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Community Property and Tax Liabilities

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Community Property and IRS Tax Liabilities

What is Community Property?

Texas is a community property state, which means that all “community property” is owned jointly and equally by both spouses.  In Texas, all property accumulated during marriage is community property unless it is received by gift, devise, or inheritance.  Tex. Fam. Code Ann. § 5.01.  Even income derived from separate property—including interest and dividends from separately owned securities—is considered community property.  Commissioner of Internal Revenue v. Chase Manhattan Bank, 259 F.2d 231, 239 (5th Cir. 1958), cert. den., 359 U.S. 913 (1959).  Texas’s community property laws can have unusual implications for married couples’ federal income tax liabilities.

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Innocent Spouse Relief

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Innocent Spouse Relief

When a husband and wife sign a joint tax return, each spouse is jointly and severally liable for all taxes relating to that year. Where one spouse does not believe he or she should be liable for the  full amount of the tax liability, that spouse may seek innocent spouse relief under IRC 6015. Read more

Former IRS Revenue Officer Sentenced for Tax Evasion

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Former IRS Revenue Officer Sentenced for Tax Evasion

In an ironic twist, a former IRS revenue officer was recently sentenced to prison for tax evasion and impeding the due administration of internal revenue laws.

From 1989 to 2014, Mr. Henti Lucian Baird operated a tax preparation and consulting businesses under d/b/a “HL Baird’s Tax Consultants.” Previously Baird had worked as an IRS revenue officer for 12 years. Although he filed his tax returns every year,  he failed to pay his taxes since 1998 and used his knowledge and experience as a revenue officer to evade paying taxes.

Here are some of the facts that supported the charges brought in this case:

  • Baird hid hundreds of thousands of dollars earned from his consulting business in bank accounts created in the names of his children and used money order and cashier’s checks to pay personal expenses.
  • After IRS collections contacted him regarding his back taxes, he submitted a false collections information form (Form 433) in which he claimed to only have one bank account and concealed his nominee accounts. When he learned that the IRS had discovered the accounts and were going to levy the accounts, he withdrew the funds.
  • To stall impending liens and levies, he submitted a cash offer in compromise in bad faith
  • During the time he failed to pay his taxes, Baird continued to pay the mortgage on his 4,300 square foot home, annual fees for his timeshare in Florida, and car payments for his BMW.
  • Baird corruptly used his stepson’s identity, without his knowledge, to apply for a Preparer Tax Identification Number that he used to file over 900 tax returns.
  • He advertised himself to clients as specializing in “IRS problems, delinquent returns, offer-in-compromise, tax problems, delinquent employee taxes and release of liens and levies,” and submitted at least 120 power of attorney forms to the IRS on behalf of clients falsely claiming to be an enrolled agent, even though the IRS revoked his authorization to represent taxpayers in 2009.

Sentencing and penalties assessed:

  • Baird pleaded guilty to all charges in October 2016.
  • He was sentenced to prison for 43 months and ordered to pay $573,422.74 in restitution to the IRS.

One key takeaway from this is the importance of being truthful and honest when filling out a Form 433, Collections Information Statement, to the IRS. Form 433 is generally required by the IRS for any tax debt greater than $50,000. Purposely falsifying the form in an attempt to conceal assets can lead to civil and criminal penalties, and in very egregious cases even jail time.

The second takeaway is to do your research before hiring someone to help resolve your tax debt. Baird was providing tax debt resolution services, when clearly he was clearly unqualified to do so. There are numerous “tax resolution firms” that advertise online, radio, television, and in print. If you’ve been victimized by a “tax resolution firm”, the FTC has a webpage set up for complaints regarding tax relief companies. You can file a complaint here.

Source: DOJ Website

IRS to Begin Using Private Debt Collectors

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IRS to Assign Millions of Collections Accounts to Private Debt Collectors

The IRS announced several months ago of its plans to assign millions of taxpayer collections accounts to private debt collectors in accordance with Congressional legislation. The IRS has now announced that it will begin implementing the plan this spring. Here’s what you need to know.

Why is this happening?

There are 19 million people who owe more than $400 billion in back taxes. With a funding starved IRS unable to collect this money on its own, Congress passed legislation requiring the IRS to turnover certain accounts to private debt collections agencies.

Has this happened before?

Yes, the first attempt started in 1996 and the second from 2006 to 2009. These programs were ended after studies showed that collections by IRS employees was more cost-effective than use of private debt collectors.

