Howard's IRS and the Law Blog

It’s an old story that the IRS combats everyday:  When a business struggles and cash flow is tight, when there is not enough money to pay both rent and employment taxes, the IRS takes a back seat, and the business uses employee withholding taxes to keep the lights on.

The result is that the IRS is made an unwilling lender to fund operations.   Your hope is that the tide will turn and the IRS can be repaid before they come calling.  Your business is your baby, but this is can be a dangerous bet, and as we will see, it is especially dangerous in employment tax cases.

Liability for employment taxes does not just stay with the business; rather, the IRS spreads it to you, too – the business owners, officers, and even employees – anyone who had decision-making power over the company’s finances can be personally liable for a part of the unpaid taxes.  This is called a trust fund recovery penalty investigation.

Simply put, unpaid employment withholding taxes are a cancer.

As the IRS casts a wide net to collect employment taxes, a three-tiered defense is usually required:  to the initial collection of the employment taxes from the business (Tier-1); to the ensuing trust fund recovery penalty investigation into who in the company made the decisions not to pay the IRS (Tier-2); and to the eventual collection of the trust fund taxes from those in the business who were responsible for the decisions not to pay the IRS (Tier-3).

The best employment tax defense will recognize each step the IRS will pursue in advance, will see what is coming, and will prepare for it.   With that background, here is the IRS’s step-by-step game plan in a civil employment tax investigation.

STEP 1.     ASSIGNMENT OF AN IRS REVENUE OFFICER TO COLLECT THE TAXES FROM THE BUSINESS.

The IRS considers employment tax liabilities to be a serious matter, and as a result, will assign an employment tax case to its highest level collection personnel, a Revenue Officer.

Chances are, the first move the Revenue Officer will make is to have an unannounced visit your business.  Expect the Revenue Officer to drop off her business card, along with (1) ) Form 9297, Summary of Taxpayer Contact and (2) Letter 1058, Final Notice of Intent to Levy and Notice of Your Right to a Hearing.

The Revenue Officer’s initial knock on the door is to collect the employment taxes from your business.  That will soon change.

You do not know it yet, but the Revenue Officer does not intend to just investigate collection of the employment taxes from your business.  The Revenue Officer will also be launching an investigation into the operations of the business.  The investigation will be focused on control over company finances:  Who had the decision-making authority that resulted in the employee withholding taxes not being paid to the government?  That could be you, that could be your CEO, a co-owner, or your spouse.

This is called a trust fund recovery penalty investigation.  It permits the IRS to collect part of the unpaid employment taxes personally from the individuals who were in control of the business and were able to make financial decisions to not pay the IRS.

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You paid your subcontractors, but did not send them a Form 1099 for the payments. You get audited, the IRS requests verification of the labor expense, and you provide the auditor with copies of your checks verifying the payment.  No problem, right?

But the IRS auditor says you cannot deduct an expense if you did not send out Form 1099.  Your subcontractor labor can be a pretty significant amount, maybe your largest expense.  The tax you would owe if your subcontractor labor expense is disallowed would be staggering.

But you paid the expense, and can prove it.  Huh? Is that possible, it seems so unfair.

It is not possible, and its wrong.

The IRS auditor is confusing two separate rules.  Here are the rules, what they mean, and how to navigate the audit to get your expenses allowed:

  • Rule 1:  Proving that the expense was a necessary part of your business, and that you paid it.

Section 162 of the Internal Revenue Code allows a deduction for ordinary and necessary business expenses that are paid or incurred during a year.  In the case of subcontractor labor, you would need to show the IRS auditor that the work the contractor performed was done in the ordinary course of your business and was necessary to it, and then prove that you paid the contractor.  A check to the contractor proves the payment (it is best if the check has a notation in the memo portion, notated along the lines of “labor for Smith job,” but that’s not absolutely necessary, just good practice for the future.)

And it’s even okay if you paid in cash, not by check.

These are evidentiary problems, but they are solved by application of the case of Cohan v. Commissioner, 39 F.2d 540 (2nd Cir. 1930).

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It is always an honor to be invited to speak at the Annual Conference of the National Association of Enrolled Agents.  Over the past 20 years of working with enrolled agents, I have seen firsthand their strong commitment to education, to learning and staying at the forefront of IRS representation.  In addition to the education, the conference is a great opportunity to make lasting friendships with enrolled agents across the country.

