Howard's IRS and the Law Blog

Know the IRS warning signs of levy or seizure: IRS Letter 3174, New Warning of Enforcement

May 5, 2013

in Cincinnati Ohio IRS, IRS collection notices, IRS Collection Problems, IRS levies and property seizures, Revenue Officers

When working with an IRS Revenue Officer, there are two warning signs that levy action is imminent.

The first sign is the IRS Final Notice of Intent to Levy.  This notice is required by law (Internal Revenue Code 6331) and provides a 30 day right to stop levy action by filing an administrative appeal.  The appeal puts resolution in the hands of an IRS settlement officer (as opposed to an IRS enforcement officer).  This is known as a collection due process appeal because levy action cannot occur until you have exhausted your rights to review.  And if you cannot reach resolution with a settlement officer, there are additional rights of appeal to U. S. Tax Court.  While this process is pending, there is no levy action.

If you missed filing the appeal, there are virtually no restrictions on the IRS’s ability to levy your wages, bank accounts, etc.  Which leads to the second sign that levy action could occur: IRS Letter 3174, New Warning of Enforcement.

The IRS does not have to issue Letter 3174 before levying  – but by their own administrative rule (Internal Revenue Manual 5.11.1.2.2.7), the IRS does send a second warning in certain circumstances. The purpose of Letter 3174 is to provide a refresher to taxpayers if a long time has passed since the Final Notice of Intent to Levy was issued.  As an alternative to sending the letter, a Revenue Officer can also give the notice intended by Letter 3174 verbally.  This is an IRS administrative courtesy. The point here is to recognize the signs of when levy may be imminent.

It is important to recognize the circumstances that will lead to the IRS sending Letter 3174, New Warning of Enforcement.  Of course, there has to first be the Final Notice of Intent to Levy.  And you should not receive Letter 3174 from the IRS Automated Collection Service (ACS) – just IRS Revenue Officers.  Automated Collection Service letters are all computer generated – no human function involved.   Letter 3174, New Warning of Enforcement is generated by a Revenue Officer.  So, expect to receive Letter 3174 only if you are working with a local IRS Revenue Officer, who will manually generate the warning letter.  In most every other situation, it is unlikely you will get a refresher notice after a Final Notice of Intent to Levy has been issued.

There is also a time frame that Revenue Officers that follow in issuing the refresher levy warning notice. Revenue Officers are instructed to issue Letter 3174 if more than 180 days have passed since the Final Notice of Intent to Levy was issued, and no enforcement action or warning of enforcement has occurred in that time frame.

If you receive Letter 3174, it is important to call your Revenue Officer within 15 days of the date on the letter. That is the window the IRS provides before starting enforcement again. In most cases, all you need to do is make contact with the Revenue Officer, find out what it is she needs from you (i.e., a financial statement), and set a date to provide it. You should not need to resolve the case in 15 days, just make efforts to communicate with the Revenue Officer. Not responding to the notice will likely result in levy action against your wages and bank accounts.

How owing the IRS helps avoid bankruptcy means testing

April 20, 2013

in Bankruptcy - Chapter 13, Bankruptcy - Chapter 7, Bankruptcy and the IRS, Cincinnati bankruptcy

It is complicated enough to understand when taxes can be discharged in a bankruptcy.  But once it is determined that your taxes can be done away with in bankruptcy, another potential hurdle rears its ugly head:  Bankruptcy means testing.

Means testing determines what type of bankruptcy you qualify to file – Chapter 7, which eliminates debts (including taxes) without repayment, or Chapter 13, which forces you to repay a percent of your debt through a payment plan approved by the bankruptcy court.

Means testing is a financial calculation that “tests” whether your income is higher than the median income for a family of your size in your state.  The purpose of the test is to determine if you make too much money to eliminate your debts without repayment (Chapter 7), and if repayment is appropriate, what the minimum amount should potentially be.  If you “flunk” the test – meaning you make more than the average family – there is a presumption that you can afford to repay your debts (Chapter 13) rather than wipe the slate clean (Chapter 7).

The good news is that a tax debt to the IRS can help you avoid the effects of means testing (yes, owing the IRS can be a good thing).  Here’s why:

The means test applies only to what is known as consumer debts.  Consumer debt is defined in Section 101(8) of the bankruptcy code to be a debt that is primarily incurred by an individual for personal, family or household purposes.  This typically includes debts such as credit cards, home mortgages and car loans.  But not taxes.

