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Choosing a Tax Professional

Houston Tax Attorney

1

Choosing a Tax Professional

Who should you hire when you have a tax problem?

Enrolled Agent (EA)

An enrolled agent is authorized by the IRS to represent taxpayers before the IRS for audits and collections. EAs can advise and prepare tax returns. While there is no educational requirement to become an EA, there is a short exam administered by the IRS that a person must pass in order to become an EA.

Certified Public Accountant (CPA)

The educational and licensing requirements for obtaining a CPA are:

  • 5 years of education (bachelors and usually a masters)
  • A passing score on the CPA exam

CPAs do not all specialize in tax. The accounting profession is broken down into internal audit, tax, and consulting. Even within tax, CPAs can specialize in individual, corporate, state and local, and international tax. CPAs prepare returns, ensure you are in compliance with tax code, and maintain business and financial records. A CPA is a great choice if you are current on your taxes and do not have outstanding tax issues.

Tax Attorney (JD)

The requirements for a licensed attorney are as follows:

  • 7 years of education (bachelors and juris doctorate, JD)
  • Passing score on the bar exam

Attorneys can specialize in estate planning, personal injury, criminal law, bankruptcy, immigration, and more. Some may decide to specialize in two or three areas. There is no formal requirement for an attorney to call themselves a “tax attorney” or “immigration attorney.” As with CPAs, you want to ensure that the attorney has experience in the specific area of tax for which you are seeking help. Tax is probably the most specialized of the different practices. Some lawyers will take an additional 1 year of law school to earn a tax LLM in order to learn this specific body of law. However, for attorneys that have tax experience, an LLM is unnecessary.

Attorneys are trained to advocate for your legal rights and will fight to ensure that your rights before the Internal Revenue Service are protected. A good tax attorney should have a solid understanding of IRS procedures for tax controversy cases.

Situations Where you may Need a Tax Attorney

  1. Audit representation – An EA, CPA, or attorney can represent you in an audit, but only an attorney can litigate your case in tax court if needed. There are some exceptions whereby an EA or CPA can take an exam administrated by the US tax court, but only a 100 have passed nationwide in the past 16 years combinedSource. Cases are very rarely litigated and are usually settled prior to trial by IRS Appeals; however, the IRS knows that if you’re represented by an attorney that the case has the potential to go to litigation. The IRS is required to consider the hazards of litigation in determining an appropriate settlement. An attorney can stick with you through the entire process and is able to leave all options on the table when dealing with the IRS. You have much more leverage with attorney representation.

CPAs who specialize in taxation tend to be adept at preparation of income tax returns. But CPAs are not trained in law or advocacy. If a case does not resolve administratively, a CPA is unable to take it to the next level—litigation. Petitioning the U.S. Tax Court, or the knowledge by IRS counsel that the taxpayer’s representative is capable of litigating the case, is important in resolving a tax case. Pursuant to IRS practice, once a case is docketed in U.S. Tax Court, it is sent back to IRS Appeals for another attempt at administrative resolution. IRS Counsel have ultimate settlement authority over a docketed case—they tend to be the most reasonable of all IRS representatives. Forbes

  1. Potential fraud – If you need attorney-client privilege to discuss a potential tax fraud issue. Attorneys can maintain attorney-client privilege and cannot be forced by a third-party, including government entities, to provide confidential information. Under federal law, CPA/accountant-client privilege is not recognized. Enrolled agents may have limited privilege in connection with a tax audit or collections, but it does not extend to tax return work-papers or to criminal proceedings. In order to resolve your issues it is important that you are able to discuss freely with a tax professional without worrying whether the information you provide may be used against you by the IRS, whether in a civil or criminal investigation.
  2. Tax debt – If you owe back taxes, only attorneys can represent you in bankruptcy proceedings. Many non-attorneys in this field are not even aware that federal taxes can be discharged in a Chapter 7 bankruptcy discharge. However, for small tax due balances (under $50K) or where a Chapter 7 is definitely not a option for you, a CPA specializing in tax debt cases should suffice.
  3. Tax return delinquency – If you have not filed your tax returns for many years, you could be subject to fraudulent failure to file penalties and even criminal prosecution in extreme cases.
  4. Unreported foreign accounts – The IRS aggressively pursues individuals who have unreported foreign income and assets, assessing civil and criminal penalties in some cases. There are offshore compliance options for such individuals that a tax attorney can guide you through to minimize your risks.