This year, the conference is on August 3-5, 2014 at the Cosmopolitan Hotel in Las Vegas.

At the conference, I will be presenting on the use of bankruptcy to solve IRS problems; defending against IRS employment tax investigations and the trust fund recovery penalty; and how to prove to the IRS that a levy would cause economic hardship. Here is an overview of each topic:

  • Using bankruptcy to solve IRS problems.

Bankruptcy can be a very effective tool to eliminate tax liabilities and get out of a tough bind with the IRS.  But the bankruptcy code has rules that must be followed detailing when a bankruptcy petition can discharge a tax debt.  We will learn those rules, and how bankruptcy operates on the IRS.  We we also dig into how the most common bankruptcies work (Chapters 7 and 13); cover the advantages of bankruptcy on the IRS, including benefits that are not available from direct negotiations with the IRS; and discover how bankruptcy can be a better alternative to offers in compromise, installment agreements or currently uncollectible.

  • IRS employment tax investigations and the trust fund recovery penalty.

Liability for unpaid employment taxes can be a cancer, with the tax laws allowing the IRS to go past the business and sweep owners and employees into the collection mix. We will develop a comprehensive understanding of how the IRS can get tough in employment tax cases, and learn how to (1) defend against the IRS’s initial pursuit of collecting unpaid employment taxes from the business (2) defend against the IRS’s methods of finding out who in the business could be found personally liable for repayment of the taxes (known as the trust fund recovery penalty) and (3) prepare for the IRS’s eventual collection of the employment taxes from those who are assessed with personal liability.

  • Preventing an IRS levy from causing economic hardship.

How do you prove to the IRS that an attempt to levy would cause economic hardship?  We will learn how to prove economic hardship – and prevent levies – in the tough cases, when the IRS wants a retirement account, or wants to seize equity in a house, or take a vehicle or valuable business equipment.  We will cover the limitations the Internal Revenue Code puts on the IRS’s ability to seize, including rules against no equity seizures and court approval for seizures of personal residences.  We will also learn the internal polices and procedures that the IRS must follow in the Internal Revenue Manual before making a seizure, all of which can prevent, not cause, economic hardship.

Hope to see you there!

A concern frequently voiced by my clients is whether entering into an installment agreement with the IRS automatically extends the time the IRS has to collect.

The perception is that if you agree to an installment agreement with the IRS, you are in it forever.

Quite simply, you aren’t.  IRS installment agreements have end dates.  The end date is 10 years from when your IRS liability began.

When does an IRS liability begin?  The time the IRS has to collect begins when they place your debt officially on their books.  This is called an assessment.  Assessments typically occur in three situations: (1) after you file your tax return and there is an amount due but not paid (2) if you did not file a return, the IRS will make an estimated return filing and put an estimate of your debt on their books (3) after the IRS completes an audit of your tax return.

After the debt is put on the IRS’s books (assessed), the IRS has 10 year to collect the tax debt from you.  The legal reference is Internal Revenue Code 6502(a)(1).

During those 10 years, the IRS can levy your wages, your bank account, or take your property (possible but unlikely).

Agreeing to an payment plan with the IRS – a better approach than letting them have it at – does not change how much time they have to collect.  If you enter into an installment agreement with the IRS, the rule remains the same:  They have 10 years to collect, and you have no more than 10 years to pay.

An IRS installment agreement does not extend the time frame the IRS has to collect.

Let’s put this to practical application with an example.

Example:

Your IRS liability started, say, 4 years ago, maybe you were self-employed and did not understand how to handle your taxes, or maybe you took a retirement plan distribution and did not have enough taxes withheld.  Either way, 4 years ago the IRS made its assessment against you, and put your debt on their books.  The IRS made their assessment 4 years ago, and they have 6 years left to collect, for a total of 10 years.  An IRS Revenue Officer contacts you, or maybe you are prompted by a threatening letter from the IRS Automated Collection Service. Either way, you agree with the IRS to make monthly payments.

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Owing money to the IRS comes with fear – fear of losing your house, your property, your bank accounts, even going to jail.  And the fear of your employer finding out you have a tax problem.

Your employer would discover your IRS problem if the IRS sent a wage levy to your job in an attempt to garnish your paycheck.  That’s embarrassing.

But can your employer fire you for it?  Can you actually lose your job because of your IRS problem?

