Howard's IRS and the Law Blog

You decide to tell the IRS collection representative what you make, give them your paystubs, and innocently list your monthly living expenses.  You would like a payment plan, and have some idea of what you can afford.  Or you do not think you can afford any payment, and would like the IRS to put your debt in forbearance.

You nearly drop after the IRS plugs all of your numbers into their calculator, applies their living expense allowances, and tells you what they think you can afford to pay to them.

Needless to say, the IRS thinks you can pay more than what you have offered, mainly because your living expenses are higher than what the IRS thinks they should be.  It could be that you have an old house and high utilities, or have a car or mortgage payment that exceeds the IRS financial standards.

Either way, the IRS is demanding the difference and threatening levy action if you do not agree.

The IRS and you are in two different worlds, and you simply do not have the extra money.

The good news:  The IRS does have solutions for when their expense allowances do not match your reality.  (They just do not always tell you about it or offer it .)

Solution #1 to IRS expense guidelines.  The Five Year Repayment Rule.  This can be found in Internal Revenue Manual 5.15.5.10.  Simply put, if your budget allows you to repay the IRS in five years, the IRS can allow all of your expenses, and not apply their rigid financial standards.

Solution #2 to IRS expense guidelines:  Streamlined installment agreement.  In streamlined installment agreements, the IRS will give you as long as 6 years to repay them without a full financial disclosure of your income and living expenses.  You can qualify for a streamlined agreement if you owe under $50,000 and can repay in 6 years.  As streamlined installments require minimal financial disclosure, the IRS does not apply their expense guidelines.

Solution #3 to IRS expense guidelines:   Chapter 13 bankruptcy.   Chapter 13 is a repayment plan supervised by the bankruptcy court, not the IRS.  It can result in a payment plan using your real budget and actual cash flow, not the IRS’ version.  Chapter 13 has added benefits, including stopping accruals of interest, penalties, and possibly reducing how much tax you have to repay (benefits not available internally with the IRS).  A Chapter 13 can last between 3 to 5 years.

When the IRS applies their often overbearing expense and financial standard allowances and demands a payment you cannot afford, know how to craft a solution that works for you.

Chapter 7 is for you if you do not have any money left at the end of the month to repay your creditors.  It is designed to give you a fresh start from honest mistakes you made in your finances – too much credit card debt, medical bills, a failed business and yes, unpaid taxes.  If you qualify for the Chapter 7, when your case is over, these debts will be discharged – meaning that creditors can no longer involuntarily collect them from you.

A Chapter 7 is known as a liquidating bankruptcy.  If you have property with equity, you could lose that property to a bankruptcy trustee, who will sell it and pay the proceeds to your creditors.  Equity is the cash that would result from a sale of your property.  Most Chapter 7 bankruptcies are known as no asset cases because there is not enough equity in your property to result in any meaningful payment to creditors.

Most people filing a Chapter 7 do not lose any property because of laws that protect it. These laws are known as exemptions, and are intended to ensure that you come out of Chapter 7 with property that is essential for day-to-day living.  For example, Ohio law protects up to $3,225 of equity in a car, $20,200 of equity in your house and $10,775 in household goods. There are also protections for money in your bank account, jewelry and retirement accounts.

A Chapter 7 generally lasts between 4-6 months.  The bankruptcy filing lists all of your assets and their garage sale value, your monthly income and living expenses, and your creditors.

There is a meeting with a bankruptcy trustee about 5 weeks after you file, where you will be asked questions under oath about your property and financial affairs, primarily to verify that you have been honest in what you have listed in your filing.  This takes about 10 minutes, on average.  Creditors can also attend this meeting and ask you questions, but this is fairly uncommon.

If you have been honest, are truly experiencing a hardship in repaying your creditors, and have no assets of value past exemptions, you should pass through the meeting successfully.

The bankruptcy trustee works for the Department of Justice, and is appointed to ensure you qualify for the benefits of a fresh start, to ensure that your creditors are treated fairly, and, in situations where there are assets of value, to work to recover them from you.

After the meeting with the bankruptcy trustee, the trustee and creditors have 60 days to object to your bankruptcy.  Again, this is the exception for honest people who cannot afford to repay their debts.  After the 60 days expires, the court is then able to issue your discharge, and your case is then closed and over.

With that background, let’s address the impact your Chapter 7 bankruptcy could have on the IRS.

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Unpaid employment tax liabilities results in the highest level of IRS enforcement.  The IRS usually assigns its most experienced Revenue Officers to investigate employment tax cases, including pursuing the individuals in the business personally for not paying their employees taxes.

If your business owes employment taxes to the IRS, what does this mean to you and where does it lead?

Let’s break it down – 10 tips on what to expect from the IRS, and how to handle the IRS scrutiny.

1.     Yes, the IRS will make an unannounced first visit to your business.  Be respectful and courteous.  This the Revenue Officer’s first impression of you – make it count.  Build credibility and confidence with the Revenue Officer.  You do not have to make any promises or statements, but be sincere.  Tomfoolery will get you nowhere.

