the return was filed on April 15. If you had an extension until October 15 and filed the return on September 1, the limitation period starts on October 15.

If you filed the return late, the law says that it was filed on the day the IRS received it.

In California, the Franchise Tax Board generally enjoys more liberal state laws than the federal IRS. The FTB has four years to assess more taxes on a filed return.

There is a big difference between how the IRS and the FTB go about “assessing” a tax, and how their audit procedures work. For the IRS, assessment occurs at the end of the audit process. Thus, the IRS generally tries to reach potential audit targets within a one-to-two-year window after the return is filed. If the three-year clock has been ticking for two years and ten months, and you haven’t heard from the IRS, you are unlikely to get audited for that year – although there are relatively uncommon exceptions. The IRS has to start its audit soon enough that it can complete the process and issue a Statutory Notice of Deficiency more than four months before the end of the limitation period, for reasons that are too complicated to mention here.

The relatively uncommon exceptions? The IRS gets six years to audit you if it can show a large understatement of income, and if it can show that your return is fraudulent, it can open the audit and assess at any time; there is no statute of limitations on a fraudulent return.

The FTB, on the other hand, assesses the increased tax as soon as it smells a problem. Like a deputized posse member who shoots first and asks questions later, the FTB starts its process with a Notice of Proposed Assessment; this counts as the “assessment” for purposes of the statute of limitations. This notice can be mailed on the last day of the four-year clock, and it’s still effective.

If the taxpayer gets audited by the IRS and agrees to a higher assessment, the taxpayer has a duty to inform the FTB within six months. The FTB then has two years to make its assessment. If the taxpayer doesn’t make the six-month deadline, there is no limitation period – the FTB has an infinite amount of time to make the assessment.

These assessment clocks can be tolled (and often are) by agreement between the taxpayer and the taxing authority. Sometimes this is a good idea, especially if the taxpayer just needs a bit more time to gather records to show to the auditor. Sometimes it’s a bad idea, if the tax authority’s case is not very strong.

Obviously, the laws strongly favor the taxing authorities: our legislatures want to make sure that people do not get out of taxes owed by skillful procedural. And while the FTB’s laws sound even more tilted against the taxpayer, there is a counterbalance: the FTB is generally less effective at opening and closing audits, and investigating a taxpayer’s affairs, than the IRS. “Generally,” of course, doesn’t mean that it can’t be extraordinarily effective if it wants to be.

Collection – Ten Years IRS, Twenty Years FTB

Once the assessment is made, the taxing authority then has to try to collect it. The IRS has 10 years. The date that the collection authority ends is called the “CSED” (Collection Statute Expiration Date). The ten-year clock can be tolled by any of several events: bankruptcy, offer in compromise, or collection due process hearing. Installment agreements do not toll the collection period.

For the FTB, the statutory period is 20 years. Installment agreements, bankruptcy, military service, presence in a disaster area, and child support collection actions all toll the statutory period.

While I have counseled taxpayers at the end of the IRS’s 10-year period, I have never counseled anyone at the end of the 20-year period. The main reason is that the statute of limitations is less than 20 years old: prior to July 1, 2006, there was no statute of limitations on collection actions for income tax in California. No one has yet had their California tax liability extinguished by operation of time.

Period before Dischargeability in Bankruptcy – Three-year, Two-year, 240-day Rules

Taxpayers may discharge their liabilities in bankruptcy. However, the law requires the taxing authorities to have a chance to collect those liabilities before the taxpayer can discharge them. Thus, 11 USC Sec. 507(a)(8) and 523(a) work together to create several rules, familiar to most bankruptcy attorneys: in order for a tax liability to be discharged, it must come from a return last due more than three years before the bankruptcy filing (this is October 15 if the taxpayer got an extension), actually filed more than two years before the bankruptcy filing, and the tax on that return must have been assessed more than 240 days prior to the bankruptcy filing (this becomes relevant in an audit situation). These periods may be tolled by bankruptcy, collection due process hearings, and offers in compromise.

Because these rules are set by federal bankruptcy law, not federal and state taxation law, they are identical for the IRS and the FTB. But there is yet a wrinkle between the two: the 240-day rule operates slightly differently for the FTB than for the IRS.

The “assessment date” for the IRS is straightforward: it is the date appearing on the transcript, the date that the tax return was received, the taxpayer agreed to an increased assessment, or the date that a Tax Court decision became final. For the FTB, it is the date that the assessment proposed in the Notice of Proposed Assessment becomes “final.” While the NOPA serves as the assessment date for all kinds of clocks (including the inter-agency agreement determining priority of liens), it does not serve as the starting period for the 240-day rule. Rather, the 240-day clock starts 60 days after the NOPA, thus effectively giving the FTB a 300-day period before dischargeability is allowed.