The good news is that you cannot be fired from IRS attempts to levy your paycheck.

The Consumer Credit Protection Act protects you from termination due to a wage garnishment, including one from the IRS. But that’s not the end of the story for your employer.  An employer can fined up to $1,000 for retaliating against your IRS problem, and can actually be imprisoned for up to one year.  These matters would be handled by the U.S. Department of Labor.  The legal citation is 15 U.S.C. 1674, and the IRS citation is Internal Revenue Manual 5.11.5.2.

But you want your job, and for the IRS to leave you alone, not a case with the Department of Labor.

If you have a threat of being terminated due to an IRS levy, I suggest the following steps to resolution:

  1. Communicate with the IRS.  In most every case, the IRS issues a wage levy because of poor communication from you.  The IRS has tried to contact you, has sent out letters requesting payment, and believes there has not been a satisfactory response.  All the IRS wants is for you to contact them and make payment arrangements.  When IRS doesn’t hear anything, they take action into their own hands.
  2. You probably can’t afford the levy taking your paycheck.  The IRS needs to know that. They want to know what you earn, your monthly bills and what you own.  In other words, how can you pay them back?  Or maybe you can’t pay them back.  Either way, the IRS needs to know.  The IRS accepts financial hardship, no pay cases – their terminology for it is currently uncollectible.
  3. We may need to complete an IRS collection information statement.  This tells the IRS how you can – or can’t – pay them back.  Remember, the IRS is levying because they want information, and have not received it.
  4. If you owe under $50,000, and can repay the amount you owe within 72 months, the IRS does not need a detailed financial disclosure from you, and the levy release can be expedited with payment terms over the 72 month time period.
  5. If you have any unfiled returns, those need to be completed and filed.  The IRS calls this compliance – they want you to be current on any unfiled returns.  If completing the returns quickly is too burdensome, and the levy is causing an economic hardship on you, the IRS does have rules that permit a levy release without the returns and only a financial statement.
  6. Get the levy released.  What you really want is to keep your job, not to sue your employer or contact the Department of Labor.  With communication, IRS financial arrangements and compliance, the IRS will let go, and release the levy.
  7. Provide your employer with a copy of the levy release.  I usually have the release expedited, with the IRS faxing a copy to me and your employer immediately, alleviating any delays by mail.  When your wages are levied, time is the most important factor.
An IRS wage levy is solvable situation.  It does not have to result in threats of being fired from your job.  All the IRS wants is communication, information, and compliance. With that, we can put the bear to rest, and get back to living.

It can be overwhelming when the IRS demands payment, considering the power the IRS has to levy your wages, bank accounts, house, and business.  When you have an IRS problem, it is natural – and easy – to feel not only overwhelmed, but desperate.

I like to help my clients better understand their situation and why their perception of having no options may not match reality.  After all, there is almost always a better approach than acting out of desperation.

To put things in perspective, let’s take a walk through a better understanding of five desperate situations that do not always necessitate desperate measures.

When negotiating with the IRS, do you need to:

-     Liquidate your retirement account?

-     Transfer property out of your name to try to keep it away from the IRS?

-     Borrow money against your house to pay the IRS?

-     Sell your primary vehicle or work vehicle due to IRS demands?

-     Borrow money from friends and family members and give it to the IRS?

Let’s take these one at a time.

1.  Do you need to liquidate your retirement account?

Before you liquidate your retirement account to pay the IRS, you should know that the IRS does not like to seize retirement accounts. It makes for bad public relations, and is near the very bottom of the IRS list of preferred seizures.

But what if the IRS is demanding that you pay the money for your retirement to them?

The IRS should be taken seriously when they bark, but it is important to know how much bite is behind the demand.

The IRS has guidelines as to when it is okay to take a retirement account.  Those guidelines can be found in Internal Revenue Manual 5.11.6.2. And the Internal Revenue Manual – which is the IRS’s internal guidelines – make it clear that it is not always okay.

To begin with, if you are employed, and have a retirement account through your employer, there are restrictions on your withdrawal of the money.  These same restrictions apply to the IRS taking your 401k. Most retirement plans prevent an employee from liquidating until separation from service, death or disability.   In other words, if you can’t get to it, neither can the IRS.

But what if you do not have restrictions on access to the retirement money?

