Howard's IRS and the Law Blog

IRS problems and divorce often come bundled together.  Here is my response to a question I recieved about how a divorce decree impacts the IRS in the collection of an unpaid tax liablity:

My ex was self-employed when we were married, and he never paid his taxes. I made the mistake of signing joint returns. When we got divorced, we signed papers stating he would pay our back taxes, but the IRS coming after me.  Will my divorce decree help?

The decree may have value to you if you believe you are an innocent spouse. The IRS does consider the decree as one of several factors in reviewing your claim.  Those factors include abuse, what you knew about the unpaid taxes, involvement in family finances, and whether you benefited from the unpaid taxes.

Bear in mind that your divorce decree does not, standing alone, bind the IRS. When you signed the return, the liability became “joint and several.”  You became responsible for the accuracy of the return and for the payment of the liability on it, even if it was not yours.  The decree will not automatically make it go away or cause the IRS to shift their attention to your ex.

If you can prove to the IRS your signature on the joint return was forged or you signed the return under fraud or duress, the IRS will convert your joint liability to a separate one.  This relieves you of paying your ex’s taxes.

You may also have solutions to the collection of the liability against you: Bankruptcy, offer in compromise, uncollectible, or the statute of limitations on collection.

All recent indications are that the IRS is plowing ahead in its collection efforts under a weakening economy.  Revenue Officers continue to push hard, and there are no signs that Automated Collection Service has backed off its levy and lien filings.

The unfortunate result of this pressure is that more and more clients are turning to a tax bankruptcy to resolve IRS problems.  The advantages of a tax bankruptcy are often significant.  Here are a few:

1.     Bankruptcy stops the IRS and releases levies and seizures.

A tax bankruptcy immediately secures the release of an IRS levy on bank accounts and wages, and stops seizures of assets like houses, cars and business equipment.  This is absolute under bankruptcy law – once bankruptcy is filed, all collection actions must stop, including those of the IRS (this is referred to as a “stay”).  In most cases, bankruptcy frees property from the IRS the same day it is filed.

2.     Bankruptcy ends IRS discretion in its case handling.

Once bankruptcy is chosen, it is no longer just up to the IRS.  IRS personalities and procedures yield to bankruptcy law.  Installment agreements that could not be agreed to under IRS standards may be obtained in a Chapter 13 repayment plan.  Chapter 13 adds the benefit of stopping the accruals of interest and penalties while payments are made, a virtual impossibility with direct IRS negotiations.  Taxes that could not be solved by an administrative IRS offer in compromise can be eliminated in a Chapter 7.

3.     Bankruptcy eliminates taxes, interest and penalties.

Income taxes owed on returns that were actually filed with the IRS more than 2 years before the bankruptcy and were due to be filed with the IRS more than 3 years before the bankruptcy can be wiped out in a Chapter 7.  Bankruptcy is a powerful means of IRS resolution on these older income taxes.  If the bankruptcy rules are met, all the taxes, interest and penalties will be gone after a Chapter 7 bankruptcy is completed (usually 4-6 months).

4.     Bankruptcy is an alternative to an offer in compromise.

The IRS is accepting only 25% of compromises.  The IRS offer in compromise program has historically been an good source for resolving unpaid taxes.  With the current low acceptance rate, the reality is the IRS offer program is now broken.  Because of that, filing a tax bankruptcy on the government has become a viable option for a fresh start with the IRS.

5.     Bankruptcy is a complete solution to all debt problems.

A tax bankruptcy solves IRS problems, but it also can eliminate state taxes, overwhelming credit card debt, well-intentioned medical bills, debt from a failed business – and it stops foreclosures.  With the present state of the economy, a comprehensive “all in one” solution to financial problems can take priority.

More details on handling taxes in bankruptcy can be found in my recent article for the Journal of the National Association of Enrolled Agents.

Retirement accounts are considered to be an investment that is protected from creditors.  But here is an interesting question from a reader about a big exception to that rule (yes, it is the IRS):

Several years ago, I liquidated all of my retirement money to pay for gambling trips to the casinos.  My husband and I had a fairly substantial amount of tax due from the early withdrawal penalties. Now, I have been contacted by an IRS Revenue Officer, who is demanding that my husband liquidate his retirement money to pay our taxes.  It is the only savings we have, and I thought it was safe.  My question is: Can the IRS seize retirement accounts?

The IRS can seize retirement accounts, including 401k plans, IRAs, and self-employed plans like SEP-IRAs and Keogh plans.  There are no prohibitions in the Internal Revenue Code against it.      