How will this affect taxpayers that are currently owe and are not in an installment agreement or other alternative?

It’s expected that very old cases and lower balance debts will be sent to private debt collectors. This may allow the IRS to focus on enforcing collections against higher balance accounts, trust fund recovery penalty and other high priority cases. Private debt collectors will not have enforcement authority. They will not be able to file liens or issue levies. The IRS will notify taxpayers that their case has been assigned to a private debt collector. Here’s a draft of the letter.

How do I protect myself from private debt collectors?

Debt collectors must abide by the federal Fair Debt Collection Practices Act and state debt collection laws. It is expected that private debt collectors will at times be overly aggressive since the collections agencies will receive a percentage of the collected debt. See the Texas Attorney General’s consumer protection page to learn more about your rights against private debt collectors.

Also be aware that telephone scams will likely increase. We used to be able to tell clients that the IRS would never call to collect debt. However, that will no longer be the case, and it may be difficult to identify telephone scams. You will receive a letter both from the IRS and the private debt collector before a phone call.

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US Citizens Owing Back Taxes Now Getting Passports Revoked

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US Citizens Owing Back Taxes Now Getting Passports Revoked

More travel complications are in store and it’s not just for foreigners. Under new rules to be implemented soon, American citizens can be banned from travelling by having their passports revoked for unpaid tax debt.

Certification of Individuals with Seriously Delinquent Tax Debt

A new law passed by Congress in 2015 authorizes the IRS to certify to the State Department if a taxpayer has seriously delinquent tax debt. IRC § 7345. According to the IRS website, the IRS has not yet started certifying tax debt to the State Department but it is expected to begin in early 2017.

What is Seriously Delinquent Tax Debt?

Under the new law, seriously delinquent tax debt is an individual tax debt totaling more than $50,000 (including penalties and interest) for which a (1) Notice of Federal Tax Lien has been filed or (2) Levy has been issued.

However, taxes that are being paid under an installment agreement or other alternative form of relief are not considered to be seriously delinquent tax debt under this provision.

Revoking of Passport

Upon receiving certification, the State Department may revoke your passport. There is no grace period prior to the revocation.

If you’re currently applying for a passport, the State Department will hold your application for 90 days to allow you to enter into a payment agreement or apply for one or more forms of tax debt relief.

If Your Passport is Revoked or Denied

You can file suit in the US Tax Court or a US District court to have the court determine whether the certification is erroneous.

If the certification is valid, you should immediately pay the debt, enter into a payment arrangement, or make an alternative arrangement such as an offer in compromise to keep your passport. The IRS will reverse the certification within 30 days of resolution of the issue.

If you are Planning on Leaving the Country and Owe Significant Tax Debt

If you are a US citizen, you are free to travel until the State Department has received a certification from the IRS. If the certification is received while you are abroad, the Secretary of State may limit your passport to allow you to return to the US.

If you are not a US citizen, do not travel abroad if you owe significant tax debt! You should inform your immigration attorney of your travel plans and retain a tax attorney to resolve the back tax issues prior to your travel.

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Source: IRS

Discharging Tax Debt Under Chapter 7

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Discharging Tax Debt Under Chapter 7

A common misconception is that federal taxes cannot be discharged through bankruptcy. A Chapter 7 filing can be a very powerful tool in obtaining relief for past due taxes.

What is Chapter 7 Bankruptcy?

A petition filed under Chapter 7 of the Bankruptcy Code is used to discharge debt through liquidation of assets. However, exempt and excluded assets are retained by the debtor. Examples of exempt assets include your homestead up to 1 acre, personal property ($30-60K), life insurance, pensions for state and local employees, tools of trade, earned but unpaid wages, and unpaid commissions up to 75%.

What does Filing a Chapter 7 do to Taxes?

Filing a bankruptcy petition gives rise to an automatic stay which immediately halts IRS collections. The IRS cannot file additional liens, send notices requesting payments, issue a summons, or levy your assets for any tax debt that arose prior to the bankruptcy petition. The automatic stay continues through the remainder of the bankruptcy process.

However, filing bankruptcy freezes the collections statute. If any of the tax debt is nearing statute expiration, you would not want to do anything that could freeze the collections statute. All tax returns must be filed prior to filing a bankruptcy petition. Additionally, failure to file tax returns or obtain an extension for returns that are due after the bankruptcy petition will result in the dismissal of your case.

