Howard's IRS and the Law Blog

What is the impact of successive bankruptcies on the tax discharge timing rules?

January 27, 2010

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

A great question from a reader about discharging taxes when  successive bankruptcies are filed:

Mr. Levy – I hope you can help me.  I owe back taxes and filed a Chapter 13 to repay the IRS.  The Chapter 13 was dismissed because I could not keep up with the payments.  Now I would like to file a Chapter 7 to eliminate what I did not pay.  My attorney mentioned something about a stopwatch while I was in the Chapter 13.   What is this all about?

You are correct in recognizing that eliminating taxes in bankruptcy is all about timing - keeping an eye on the “stopwatch.”  You are referring to the requirement that taxes can be discharged in bankruptcy only if your return was due to be filed at least three years before your bankruptcy started and was actually filed at least two years before your bankruptcy. 

But if you file a bankruptcy before these timing rules are met (like you apparently did with your Chapter 13), does the “discharge clock” keep ticking?  Are taxes that were not eligible for a tax discharge when you entered the Chapter 13 now eligible when you come out of it and want to file a Chapter 7?  Was time on your side? 

The U.S. Supreme Court resolved this issue in 2002 in the case of Young v. U.S., 535 U.S. 43.  In that case, Cornelius and Suzanne Young filed a Chapter 13 bankruptcy to try to repay their debts, including $13,000 to the IRS.  The Chapter 13 was filed before the tax discharge timing rules were met. 

Unable to make their bankruptcy payments, the Youngs dismissed their Chapter 13 and filed a Chapter 7 instead.  By the time the Youngs had filed their Chapter 7, the taxes had aged to the point of being old enough for a discharge under the bankruptcy tax timing rules.  

The IRS argued that the bankruptcy discharge rules were “tolled” during the Young’s Chapter 13.   The government also argued that since it was prevented from collecting during the Chapter 13, the tax discharge stopwatch should be treated the same way – tolled.

The court agreed with the IRS, recognizing that any other ruling would create a loophole for taxpayers - filing a Chapter 13, getting time on the discharge rules without any risk of collection, and then filing a Chapter 7 when the time was right.   

The prior Chapter 13 never happened for purposes of bankruptcy discharge timing rules.

In 2005, Congress codified the Supreme Court’s ruling in Young  – see Bankruptcy Code 507(a)(8)(a)(i) - and added an additional 90 days to the tolling period.   

Summary:  If you filed a Chapter 13 too early to eliminate your taxes, had it dismissed and now want to try a Chapter 7, ou cannot add in the time the Chapter 13 was pending to your tax discharge calculations.

Five ways to lower the value of your offer in compromise

January 22, 2010

in Form 433A, Form 433B, IRS Financial Statements, Offer in compromise

Being successful in an offer in compromise can depend on how much you know about IRS settlement guidelines.  An offer in compromise is a negotiation – you may have points to make with the IRS that only you can raise. 

Here are five pointers to lower the value of your offer in compromise: 

(1)      Make sure you claim property the IRS cannot take from you as “exempt” on your IRS financial statement (Form 433A).  Exempt assets that the IRS cannot take includes everyday belongings in your house (Internal Revenue Code 6334(a)(1)).  It also includes certain tools from your business.  The value of these assets should not be included in the value of what you offer the IRS.   

(2)     Use the possibility of bankruptcy as leaverage.   Internal Revenue Manual 5.8.5.6(5) allows the IRS to consider the impact of a possible bankruptcy on the value of a compromise.  If your taxes are eligible to be discharged in bankruptcy, the IRS could get nothing if you chose that route over an offer in compromise.  Make sure you know how to use that leaverage to get an offer in compromise and avoid bankruptcy. 

(3)     Know how to properly utilize IRS living expense guidelines.  For example, if you car is over  six years old or has over 75,000 miles, the IRS can allow a $200 monthly replacement cost.  See Internal Revenue Manual 5.8.5.6.3.  Make sure you know the IRS guidelines in an offer in compromise and how to maximize the amount the IRS will allow you. 

(4)     Understand how to properly reduce the value of your property to quick sale value.  Start with what it would sell for at resale – that is fair market value.  IRS guidelines permit you to reduce fair market value by 20% to arrive a quick sale value.  If your house is worth $100,000, this can save you $20,000 ($100,000 x 20% reduction).  Make sure you take the “quick sale value” reduction on your property, including houses and cars. 

(5)     You may have income that the IRS cannot take.  If you do, request that it be excluded from offer calculations.  The IRS cannot seize workers compensation, unemployment benefits, supplemental social security for the disabled, blind or aged and service-connected disability benefits (Veterans).  If they cannot levy it, then it should not be considered as an income source.      

There are many factors that play a part in a offer in compromise negotiation.   The more knowledge you have about the IRS settlement process, the better.

Does the IRS have the right to see your personal finances before completing a trust fund investigation?

