Howard's IRS and the Law Blog

Today’s Cincinnati Enquirer published an editorial of mine about offering IRS amnesty to non-filers.

There are 6.1 million non-filers – to find out how to bring them back into the system with a fresh start and stimulate the economy, read the article here.

When negotiating with IRS Revenue Officers, it is important to remember the many enforcement tools they have at their disposal.  These powers include:

1.     Filing a Federal tax lien securing the IRS’s interest in a taxpayer’s property.

2.     Issuing a levy to seize bank accounts, wages and subcontractor income.

3.     Seizure of “hard assets” that have equity, such as real estate, automobiles and business equipment.

4.     Using a summons to compel a taxpayer to appear at the Revenue Officer’s office and complete a financial statement (subsequently used to enforce #1, #2 and #3, above).

5.     Investigate owners and managers of a business for liabilty for the trust fund recovery penalty.

6.     Prepare “substitute returns” to put a liability on the IRS’s books when there is a refusal to voluntarily file returns.

7.     Make referrals to the IRS Criminal Investigation Division.

8.     Grant installment agreements and uncollectible status.  Field Revenue Officers do not directly investigate and make determinations on offers in compromises and innocent spouse claims.

9.     Pursue recovery of transfers of property to third persons intended to defeat the IRS’s interest, including via transferee liability and nominee liens.

10.   Make personal visits to a taxpayer’s house or business.  If you are not home, expect a card in the door.  Best times for the visit:  before long weekends.

Always respect an IRS Revenue Officer and their powers.

Internal Revenue Code section 6334(a) shields certain taxpayer assets from the IRS collection powers.  As these assets are beyond the reach of the IRS, it is important to remember to always exclude their value from IRS financial statement Form 433A.

Claim as “exempt” the following:

1.     Tools of the trade or profession up to $3,950 in value.  At Page 6, Item 59a (“Business Assets”) of the Form 433A, the IRS requests itemization and valuation of business assets; provide it, but write in “exempt” as to the net equity value available to the IRS pursuant to IRC 6334(a)(3).

2.     Household goods and furniture up to $7,900 in value.  At Page 3, Item 19a (“Personal Assets”) of the Form 433A, the IRS requests itemization and valuation of personal assets; provide it, but write in “exempt” as to the equity value available to the IRS pursuant to IRS 6334(a)(2).

3.     Also, be sure to reduce asset values of other assets (cars, houses) at 80% of fair market value, pursuant to Internal Revenue Manual 5.15.1.16(2). This reduction is to arrive at quick sale value, which is what the IRS uses to estimate the price for the asset if it were to be sold in a short period of time under financial pressure.

It is important to always claim these exemptions and reductions when submitting an offer in compromise to ensure the value offered is not overstated.

Keep an eye out for future posts on income sources that could be excluded from an IRS financial calculation and compromise calculation.

With new clients, I spend time discussing the options for obtaining a fresh start from IRS problems. The consultation most always involves making the client aware of the pros and cons of resolution by compromise, and by bankruptcy.

In that spirit, here then is the first of a continuing series on the use of an offer in compromise vs. bankruptcy to solve an IRS problem.  Future topics will include the impact of each on Federal tax liens, limitations on their scope and use, expectations of success, life after each, situational examples, and their ability to stop IRS collections.

For now, which one can be the lowest settlement amount?

CHAPTER 7

In most cases, the lowest settlement amount to the IRS will be in a no-asset Chapter 7 bankruptcy.   You can’t go lower than zero, which is the IRS recovery in these cases.

The term “no-asset” means that your property does not have enough value to entice a Chapter 7 bankruptcy trustee to take it.  Most Chapter 7 cases are no-asset cases.   Because of this, you keep all of your assets in “no-asset” Chapter 7 cases.  And the amount you owe the IRS is discharged by bankruptcy law if you meet three rules:  (1) the taxes you owe are income taxes, (2) you filed the returns more than two years before you filed the bankruptcy, and (3) the tax returns you owe money from were due to filed more than three years before you filed the bankruptcy.

In other words, income taxes that have been filed and are a little bit older can be wiped out in a no-asset Chapter 7.  There is no repayment if there are no assets.

CHAPTER 13

A Chapter 13 bankruptcy entails monthly payments to the IRS over a course of three to five years.  You make monthly payments in a Chapter 13 because you can afford to;  in most cases Chapter 7 is for those who cannot afford a repayment.

