It is always important to understand what the IRS is asking, and why.
Resolution of most collection cases involves providing answers to IRS questions about you. The questions are asked on an IRS financial statement, known as Form 433A.
One question the IRS asks: Have you lived out of the country for more than six months in the last 10 years?
Why does the IRS want to know that as part of its efforts to collect taxes?
Because it extends the statute of limitations on collection under Internal Revenue Code 6503(c). The IRS has 10 years to collect – any continuous absence of six months or more suspends the collection timeframe. Internal Revenue Manual 18.104.22.168.7 summarizes the interest in this question: “The application of this paragraph can result in the CSED (collection statute expiration date) being suspended for a very long time.”
This is information that the IRS ordinarily would not know, so it is asked as part of the financial investigation into case resolution.
Simple questions, big ramifications. A “yes” answer may be called for, but it always helps to know how the other side thinks.
The IRS is hiring revenue agents (auditors), revenue officers (collectors), and special agents (criminal investigators). This has been made public by the IRS, but I attended a joint conference with the IRS last week in which every IRS panelist – from IRS auditor managers to taxpayer advocates to senior IRS attorneys – confirmed the trend in their respective divisions.
Expect enhanced IRS enforcement in the coming years from the increased staffing. Enforcement hires will be in training first, then be dispatched to the field and mentored by senior personnel. Check out what is available at the IRS website.
Having worked for the IRS as a trial attorney in the Office of Chief Counsel, it is a good place to be – I received great experience there and made many friendships that I still maintain. You may just find that the IRS agents you fear are really not all that bad behind the scenes. Sometimes, they have a job to do.
A common problem with IRS audits is not seeing eye to eye with the auditor. The auditor sees the case narrowly, while you see the big picture. You know you incurred that expense or did not have unreported income, but the auditor’s criteria is difficult to satisfy.
Here are some ways to get problem IRS audits resolved:
1. Try to work it out with the manager. Every auditor has a manager. Sometimes, a call to the manager can resolve thorny issues.
2. Take the case to IRS appeals. IRS Appeals Officers settle cases on what is known as the “hazards of litigation” – meaning if you went to Tax Court, what would an impartial judge say about your case? Auditors rarely consider that, which is often the cause of the bottleneck.
3. Go directly to Tax Court. If you are at a standstill, request that the auditor close the case out and issue a Notice of Deficiency so you can take your case directly to Tax Court.
An advantage to going to Tax Court first and then conducting settlement negotiations is that the trial is real. The “reality” of a pending trial can help negotiations, especially if the IRS evidence is weak. See my prior post “Tax Court – providing a level playing field in IRS audits.”
4. If you already are getting billing notices from the IRS, request audit reconsideration. If you did not take advantage of going to IRS Appeals or Tax Court and you are getting billing notices for an amount you do not owe, you can still request that the IRS reconsider the audit after the fact. You do not need to overpay your liability if you have documentation that supports your position and it was not adequately considered during the audit.
On more than one occasion I have used the possibility of bankruptcy as leverage in reducing the value of a offer in compromise. The possibility of bankruptcy can have a big impact on an IRS offer in compromise.
1. A Chapter 7 bankruptcy can “discharge” a tax liability.
2. Any taxes that could be discharged by a potential bankruptcy cannot be collected against the future income of the taxpayer.
3. A critical component of an offer in compromise is an IRS calculation of how much can be collected from future income.
4. If bankruptcy is “Plan B” to an offer in compromise, the IRS may reduce the value of future income to account for the limited collection potential.
The Internal Revenue Manual 22.214.171.124(5)) on reducing the value of a compromise from bankruptcy states as follows:
“Some situations may warrant placing a different value on future income than current or past income indicates…if a taxpayer will file a petition for a liquidating bankruptcy (Chapter 7)…consider reducing the value of future income.”
It is important to know when bankruptcy can discharge taxes to do this – it often will need to be explained in detail to the IRS offer investigator, who may not be familiar with taxes and bankruptcy. The taxes being compromised would need to have been (1) due to be filed three years prior (2) filed two years prior and (3) the tax assessed 240 days prior to the potential bankruptcy filing.
When properly inserted into the compromise negotiations, Internal Revenue Manual 126.96.36.199(5) can have a significant impact on the value of a compromise. It can also avoid a bankruptcy filing by pushing a compromise over the goal line.
For more on taxes and bankruptcy, see my article in the Journal of the National Association of Enrolled Agents, presentation outlines and my other tax bankruptcy related posts.
I received this question about using an offer in compromise on interest and penalties:
I owe $25,000 in tax, but the interest and penalties have made the amount I owe almost double. Won’t the IRS be happy just to get the principal I owe back and forgive the interest and penalties?
In an offer in compromise, the IRS considers all of your liabilities – tax, penalty, interest – as being of equal stature. The amount you owe in penalties is as equally important to the IRS in an offer in compromise as the tax. Although it may seem logical to assume that the penalties and interest are “extras” and more easily forgiven, this is simply not true with the IRS.
To the IRS, the tax, penalty and interest all bear equal weight. There is no formula to abate interest and/or penalties in an offer in compromise. It is purely a collection formula. If the IRS believes they can collect it, they will not compromise it. The IRS does not consider “tax only” offers unless for some reason that is the exact amount that can be collected.
If you believe the IRS should not have charged you penalties, then the proper course is to request abatement outside of the compromise process. This involves an administrative decision of the IRS to forgive penalties they have already determined you are responsible for. Penalty abatement involves proving to the IRS factors that there were beyond your control that prevented timely payment or filing. Interest can be abated if the IRS unreasonably fails to perform a ministerial or administrative function. The additional interest can be abated during the period of delay.
A better option on eliminating interest and penalties is often bankruptcy. A Chapter 7 bankruptcy can completely eliminate tax, interest and penalties. A Chapter 13 bankruptcy repayment plan can stop IRS interest accruals and force the IRS to accept a reduced amount of penalties by bankruptcy law, not tax law. An offer in compromise can result in the IRS forgiving tax, penalties and interest, but only if the collection is in doubt.
It really does happen – you can overturn an IRS audit in Tax Court.
My client disagreed with an IRS audit that determined she should pay a 10% tax on early distributions from her retirement account. She had taken early retirement, and wanted to start taking withdrawals from her retirement account. Ordinarily, this would cause a 10% early distribution penalty. But she chose to take the distributions in substantially equal amounts each year, an exception under Internal Revenue Code 72(t).
One year, in addition to the substantially equal distributions, she took additional money out of the retirement account as an early distribution to pay for her son’s college tuition. Withdrawals to pay for college education are also not subject to the 10% early distribution tax.
The IRS audited the return and determined that the education withdrawal modified the substantially equal distribution. The IRS argued that to avoid the 10% tax on the substantially equal payments no other distributions can be made from the retirement account. The theory was that the college education withdrawal modified the other distributions so that they were no longer equal in amount every year. If the IRS was correct, all the substantially equal distributions would have been modified and subject to the 10% tax.
We took the IRS audit decision to Tax Court.
The Tax Court’s decision – Benz v. Commissioner, 132 T.C. 15 (2009) – overturned the IRS audit with some common sense – a permitted distribution (education) does not modify and disqualify another permitted distribution (substantially equal payments). The substantially equal payments were not modified and were not subject to the 10% tax.
Tax Court can be a great equalizer in setting straight IRS administrative decisions.