Archive for the ‘ Tax Collection Issues ’ 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.

Tax “Love Gifts”

Churches and ministers receive many tax breaks: churches do not need to withhold social security taxes from their ministers’ pay; churches receive income tax-free; and ministers do not pay tax on the cash value of church-provided housing. But receiving a tax-free salary is not one of the breaks ministers receive.

I have client who’s a minister and is trying to come clean to the IRS after years claiming that he owed no income tax. He has come to his senses and wants to “render unto Caesar what belongs to Caesar,” (Matthew 22:21) and start paying his back taxes but in such a way that the IRS doesn’t take all his income.

To get to this happy result, he and I need to report his ongoing income -not just because it belongs on his tax return, but because we need to show the collection agent how little income the minister collects above what the IRS budgets for living expenses before they beginning levying on everything above that amount.

However, determining my client’s exact income is challenging, primarily because a substantial portion of his income comes from self-described “love gifts,” or cash donations made directly by church members to him personally at the behest of the church’s deacons. In churches where this is a tradition, the congregation is asked not to record the donations or seek a tax deduction, specifically so that the minister may receive the money tax-free.

No matter how generous the intention behind this practice, it’s still illegal. The income tax applies to “all income from whatever source derived,” in the uncompromising words of the Internal Revenue Code. Just because the money showed up in a way that the IRS cannot trace (cash donations) does not mean that it was not income to the minister.

But aren’t gifts excludible from income? Yes, except when an employment relationship exists, such as between a minister and his church, then all payments are assumed to be made within that relationship, and the income must be included on the tax form.

My minister thus will have a tough time getting himself right with the IRS, because the prior “love gifts” are taxable, and because he will need to keep track of all cash he receives in the future. I’d recommend to the church that it make these gifts by check, so that the donors can get a deduction and so that the minister has an easier time keeping records.

In the interim, we can contemplate his parish’s lovely generosity on this Valentine’s Day…

It’s satisfying when tax law actually does the right thing morally – such as providing a strong financial incentive to pay spousal support on time. Here’s an example.

David and Christie Iglicki divorced in Maryland after eight years of marriage. David was ordered to pay Christie $735 per month in child support and $1,000 per month in spousal support.

David moved to Colorado shortly after the divorce, and stopped paying. In 2003, Christie successfully sued him for back spousal and child support. Tax law does not allow David (or anyone else) to deduct child support payments from their taxes. However, spousal support is deductible. But what about when the spousal support is not made in a timely monthly manner, but rather is the result of a legal judgment, as is the case with the $39,350 portion of the judgment Christie received for her spousal support – a judgment rendered almost a decade after David first stopped paying? Is that tax deductible? Here’s where the tax court said no.

In the normal course of business, I would have advised David to deduct the spousal support portion of the judgment because judgments are typically deductible, and blind with respect to the nature of the underlying judgment. However, the Tax Court found otherwise in Iglicki v. Commissioner, T.C. Memo. 2015-80, making thenature of David’s judgment a central feature of its decision.

The Tax Code defines deductible alimony as any payment received by a spouse under a divorce or separation document, where the document (1) does not designate the payment as includable in the payor’s gross income, (2) the payee does not live in the same household at the time of the payment, and (3) the payor has no further obligation to pay after the payee dies. I.R.C. § 71(b)(1).

Applying this rule to David’s garnished wages, the Court noted David paying a judgment for a specific amount, and that Christie’s heirs could continue to collect it until satisfied in full. Also, the Court pointed out that the judgment was not a divorce agreement or judgment; it was a money judgment. The Court reasoned that David had had every opportunity to pay the alimony on time, and thus take the tax deduction. However, because David failed to pay alimony on time, he thereby lost the privilege of taking the tax deduction on the back alimony. In short, David had to pay Christie $39,350, in after-tax dollars.

The opinion mentions nothing about Christie’s tax debt. It would seem right to allow her to collect the past-due spousal support without paying tax on it; after all, it was paid in after-tax dollars. However, because she lives in a separate household from David, the payment was income to her, regardless of whether David was taxed on it. She would need to declare the income on her tax return, too; Uncle Sam gets two bites at this transfer of funds.