Can I Afford a Tax Attorney?

Often clients call wondering if they can afford to hire a tax attorney.

First, are you low income taxpayer? If so, there are various free resources available to you. There’s also the Houston Volunteer Lawyers program.

Second, how serious is your tax issue? If you have a simple correspondence audit (an audit letter requesting you to submit documents in the mail), you do not need a tax attorney. Or if you have a small tax due amount less than $50,000, you do not need a tax attorney, unless perhaps you are considering innocent spouse relief.

Third, many attorneys will offer payment plans if you are not able to pay in full.

“Tax Professionals” You Should Always Stay Away From

There is an abundance of individuals that call themselves “tax professionals” that you should never hire. The IRS will almost always hold you responsible for additional taxes, penalties, and interest, regardless of the person who prepared the returns.

Tax resolution firms. “Tax resolution” firms advertise heavily on television, online, and on the radio, promising relief which they can not deliver. They have generic-sounding business names and don’t use any of the owners’ names in the business name. As a result, if the company goes under or enough complaints are filed, they can just shut down the business and open up another with no personal accountability. These firms use high-pressure sales techniques to extract substantial retainers. Unlike lawyers or CPAs, these firms are not subject to any professional regulations. They are allowed to charge whatever fees they are able to extort from their clients. Some common characteristics of these firms are to use BBB accreditation and hundreds of fake online reviews to convince clients of their legitimacy.

Here’s an example of a marketing video for a tax resolution firm that went out of business. They marketed to those with tax debt of greater than $20,000 and suggested they could reduce their debt to $1,500 or less. After being sued by the FTC and thousands of clients they ripped off, the owners probably still walked away with a substantial amount of money. If you’re in Houston, you may also have heard of Tax Masters. They went out of business and the owner spent jail time for tax fraud, and the clients who went to them were left on the hook. Here are some more examples of resolution firms that have been sued and gone out of business:

– American Tax Relief
– Roni Deutch “the tax lady”
– JK Harris

We get a lot of fallout clients from companies such as these, but unfortunately for many clients, by the time they come to us they’ve already spent thousands of dollars without any results.

Unregistered tax preparers. Unregistered tax preparers have no professional certifications and have not been able to demonstrate any sort of tax competence. These tax preparers will seek to maximize your refunds without adequate support in order to get your repeat business. Many will outright steal part or all of your tax refund. While the IRS has been vigilantly trying to shut down these businesses, it’s hard to catch “phantom” unregistered tax preparers who prepare returns but do not sign as the tax return preparer on the tax returns. This makes these individuals hard to detect. You could end up owing a substantial amount of money to the IRS if false deductions and credits were taken. Within the group of unregistered tax preparers, there are businesses called “notario publicos” or commonly just “notarios“. Notarios prey especially on the Hispanic population and take advantage of immigrants’ poor understanding of U.S. law. They mislead and steal from customers. They will often tell their clients that they are attorneys or CPAs. If you’re unsure of a person’s credentials, you can look up their information as follows:

EA verification  |  CPA verification (TX)   |  Attorney verification (TX)

When you are ready to work with an experienced attorney to put your tax problems behind you, give us a call (281) 746-6066.

Rental Property Losses

Houston Tax Attorney

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Rental Property Losses

It is not uncommon for real estate investors to have rental property losses. The goal for many investors is not cash flow, but rather to hold on to the property for future appreciation.

The deductibility of net rental losses on your personal tax return depends on many factors.