Following Internal Revenue Manual 5.11.6.2, an IRS collection agent must consider the following three issues before levying a retirement account that you have access to:

     >    Is there a better way to collect the liability than taking away retirement funds?

Know that the IRS generally wants to collect in the least intrusive manner possible.  They may not tell you that – after all, if an IRS Revenue Officer sees a way to collect a liability (i.e., your retirement), he is going to do his job and go after it. That’s fine. But that’s also only half of the story.

The rest of the story is that the IRS will consider alternative collection methods to payment – i.e., better options that are less intrusive than taking your retirement.  

Do you qualify for an installment agreement that would make a dent in the liability?  Or do you have other assets that can be used to pay the liability?  These factors should be used to negotiate the IRS away from an intrusive seizure.

      >    Has your conduct been flagrant in not paying the taxes?

The IRS’s desire to levy on your retirement account rises and falls based on you.  How you act, and how you acted in regard to your tax debt, can make a difference.

The IRS considers good acts/bad acts as factors in taking retirement accounts.  The Internal Revenue Manual directs an IRS Revenue Officer to seize retirement accounts only in situations of flagrant conduct.

Flagrant conduct is defined by the IRS to include tax evasion, fraud, assisting others in evading tax, not complying with IRS requests for information, not taking necessary measures to stop accruing new tax debt (known as pyramiding), demonstrating a pattern of uncooperative behavior, and concealing or attempting to transfer assets out of the reach of the IRS.

Honest life mistakes that created a tax problem, whether it be divorce, business failure, poor judgment = IRS having less desire to wipe out your retirement.

Bad acts on your part, and a general disrespect for the obligation to pay taxes = IRS not sympathizing on your retirement.

The IRS needs to know you are a good person that made some bad mistakes, and that you did not act towards the IRS in a manner that necessitates having your retirement taken away.

     >    Do you – or will you in the near future – depend on the retirement account to pay needed living expenses?

Here, let’s directly quote the Internal Revenue Manual to make our point.

Internal Revenue Manual 5.11.6.2(7) states:

“The final step in deciding whether to levy on retirement assets is to determine whether the taxpayer depends on the money in the retirement account (or will in the near future) for necessary living expenses. If the taxpayer is dependent on the funds in the retirement account (or will be in the near future), do not levy the retirement account.”

Some peace of mind for our negotiations:  If losing your retirement account to the IRS will put you in financial distress and unable to pay bills – whether now or in the near future – the IRS guidelines are for them to back off.

Now that you know the rules, you know that liquidating your retirement account in knee-jerk reaction can indeed be a desperate measure that may not be necessary to IRS resolution.

2.  Should you transfer property out of your name to try to keep it away from the IRS?

Don’t do it.  Unless, of course, you want to anger the IRS, lose credibility, and give them reason to become extremely aggressive and take your property.

Hiding property from the IRS in an effort to keep it away from them is a no-no.  It will make any effort to resolve your tax debt even more difficult.  After all, when your head is in the mouth of the bear, say nice bear.

And rest assured that the IRS has ways to recover that property that you are trying to hide. They can file tax liens against it, even if it is no longer in your name (these are called nominee liens).  They can also go after the person who holds your property up for legal recoveries that include transferee liabilty, successor liability, fraudulent transfers and nominee/alter ego theories.

Do you want to spread your IRS problems to others (and you don’t, by the way)?  The transfer your property to them.

In other words, it it’s to good to be true, think twice.  And putting property out of your name, or hiding it from the IRS, is too good to be true.  The IRS has plenty of remedies to undo your dirty work, and won’t be happy about having to use them.

In most cases, when you owe money to the IRS, a full financial disclosure of your assets is required.  That often is not as bad as you fear – like retirement accounts, the IRS usually does not want to take your stuff, and problems tend to have workable solutions.  But hiding your assets from them changes the equation and wakes the bear.

3.  Do you need to borrow money against your house?

Okay, so we know that the IRS does not like to take retirement accounts, right? Add taking your house to the top of the list.

Despite your fears, the IRS does not want to put you on the streets.

Let’s use the numbers to demonstrate how likely (or unlikely!) an IRS house seizure is.  In 2013, the IRS made 547 seizures of real and personal property – houses, cars, business equipment.  This is nationwide – of all the taxpayers who owe the IRS, and it is in the millions – the IRS saw that only 547 cases necessitated drastic measures of seizing real estate, business equipment and personal belongings.