Will my Tax Debt be Discharged Through a Chapter 7?

It depends on what types of tax claims are present. Tax claims will fall under one or more of the following categories, listed from highest to lowest priority:

  1. Secured tax claims
  2. Unsecured tax claims
    1. Administrative taxes that accrue while the bankruptcy case is proceeding
    2. Gap taxes
    3. Unsecured tax claims that meet the criteria to be priority claims
    4. General unsecured (i.e., nonpriority) taxes

Secured Tax Claims

If the IRS has recorded a Notice of Federal Tax Lien, those taxes are considered secured tax claims. The underlying debt against the individual may be discharged, but the tax lien will stay on the property until it is sold, at which point the debt will be paid through the sales proceeds.

Priority Claims

Taxes that are priority claims are not dischargeable in a Chapter 7 to the extent not paid out of the assets. Such claims include:

  1. Trust fund recovery penalties
  2. “Three-year Rule” taxes: Income taxes for which the due date of the return, including extensions, is within three years before the date of bankruptcy filing
  3. “240-day Rule” taxes: Income taxes assessed within 240 days of the date of bankruptcy filing
  4. “Two-year Rule” taxes: Income taxes related to a late return filed within 2 years of bankruptcy

General Unsecured Taxes

Unsecured taxes will be fully discharged.

Example

Bob owes taxes for 2010, 2011, and 2012, owing $25,00 for each year. All returns were timely filed prior to their October 15 extensions. Bob owns a home worth $500,000 with an equity of $300,000. IRS has filed a tax lien for 2010, but not the other years. If Bob files a Chapter 7 bankruptcy, the 2011 and 2012 taxes would be completely discharged since they meet the 3-240-2 rules and are nonrpriority tax claims. The 2012 is discharged against Bob personally, but a lien will remain on the property for $25,000 because it is a secured tax claim. The IRS legally could choose to enforce the lien by foreclosing on your home after the bankruptcy. However, this is not something that is commonly done, and almost never where the equity is less than $100,000.

Should I File a Chapter 7?

If you’re considering filing a Chapter 7 to discharge federal tax debt, you need to speak to a tax attorney first to determine whether that is an option for discharging the debt. Some of the factors that need to be considered include:

  • Whether you primarily owe tax debt, or if you also have significant consumer debt. If you have consumer debt, you may be subject to the means test.
  • The dates the returns were filed and taxes were assessed
  • Whether any tax liens have been filed
  • What types of assets and amount of equity in assets you currently own
  • Whether there are any trust fund recovery penalties assessed

How to Settle IRS Debt

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How to Settle IRS Debt

If you’re struggling with tax debt, you’re probably looking to learn how to settle IRS debt. This is a process known as an Offer in Compromise – Doubt as to Collectibility (OIC). While many taxpayers might think this requires “negotiating” or “playing tough” with the IRS, it’s actually all about the numbers. There’s almost nothing you or your tax practicioner can say or do that will affect the outcome of an offer, unless it’s in the Internal Revenue Manual (IRM). Here’s how to settle your IRS debt through an OIC.

Step 1: Determine if you are Current on your Tax Obligations

You must be currently be in full compliance (1), which means:

  • You’ve filed all your tax returns that you are legally required to file
  • You’re having the correct amount of taxes withheld based on your Form W-4 or paying your estimated tax payments for the current year if you’re self-employed
  • Businesses must be making their current quarter’s payroll tax deposits
  • Continue to remain compliant through the rest of the process

Step 2: Calculate your Discretionary Monthly Income

Next, you should calculate your discretionary or remaining monthly income, which is basically your monthly income minus necessary living expenses. See IRS Form 656B for a worksheet. For a lump sum offer, your remaining monthly income over the course of 12 months would have to be more than what the IRS could collect before the expiration of the statute on an installment agreement (more in step 3). If your remaining monthly income over the course of 12 months exceeds your tax debt, then obviously there’s no point in submitting an offer in compromise, unless you’d like to pay the IRS more than you have to.

Step 3: Obtain a copy of your Tax Account Transcripts

Before you can resolve any problem, you need to understand the problem. Simple right? Get a copy of your account transcripts from the IRS for the tax year(s) for which you currently owe taxes. Determine the amount that you owe, including penalties and interest. Then determine the collections statute of limitations (CSED). If your CSED is about to expire, you might want to hold off on submitting an OIC as this will “freeze” the statute.