Moral of the story: if you want to take advantage of tax breaks, be sure to follow the rules governing the break in their entirety. Oh, and don’t expect a deduction for alimony if your spouse had to sue you to collect.

US Tax Treatment of Foreign Bank Accounts

The United States has an unusual tax regime: it taxes its citizens and residents on their worldwide income, not just on what is earned in the United States. The only other country that does this is Eritrea. Can you even find Eritrea on a map? What else does it have in common with the United States?

Because of this regime, the US government has always pressured tax haven countries to disclose more of their account-holders’ data. Diplomatic efforts have finally cracked open the Swiss banking system: after centuries of secrecy, Swiss banks are now required to disclose the names of their US account holders to the US Department of Justice.

US taxpayers have been required to report these accounts for years. However, taxpayers treated this requirement as voluntary, since there was no way for the IRS to verify unreported foreign investment earnings in the absence of reporting by the foreign banks. No longer.

Foreign nationals living in the US and US citizens holding foreign bank and investment accounts must file FBARs (Foreign Bank Account Reports) annually. When they haven’t been filed, the taxpayers must file reports for past years. Fines are staggering: up to 50% of the account’s value for every year missed. It’s possible to rack up more in fines than the account is worth.

If you know someone with this problem, I can help. Have them call me.

Debtors can discharge their taxes in bankruptcy so long as they meet certain tests: the three-year test, the two-year test, the 240-day test and no fraud. I lay it out in the first paragraphs here  and in the last paragraphs here .

One of the tests is that the return has to have been actually filed: “A discharge … does not discharge an individual debtor for any debt … for a tax or a customs duty … with respect to which a return … was not filed or given.” 11 USC § 523(a)(1)(B)(i).  A “return” must satisfy non-bankruptcy law, and can be a return prepared by the IRS under IRC § 6020(a), but not under 6020(b). 11 USC § 523(a).  Got that?

This jargon and its cross-references mean that a taxpayer has to have submitted their own good-faith tax return in order to have the resulting tax be dischargeable.  Under IRC § 6020(b), the IRS can prepare a return without the taxpayer’s cooperation and make an assessment on it.  This is known as a “substitute for return” (or SFR), and its assessment is never dischargeable.  The taxpayer can never replace the SFR with a late-filed return after taxes owed from an SFR have been assessed.

How do you know that the IRS has filed a substitute for return?  You look at the taxpayer’s account transcript.  The first entry is almost always under TC (transaction code) 150.  When the taxpayer files his own return, the entry states “tax return filed,” and it shows the taxes due on the return, such as here.  When the IRS files the taxpayer’s return, the entry states “Substitute tax return prepared by IRS,” and it shows a dollar entry of “0.00,” such as here.

Just because the IRS has filed a substitute for return, however, does not mean that the IRS has assessed a tax based on that return.  The SFR is only one step in the audit process: it comes after the IRS has failed to reach the taxpayer, but before it has figured out how much the taxpayer owes.  Having filed the substitute for return (usually a blank form 1040), the auditor sets it aside for a few months, then pulls wage and income transcripts to find out how much money third parties report that the taxpayer received.  The auditor figures out the tax owing based on no deductions and single filing status; in other words, the least advantageous situation for the taxpayer.

But sometimes a taxpayer shows up after the SFR has been filed, and before the IRS has assessed the taxes. If the taxpayer brings the IRS information regarding his or her liability, signs a tax return, and hands it to the auditor, that is “filing” a return.  If the IRS assesses the tax based on this return rather than its audit, then the tax is dischargeable.  If the IRS rejects the return because it does not appear honest, then the tax can’t be discharged.

IRS personnel will routinely deny discharge to any tax year that shows a substitute for return. They don’t take the extra step of looking to see if the taxpayers filed a return after the SFR and before assessment.  I have recently been successful in overturning this decision by showing that the taxpayer filed a return after the SFR was filed but before it was assessed.  On the account transcript, this shows as a “duplicate return filed.”

The key here is what led to the assessment of the tax: was it the IRS audit, or was it the taxpayer’s proffer of information?  If the latter, then the tax will be dischargeable, even if IRS initially balks at discharging it.

