Howard's IRS and the Law Blog

The IRS takes the decision to use employee tax withholdings to pay business operating expenses rather than the IRS quite seriously.  The owners and managers of the business who make these decisions will find the IRS coming not only to the business, but to them, to recover a portion of the withholdings.

This is an exception to the usual rule that the business debts of a corporation or limited liability company do not extend to its owners.  These actions in paying creditors, not the IRS, put the assets of the owners and managers at risk.  The IRS calls this a trust fund recovery penalty because the employee taxes should be held in trust by the business for payment to the IRS.

The IRS is aggressive in investigating and holding business owners and managers responsible for the repayment of these withholding taxes.

But it is important to understand this: the investigation and assessment of the business taxes against owners and managers is often the end of IRS activity against them.  Collection enforcement of a trust fund liability is often light after the fact, with little or no contact afterwards.

The IRS Taxpayer Advocate reported that the IRS collected 3% of the withholding taxes it assessed against business owners and managers in 2007. Consideration of the extent of IRS active enforcement is an important factor in determining the best way out for those that cannot personally repay these trust fund withholding taxes.  Sometimes it is best to know when – and how – to hold tight.

The IRS is aware of the problem, but it remains reality nonetheless. A request should always be made during an IRS withholding tax investigation for an upfront collectibility determination before these taxes are laid on those behind the business.  But note that these requests are rarely taken to heart by the IRS.

Without an upfront collectibility determination, these taxes are put on the books against those running the business, and the IRS then has 10 years to collect the taxes from them.  At this point, time is often the best healer for ownership and management. Time often works best for those that cannot repay as trust fund taxes are generally harder to compromise than a straight income tax liability and are not dischargeable in bankruptcy.

A client came in today with an older tax liability that appeared to have only two years left on the IRS statute of limitations on collection.  The client had not heard from the IRS in years.

A statute of limitations is the time the IRS has to do something.  For IRS collection cases, it is the time the IRS has to collect  – 10 years.  After 10 years, the liability is cleared off the IRS books.

When was the end for my client?

Since all had been quiet, it was important to get a better feel for when the IRS statute of limitations began and ended without waking a sleeping giant.

The answer to determining a quiet end for my client was a review of the Federal tax lien the IRS had filed against him.

A Federal tax lien lists the date the IRS statute of limitations on collection begins, and lists the date it ends. Federal tax liens are public record, filed at a county clerk’s or recorder’s office.   After obtaining the tax lien, we had a good idea of when the statute of limitations on collection ended without having to call the IRS and disrupt still waters.

As part of the reliance on tax liens, it is important to get a clear understanding whether any events have transpired that could change the statute date that would not be evident from the Federal tax lien.  The most common events that will add to the collection timeframe shown in the Federal tax lien include the submission of offer in compromise, filing a collection due process appeal or innocent spouse claim, or going into bankruptcy.

With an initial determination made on the statute of limitation on collections from the Federal tax lien, we set a later date to contact the IRS – when we believed the liability would no longer be collectible, rather than while it still was.

Today IRS Commissoner Douglas Shulman gave an interview on National Public Radio (NPR) about how the IRS will be dealing with hardship cases during these difficult economic times.

Shulman did not addresss what is really holding up IRS collections – an offer in compromise system that accepts only 25% of the offers it receives.  The IRS collection guidelines have long been too rigid, resulting in an increasing number of taxpayers opting for bankruptcy on the IRS.  This almost always results in a lower recovery to the IRS than an offer in compromise.  And how is more bankruptcy good for our economy?

Here’s to Shulman truly being in sync with the hardships that taxpayers are going through and pushing through real changes – more administrative settlements that gives fresh starts and brings in dollars.

My clients are honest and usually have had some bad breaks – business failure, divorce, medical issues – it could happen to anyone.  Opening up the compromise progaram will provide more fresh starts, bring in money to the Treasury and get those with IRS tax problems back to their full abilities, including homeownership.

In determining whether you can repay a delinquent tax liability, the IRS uses its own expense allowances to arrive at your cash flow.  Just because you have the expense does not mean the IRS will allow it.