Step 4: Complete a Financial Analysis

Complete a financial analysis by calculating your reasonable collections potential (RCP). This is a very critical calculation as it determines whether your offer will be ultimately accepted or rejected. The RCP is basically a calculation of your ability to pay which is a combination of your future monthly discretionary income (over a course of 12 or 24) months and what the IRS could potentially collect from seizure of your assets. (2) The IRS will calculate an 80% quick sale value on the fair market value of your assets for purposes of calculating the RCP, minus the loan balance, if any. (3) Your Offer must equal or exceed the RCP to be accepted. (4)

RCP as expressed in a formula:

RCP = (DMI x #MO) + (FMV x 80% – LB)

DMI = Discretionary Monthly Income (Gross monthly income – IRS allowed personal living expenses)

MO = 12 or 24 months (depends on whether you’re applying for a lump sum or periodic payment offer).

FMV x 80% – LB = total equity in assets, or total fair market value x 80% – loan balance

When the calculations show that you are eligible for an Offer in Compromise based on Doubt as to Collectibility, in addition to the financial analysis you should carefully consider the impact of the CSED (Collection Statute Expiration Date). In accordance with IRM 5.8.4.3 Offers should not be accepted where the tax can be paid in full as a lump sum or can be paid under current installment agreement (IA) guidelines, unless special circumstances are identified that warrant consideration of a lesser amount. The offer should be recommended for rejection based on the taxpayer’s ability to full pay under current IA guidelines. In other words if taxpayer has a remaining monthly income and can pay the entire amount of liability before the CSED expires or under a PPIA (Partial Pay Installment Agreement) the IRS could potentially receive a substantially higher amount than the proposed offer, the offer will most likely be rejected as “not in the government’s interest”, provided that no special circumstances exist.

Step 5: Submit your Paperwork and First Payment

If you’ve determined that you have an offer that is acceptable (and also taking into consideration the CSED), then you’ll submit the following to the IRS:

  • Completed and signed Form 656
  • Completed and signed Form 433-A (individuals) or 433-B (businesses)
  • Photocopies of all required supporting documentation
  • A check or money order payable to the “United States Treasury” for the initial payment
    • If making a lump sum offer, you must make a payment of at least 20% of the total offer amount, and the remaining balance to be paid in 5 months. (5) *
    • If making a periodic payment, the first payment must be paid with the offer and the rest within 6 to 24 months per the terms of the offer.*
  • A separate check or money order payable to the “United States Treasury” for the $186 application fee.*

*There are exceptions for taxpayers that qualify as low income.

Mail the above documents to the appropriate IRS processing office in your state.

Step 6: Continue to Make Payments and Remain in Compliance

While your offer is being reviewed (anywhere between 6-12 months or longer), you must continue making payments per the offer terms as if the offer has been accepted. Additionally, you must remain in full compliance with the tax code for 5 years after the acceptance of the Offer. If a tax return is late or a new tax debt is incurred during this 5 year period, your offer is revoked and the complete amount of the existing debt with interest becomes collectible. (6)

The Risks of Submitting an Offer that is Rejected

  1. Applying for an offer in compromise requires you to send complete financial information to the IRS that they would not have had otherwise, including your bank account information, assets, and household expenses. If your OIC is rejected, you’ve just given the IRS all the tools they need to accelerate collections against you.
  2. If the IRS rejects the offer, it will NOT return the application fee or any other payments made with the offer. (7) 
  3. Filling a Offer in Compromise freezes the statute of limitations. If you or your practicioner didn’t consider an imminent collections statute expiration, you’ve probably cost yourself a lot of money that could have been wiped out by the statute expiration. In fact you’ve given the IRS more time to collect since the statute will be “frozen” during the 6-12 month or longer process.

Do I Need to Hire Someone to do this?

As you can see the OIC process is time-consuming and exhausting. Which makes sense – this is tax that you owe and you’re asking the IRS to write it off. This type of relief is not given out easily. If you’re a do-it-yourself type, carefully understand the risks of a rejected offer. You may not need to hire a tax attorney if you are willing to take the time to fully understand the IRS collections process. I honestly don’t know of many people that have the time or patience required to do so.