The key to defending retirement accounts from IRS seizure is to understand that the IRS stands in your shoes, and can only get what you can get.  This means that if you cannot get to the retirement money, the IRS cannot get to it either.

Many retirement plans do not provide for present rights to the money, allowing access only at separation from service, retirement or death/disability. If you are still employed, you likely have no ability to withdraw the retirement money, and the IRS has no ability to seize it.  Reference is found in Internal Revenue Manual 5.11.6.2, which governs IRS seizures of retirement accounts.

If you do have rights to the money and the IRS can get to it, it becomes important to understand (1) whether your conduct leading to the liability was flagrant and (2) whether you depend on the money in the retirement account, or will in the near future. Flagrant conduct includes tax evasion, fraud or making contributions to the account while the unpaid taxes were becoming due.  If it can be developed that your conduct was not flagrant or that you will depend on the retirement money, Internal Revenue Manual 5.11.6.2 specifically states that the retirement account is not to be levied.    

I have seen the IRS readily back off when it is established that there are no rights to the money.  I have also seen aggressive IRS Revenue Officers agree not to take a retirement account, but decide to put pressure on as to a levy on wages if the retirement money is not voluntarily withdrawn.

The IRS is generally reluctant to take retirement accounts, and many times they cannot take action (such as when there are no rights to the money), but proper handling, negotiation and an understanding of the process is extremely important as to defending this very sensitive asset.

After conducting an extensive review of their use of outside private debt collectors, the IRS has decided to eliminate the program in its entirety.  The program lasted for all of 30 months.

But the IRS is not standing still.  This is not a downsizing mode. The IRS is beefing up collection efforts.

Significantly, the IRS will replace the private debt collectors with a hire of over 1,000 new internal collection officers.  This is significant as the private debt collectors had no ability to take any enforcement action against taxpayers.  They were used as what amounted to an outsourced IRS call center.

By comparison, internal IRS collection officers have access to a wide range of enforcement tools – levy, lien, seizure and the power to summons – as well as the ability to conduct detailed investigations and visit a taxpayer’s home and business.

In announcing the new collection hires, IRS Commissioner Doug Shulman stated “I believe this work is best done by IRS employees, and I believe we have strong support from the Administration and the Congress for increased IRS enforcement resources going forward.”  So much for kinder and gentler in a troubling economy.

As the year progresses, time will tell how these hires are disbursed – into local enforcement efforts (Revenue Officers) or centralized processing (Automated Collection Service).

IRS Revenue Officers are the most experienced and sophisticated collection employees within the IRS. They work high dollar cases identified by the IRS to be of significance.  Focus is often given to business cases, employment tax liabilities, repeat offenders and non-filers.

The Revenue Officer function is localized, with their offices located near your home or business.  Revenue Officers are “field agents,” meaning they are expected to get out of the office and get into the “field.”

If you case has been assigned to an IRS Revenue Officer, expect an initial unannounced visit to your place of business or residence.  These visits are known to occur on Fridays and often before holiday weekends. If you are not in your office or at home, the Revenue Officer will leave a “calling card” in the door, requesting that you contact them by a set date.  If you do not voluntarily comply, the Revenue Officer has the power to summons your attendance at an IRS office.

If there is a lack of cooperation on your end, expect the Revenue Officer to start procedures to take your bank accounts, wages, retirement accounts, receivables.  Revenue Officers can also seize any equity you have in cars, autos and business equipment, but these are usually last resorts in severe cases.

And remember:

(1)     The Revenue Officer wants case resolution and a closed file as much as you do.

(2)     Case resolution can mean an offer in compromise, installment agreement or even having your case closed as uncollectible – it all depends on your finances; and

(3)     When your mouth is in the head of the bear, say nice bear.

In these difficult economic times, repaying the IRS is becoming harder than ever.  Installment agreements may be entered into in good faith, but while payments are being made, interest and penalties continue to run.  Every five years, interest and penalties double the original tax.  Most attempts to repay the IRS result in the amount owed increasing, not decreasing, because of this.

Very few people that owe money to the IRS want to be there.  For most, it is a life situation that puts them there – a failed business venture, divorce, medical problems.  But the weight of IRS interest and penalties often makes it impossible to get a fresh start – purchase a home, get remarried, start a new profession.  This economy amplifies the impact.

Because of that, I have proposed to Treasury Secretary Timothy Geithner that he implement a program of relief for IRS interest and penalties.  For those that are out of the system and who come forward, and for those that are in the system but are treading water, forgive interest and penalties if the tax can be repaid over an agreed upon payment plan.

This would bring people back into the system, close the tax gap and stimulate the economy by helping taxpayers get out of debt.

My letter to Geithner is here.

Let me know what you think.

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