General Rule: Rentals are Passive Activities

Under IRC § 469(c)(2), rental income and losses are considered to be passive income/loss, and are therefore subject to passive activity rules. Passive losses can only be deducted against passive income. For example, if your rental home produces a $15,000 loss on Schedule E, you are generally not able to offset your other (non-passive) income against this loss. The loss is carried forward to the next year.

Exception 1: The taxpayer actively participates in a rental real estate activity and qualifies for the $25,000 special allowance.

Exception 2: There is a qualifying disposition under IRC § 469(g). A qualifying disposition would be a sale of the property.

Exception 3: The taxpayer meets the requirements of IRC § 469(c)(7) for real estate professionals.

$25,000 Special Allowance Loss

A taxpayer may deduct up to $25,000 in rental real estate losses as long as the taxpayer actively participates and his modified adjusted gross income is less than $100,000.

Active participation test: As long as a taxpayer participates in management decisions in a bona fide sense, he actively participates in the real estate rental activity.  There is no specific hour requirement.  However, the taxpayer must be exercising independent judgment and not simply ratifying decisions made by a manager. Most taxpayers are able to meet this test if they can show they made important management decisions in regards to their rental property. You can have a management company if you are making the key decisions, such as accepting tenants, signing the contract, making the final determination on the rental price, etc.

Modified adjusted gross income (MAGI) is calculated by taking your Adjusted Gross Income and subtracting:

  • Any passive loss or passive income, or
  • Any rental losses (whether or not allowed by IRC § 469(c)(7)),  or
  • IRA, taxable social security or
  • One-half of self-employment tax (IRC § 469(i)(3)(E)) or
  • Exclusion under 137 for adoption expenses or
  • Student loan interest.
  • Exclusion for income from US savings bonds (to pay higher education tuition and fees)
  • Qualified tuition expenses (tax years 2002 and later)
  • Tuition and fees deduction
  • Any overall loss from a PTP (publicly traded partnership)

The full $25,000 allowance is available for taxpayers whose MAGI is less than $100,000.  For every $2 a taxpayer’s MAGI exceeds $100,000, the allowance is reduced by $1.

Qualified Disposition

In the year that you sell your rental property, you can deduct all of the carryover passive losses that you accumulated during the rental period. For example, Bob has $100,000 of W-2 wages in year 10. From years 1-9 he had $30,000 of passive loss carryovers from his rental property because they were not deductible on his tax returns. In year 10 he sells the rental property for a gain of $10,000. He therefore has total income of $110,000 (the W-2 wages and gain from the sale). However, his net income (before deductions) will be $80,000 since the $30,000 passive loss carryover will be applied.

Real Estate Professional

If you are considered a real estate professional, then your rental income/losses are not subject to passive activity loss limitations and all losses can be fully deducted on your tax return. In order to be considered a real estate professional, you must meet the material participation test, which involves meeting at least one of the following:

  1. The taxpayer works 500 hours or more during the year in the activity.
  2. The taxpayer does substantially all the work in the activity.
  3. The taxpayer works more than 100 hours in the activity during the year and no one else works more than the taxpayer.
  4. The activity is a significant participation activity (SPA), and the sum of SPAs in which the taxpayer works 100-500 hours exceeds 500 hours for the year.
  5. The taxpayer materially participated in the activity in any 5 of the prior 10 years.
  6. The activity is a personal service activity and the taxpayer materially participated in that activity in any 3 prior years.
  7. Based on all of the facts and circumstances, the taxpayer participates in the activity on a regular, continuous, and substantial basis during such year. However, this test only applies if the taxpayer works at least 100 hours in the activity, no one else works more hours than the taxpayer in the activity, and no one else receives compensation for managing the activity.

If you are a W-2 wage employee or have another significant source of income, and you do not spend significant time managing the rental property, you most likely will not meet the test. Real estate agents or those with real estate businesses are generally able meet at least one of the requirements.

Whether you are able to deduct your rental loss in the current year or not, the losses are not “lost.” You can carry them forward to future years and deduct them fully when you sell the property. It is important to keep track of your loss carryovers and to log the time you spend participating in rental activity if you are a real estate professional.