The only thing worse than making a half-measured attempt yourself is hiring a tax resolution firm. You can expect to pay $5,000 and more in fees in addition to your offer amount. You can identify these firms through their generic sounding business names and dozens of 5 star reviews, often posted by the company. These resolution firms will sometimes refund part of your fees if you don’t qualify, but you’ll still incur a loss for the amount you paid to the IRS, not to mention the valuable financial road-map you’ve now provided to IRS. I would also not hire any tax “professional” that blatantly advertises how much they’ve saved their clients. These are not typical cases, and there’s no government agency verifying these claims (or for you to verify the claims).

The truth is very few taxpayers will have a shot at an offer in compromise. The key for any practitioner is to review the client’s transcripts and financial information. I do not suggest an OIC for clients that do not have a high chance of succeeding, both in the offer itself as well as after the offer is accepted.

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References

1 IRM § 5.8.4.6

IRM § 5.8.5.25

IRM § 5.8.5.4.1

IRM § 5.8.5.28

IRM § 5.8.5.28

IRM § 5.8.9

IRS Topic 204

The Five Biggest Mistakes Tax Practitioners Make When Filing an Offer-in-Compromise!

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The Five Biggest Mistakes Tax Practitioners Make When Filing an Offer-in-Compromise!

The Internal Revenue Service’s (“IRS”) Offer-in-Compromise program continues to be one of the most popular programs with both practitioners and taxpayers when they are considering a way to resolve their back tax issue.  Yet, only 42% of Offers filed by taxpayers are ultimately accepted.  Why are less than half of the Offers filed being accepted? Read more about common offer in compromise mistakes.

Mistake #1: Not Checking the Statute of Limitations

There is a ten-year collection statute.  What this means is the IRS has ten years from the date it assesses the tax liability to collect that tax.  Easy enough.  However, taxpayers often do things that may toll or freeze the statute, preventing it from running.  These actions include anything that prevents the IRS from taking collection action, including:

  • Filing an Offer-in-Compromise
  • Filing bankruptcy
  • Filing a request for an installment agreement (payment plan)

Practitioners who are considering an Offer-in-Compromise for a client should first obtain power-of-attorney and pull updated transcripts for taxpayers, because it is critical to understand what has occurred and how much time remains on the statute.  The reason is that if the ten-year statute is about to run out, then the last thing practitioners should do is file an Offer-in-Compromise.  Instead Practitioners should consider filing a Collection Information Statement (Form 433-A) and arguing for a taxpayer to be deemed uncollectable, which does not stop the collection statute from running.  Why have the taxpayer incur the expense and stress of fighting for an Offer if we can allow time to take care of the liability?  By filing an Offer without considering the statute of limitations, practitioners may be doing extreme harm to their clients, and arguably are committing malpractice.

Mistake #2: Not Dealing With The Taxpayer’s Current Compliance

In order to make a deal with the IRS – any deal – the taxpayer must be in “tax compliance.” “Tax Compliance” means that they have filed all the tax returns required and are making their current tax payments.  For businesses, this means they are making their current quarter’s payroll tax deposits.  For individual taxpayers, it means they are having either the proper taxes withheld from their pay (wage earners) or have made the current year’s estimated tax payments (if self-employed).

Taxpayers who are not in compliance are not eligible for an Offer-in-Compromise, and any Offer filed will be returned and the filing fee and deposit paid with it kept by the IRS.

Mistake #3: Not Properly Calculating Future Income

So many taxpayers and practitioners list taxpayer’s income and then deduct what the taxpayers are actually spending, the result being the taxpayers show no future income!  It’s terrific: the taxpayers have zero future income in their Offer calculation and can offer almost nothing, just like those late night commercials.

Unfortunately, this is not how the Offer process works.  The IRS uses a taxpayer’s gross monthly income and then reduces the income for “allowable expenses”, which are frequently less than those actually being paid by the taxpayer.  The IRS allowable expense tables are based on the Department of Labor statistics and often represent county or state averages.  It is therefore not uncommon for a taxpayer to have negative cash flow when actual expenses are used, but to be positive once the IRS standards are applied.  The change can drastically change the results of the Offer calculation and can mean the difference between an Offer that is accepted and another that is ultimately rejected.

Mistake #4: Not Looking at What the Taxpayers are NOT Spending!

As an extension of Mistake #3 above, when a practitioner calculates the taxpayers’ future income based upon IRS allowable expense standards, taxpayers often ends up with a positive cash flow on paper, which can increase the Offer calculation above the point where taxpayers can afford to settle the back tax debt.