In other words, owing the IRS is serious, and despite all negative publicity to the contrary, the IRS is not a heartless machine.  The heart is there, it is just a matter of knowing how to find it.

The IRS does not want to put a family on the streets, or take the home of a retiree.

That changes, however, when, bad acts come into play – hiding assets, not cooperating, pyramiding tax liabilities, outwardly trying to cheat and take advantage of the IRS.

If you are honest but just made some mistakes in paying your taxes, the IRS should consider alternatives to taking your house.

And taking your house is not easy for the IRS.  Here are some of the steps they need to go through:

     >     The IRS needs high-level internal approval to seize a house, and after that, the IRS has to send your case file to the Department of Justice for handling.

The IRS cannot just show up one day an unexpectedly take your house.  First, they have to send you a Final Notice of Intent to Levy.  And an IRS collection agent has to write-up a recommendation for seizure, and get that approved by IRS management.  But that’s only the start of the process.  The IRS wanting your house does not mean the IRS gets your house.  If the IRS says yes, the case has to be transferred to the Department of Justice for the second step.

The Department of Justice gets your case because the IRS cannot, on its own, take your house.  The government has to get an U.S. District Court judge to approve the seizure.  That means the Department of Justice has to sue you in court, and get the judge to order your house to be sold.  If you get sued by the Department of Justice for a house seizure, you have the right to file an answer in court, just like any other lawsuit, and defend the litigation.

Only a judge can order your house sold; the IRS cannot do it on their own.

The legal citation is Internal Revenue Code 6334(e).

     >     The IRS cannot take your house unless there is enough equity in it that will result in a payment on your liability.

Internal Revenue Manual 5.10.1.2, which lists prohibited IRS seizures, states “The following types of seizures are prohibited in light of restrictions in the Internal Revenue Code (IRC):  Seizures where the taxpayer has insufficient equity in the propertythere must be sufficient net proceeds from the sale to provide funds to apply to the taxpayer’s unpaid tax liabilities.

In other words, unless the IRS will get money from the seizure, it won’t happen, and can’t happen.

     >     The IRS should not take your house without considering better alternatives to get paid.

That’s right – seizure action is usually the last option in the collection process.  The. Last. Option.

Let’s do another direct quote here, go straight to the source.

IRS Policy Statement 5-34, Internal Revenue Manual Section 1.2.14.1.8 states:  The decision to seize must be satisfied that other efforts have been made to collect the delinquent taxes without seizing. Alternatives to seizure and sale action may include an installment agreement, offer in compromise, notice of levy, or lien foreclosure. Seizure action is usually the last option in the collection process.

Contrary to popular belief, in most situations the IRS really does not want your house.  And because of that, alternatives should be considered and negotiated before borrowing against it.

4.  Do you have to sell your primary work or business vehicle to pay the IRS?

Hopefully, the picture is developing for you that the IRS treads lightly on property seizures that could put you in a hardship situation.

In the same vein, an IRS Revenue Officer will be hard-pressed to justify taking your primary vehicles and not allowing you to work or transport your family.

If the IRS wants you to sell a car you use for personal or business purposes, respectfully let them know that to do so would create an economic hardship for you and your family. And the Internal Revenue Manual (the IRS guidelines) really is not about creating economic hardship on honest taxpayers.

5.  Should you borrow money from friends and family members and give it to the IRS?

Your friends and relatives do not owe the IRS, and the IRS cannot collect from them.  So, before you borrow money from them to pay the IRS, make sure that the reason is justified and the money is not taken out of desperation.

If the IRS is threatening to take your property, and you feel you have to borrow money to get them to leave you alone, it is important to separate the threat from the reality.  The threat is serious, but you may have options the IRS is not telling you about – like the limitations in the Internal Revenue Manual and Internal Revenue Code on taking retirement accounts, or houses, or any real or personal property.

You may be able to box your way out of it and keep your stuff before having to rely on friends and family members.

To be clear, paying the IRS is a good thing.  But it is important to be fully informed and know your rights before borrowing or liquidating in a manner that may not be necessary, or may cause a hardship to you.

To summarize, taking desperate measures to solve an IRS problem should carefully considered and weighed before being implemented.  There is often a better alternative that can be found in the IRS collection laws and procedures.

Your fear, and the IRS’s threat, may not be equal the reality of the situation.

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