Howard's IRS and the Law Blog

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.

One rule to follow in bankrupting income taxes is that the liability must be from a return that was due to be filed three years before the bankruptcy is commenced. The key is to be careful to include extensions of time to file in calculating the due date of the return, especially starting in 2009.

Until 2004, the IRS used a two step process for extensions, with an automatic four month extension allowed until August 15, followed by a second to October 15.  For 2005 returns due in 2006, the IRS streamlined the process, allowing one automatic six month extension to October 15.  Those 2005 returns (due in 2006) are now becoming ripe for bankruptcy in 2009.

In preplanning for clients, I have already seen automatic six month extensions for 2005 tax returns to October 15, 2006, but the return was filed sooner, maybe in August, 2006.  This discrepancy was less likely under the prior rules, when if all that was needed was time until August 15, that was what was requested and granted.

Don’t be fooled by the likelihood of seeing earlier return filing dates.   Continue to focus on and use extension dates in calculating the three year rule.

More on bankrupting taxes can be found in my recent article in the Journal of Enrolled Agents “But I thought you can’t eliminate taxes in bankruptcy,” or in this presentation outline on bankruptcy and the IRS.

Entrepreneurs justifiably take great pride in their business.  But this pride often gets in the way of a clear understanding of the risk of continuing to operate into a storm of IRS trouble.  The IRS comes down hardest on businesses with tax troubles, and owners and management are usually implicated as well.

Here are a few warning signs of tax troubles:

1.     Using employee tax withholding money to pay other creditors.  Falling behind on employment taxes is a vicious circle, with interest and penalties causing the liability to increase substantially to the point of making a planned repayment difficult.  Additionally, ownership and management can be held personally responsible for the unpaid taxes (this is called a trust fund recovery penalty).  If the business can’t repay the taxes, the IRS will seek to collect from the personal assets of the individuals.

2.     Failing to make quarterly estimated tax payments.  Many business owners, especially those that are self-employed, are responsible to account for their own income tax payments.  Employees have a withholding mechanism; owners often do not.  The cash crunch from the business impacts the ability to pay personal living expenses, resulting in income taxes being left out of the household budget. Groceries and mortgages need to be paid, but the IRS is delayed.  The IRS is as important as the mortgage; after all, what good is it to pay your mortgage while giving the IRS a claim on your house?

3.     Delaying the filing of tax returns.  If you can’t pay, not filing is not the answer.  The money is still due, and filing late only adds penalties to the amount owed.  It also puts off addressing the problem, compounding the issue.  And the IRS tracks unfiled returns, especially in employment tax cases.  Not filing is a great way to get the attention of the IRS and have them assign a local Revenue Officer to investigate.

4.     Plowing retirement money into the business, and using it to pay personal living expenses.  The hope is that tomorrow will be better.  And it might be.  But the creditors that are being paid with the retirement money (suppliers, etc.) have no claim to it – in most situations, retirement money is an asset that no creditor can reach.  Except the IRS.

5.     Unmanageable credit card debt.  Before the retirement money goes into the mix, credit cards are often maxed out.  Stop at this point; the situation is already unmanageable.  Do not dip into the retirement money.  And do not pay the credit cards before paying the IRS.  The credit cards are at the bottom of the barrel – they can be eliminated in bankruptcy, and many times they will end up writing off the account.  Not paying credit cards is uncomfortable, but not as uncomfortable as the IRS can make things.

These are tough situations.  A failing business brings the stress of obligations to employees and personal family members.  But the longer it goes unchecked, the deeper it gets.

Can the IRS continue to audit me year after year?

by Howard Levy on December 22, 2008

in Audits, Tax Court

There are limits on the IRS continuing audits year after year.  These audits are known as “repetitive audits.” Their scope is limited by Internal Revenue Manual 4.10.2.8.5.

The Internal Revenue Manual states that if you are contacted by the IRS, and had a similar issue examined by them in either of the two prior years, and there was no change or a small change in the tax from the audit, the new examination will be discontinued.  If a substantive tax change resulted from the prior audit, the IRM provides that the repetitive audit procedures do not apply and the examination will go on.

The issue in a potential repetitive audit is whether the prior case had a small change (discontinue) or a substantive change (continue).

What if the IRS accepts 97% of taxpayer verifications in a one year audit, resulting in a $5,000 tax deficiency, but seeks to audit the next year’s return after completing the audit?  This is a real life case currently pending with one of my clients before the IRS, involving a successful real estate agent who was able to verify 97% of auto mileage, subcontractor labor and match income on the return to that on his bank statements.  But the IRS wanted to audit a second year.

Isn’t a 97% verification rate saying the taxpayer is abiding by the laws?  Or is a $5,000 deficiency substantial enough to continue on?  IRS Policy Statement 4-21 provides that auditors are to make efficient use of examination staffing and resources and promote the highest degree of voluntary compliance.  How does this situation fit within that directive?  Is further pursuit of a 97% verification rate promoting more voluntary compliance?

There are no limitations by law as to repeat audits.  The limitations are administrative and discretionary within the IRS from the Internal Revenue Manual.  That being said, if you are being audited and the IRS has found minimal changes, but wants to go into other years, be sure to assert your rights against repetitive audits.

Here are the final five situations to look for when the IRS cannot take collection action:

  • When the value of the property is protected by exemptions provided by Section 6334 of the Internal Revenue Code.  There is certain property that the IRS cannot take under any circumstance, including your furniture and household goods valued up to $7,900, necessary clothing, unemployment benefits and child support.  More on that here at “Can the IRS take my stuff?
  • When the liability is $5,000 or under, the IRS cannot seize your personal residence.
  • When business assets of an individual are at stake, only if a determination is made by the IRS that other assets are insufficient to pay the liability.  In addition, the proposed seizure must be approved by an IRS Area Director.  See Internal Revenue Code Section 6334(e).
  • When the IRS has requested your appearance by summons to ask you questions and determine your assets, no collection can occur on the day of your appearance.  See Internal Revenue Code 6331(g).
  • When you can show the IRS that the amount you owe is likely incorrect, IRS policy is to exercise restraint in collections until the issue is reasonably resolved.  See IRS Policy Statement 5-16.

With the situations listed in Part I and Part II, that makes 15 situations where you are protected from the IRS.  This is not meant to be an exclusive list – there are actually more, but these are some of the more common and practical situations.

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