By understanding the allowable expense standards the practitioner can help taxpayers.  A Practitioner should consider what expenses the IRS allows that the taxpayers are currently not spending already and have them adjust their financial picture accordingly.  These “allowable” expenses that taxpayers often do not have include insurance, as many taxpayers in financial trouble drop health their health insurance, life insurance and disability insurance, yet these expenses are not only allowed but are necessary to protect the taxpayer’s health, family and income sources.

It’s important to know that the IRS will only allow those expenses that the taxpayers have a history of paying, meaning for at least three months as reflected by the bank statements or cancelled checks.

Mistake #5: Not Properly Calculating Reasonable Collection Potential

What is “Reasonable Collection Potential,” or “RCP”?

RCP is the amount the IRS calculates it could collect from the taxpayer if it obtained the net equity in the taxpayer’s assets and from twelve months of future income (or 24 months if applying for a differed offer).  We discussed the future income calculation in Mistakes #3 and #4.  What about the net equity in assets?

The IRS Offer forms contained in the Offer Booklet walk taxpayers through the net equity in assets calculation.  The issue arises when taxpayers assume that, because they cannot access the equity in the asset the IRS will not include it in its available equity calculation.  This is Mistake #5.

IRC § 7122 authorizes the IRS to agree to a compromise of a taxpayer’s debt, but it does not make the acceptance of a taxpayer’s Offer mandatory.  The decision to accept or reject a taxpayer’s Offer rests with the IRS.  In fact, the IRS will reject an Offer if the agency feels it is “not in the best interest of the government” to do so.

Practitioners need to remember that, unlike a payment plan or a request to be deemed uncollectable, the Offer-in-Compromise is asking the IRS to write off a debt it is otherwise entitled to, and a debt that most other taxpayers pay every year voluntarily.  This is not something the IRS does lightly, and the fact that taxpayers have assets that they cannot access does not change the fact that the taxpayer has assets.

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Payroll Taxes – When the IRS Doesn’t Mess Around!

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Trust Fund Recovery Penalty

The IRS may be kinder and gentler after the 1998 IRS Restructuring and Reform Act, but that certainly doesn’t seem to be the case with payroll taxes. When a business is doing poorly, a small business needs to make a decision – to reduce staff or not pay the bills. Oftentimes, a struggling business owner, for emotional or other reasons, may not want to lay off employees. At the same time business expenses need to be paid to keep the business running. A tempting solution can be to dip into their employees’ payroll tax funds to pay off business expenses. This ends up being a recipe for disaster. The struggling business gets behind on payroll taxes, continues to incur new payroll taxes and business expenses, and is unable to catch up. Eventually when the business shuts down, the owner will be personally liable for some of the payroll taxes. The IRS will prioritize collection of these taxes from the owner and other responsible parties. I’ve seen clients with excess of $300,000 in income tax debt who were not contacted by a revenue officer for years. In most of my payroll tax cases, however, the case was picked up by a revenue officer for enforced collection action within a year of the assessment.

Payroll Taxes vs. Trust Fund Taxes

Employers must withhold federal income taxes, social security, and Medicare tax from their employees’ pay. All of the federal income tax and ½ of the social security and Medicare taxes are paid by the employee, while the employer pays the other ½. The employees’ portion is referred to as trust fund taxes. Payroll tax is comprised of trust fund and non-trust fund taxes.

Failure to Pay Trust Fund Taxes

The IRS considers it a theft of government money when employers dip into the trust fund portion and fail to pay these taxes to the government. And it’s easy to see why – the employees are still able to deduct their payroll taxes on their tax returns, while the government is left holding an empty bag.

When an employer fails to pay the trust fund portion, the IRS has the authority to assert a trust fund recovery penalty (TFRP). A TFRP may be asserted against those determined to have been responsible and willful in failing to pay over the tax. The persons responsible could include:

  • an officer or an employee of a corporation,
  • a member or employee of a partnership,
  • a corporate director or shareholder,
  • a member of a board of trustees of a nonprofit organization,
  • another person with authority and control over funds to direct their disbursement,
  • another corporation or third-party payor,
  • payroll service providers (PSP) or responsible parties within a PSP,
  • professional employer organizations (PEO) or responsible parties within a PEO, or
  • responsible parties within the common law employer (client of PSP/PEO).

