Archive for the ‘ Tax Collection Issues ’ Category

I love having my 18-year-old daughter work in my law firm.  She’s smart and motivated.  She gets to see law in action.  She’s done wonders for my website, and she gets the mail out.

She keeps a timesheet.  I pay her through a payroll company, which withholds funds for income and social security taxes, among other deductions.

Not every employer is as honest and real-world as I am about the employment relation with a child.  Hiring your child is perfectly legal, in fact, I encourage it, but it must be done carefully and transparently.  Some parents mistakenly believe that if they take some of their income and pay a child, they may take a deduction on the payment to the child and the child will pay tax at a lower marginal rate than the parent: a seeming win-win. Not so.

The IRS frowns on these schemes. The latest person to fall foul of the rules is a Ms. Patricia Diane Ross, who took her case to the Tax Court and lost: T.C. Summary Opinion 2014-68.

Ms. Ross owned a Schedule C business, Ross Professional Services, LLC, that helped government agencies staff their operations.  She had three children, ages 8 through 15.  The children, according to Ms. Ross, shredded paper, stuffed envelopes, copied, sorted checks, filed documents, put out the trash, carried equipment, and helped her shop for supplies. For these tasks, she paid the children.  But she made some mistakes that came back to haunt her:

  1. She paid the children in pizza.  Rather than give the children a paycheck, she claimed she kept a ledger of how much they had earned and deducted the cost of their restaurant meals and a tutoring/play activity service from that ledger.  These expenses sounded to the IRS and the Tax Court judge more like the regular kind of a support that a parent is expected to give to her children.

When I represented the Commissioner of Internal Revenue, I came across a family that paid their minor children a very regular wage: $5,000 twice a year, two days before the children’s private tuition bill was due.  The tuition bill got paid out of the children’s accounts.

Lesson one: if you employ your children, pay them in money rather than support.

  1. She did not pay a regular hourly wage.  Dividing “wages” paid by the hours Ms. Ross reported for each kid resulted in an hourly wage varying from $4 to $30 with little correlation between the child’s age, skill, or task, and the wage paid.

Lesson two: if you hire your child, keep good timesheets and pay a regular wage.

  1. She did not withhold Federal income tax or other deductions, saying that the children did not need to file tax returns.  But anyone who makes more than the standard deduction ($6,200) plus the exemption amount must file a tax return.  When the child is being claimed as a deduction on Mom’s tax return, the exemption amount is zero.

Lesson three: treat your employed child as a real employee subject to withholding.

  1. The children got paid for chores: “the activities performed by petitioner’s children seem analogous to . . . washing windows, cleaning screens; shoveling snow; moving grass; tending shrubs, trees, and underbrush; assembling papers; picking up mail.”  The Court found these activities sounded more like parental training and discipline, not services performed by an employee for an employer.

Lesson four: pay your children only for tasks that advance the business, not for tasks that advance the household.

  1. She did not give the children their own bank accounts.  Well, the children actually had bank accounts about 200 miles away (where their father lives?), but Ms. Ross said she was too busy to open local accounts for them.  Thus, she said, it was “more convenient” to pay for things as the children directed her to, matching spending against their “earnings.”  It does not appear that the judge found this explanation convincing.

Lesson five: give your employed children real accounts in a real bank.

I am pleased to say that, if the IRS were to audit my law firm, it would find that my daughter’s earnings are real earnings and a real deduction from the income I collect.




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.