Chapter 13 is an excellent alternative to an IRS installment agreement because it can stop interest and penalties accruals on many IRS claims.  It is often the interest and penalties accruals that make installment agreements so difficult.  Chapter 13 shrinks the IRS claim.

Chapter 13 also provides for older income tax liabilities (and the interest and penalties on the taxes) to be repaid a small percent of what is owed (called a “cramdown.”).  On these older claims, you repay what you can afford monthly.   The amount you cannot repay is eliminated by bankruptcy law.

Because of the ability of a Chapter 13 to stop interest and cramdown older tax recoveries, there can be substantial savings in making monthly payments by modifying IRS claims through a Chapter 13 tax bankruptcy.  Chapter 13 can also modify and lower other debt repayments, such as credit cards and medical bills.

Chapter 13 bankruptcy laws has less power to modify the repayment on more recent tax liabilities (last three years), trust fund taxes and property subject to an IRS tax lien.

OFFER IN COMPROMISE

The cost of an offer in compromise will be (1) equity in your assets and (2) the value of your cash flow to the IRS in the future.  If the IRS predicts there will be enough cash flow over the timeframe that they have to collect the liability, there will be no compromise.   The timeframe is 10 years from when the tax liability was put on their books.  Most assets will be reduced in value by 20% to get arrive at IRS valuations.

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The IRS cannot take collection action against the separate income of a non-liable spouse.

If separate tax returns are filed, only the person who signed and filed the return is legally obligated to pay the taxes.  If your spouse did not sign or file a joint return with you, then the IRS cannot collect from him or her.

If joint returns were filed during a prior marriage, the IRS cannot collect your old liability from your new spouse.

Even if a joint return was filed, the IRS has innocent spouse rules to protect a spouse who claims “innocence” as to the liability.  Innocence generally means the spouse did not know or had no reason to know of the liability and received no benefit from the unpaid taxes.  If the IRS grants relief, it will not collect from the innocent spouse even if a joint return was filed.

The IRS also cannot take any separate assets of your spouse, like cars and real estate.  However, if the asset is yours and you place it in your spouse’s name, the IRS can pursue your spouse for recovery.

If you cannot pay your delinquent taxes because of an economic hardship, the IRS can suspend collection efforts against you.  This does not mean your debt is forgiven; just that the IRS will defer collection and not take your wages or bank account.

Internal Revenue Service Policy Statement 5-71 permits hardship status on IRS accounts, as follows:

If there are limited assets or income but it is determined that levy action would create a hardship, the liability may be reported as currently not collectible. A hardship exists if the levy action prevents the taxpayer from meeting necessary living expenses. In each case a determination must be made as to whether the levy would result in actual hardship, as distinguished from mere inconvenience to the taxpayer.  If, after taking all 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.

Internally within the IRS, hardship aka currently not collectible, is known as a “53” case, for the transaction code the IRS inputs into your account to indicate a suspension of collection activities.

To obtain hardship status, the IRS requires a complete financial disclosure of your monthly income and living expenses, as well as a valuation of your assets and liabilities.  The IRS will compare your monthly expenses to their charts of food and clothing, housing and utilities and car expenses.  For example, if you have a $600 monthly car payment, the IRS will object to hardship status.  Your car payment, according to their charts, would be too high for you to claim a hardship.

The IRS requires you to have no cash flow to be a hardship.  You may think you have a zero budget; the IRS may feel differently.  There are procedures to give you time and opportunity to adjust your budget.  For those who cannot adjust expenses to the satisfaction of the IRS, sometimes a Chapter 7 or Chapter 13 bankruptcy is a better option to eliminate the taxes.  You can learn a little more on bankruptcy and the IRS here.

Economic hardship does not forgive interest and penalties.  Expect the amount you owe to double every five years from the running of interest and penalties.

In many situations, being on a continued hardship status is an effective method for resolution of an IRS liability.  The IRS has 10 years to collect the amount you owe.  After the 10 years lapses, the IRS will clear the account balances to zero, as required by law (read more on that here).

The IRS can also settle a hardship case by submission of an offer in compromise rather than have it linger in the system.

A comparison between the pros and cons of resolution by sitting on a hardship status, filing bankruptcy or submitting an offer in compromise is essential to resolving a tax delinquency.  No option should stand alone.

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