If over half of your debt is not consumer debt (taxes), the means testing calculations do not apply. Pass go, collect $200.  You are not subject to bankruptcy means testing.

Example:  You have a mortgage on your house with $120,000 owed, $25,000 of credit cards and a car loan with an unpaid balance of $5,000.  This is $150,000 of consumer debt.  But you also owe the IRS, say, $175,000.  This is not consumer debt.   Your total debt is $325,000, and over half ($175,000) is non-consumer debt.  You can check the box on your bankruptcy petition that the means testing does not apply because the majority of your debt is not from consumer purchases.  (Business debt, like guaranteed loans, are also non-consumer debt.)

There are three distinguishing factors that makes tax debt a non-consumer debt:  Consumer debt is considered to be voluntary; taxes are not.  Taxes are for the public welfare, and consumer debt is for personal and household purposes.  And taxes are imposed on earnings, while consumer debt is based on consumption.  A good court decision on this is In re Westberry, 215 F.3d 589 (6th Cir. 2000).

Tax debt for bankruptcy means testing purposes includes money owed to the IRS and state and local taxing authorities.  When considering bankruptcy, know that your tax debt can help you avoid jumping through hoops.

An IRS letter that you want to receive: Case Closed – Currently Not Collectible

March 25, 2013

in Automated Collection Service, Currently Not Collectible, Economic hardship and the IRS, IRS collection notices, IRS Collection Problems, Ohio IRS, Statute of limitations on collections, Uncollectible

There are many options to resolve an unpaid tax liability – you can agree with the IRS to make monthly installment payments, reach a settlement with an offer in compromise, eliminate the taxes in bankruptcy, or have the IRS place your account in currently not collectible status.

Let’s focus on currently not collectible.

Currently not collectible status occurs when the IRS agrees that you cannot afford to repay the debt, and doing so would create an economic hardship on you.  It is forbearance by the IRS, a break from enforcement that can last years.

To obtain currently not collectible status, a financial statement must be provided to the IRS listing your household income and monthly living expenses.  If the IRS agrees that – after paying expenses like rent, a car payment or medical expenses – you have no money left to pay them, they will mark your account as uncollectible.

Yes, the IRS will take a back seat to your necessary living expenses, but the expenses have to be reasonable for the IRS to consider you to be in hardship.  The IRS applies internal expense guidelines that limit your living expenses – for example, car payments are capped at $517/month; housing and utilities for a family of four in Hamilton County, Ohio are capped at $1,910/month;  food, clothing and supplies for a family of four is limited to $1,450; no allowance is usually provided for credit card payments in your budget.  The IRS calls this Collection Financial Standards.

On the asset side, the IRS will consider you in hardship if your seizing your assets would either not result in any money paid (i.e, no equity in your property) or doing so would create a hardship (seizing your car means you cannot get to work, go to the grocery store, etc.).

If, after applying the IRS expense guidelines (Collection Financial Standards) it can be shown that there is no money left to pay the IRS and doing so would put you in a hardship to pay reasonable living expenses – food, rent, gas, car payment, child support, day care – and seizing your assets would also create a hardship – the IRS will place your account in currently not collectible status and, yes, leave you alone.

The IRS sends a letter out confirming you are uncollectible and that they will not bother you.  This is IRS Letter 4223 – at the top, in bold print, it has the words “Case Closed – Currently Not Collectible.”

The first two lines of the IRS uncollectible letter tell you everything:  ”We have temporarily closed your collection case for the tax types and periods listed below.  We have determined that you do not have the ability to pay the money you owe at this time.”

The IRS’s authority for marking an account as uncollectible can be found in IRS Policy Statement 5-71, which states that (1) if, after taking all the steps in the collection process it is determined that an account receivable is currently not collectible, it should be so reported in order to remove it from active inventory (2) a hardship exists if the levy action prevents the taxpayer from meeting necessary living expenses.  Internal Revenue Manual 5.16.1 has comprehensive instructions for the IRS marking accounts as uncollectible.

Internally, the IRS will make a notation in their computer database that your account is currently uncollectible.  In addition to Letter 4223, IRS account transcripts can be obtained with a line item reading “Case Currently Not Collectible.”

Uncollectible is a great option to combine with the limitations on how long the IRS can collect from you – the IRS has 10 years to collect a debt, starting from the date you first owed them (i.e., filed the return).   An uncollectible determination can last for years – as long as you’re in hardship, allowing you to live uninterrupted by the IRS debt and having time lapse to your benefit.  The IRS can be fair to those who truly cannot afford to repay taxes from past mistakes.