There are hundreds of strategies for handling IRS issues. But not all strategies are as effective as others.

A car-repair owner got audited and brought his tax-return preparer (Jim) to handle the audit. The preparer said to give the IRS as little information as possible . “The IRS won’t want to go to trial, and they’ll cave in at the last minute,” he said. But something didn’t seem right to the car-repair owner. Perhaps it was the approaching trial date, the lack of apparent concern on the IRS side or (most likely) the way the IRS threw Jim, the return preparer, out of the meeting when Jim became too confrontational. Whatever the reason, the tax-payer called me.

I explained why Jim’s advice was off-base: the law requires that taxpayers prove their expenses; the IRS does not disprove expenses. Unless there is a receipt and a valid reason for an expense, the IRS – and the Tax Court – will not allow it. Trial for an IRS attorney litigating expenses is a walk in the park; the IRS does not ‘cave’ in these situations, no matter how aggressive or obnoxious your accountant or tax attorney is.

I also told the taxpayer a bit more about ‘Jim’. I had handled a case against him when I was an IRS attorney and he obstructed that case to the point where I needed to tell the taxpayer to fire him. Jim was a disbarred attorney from another state. His advice routinely lost his clients’ cases, while costing them thousands of dollars.

I worked to get the best outcome for the car repairman, despite a poorly-prepared return. Jim had included many unsubstantiated expenses. My client ended up owing, but the audit ended more quickly and the final bill was lower than if Jim had continued stonewalling the IRS.

When it comes to expense substantiation, it’s always best to provide information, documentation, and answer questions quickly. Any advisor who tells you otherwise is simply wrong. Check credentials: a valid law license or an up-to-date CPA license won’t guarantee a good result, but they do indicate some level of responsibility.

If the government can prove that you “willfully attempted in any manner” to “evade or defeat” a tax, then you cannot discharge that tax debt in bankruptcy. 11 U.S.C. 523(a)(1)(c).   I’ve always seen this as a very low bar for the IRS to prove, because the elements are simple: 1) the taxpayer had a duty to pay a tax; 2) the taxpayer knew that he had this duty; and 3) the taxpayer voluntarily and intentionally violated that duty. Payment of any expense beyond subsistence, such as a child’s college tuition, at a time when taxes remain unpaid, could meet the standard. That’s what the cases around the country teach.

The 9th Circuit, however, has changed the standard here in California and elsewhere in its domain. In Hawkins v. FTB, Case No. 11-16276, decided on September 15, 2014, the court has held that the taxpayer needs to have a specific intent of evading tax for this discharge exception to apply. Outside the 9th Circuit, a “willful attempt “ to intentionally violate the duty to pay tax means a deliberate act that results in nonpayment of tax. Here in the 9th Circuit, the “willful attempt” means a deliberate act with the intent of evading tax.

The facts in Hawkins are rather shocking to this former IRS attorney. The debtor-taxpayer made a fortune in Silicon Valley enterprises, and tried to shelter some of his capital gains through sophisticated yet dubious transactions. A large tax bill ensued, and then his enterprises lost a great deal of money. Yet he continued to live large: in the face of of a $25 million tax bill, he continued to maintain two residences worth a total of more than $6 million, and bought a fourth family car (in a two-driver family) for $70,000. The family spent between $17,000 and $78,000 more per month than its income for several years.

I think that the result in Hawkins is wrong. This kind of spending by a taxpayer who knows he owes $25 million in taxes is dishonest. As a taxpayer, I do not want my fellow Americans to get away with this by saying “gee, I wasn’t trying to avoid paying the taxes, but I just couldn’t stop myself from spending.  But I do salute the attorneys who reached this result. It is a good result for my clients, and I intend to use it until the Supreme Court reverses the 9th Circuit.