In most cases, your housing/utilities and auto operating expenses will exceed IRS guidelines.  Credit card payments are rarely allowed.  This results in the IRS requesting payments you cannot afford to make.

There are EXCEPTIONS if you have expenses that exceed IRS allowances.

If the liability can be repaid within five years, the IRS has discretion to allow all expenses.

The IRS will also allow up to one year to eliminate the unallowable expenses, but in most situations this is usually quite difficult to accomplish.  How do you suddenly retire that credit card debt in 12 months?

These expense allowances are at the heart of every IRS collection case – the value of an offer in compromise, the amount of an installment agreement, or whether your debt is uncollectible.

Here is an overview of what the IRS will allow (click on the highlighted area for the IRS monthly household living expense allowances):

      Food, housekeeping supplies, clothing, personal care products.  This is good news – the IRS will give you their allowance even if you spend less – you do not have to prove it.  You will, however, have to show unusual circumstances to get more (i.e, specialized diet).   

Mortgage, rent, real estate taxes, insurance, maintenance, gas, electric, water, trash, sewer, heating oil, telephone and cellular phone.   These allowances are localized – someone living in Los Angeles County will be allowed more housing and utility costs than than if they were living in Hamilton County, Ohio.  It is based on the number of dependents in your household.  In most cases, the IRS allowances are not enough to cover actual living expenses. Extenuating circumstances must be present for the IRS to allow more.

Auto payment and operating expenses.  You are allowed a car payment not to exceed $489/month; if your payment is less than $489, then what is paid is what is allowed.

Operating expenses (gas, insurance, tags, maintenance) for your car is based on local allowances – if you live in Cleveland, for example, the IRS will allow $186/month per car; if you live in Dallas, the IRS will allow $228/month per car – usually short of reality.  Operating expenses have to be proven if you claim an entitlement to more than the allowances, which is most often the case.

      Medical expenses.  The IRS will allow health insurance premiums – no limitations provided it is necessary.  Medical out of pockets – prescriptions, copays, etc. – are allowed at $60/month per dependent under age 65, $144/month for those over 65.  If you spend more than that, you must prove it.

Other expenses, including credit card payments and charitable contributions, are usually not allowed, while child support and student loans usually are. In most cases, the credit card payments would have to be necessary for the health and welfare of your family (hard to prove) or for your business.

Yes, the IRS wants the credit card money, and so does the credit card companies – who gets the pie?

The dilemma over your reality vs. the IRS expense allowances often forces a Chapter 7 or Chapter 13 bankruptcy reorganization, using federal bankruptcy law to determine payment priorities, not IRS guidelines. This often results in paying less on the credit cards and less to the IRS.

IRS financial statements should be prepared only with a full understanding of how to  work though the IRS expense guidelines.  It is important to capture all allowable expenses – like arguing for an allowance to replace a 10 year old truck with no car payment when one is necessary.

With tax season in full bloom, a little reminder to avoid making false or fraudulent claims on your tax return is in order.

If you want to see what a criminal tax case looks like, the IRS makes it easy – here are the fact patterns and sentencing results of over 50 criminal tax cases from the last six months – business owners, physicians, public officer holders, ministers, and accountants included.

A primary purpose of criminal investigations is to protect the integrity of the tax system – like those listed, you will be exposed to deter others.

Overall, the IRS does not undertake a significant amount of criminal investigations – in 2008, there were 3,749 investigations initiated.  But make no mistake, this is serious territory.  Once the IRS digs in, there is a 75% chance you will be referred for prosecution.  You do not want to go there.

Having two IRS criminal investigators make an unannounced visit to you, flash a badge and request to sit down and ask you questions will make your world spin.

If an IRS Special Agent contacts you, stop.  State that you do not wish to answer any questions without retaining professional representation.  There is a right time and way to properly respond to this type of IRS investigation, and answering alone, on the spot, without understanding the implications of what is transpiring is dangerous.  The IRS may know more than you think at this point. There is no benefit to letting them compare notes.

An IRS criminal investigation can bring financial and social ruin, loss of career and incarceration.  The perceived gain from the act is simply not worth it.

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