Whereas when an employer fails to pay the non-trust portion (i.e., the employer’s share of payroll tax), the IRS may only hold the company responsible, and the liability generally does not extend to the owners or partners.

Trust Fund Recovery Penalty Process

TFRP cases begin when the employer files a Form 941 with a balance due or an IRS FTD (Federal Tax Deposit) alert is created. FTD alerts identify employers that have not made current deposits or made them in substantially reduced amounts.

The alerts are then routed to a Revenue Officer (RO) and a pre-contact analysis is performed. If the analysis shows that the funds have been paid after the alert was created, the RO will close the case. Otherwise, the revenue officer is required to make initial contact with the taxpayer within 15 calendar days. During the initial contact, the RO is required to explain the TFRP and provide a copy of the TFRP calculation. The IRS will then conduct an interview and record their notes on Form 4180. This is the RO’s time to begin asking questions and gathering documents for purposes of asserting the penalty.

Taxpayers are encouraged to retain a representative to complete the interview on their behalf. The IRS cannot force a taxpayer to attend absent the issuance of a summons.

The RO will then assemble the core evidence necessary to assess a TFRP, such as the interview notes on Form 4180, business operating agreement and certificate of formation, bank signature authority cards, and a sampling of cancelled checks showing payments to other creditors instead of the government.

After all responsible persons are interviewed and documents are reviewed, the RO will submit a recommendation of assertion or non-assertion of TFRP on Form 4183. If the RO group manager confirms, a Letter 1153 and Form 2751 will be issued, notifying each responsible person of the proposed assessment.

If you are the recipient of a Letter 1153 and Form 2751, you should not sign the form without talking to an attorney! Form 2751 waives the restriction on notice and demand. You waive your right to a 60-day notice and give the IRS the authority to assess the TFRP immediately and initiate collections action.

Relief from Trust Fund Recovery Penalties

A Trust Fund Recovery Penalty asserted against you can be overwhelming. While there may be multiple responsible parties, the IRS has the authority to collect all the tax from any responsible individual (joint and several liability). That individual would then have a right to bring suit against the other responsible parties to pay their portion in civil court.

Statutory prerequisites. The first step if you’ve been asserted a TFRP is to determine whether you meet the statutory prerequisites – responsibility and willfulness. There are a multitude of TFRP cases where the tax court has found that the IRS overreached in asserting these penalties against parties who were not responsible.

Statute of limitations. Absent fraud, or failure to file, the TFRP must be assessed within 3 years of the date the Form 941s were filed.

Payment strategies. Often a company will owe both trust fund penalties as well as income taxes (non-payroll). Since TFRPs are asserted on the individual members and pursued aggressively, it would be advantageous to pay the trust fund portion first before paying the income tax.

Criminal Liability

While criminal prosecution by the IRS is rare, criminal cases involving TFRP are on the uptick. This is especially the case where the taxpayer has a history of unpaid payroll tax. Recently a trucking firm owner was sentenced to 18 months in prison for failing to pay $300,000 of payroll taxes between 2007 and 2012. See IRS Press Release 3/4/16.

IRS Installment Agreement

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IRS Installment Agreements

This section only applies to taxpayers with total tax debt greater than $50,000. For debt less than $50,000, the process is different.

Example: Bob has $100,000 of total tax debt. He has gross monthly wages of $150,000. He has $25,000 equity in his home and $75,000 in his company 401(k). After his attorney reviews his options, they decide that an installment agreement will be his only option.

IRS’ goal: Receive full payment of the debt in the shortest period of time possible.

Bob’s goal: Minimize his monthly payment and protect assets from seizure.

Will the IRS Enter into an Installment Agreement?

The IRS will consider an installment agreement only if the taxpayer is current on his tax liabilities, which means that:

  • Bob must have filed all of his tax returns
  • Bob must be in compliance with his current year tax obligations. He needs to be current on his withholdings and estimated tax payments for this year. If in 2016 Bob files his 2015 return and owes on the return and is unable to pay, the IRS will not enter into an installment agreement. He will have to wait until 2017. He should adjust his withholdings so that he isn’t in the same tax owed position in 2017. Bob may not have the option to wait until 2017, in which case he should take out a loan to pay off his 2015 return liability before applying for an installment agreement

How will the IRS Determine the Monthly Payment Amount?