Hire an Independent Contractor or an Employee?

Houston Tax Attorney

1

Hire an Independent Contractor or an Employee?

Your business is growing and you need help. Do you hire an employee or an independent contractor?

Difference between an employee and independent contractor

It can be at times difficult to make a clear-cut distinction between an employee and independent contractor. The term independent contractor has been defined by common law, the Fair Labor Standards Act, and court cases. The IRS looks at the degree of control and independence of the worker. The tests for making this determination fall into three categories:

  1. Behavioral: Does the company control or have the right to control how the person does her job?
  2. Financial: How is the worker paid, how are expenses reimbursed, and who provides the the tools, etc?
  3. Type of relationship: Are there written contracts or employee-like benefits? Will the relationship continue, and is the work performed a key aspect of the business?

The IRS has an extensive 20 factor test for determine whether the person is an employee or independent contractor. Basically, if you are directing the person how to do the work, providing significant training, and paying a guaranteed set wage amount, you likely are in an employer-employee relationship.

The pros and cons of employee vs. independent contractor

There are major benefits to having a worker classified as an independent contractor (IC).

  1. Financial. When you hire an employee you will pay a number of expenses that you wouldn’t if you hired an IC, such as employer-provided benefits, office space, and equipment. You must also make contributions on behalf of the employee, including your share of the employee’s Social Security and Medicare taxes (7.65%), state unemployment compensation insurance, and workers’ compensation insurance. These costs could increase your payroll costs by 20 to 30%.
  2. Staffing flexibility. An independent contractor is generally hired for a specific task or project and the relationship ceases at that point. There is no headache of hiring and terminating an employee. In addition, independent contractors are already trained and can be productive on the job almost immediately.
  3. Reduce your exposure to lawsuits. Minimum wage laws, employment discrimination laws, right to form a union, and right to take time off to care for a sick family member or new child are not applicable to ICs as they are to employees

If after applying the above three factors, it is not clear whether the person qualifies as an employee of IC, you may file a Form SS-8 “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding” with the IRS. The form can be filed by either the employee or the worker and can take up to 6 months for the IRS to make a determination. This can be useful for business owners who repeatedly require the same services.

The downside to hiring an independent contractor is that you do not have as much control over the work that is performed, your right to terminate the IC is not at will, and you may b at greater risk for government audits by the IRS or Department of Labor.

Forms and taxes

If you’ve made the decision to hire an independent contractor, the first step would be to have to worker fill out a Form W-9. This is used to request the correct name and SSN/EIN of the worker. This form should then be kept in your files for future reference if required by the IRS. If you’ve paid the person more than $600 during the year, you must fill out a Form 1099-MISC. The 1099-MISC must be provided to the IC by January 31st of the year following the payment and you must mail a copy to the IRS by February 28th.

If you have hired an employee, there are several forms and taxes for which you are responsible as the employer, including:

  1. Federal income tax withholdings. You should have your employee fill out Form W-4 prior to employment in order to determine the correct amount of taxes that should be withheld from his or her paycheck.
  2. Social Security and Medicare taxes. Employers must withhold part of social security and Medicare taxes from employees’ wages and pay a matching amount. There is also an additional Medicare Tax amount that must be withheld if the employees’ salary exceeds a certain threshold.
  3. Federal Unemployment tax. Employers pay a 100% of this tax. The employee does not pay any portion of this.
  4. State Unemployment tax.

These taxes must be deposited by the employer with the IRS according to two schedules, monthly and semi-weekly. At the beginning of the calendar year you will need to determine the correct schedule to use. The state unemployment tax is deposited with the Texas Workforce Commission.

Conclusion

There some strong advantages to hiring an independent contractor. But employers would be well-advised to understand the importance of classifying their workers correctly. Misclassification can result in having to pay back state and federal taxes for unemployment, disability, social security, and Medicare, as well as expenses, overtime, and retirement benefits.

It is important that you make the correct determination the first time to avoid costly mistakes. The Law Office of Kunal Patel, LLC can guide you through every stage of this process and save you time and money down the road.