January 17, 2010

in Employment taxes, Form 433A, IRS Financial Statements, Trust fund recovery penalty

IRS trust fund recovery penalty investigations are a sure source of unease.  Trust fund investigations can place personal liability on you for not paying your employees’ withholding taxes to the IRS.

Adding to the dilemma is an IRS request during the trust fund investigation for a personal financial statement (Form 433A) detailing your assets, income and living expenses.

If the IRS makes a request for a personal financial statement during a trust fund investigation, two questions must be answered:  (1) Is the IRS entitled to know your finances before its investigation is complete? and (2) How can an early disclosure of personal financial information help in defense of a trust fund assessment?

First, there is no legal requirement that the IRS is entitled to financial information from you during the trust fund investigation.  The Revenue Officer assigned to your case is making the request for financial disclosure BEFORE final assessment of the trust fund taxes against you.   Personal liability is still in the fact-finding phase.  

Unless there are other assessments against you already, the IRS has no ability to force a financial disclosure as part of a trust fund investigation.   Disclosing financials to the IRS in this manner is providing collection information before there is even a balance due.

Saying “no” to such a request must be done with balance:  respect as to an IRS investigation yet properly raising and protecting your rights as a taxpayer.

Sometimes, however, disclosing the financial information early can help resolve the trust fund investigation in your favor.   If your financials shows that the IRS could never collect from you if you were held personally liable for the employment taxes, the IRS has discretion to not assess the trust fund recovery penalty against you.

Internal Revenue Manual 5.7.5.3.1, Nonassertion Based on Collectibility, provides that “After reviewing and verifying the financial information, if the present and future collection potential is minimal, do not recommend assertion of the TFRP.”

It is not guaranteed that every Revenue Officer will drop a trust fund assessment due to uncollectability.  It is important to know your Revenue Officer if collectability is a defense to the trust fund recovery penalty.   Collectability is a valid consideration in investigations of the trust fund recovery penalty – know when to let the cat out of the bag.

What’s the difference between an IRS tax lien and a tax levy?

January 11, 2010

in IRS levies and property seizures, IRS Seizures, Tax liens

The IRS has two ways to collect back taxes:  a Federal tax lien and tax levy.  A tax lien is different from an IRS levy – the lien does not result in the IRS taking your property from you.  That is done by levy.

You have rights to defend the filing of a lien, and prevent the issuance of a levy.  To be able to assert your rights and protect your property, it is important to  understand and recognize the tools the IRS uses.

Here is what you need to know about the IRS tax lien and IRS tax levy:

IRS TAX LIEN

An IRS tax lien protects and secures the IRS’s rights to your property.  The lien attaches to property you own when it is filed, and property you purchase later.  A Federal tax lien most commonly impacts real estate.

If you own a house, and the IRS files a tax lien against you, the lien would give the IRS an interest your home similar to that of your mortgage company.

Example:  Your house is worth $100,000, and you have a mortgage of $75,000 on it.   There is $25,000 of equity in your house.  Before the IRS filed its tax lien, that equity would be yours.  Now that the lien has been filed, the equity belongs to the IRS.   If you want to sell your house, the IRS gets your equity at closing, not you.

The IRS usually files its Federal tax lien with county recorder or clerk of courts in the county where you residethe property is located.   For the tax lien to affect real estate, it must be filed in the county where the property is located.  It would then encumber all of your real estate in that county.  A federal tax lien does not name the property it attaches to – it automatically encumbers all your real estate in the county it is filed and all of your other personal property.

If the IRS files a lien against you, you have a 30 day window to file an adminsitrative appeal to request reconsideration of the filing.  This is called a collection due process appeal.

The lien expires when the IRS statute of limitations on collection expires – in most cases, 10 years.

IRS TAX LEVY

The purpose of an IRS levy is to take your property.  An IRS levy is the same as a seizure, or garnishment.  The IRS can levy on your wages, bank accounts, subcontractor pay, accounts receivable, even retirement accounts.  The IRS can seize your house, car or your business equipment (although those are rare).   For most people, it is the levy, not the lien, that hurts.

There are only a few things the IRS cannot levy  – these “exemptions” are listed in Internal Revenue Code 6334.   The exemptions you can claim include the right to keep unemployment benefits, workers compensation, most household goods and some tools of your trade from the IRS.

Before the IRS can levy on your property, they must first send you a Final Notice of Intent to Levy.  This is your notice of that the IRS intends to start enforcement against you.  After you receive the Final Notice of Intent to Levy, you have 30 days to file an appeal of the proposed IRS collection action. If you file the appeal, the IRS is prevented from taking action until your hearing is completed.  The purpose of the hearing is to reach a resoluton to levy action before it occurs – offer in compromise, installment agreement, uncollectible, for example.

The IRS does not need to file a Federal tax lien as a prerequisite to levying your wages, bank accounts, etc. - just the Final Notice of Intent to Levy.