The IRS will look at the taxpayer’s monthly income, assets, and expenses to determine the amount of disposable monthly income available.

Income

  • Bob has $12,500 gross monthly income ($150,000 wages/12)

Expenses

  • Bob lives in an upscale apartment and pays $2,500/mo. He drives a luxury car with a $1,500/mo payment. He dines at expensive restaurants and has a shopping addiction. At the end of the month, he saves on average $100. Bob thinks his discretionary income is $100.
  • The IRS cares very little about how much Bob actually spends. The IRS has federal and local standard tables based on the taxpayer’s family size and location. For example, based on Bob’s location and family size (1 individual), the IRS applies the following federal standards:
    • Food – $307
    • Housekeeping supplies – $30
    • Apparel & Services – $80
    • Personal care products and services – $34
    • Miscellaneous $119
    • Vehicle ownership (lease or monthly payment) – $471
  • Local standards:
    • Housing – $1,457
    • Vehicle operating cost – $281
  • Additionally, the IRS allows actual expenses for the following expenses:
    • Health insurance
    • Court ordered payments (e.g., child support)
    • Child/dependent care
    • Term life insurance
    • Tax withholdings (Federal, FICA)
    • Secured debts
    • Certain expenses (e.g., required continuing education for job)
  • After applying the above standard and actual expenses, the IRS determines that Bob actually has $6,200 discretionary income, not $100.

The IRS will expect you to adjust your living standards in order to make the monthly payment based on the calculated discretionary income. You can elect for the IRS to allow 1 year of actual expenses for car payments, private school/university education, and housing in order to give you time to modify your current spending.

While the IRS standard expenses are not cast in stone and there is some flexibility, you should not expect much deviation unless you meet the 6 year rule* or have a very good argument why a particular expense should exceed the federal or local standards. The amount of flexibility will be determined by your attorney’s knowledge of procedure and negotiation skills, the personality of the IRS representative, and your particular situation.

Assets

  • Bob has $25,000 equity in his home, some of which is available to be borrowed against through a home equity loan
  • Bob has $75,000 in his 401(k). His 401(k) plan allows Bob to take a loan up to 50% of the value
  • If the installment payments will not result in full payment of debt before the expiration of the collections statute, the IRS will likely require Bob to tap into the equity of his home and/or take a 401(k) loan to make additional payments to cover the shortfall.

If the monthly payments will not result in full payment of debt before the collections statute expires, the IRS will determine if you have any equity available in your assets to borrow against or if you have any assets that can be sold (e.g., jewelry, collectibles, etc)

Alternatives to Installment Agreements

While taxpayers with little income and future earning potential are able to negotiate a lump sum deal with the IRS through an Offer in Compromise, Bob has a good, steady source of income. He does not qualify.

His only other option is bankruptcy. Taxes can be discharged in bankruptcy subject to certain requirements. The main requirements are that 240 days have passed since the taxes were assessed and at least 3 years have passed since the due date for the tax return. It is possible to have part of the debt discharged in bankruptcy if 3 years have passed for some of the tax years but not others. It is also possible to enter into an installment agreement for 3 years and then file for bankruptcy. We will go over all of your options with you. While we do not currently represent clients for bankruptcy, we can refer you to a reputable bankruptcy attorney.

The Doing Nothing AKA “Sticking your head in the sand” Method

If you do absolutely nothing and ignore the collections notices, the IRS will start levying, which can involve garnishing your wages, levying your bank accounts, seizing your vehicle, and sending levy notices to anyone that has issued you a 1099 in the past instructing them to send any payments owed to you directly to the IRS. In extreme cases, the IRS will seize your home and keep the equity up to the amount of your debt. The IRS will be more aggressive where there are multiple tax years, a large amount of debt, and/or a short collections statute.

Sometimes the doing nothing method works out if you don’t have a large balance (over $50,000) and the IRS is not able to identify any assets or sources of income (i.e., you don’t receive W-2s or 1099s, and have no reported assets and bank accounts). I still would never recommend this method to a client.

Some clients have asked, “if the IRS will require monthly payments anyway, why not do nothing and let the IRS garnish my salary.” Because the IRS will leave you with as little as $400 after garnishment on your biweekly pay. Additionally, your employer will now know about your IRS debt, which may be embarrassing or damaging to your reputation.

The longer you wait to resolve your tax debt, the more you limit your options.