Proving to the IRS that you qualify for hardship status and receiving IRS Letter 4223 – Case Closed – Currently Not Collectible, can be the beginning of the end to your tax problems.

Offer in compromise vs. bankruptcy: Which one takes longer on the IRS?

March 9, 2013

in Bankruptcy - Chapter 13, Bankruptcy - Chapter 7, Cincinnati bankruptcy, Cincinnati Ohio IRS, Offer in compromise

Deciding whether it is best to submit an offer in compromise or file bankruptcy on your taxes involves thoughtful consideration of many factors.  Those factors include how long each can take, which option will have the lowest settlement payment, which is most likely to be successful, and post-settlement terms (like tax lien releases in bankruptcy or future compliance in compromises).

Each of these factors is worthy of their own post.  For now, let’s focus on how long each option takes – when should you expect to get to the finish line in an offer in compromise vs. the filing of bankruptcy?

1.    Offer in compromise – how quickly does the IRS work?

An offer in compromise is not necessarily a quick fix.  It can take the IRS, on average, 6-9 months at a minimum to complete its initial investigation.  But here’s the catch:  many offers are not initially accepted.  That means an appeal of the errors the IRS made in the initial review is usually necessary.  An appeal of a rejected offer can take another 6-9 months.  With the initial review and appeal, go into an offer in compromise presuming a 12 -18 month time frame to completion.

If you get a “yes” on the compromise, then you have to pay the amount offered to the IRS. The IRS will give you up to two years to pay the settlement to them.  But your “yes” is conditioned on the final payment being made – meaning you still owe the IRS and have not been given your fresh start until then.  If you want your tax lien released and credit cleared, presume it stays on until final payment is made.   It is not until final payment of the compromise settlement that the IRS makes an entry into their database to reduce your account balance to zero (yes, they really do that).

So, 12-18 months for investigation (and appeal), then up to two years for payment.  Yes, it can be shorter if appeal is not necessary, or if you can pay in the settlement quickly, but there is a wide time range to completion.

Let’s compare that to bankruptcy.

2.     Chapter 7 bankruptcy – quick relief without IRS passing judgment.

A Chapter 7 bankruptcy is a swift and efficient way to eliminate an IRS debt.  (Yes, bankruptcy can eliminate IRS tax debt.)  A Chapter 7 should be completed within 4 months of filing.

Here is what happens in a Chapter 7 bankruptcy:  Approximately 5 weeks after the filing, a hearing is scheduled with a bankruptcy trustee.  This trustee is employed by the Department of Justice – generally speaking, his or her job is to make sure that you have  been honest in your bankruptcy filing, and to determine if you have any assets available to sell to pay your creditors (rest easy, most assets are protected from creditors by state and federal law, very few Chapter 7 bankruptcies on the IRS result in loss of any property).  After your hearing with the trustee, your creditors – and the trustee – then have 60 days to object to your bankruptcy.  This is also rare – usually in cases where the bankruptcy laws are being “abused.”   If no one objects, the court issues you what is known as a “discharge.”

The court sends a copy of this discharge to the IRS.  If your taxes are eligible to be wiped clean from the bankruptcy (determined before we file by analyzing IRS account transcripts of your taxes, and applying that the tax bankruptcy discharge laws), the IRS then makes an entry in their database that reduces your account balance to zero from the bankruptcy filing.  After the bankruptcy, fresh IRS transcripts can be obtained that verify that the bankruptcy eliminated the taxes (your account balance will be cleared to zero).

3.     Chapter 13 bankruptcy – good option to installment agreement.

A Chapter 13 bankruptcy can last between 3 to 5 years, making it  potentially the longest option in the world of bankruptcy v compromise, with most cases lasting 5 years.  (There are other IRS solutions, like temporary forbearance on collection – known as uncollectible, and the 10 year time frame the IRS has to collect.)

There are differences between filing a  Chapter 7 and Chapter 13 bankruptcy on the IRS.  The main distinguishing factor is that Chapter 7 is a liquidating bankruptcy (but remember most cases do not result in property being lost) for those that cannot afford to repay their taxes and other debts (credit cards, medical bills).  A Chapter 13 is for those that can afford monthly payments on these debts after their reasonable living expenses are paid – in other words, extra cash.  Chapter 7 is quick because there is no repayment plan – your case passes through trustee review, and is over.  Chapter 13 involves repayment – because you can – and the payment term generally depends on how much money you earn (most filers earn enough to be required to commit to a five year repayment term).