In the rare cases of seizure of a house, the IRS must get court approval first.  To do this, the Department of Justice will usually file a lawsuit against you in Federal District Court seeking approval to foreclose and take your house.  Again, this is not a preference of the government.

The Federal tax lien and tax levy gives the IRS different rights against you – the lien as to security in your property, the levy to take it.  Together or apart, the lien and levy are powerful tools for the IRS.

Will the IRS take my house? Seize my car?

January 7, 2010

in IRS levies and property seizures, IRS Seizures

One of the most common concerns about owing the IRS back taxes is that they will show up one day and take your house or car from you.

No matter what the IRS may tell you or what you may have heard, it is very unlikely the IRS will levy on your house, car or furniture.  The assets you may be most concerned about the IRS taking are the one’s the IRS is least likely to take from you.  This is important to know in negotiating with the IRS.

Last year, the IRS made only 600 seizures of houses, cars and other personal property.  In case you are wondering, 600 seizures across the country is a very low number (compare to the 2 million levies the IRS sends on bank accounts and wages – now that is a concern worthy of attention).

The reason?  If you do not have any “equity” in your property the IRS will not levy it.

Internal Revenue Manual 5.10.1.2 states that seizures are prohibited  “where the taxpayer has insufficient equity in the property.”  Internal Revenue Code 6331(f) prevents the IRS from making an “uneconomical levy” – meaning there must be an economic recovery to the IRS to do it.

Examples:

Your car? If your car is worth $7,500, and you owe $7,500 on it, you are protected.

Your house? Take the value, subtract your mortgage, and reduce it further by the costs of sale.  There has to be a fairly substantial amount left afterwards for the IRS to be interested under the equity rules.

Even if there is equity, a seizure is still generally something the IRS does not desire to do.  You will need to force them – meaning a lack of cooperation after repeated attempts by the IRS to work it out.  Most seizures need managerial approval before being sent to an IRS property liquidation specialist.  Some, like a personal residence, require outside court approval (See IRC 6334(e((1)).

In most cases, the IRS is prohibited by tax law and their own internal guidelines from making a seizure when there is no recovery.  Because of that, the IRS focuses the most on levying wages and bank accounts.  Knowing the difference allows you to put your energy into protecting what really matters to the IRS.

IRS installment agreement vs. Chapter 13 bankruptcy: Which repayment plan saves you the most?

January 2, 2010

in Bankruptcy - Chapter 13, Bankruptcy and the IRS, Installment agreements, Interest and penalties

Trying to repay the IRS in an installment agreement can be difficult.  The interest and penalties the IRS charges doubles the original amount of tax you owe every five years.

Your installment agreement may keep the IRS at bay, but your tax liability does not get paid off.

The tax code and the IRS offers no real way of stopping interest and penalty accruals.  That is frustrating, but there are solutions.

The solution for many is in the bankruptcy code.  An IRS repayment plan made through a Chapter 13 bankruptcy can stop IRS interest and eliminate penalties. Chapter 13 can even reduce the amount of tax you pay.  This often results in a shortening the time it will take you to repay the IRS.

No one really wants to file bankruptcy, but making your installment payments by bankruptcy law, not tax law, can result in substantial benefits to you.

A Chapter 13 bankruptcy repayment plan can help you with the IRS.  Here’s how:

(1)     Interest stops.  Chapter 13 stops the IRS from charging you interest while you make your payments.  The interest you already owe the IRS can also be reduced by bankruptcy law.

(2)     Penalties can be reduced.  Chapter 13 can stop the accrual of IRS penalties.  Bankruptcy law can also force the IRS to accept a reduction in the penalties already charged.

(3)     Repay a percentage of what you owe to the IRS.   The amount of tax, interest and penalties repaid to the IRS can be as little as 1% by Chapter 13 bankruptcy law (vs. 100% in IRS installment agreements).  This is accomplished by use of the Chapter 13 bankruptcy “cramdown” rules.  You pay back olny what you can afford on older income tax debts in a Chapter 13.  Anything you cannot afford to repay on the older taxes is eliminated.

(4)     IRS collections stop.  Once you file a Chapter 13, the IRS is prevented from levying your property.  Bankruptcy creates a “stay” on the IRS.  You keep everything in a Chapter 13 tax bankruptcy.

(5)     Your budget.  If the IRS will not allow some of your expenses in an installment agreement, bankruptcy law could.  A Chapter 13 tax bankruptcy means you pay the IRS what your reasonable budget permits under bankruptcy law standards.  You eliminate much of the use of IRS “living expense standards.”

In most cases, the Chapter 13 bankruptcy results in you paying back much less than what you would in an IRS installment agreement.  What you pay does not double by tax law, but can be reduced by bankruptcy law.  Comparison of a Chapter 13 repayment plan vs. IRS installment agreement can save you time and money.

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