Incorporating your Small Business

Houston Tax Attorney

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Incorporating your Small Business

Why Should you Incorporate?

So you’ve set up your small business or sole proprietorship and you’re ready for business. The last things on your mind are taxes or potential lawsuits. But as they say “an ounce of prevention is worth a pound of cure.” Advantages of incorporating your small business are:

  1. Personal asset protection. The owner(s) have limited personal liability for corporate debts and obligations and generally are only subject to lose their investment in the business, but not their personal assets.For example: an independent cab driver who is sued for negligent driving would be personally liable if the damage exceeds what the insurance would cover. His personal bank account, investments, and other assets are at risk. Now if he had incorporated his business (e.g., L.L.C.), only his business assets would be at risk. His cab, business bank account, etc.
  2. Tax benefits. Losses are fully deductible for corporations, but for a sole proprietorship (i.e., an unincorporated business) his losses may be limited. There are also other tax benefits associated with various forms of corporate entities. Your attorney can determine which type of entity would be best for you.
  3. Business credibility. Adding the magic three letters, Inc. or L.L.C. after your business name adds instant legitimacy and credibility.

How do you Incorporate?

You must file the appropriate documents, such as the certificate of formation or bylaws, with the Texas Secretary of State.

In the certificate of formation, Texas requires the name of the corporation, initial directors (if applicable), purpose, duration, and the name and address of the corporate registered agent. You can choose who you designate as your registered agent, but it is beneficial to appoint your attorney as the agent. With a lawyer serving as the registered agent for your corporate entity, you will have the peace of mind that you will receive timely and prompt notice if your corporate entity is served with a summon and an attorney will be able to immediately to review and assess the lawsuit and provide you with legal advice on how to answer the summons.

LP, LLP, LLLP, LLC, Inc…what do I choose?

There are several ways of incorporating your small business.

Sole Proprietorship

A self-employed individual by default is a sole proprietorship. If you have not incorporated you are operating as a sole proprietor and have full personal liability for your business. Running a business without limited liability protection is like driving a car without insurance.

General Partnership

If you are a partnership and have not incorporated, you are by default a general partnership. Each partner in a general partnership is personally jointly and severally liable for their business liabilities. Owners report their share of income/losses on their own tax return and they are personally liable for their business. Just as a sole proprietorship, this not a recommended form since there is no liability protection for the owners.

Limited Partnership

A limited partnership consists of general and limited partners. General partners have personal liability for business debts but can raise funds without having outside investors manage their business. However, the general partners can limit their liabilities by forming a limited liability limited partnership. Limited partners are also protected from personal liability as long as they do not participate in management of the business. This form is commonly found in companies that invest in real estate because it is more attractive to lenders. Lenders do not like limited liability because it provides them less protection for their investment in your company.

Corporation

Fringe benefits can be deducted as business expenses and owners can split profits among themselves and the corporation. This is generally the most expensive and burdensome to set up. It is rarely recommended for small businesses.

Limited Liability Partnership

This is similar to a limited partnership, except general partners are only liable for their own debts, and not the actions or debts of their fellow partners. This may be a good option for professional services firms where the members operate independently but under the same trade name.

Limited Liability Company

An L.L.C. is a hybrid of partnership and corporation that combines the best aspects of both entities. It offers the most flexibility in terms of operation and tax planning, as well as limited liability protection for all member(s). Also, unlike an L.L.P, an L.L.C. can have just one member. If it is a sole member L.L.C., you can choose to have it taxed as a separate entity or have the income and expenses “flow through” to your personal tax return. This is often the most recommended type of structure for self-employed individuals and small businesses.

The Best Structure for Your Business

Ultimately the best option for incorporating your small business will depend on a number of factors, such as the number of owners, type of business, how the owners wish to allocate business income/losses, long-term goals, whether you will raise capital through debt or equity, etc.