That may sound grim, but Chapter 13 is a good alternative to an IRS-approved installment agreement as the length of the bankruptcy is capped at 5 years (vs. the 10 years that the IRS has to collect), can result in less than full payment of what is owed (called a cramdown, even on the IRS), and usually stops interest and penalty accruals.  After the final payment is made in a Chapter 13, the court sends a discharge to your creditors, and the IRS clears your account balance to zero (even if you did not pay them back in full).

Just a little on the basics of getting the IRS discharged in Chapter 7 or for a Chapter 13 cramdown.  As a starter, your taxes must be from a tax return that was due to be filed more than three years before you file the bankruptcy.  And your tax return also had to have been actually filed – regardless of due date –  more than two years prior to the bankruptcy.   So, as a beginning, bankruptcy works best on somewhat older taxes.

Sometimes, consideration is given to the comprehensive effect of bankruptcy – it impacts not only the IRS, but other debts, too.  And that includes state taxes, credit cards, medical bills, mortgage and car arrearages.

Is your tax return asking for an IRS audit? Five factors the IRS considers

February 24, 2013

in Cincinnati Ohio IRS, IRS Appeals, IRS audits, Notice of Deficiency

There is an uncanny consistency in the returns that I see the IRS auditing.    The process that the IRS goes through to determine whether to audit a tax return is far from random.  The IRS knows what to look for, and can spot a return that is prone to having mistakes in it, making you vulnerable.

Keep this in mind about your tax return:  it is a map of your finances.  And the IRS know the map quite well – after all, they created the map (tax forms).  You are filling the map in.

Let’s get into the mind of the IRS.  Here is a list of of five items that are red flags to an IRS audit:

1.     Returns that are self-prepared.  My only evidence of this is what I see – my clients that are audited usually prepared their own tax return.   I do not know if the IRS strategically and purposefully targets self-prepared returns, but it sure seems that way.  And thinking about it, it makes sense.  CPAs. attorneys, enrolled agents – professionals who are well-versed in the tax code and return preparation – may have less errors on a return.

2.     Returns that are illogical.   Remember that a tax return is a map of your finances  and the IRS is the map reader.  Here is an example:  If your household income is $46,000 a year, but you deduct $18,000 in mortgage interest, $4,000 in real estate taxes and $2,000 in charitable contributions – a total of $24,000 in expenses – the IRS could likely wonder how these expenses are being paid.  The income to debt ratio is too high.

Think about it.  That $46,000 of income is pretax – you actually brought home, say, $36,000 after taxes and deductions (equal to $3,000/month).  The expense deductions on the return for mortgage interest, real estate taxes and charity totals $2,000/month.  That leaves $1,000 for food, clothing, utilities, car payments, medical expenses, gas, insurance…and possibly an IRS audit because that budget may be appear unreasonable to the IRS.  To an IRS auditor, something is illogical on the tax return – are you making more and not reporting it, or deducting expenses you did not pay? Now, there may be explanations, and they can be provided – but you could be on the IRS’s radar.

3.     Schedule C losses.  This can go hand-in-hand with the tax returns not being logical.  If you are self-employed and show a loss on your tax return on Schedule C, questions can arise in the mind of the IRS:  How are you funding the loss?  How are you paying living expenses if you are losing money?  Schedule C losses offset other income on a tax return, lowering taxes and creating what can often be a significant tax benefit.  It makes the IRS curious.

4.     Schedule C deductions.  Yes, Schedule C’ makes the list twice.  The IRS targets many expenses that small business owners tend to claim.  Typical expenses that the IRS likes to scrutinize include auto/truck expenses, meals/entertainment and home office deductions.

Notice that these expenses all have the potential to be intermingled with a personal use – cars, meals, entertainment, your home.  The IRS wants to make sure that business expenses, not personal, are being deducted. And the rules to prove these expenses with a personal flavor set fairly high standards of compliance.

Auto and truck expenses require maintaining a contemporaneous log book detailing the miles driven and business purpose for use of the car.  Very few small business owners know this, much less have the time and energy to track every trip they make in the car.  And for that reason, it is an audit hot spot.

Eating and entertaining for your business also requires proof that the expense was not personal – who did you meet, where did you go? – along with receipts verifying the expense.

A home office requires that no portion of the area being used is also used for personal reasons.  In other words, your office at home should be like your office in an office building.  If your home office is the dining room table, or in a room where a TV is used by the family, you may not qualify.  Again, tough standards.