To the IRS, Every Tax Period Stands on Its Own

I received a call recently from someone already represented by a tax attorney, but who wanted my opinion on whether there was anything his attorney could have done to avoid the following, very unfortunate situation.  John Barrett owed a bunch of employment taxes on his own. He tried to make arrangements to pay them, and made good use of the Collection Due Process provisions in the Tax Code: he filed four cases against the IRS in the Tax Court to challenge the way the IRS was trying to collect almost $85,000. He settled those cases with an agreement that the IRS would place these liabilities “in a Currently Not Collectible status due to the petitioner’s financial hardship.” This is a good result, because it means that the IRS will go away and not try to collect these liabilities.

Unfortunately Barrett had other liabilities: he and his wife Carol owed $10,000 in joint income taxes for the 2002 and 2009 tax years. The IRS tried to levy on their bank accounts, so together the Barretts filed another Collection Due Process case (Tax Court case 1576-12L). They claimed that the legal doctrine of “res judicata” (“the thing has been decided”) required the IRS to make the joint income tax liabilities non-collectible too. After all, if financial hardship prevented John Barrett from paying the $85,000 in back employment taxes, that same hardship ought to extend to the $10,000 in income tax owed. When the IRS asked for financial documentation to determine collection alternatives, the Barretts produced only the signed settlement agreements from John’s employment tax cases.

The IRS disagreed that it had decided that the income tax liabilities were non-collectible, and so did the Tax Court (T.C. Memo. 2013-256). “A well-established principle is that the Commissioner [IRS] may challenge in a succeeding year what was accepted in a previous year,” according to Judge Cohen. End result: the IRS gets to levy on any accounts it finds belonging to John and Carol, and it doesn’t need to find the liabilities non-collectible.

The result is tragic, because the Barretts probably could have gotten their joint income tax liabilities into non-collectible status by providing the same documentation that John produced to find the $85,000 non-collectible. The appeals officer considering their situation had already proposed an installment agreement of $340 a month, and offered to do more for them if they provided a financial statement (Form 433A). Had I represented the Barretts, I would have had them complete the Form 433A and provided all requested documentation, while also sending the information from John’s employment tax collection effort to show how the IRS had dealt with the same taxpayer on a different liability. In truth, they may have the chance to do that now, but the IRS will have the legal right to reject their offers to pay on their terms.

The moral of this case: cooperate with the collection officer. If he asks for specific documentation, show it to him. The argument that the IRS had already considered his situation and reached a decision does not hold water, because the IRS treats each individual tax liability as a separate item – each year, each type of tax – as a separate item.

It’s Not Easy Dealing with the Franchise Tax Board

My clients owed the California Franchise Tax Board (FTB) $8,000 for the  2011 tax year; they filed their return late, and couldn’t pay it all at once.

The FTB sent a notice that it was about to levy – standard procedure, it wants to get paid, let’s scare the taxpayers into making an agreement to pay it over time.

If you look at the FTB website, it really discourages people from calling up to make an installment agreement, and my clients feared doing this themselves. So, armed with their banking information, I went online and made the installment agreement for them.  The FTB spat back a confirmation number and thanked me for making these arrangements. The client was going to pay $300 per month until the debt was paid off.

Just to be sure that the levy was going to be stopped, I called the FTB. The collection officer had no record of an installment agreement. I said “but I’ve even got a confirmation number from your website.” The officer told me that this meant nothing, that the FTB wouldn’t do an online installment agreement for an old tax year. But it looked like everything was okay on the installment agreement; if I hadn’t called him, how would I have found this out? The officer said that I would have found out when my client got levied.

I set up the installment agreement with the collection officer over the phone. It costs $34 to do this; I asked if the FTB was going to charge that fee twice, once for the online agreement and once for the phone agreement. He said no, that the online agreement didn’t exist, my clients aren’t being charged for it, and even though the FTB has all their banking records from that interaction, it won’t make automatic withdrawals based on the online agreement.

I don’t quite trust it.

The state taxation system is dysfunctional, fraught with cronyism and unfair laws. There is little oversight. If the FTB goes ahead and levies on my clients, there is little recourse; the clients owe the tax money, and they aren’t legally damaged if they pay that amount quicker through a levy than peacefully through an installment agreement.

So I’m asking my clients to watch their accounts very carefully: if they see the FTB removing two automatic payments, then I’ve got more work to do.