Beware of companies that will incorporate your business for a low fee using cookie-cutter templates. They will fill out the necessary paperwork, but they will not be able to advise you on the best entity formation for your needs. You need a qualified attorney that will review your situation to tailor the best choice for your business.

 

Attorneys’ Fees – Are they Deductible?

Houston Tax Attorney

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Attorneys’ Fees – Are they Deductible?

The good news for taxpayers is that attorneys’ fees in relation to tax services for individuals and small business issues are deductible!

Basic Rule

The basic rule is that attorneys’ fees are taxable if incurred to:

  1. Produce or collect taxable income; or
  2. Help determine, collect, or obtain a tax refund.

Simply put, you can deduct an attorney’s help to make money that you’ll have to pay taxes on; or if an attorney helps you with a tax matter such as an audit, back taxes, etc. For small businesses, you can deduct incorporation fees, tax planning, bookkeeping services, etc.

Examples of Deductible Attorneys’ Fees

Examples of fees that would be deductible are:

Examples of Non-deductible Attorneys’ Fees

Attorney fees such as the following are not deductible:

  • Filing a personal injury lawsuit
  • Drafting a will or settling a probate matter
  • Obtaining custody of a child
  • Non-tax issues in a divorce
  • Name changes
  • Civil suits that are not work or business related

Can You Settle Your IRS Debts?

Houston Tax Attorney

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Can IRS Debts be Settled?

A common misconception is that you cannot discharge federal tax debt in Chapter 7 bankruptcy. In fact you can both discharge some of your tax debts under Chapter 7 Bankruptcy, as well as settle your debts with an Offer in Compromise. However, it’s not as easy as the “tax resolution” companies often advertise with their promises of “0% down” and settling your debt for “pennies on the dollar.”

Chapter 7 Bankruptcy

Tax debt is dischargeable in Chapter 7 bankruptcy if they meet specific requirements under the Bankruptcy Code. These requirements are often called the 3-year, 2-year, and 240-day rules.

  1. The 3-year rule. The return was due at least three years ago before you file for bankruptcy. For example, Bob’s 2010 return was due on April 15, 2011. The earliest he can file for bankruptcy for his 2010 tax debt is April 15, 2014. Note that a tax return extension will also extend the 3-year rule.
  2. The 2-year rule. The return must be filed at least two years before the bankruptcy filing. For example, Bob’s 2010 return was due on April 15, 2011, but didn’t actually file his tax return until October 31, 2011. The earliest he can file for bankruptcy for his 2010 tax debt is October 31, 2013.
  3. The taxes were assessed at least 240 days ago. For most taxpayers, the taxes are considered assessed as of the date the return was filed. However, if you file an amended return or are audited and owe additional taxes, then the 240 days on the additional tax begins to run when the additional taxes are assessed.

Even if you meet the above, the tax debt is not dischargeable if:

  1. There is a tax lien. A tax lien filed prior to bankruptcy will continue to attach to your property.
  2. The tax is a “trust fund” tax such as FICA, Medicare, and other mandatory withholdings (applies to businesses with employees).
  3. The IRS has determined there is tax evasion or fraud.

A note on tax liens. As mentioned above, bankruptcy does not release a tax lien. However, if you meet the 3-2-240 requirements, you can request for IRS to release the lien, which they may do if the taxes have been discharged and there is little property for the lien to attach. If you still own significant property after the discharge, then the IRS will likely not remove the lien. However, it is possible to negotiate the tax debt on the lien.

Offer in Compromise

If paying your existing tax debts will cause significant financial difficulty, the IRS will settle your tax debt through an Offer in Compromise (OICs). The IRS wants to get the most it can in a reasonable amount of time, and if that means negotiating the debt they will.

Pre-Qualifiers for Filing an OIC

  • You must not be in an open bankruptcy proceeding
  • You must have filed all required federal tax returns
  • You must make all estimated tax payments
  • If you are self-employed, you must have submitted all required federal tax deposits

Requirements for Filing an OIC

  • There is some doubt as to whether the IRS can collect the tax bill from you – now or in the foreseeable future. The IRS calls this “doubt as to collectibility.”
  • due to exceptional circumstances, payment of your full tax bill would cause an “economic hardship” or would be “unfair” or “inequitable.”
  • There is some doubt as to whether you actually owe all or some of the debt. The IRS calls this “doubt as to liability.”