The IRS and the FTB don’t negotiate tax debt. The only leverage taxpayers have against the IRS is “litigation hazard,” that is, the chance to win against the service in court. Neither agency will write off a dime of tax debt because the taxpayer asks it to, because their mission is to inflict financial pain on everyone in accordance with the law.
Audits proceed without regard to whether the taxpayer can actually pay the debt.
But once the audit process is done and there is a number that the taxpayer owes (an assessment), the tax authority starts its collection function. Here, the IRS will write off a tax debt. It actually took an act of Congress – I.R.C. § 7122 – to give the IRS the authority to write off a tax debt. Under this code section, the IRS will enter into a contract with the taxpayer whereby it writes off part of the tax debt, in return for cooperation in paying everything that the IRS could get through collection anyway plus future compliance with tax obligations.
The Offer in Compromise process looks a lot like bankruptcy, only the IRS is the only creditor. The taxpayer provides an accounting of everything he owes, everything he owns, his income and expenses. The IRS computes the amount that it could collect from him (both by seizing and selling assets, and garnishing future earnings), and if it’s offered one dollar more than that sum, it should, in theory, take it.
The process can be complicated. What kind of expenses does the IRS allow, and not allow, to a taxpayer? How does it compute future earnings for a self-employed person? What if you’ve sold a boat before making the offer?
It definitely helps to have someone knowledgeable review an Offer in Compromise before it’s filed. I was reminded of this when I recently reviewed a Tax Court case, Taggart v. Commissioner, T.C. Memo. 2013-113.
In that case, the taxpayer made a huge series of missteps, the IRS denied his Offer in Compromise, and he filed suit to require the IRS to accept it. What kind of missteps? After an initial rejection, the taxpayer never submitted a revised Offer in Compromise to deal with the IRS’s issues; he refinanced property prior to the Offer, but used the proceeds to pay non-IRS debt; he allowed the IRS to assess a higher tax without challenging it at the time, and then claimed in his Offer that he didn’t owe so much tax as was being charged to him.
He appeared without an attorney, and nothing in the case suggested he ever had a lawyer or an accountant or even a friend help him out. Had he talked to me or to any of thousands of competent attorneys, accountants, or enrolled agents around the country, someone could have counseled him appropriately and kept him from his futile Tax Court case.

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.

Debtor’s often have Notices of Federal Tax Liens outstanding at the time they file bankruptcy. How are these handled?

First, a properly-noticed lien survives bankruptcy. It continues to attach to any property owned at the time of the bankruptcy. It does not attach to any property acquired after the petition date.

1. Lien on real property. If the bankrupt debtor owns a house and the IRS has filed a Notice of Federal Tax Lien against the debtor’s real property (in the county records), the IRS will generally keep that notice in place after bankruptcy. The house may be underwater and the IRS lien thus worthless, but if the house appreciates in value, the IRS is entitled to the new value.
If, however, the debtor acquires a new piece of land after filing bankruptcy and discharging his taxes, the IRS lien won’t attach to the new piece of land.

2. Personal property. If there is a Notice of Federal Tax Lien filed against personal property, it attaches to everything the debtor owns on the day of the bankruptcy petition. Once the debtor discharges the underlying tax, the IRS still has the right to seize all your personal assets (even those exempted) to satisfy its lien, but it just won’t. Imagine: you, as a debtor, file for bankruptcy, go through the entire process, get your debts including your tax debts discharged, and then they send the Asset Recovery Team to your house to seize your car and sofas – for which it could get how much at auction? Also, the lien doesn’t attach to newly-acquired property, so it would need to investigate whether the bracelet it proposes to seize and sell came from Aunt Tammy as a birthday gift after the bankruptcy petition was filed. The IRS long ago figured out that the PR and legal problems here are huge, so they’ll go ahead and release the lien.

Whittling a Tax Debt Down from $513,000 to $30,000!

“Impossible,” you’re probably thinking. But it’s not. Here’s why.

My client knew he had $200,000 in tax debt, only $30,000 of which was income tax debt; the remaining $170,000 was for back payroll taxes from a pizza shop he’d owned a decade earlier.

The first issue to address was whether he should file a Chapter 7 or 13 bankruptcy. I advised against a Chapter 7 (liquidation) because my client had almost no tangible assets and thus the IRS would not file a Proof of Claim (for taxes owed) since there would be no way for the agency to get money out of my client. We would miss any chance to find out exactly how much the IRS thought he owed, and contest that amount.