Labor paid to subcontractor is also a hot spot.  The IRS does not like cash transactions, and many contractors pay their labor that way.  Cash expenses without a receipt from the laborer are difficult to verify, and make for IRS scrutiny.

Also, Schedule C audits are often accompanied by the IRS requesting all of your bank statements, adding up the deposits, and comparing it to the amount of income shown on your tax return.  If you bank account deposits are greater than what you reported on your tax return, the IRS presumes you have unreported income.  This can be defended and explained (nontaxable sources such as gifts and loan), but it makes the IRS wonder.

5.   Large tax refunds.   There is nothing wrong with a large tax refund, in fact many people prefer it.  But, if other factors are present, the returns that I see being audited also have decent sized tax refunds (over $5,000).  For example, a self-prepared return with a large refund can be presumed the IRS to be an attempted manipulation of the return to obtain the refund.  These are sensitive cases that require careful defense as they can boarder on fraud.

There are solutions and ways to handle IRS audits.  Returns lacking “financial reality” may need development of  how bills where paid and how the business operates.  Mileage and entertainment logs can be recreated from calendars, etc. to verify auto and business development expenses.  Bank deposits in excess of income reported on the return can be explained away – for example, loans and other nontaxable sources of income.  Most professionals recommend that you do not go into an audit alone – let someone with expertise handle the negotiations and meetings for you.

What paperwork should I be prepared to provide to IRS collections? 10 items they may ask for

February 9, 2013

in Automated Collection Service, Cincinnati Ohio IRS, Form 433A, Form 433B, IRS Financial Statements, Revenue Officers

Resolving your tax debt often involves providing a financial statement to the IRS that discloses what you own, who you owe, what you make, and how much you spend.

Your financial disclosures are required to be made on forms designed by the IRS.  There are three forms that the IRS uses:  The 433A, which you will use if you are self-employed or a wage earner, the 433F, which is a shortened version of the 433A, and the 433B, which is used by businesses.

But what you put on the 433A, 433F or 433B is not enough.  Expect the IRS to request documents that back-up what you list – in other words, proof of how you report your financial situation.

IRS collection officers often appreciate their job being made easier – and that means providing documents that verify what is listed on the 433A, 433F or 433B.   More importantly, documents verifying your financial situation permits a Revenue Officer to move closer to making a recommendation to resolve and close your file.

Be prepared in advance – here is a list of 10 items IRS collections is most likely to request from you:

1.     Bank statements, usually at a minimum the last three months leading up to the date of the financial statements.  If you are self-employed and have both business and personal accounts, both will likely be required.

2.     Recent paystubs or proof of other income, like social security benefits, usually covering the last three months.

3.     A statement from your bank verifying the amount you owe on your home and car loans.

4.     A statement verifying the value of whole life insurance, stocks, brokerage accounts.

5.     Verification of any balances in a retirement account.  Information should also be obtained detailing indicating any inability to access the funds (age, separation from employment, etc.).

6.     Verification of certain monthly living expenses.  This can include housing and utilities, car payments, child care, child support, out of pocket medical expenses if the monthly expense is greater than $60 per dependent, health insurance premiums and payment of old state and local tax debts.

The IRS should not request verification of your expenses for food, clothing and entertainment – the IRS has a standard amount that it allows for these expenses regardless of what you spend.  Only in unusual circumstances will the IRS allow more than their standard monthly allowances for food, clothing and entertainment.

7.     If you are divorced and paying child support, a copy of your decree showing that a court requires you to make the payment and verification of the payments (usually three months).

8.     If you are self-employed, the IRS can request verification of your business expenses (this should be consistent with the profit and loss provided as part of the financial statement).

9.     If you are self-employed and are required to make estimated tax payments, expect the IRS to ask for proof that you are making your quarterly deposits.

10.   Verification of the valuation of your home and car.

Keep in mind this is intended to be a laundry list – what is actually requested is on a case-by-case basis.

Also remember that Revenue Officers need to document their case file and report to their manager that their recommendation for the case resolution (i.e., installment agreement, uncollectible) is backed up by records.  And if you are working with Automated Collection Service, I recommend having everything that could be possibly requested available when you place the call – if you are fortunate enough to have found a sympathetic IRS case worker, you do not want to have to call back and start again with someone else because documents are missing.  That someone else could be something else.

Any way you cut it, it pays to be prepared in advance and have records available that supports your IRS financial statement.

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