After you and your attorney have identified which condition(s) exists, you can start your application by completing IRS Form 656. There is a $186 application fee. In addition to the form, you will need to provide the following:

  • Financial information by filling out Form 433-A/F (individuals) or 433-B (businesses). It is extremely important to be truthful and accurate on this form.
  • Various documents to verify your income and financial assets – bank records, vehicle registration, pay stubs, etc.

How much should you offer?

You will calculate your minimum offer amount by following the instructions on Form 433. Without going into details, the formula will take into consideration the net realizable value of your assets (i.e, how much your assets would be worth if they were sold) and your excess monthly income after subtracting your monthly expenses from your monthly income.

Special circumstances

Special consideration is given to those with physical and psychological impairments, bleak financial prospects due to advanced age (over 60), drug or alcohol related problems, or a family members problem if it affects your finances. To bring these issues to the attention of the revenue officer, you will attach a letter with supporting documents (e.g., medical records).

What if your offer is rejected?

IRS will reject offers for usually one of two reasons:

  1. The offer is too low
  2. You have been convicted of a serious crime in the past

If the offer is too low, the IRS will state the acceptable amount. You can also request a copy of the Revenue Officer’s report through a Freedom of Information Act (FOIA) request.

If you wish to increase your offer, you can do so within a month by simply writing a letter without having to resubmit your application.

The second option is to appeal your rejected offer. You can further negotiate with the assigned Revenue Officer and if that fails, you can submit IRS Form 13711 to start a formal appeal.

Offer-in-Compromise vs. Chapter 7 Bankruptcy

As you recall above, one of the conditions for applying for an OIC is that you are not in an open bankruptcy proceeding. You can both apply for an OIC and file for Chapter 7, but not at the same time.

Applying for OIC before Chapter 7 filing

Under Internal Revenue Manual 5.8.10.2.2, when a taxpayer or representative states during an offer investigation that a bankruptcy petition will be filed if the taxpayer’s offer is not accepted, the offer examiner/offer specialist must determine whether the potential for a bankruptcy filing actually exists and the impact the possible bankruptcy filing may have on the collection of the outstanding tax liabilities.

The IRS will consider how likely it is for you to file for bankruptcy – have you filed in the past, is IRS the sole creditor, would the taxes be dischargeable in bankruptcy, etc. If the Service determines there is potential for a Chapter 7 filing, then the Service will negotiate your tax debt. Under no circumstance, however, will the IRS accept a settlement that would be less than what it would recover under a Chapter 7 bankruptcy.

Warning! The OIC process will suspend the 3-2-240 time period, thereby adding time to the 3-2-240 requirements while the OIC is pending. Additionally, indicating to the IRS that you are considering filing bankruptcy requires the OIC offer examiner to determine whether the IRS should file a notice of federal tax lien to protect the government’s assets. As you recall above, a lien is not automatically released after a bankruptcy discharge.

Applying for OIC after Chapter 7 discharge

Once the discharge is entered, the Service will be able to determine which taxes are discharged and will be able to make a determination of Doubt as to Collectibility under its administrative OIC procedures.

Which one should I choose?

There are many factors in determining which option would be best for your situation, such as:

  • Has the IRS filed a lien?
  • How quickly do you need debt relief?
  • Is the IRS debt itself causing financial problems, or do you also have other debt?
  • Which option will have the lowest settlement payment?
  • Which one will be most likely successful?

Since 2012 the IRS has been more willing to compromise with taxpayers on debts. Up to 40% of OICs have been accepted in recent years. You should seek the assistance of an experienced tax attorney to ensure the greatest chance of your OIC being accepted. We can help you determine whether a Chapter 7 or 13 filing or an offer in compromise would be more beneficial for you.