In a Chapter 13 bankruptcy, all creditors step forward to assert what they are owed, and the debtor proposes a plan in which the creditors are paid off over five years. Some debts (secured and priority claims) must be paid in full; other debts (general unsecured, like credit card or stale tax debt) must be paid according to the debtor’s means. If we filed a Chapter 13 for my client, then the IRS would most certainly file a Proof of Claim for the $200,000 it believed the agency was owed since the back taxes could be paid (partially) from my client’s wages over the next 5 years. And, once the IRS filed a Proof of Claim in the Chapter 13, we could contest the amount.

The second issue was the unexpected curve ball the IRS threw at us: in its Proof of Claim in my client’s Chapter 13, the IRS asserted not the $200,000 tax debt we were expecting, but rather $513,000! Huh? The agency was trying to stick my client for $313,000 in payroll trust fund taxes (the taxes withheld by employers for their employees to fulfill Social Security, Medicare and other tax obligations – this is different from payroll taxes which are the employer’s obligations on Social Security and Medicare for their employees) owed to IRS by a non-profit entity in which my client had worked at the VP of Finance years earlier. His reaction to this unwelcomed news? “That’s crazy! I had nothing to do with the payment of withholding taxes in my job there!”

Indeed, the third issue that arose in this case was whether my client was a “responsible person” who had “willfully” failed to withhold and pay withheld payroll taxes on behalf of the non-profit organization’s employees. My knowledge strongly suggested he did not meet the IRS’s “responsible person” criteria: my client did not have check signatory privileges, nor did he have the discretion to choose to pay another creditor over the IRS. (The IRS views non-payment of trust payroll – the taxes withheld from employee’s paychecks – as almost criminal: it will treat as a thief any agent of an organization who had the power to withhold employee wages and the discretion to choose which creditors of the organization to pay – the so-called “responsible person” who failed to pay the withheld wages to the government.) Obviously, we objected to the IRS’s claim that my client was responsible person. Unsurprisingly, after interviewing my client and doing a search of the documents at the non-profit organization, the IRS agreed that my client was not a “responsible person” for the $313,000 of owed trust fund payroll taxes at the non-profit he’d worked at. Whew – unexpected curveball successfully addressed.

Now on to the original $200,000 tax debt, $170,000 of which was outstanding FICA and FUTA tax owed by the debtor’s pizza shop. The pizza shop was never incorporated, so the client owed the payroll tax as an employer. The IRS never took the extra step of assessing the debtor as a responsible person for any portion of this tax, and the statute of limitations has passed, so it can no longer find him personally liable for the trust fund portion of the payroll tax. This is an important distinction: the payroll tax is dischargeable in bankruptcy, the trust fund tax is not; here, the debtor was able to put the payroll tax into the bucket of dischargeable taxes, saving himself $170,000.

The final tab: only the $30,000 in income taxes. That’s right: we went from $200,000 owed to the IRS, to $513,000 owed, to a final outcome of $30,000 owed! That $30,000 by the way, will be paid out over five years in my client’s Chapter 13 bankruptcy – or $6,000 annually which breaks down to $500 a month. I know. I didn’t hope for, or believe in, such a positive outcome at the beginning of this case either. But, the outcome of this case reaffirmed three claims I often make to my clients or potential clients on tax matters.

First, the IRS is not infallible: it makes mistakes and will admit to them when challenged. Second, it is not difficult to challenge the IRS. If the agency does not have good evidence to back up its claims against you, it will fold because it is an agency with limited resources and it will concentrate its money and manpower on more promising cases. It’s also a conservative litigator: with the law so heavily on its side, it tends to give taxpayers the benefit of the doubt in close factual situations. If your facts are good, the agency will often back down even when it sees a reasonable chance it could prevail. But note: if you’re just trying to shirk taxes you legitimately owe, then no amount of legal mumbo-jumbo will get you off the hook. Third, the cost-benefit analysis of hiring good legal counsel on tax issues is often a no-brainer. In this case, my fee to the client was around $10,000. For that amount, my client saved $483,000. While this was an unusually positive result, the amount you can save by hiring an experienced tax attorney often is very disproportionate to what you can save in debt to the IRS. Lesson? At least speak to a tax attorney before you concede to the IRS. Good, ethical attorneys will be honest with you about whether you have a good reason to contest an IRS judgment.