2.     You do not need to offer explanations, talk at length, provide documents or financial statements at the first visit.  Expect open-ended questions.  You can tell the Revenue Officer you will be getting professional assistance to solve your problem, and your representative will contact him, and respond to questions and provide all requested information.

4.     You do not have to let the Revenue Officer past a lobby area or into the business.  There is no right to tour your business or view your assets to see what you have unless (1) you voluntarily agree or (2) the Revenue Officer has a court ordered writ of entry permitting him to take a walk-through (it would be rare for a RO to have a writ of entry on a first visit).

5.     The IRS cannot take your bank accounts and customer receivables until 30 days after a Final Notice of Intent to Levy is issued.  In many cases, the Revenue Officer will hand-deliver the Final Notice during the first visit.  This notice is important – it gives you important appeal rights to resolve your case without the threat of levy with an IRS settlement officer instead of an enforcement officer.

6.     The Revenue Officer wants to set deadlines and move the case forward.  He will want unfiled returns, an IRS financial statement (Form 433B), and proof that you can make your employment tax deposits and stop the problem.  He will send you Form 9297, Summary of Taxpayer Contact listing what he wants and when.

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The general rule is that a Federal tax lien attaches to all of your property.  But there are exceptions – known as “superpriorities” – situations in which you can sell your property even though the IRS has filed a tax lien against you.

The tax code will allow you to sell your car to a buyer who does not know of the tax lien.  And most buyers of cars would not have knowledge of a Federal tax lien against you because a tax lien is filed with your local county recorder or clerk of court – it is not noted on your car title, as would a bank loan.

Your buyer’s knowledge of the lien is important because Internal Revenue Code 6323(b)(2) prevents tax liens from interfering with the sale of your car unless the buyer had notice or knowledge of the tax lien at the time of purchase.

In other words, unless your buyer knows about the Federal tax lien when he buys the car, the tax lien does not have to be paid to permit transfer and sale.

Yes, you can sell the car, and keep the proceeds, even though the IRS has filed a tax lien against you.  (Of course, the IRS can levy the proceeds of the sale if you have cash on hand.)

The tax code provides similar protections to the sale of securities and personal property purchased at retail.  If the IRS has a Federal tax lien, and you sell stock to an arms-length buyer who is unaware of the lien, the stock passes to the buyer free and clear.   If you go to a store, which owes money to the IRS and has tax lien filed against it (including inventory for sale), your purchase of an item in that inventory is unaffected by the lien if you did not know about it.  In other words, the IRS does not follow the lien to you, the innocent purchaser.

Even though it attaches to most everything you owe, the IRS usually does not enforce it unless your property (1) has value and equity and (2) is not necessary to your health and welfare (household goods, or a vehicle to get you to work, and even equipment that you must use in your business is necessary to your health and welfare).  And in most situations, the lien is good only for the timeframe the IRS has to collect from you, which is 10 years.

An IRS wage levy does not have to result in the loss of all of your paycheck.

The Internal Revenue Code has exemptions that can protect your earnings from an IRS levy.

These “exemptions” are listed in Section 6334 of the tax code, appropriately titled “Property Exempt from Levy.”   Think of exemptions as protections in certain property that the IRS cannot take from you.  Exemptions to the IRS include your household goods and clothing; your house is also protected if you owe the IRS less than $5,000.  This property is yours, protected from the IRS.

There are also exemptions that protect your wages from IRS levy.  The amount protected is a factor of how many dependents you claim on your tax return, your filing status and how often you are paid. Every year, the IRS publishes a table that shows the protected amounts (Publication 1494).

For example, if you are married, file jointly, paid bi-weekly, and claim four exemptions (say, you, your wife, and two children), the IRS could not take $1,042.31 from your paycheck. If the IRS sent a levy to your employer, and you properly completed the paperwork claiming the exemptions, you would receive $1,042.31 before the IRS got anything.

Another example:  If you are divorced, and file as head of household for you and your two children, and get paid monthly, you have $1,675 of your paycheck protected from the IRS.

These numbers are net, meaning it is what you keep after your taxes, health insurance, and other necessary payroll deductions are taken out.  The protections are for what is left for you, giving you a certain amount of money to live off.

It is important to calculate the exemptions when formulating a solution to your IRS debt.  In some situations, for example, providing the IRS with a financial statement showing what you earn and spend can result in an installment agreement that has you paying more to the IRS than you would after claiming exemptions against a wage levy.  This is often the case in two-income earner households but only one spouse owes the IRS, or if you work two jobs.

If you have a wage levy, or are contemplating solutions to your IRS problem, it is important to know and understand the protections that you have against the IRS levying your property.

IRS audits can leave your stomach in a knot and your head in your hands, often because you feel innocent of the changes the IRS is proposing to your tax return.

Notice I said proposing.

An IRS audit is not simultaneously the beginning and end of your defense, with the auditor playing the role of judge and jury.  An auditor’s report is a proposal of what he (and probably his manager) thinks the changes should be.  Auditors are sometimes right and sometimes wrong in their analysis of the law and interpretation of facts.

If you disagree with the auditor, you do not have to stop everything and accept what the auditor is proposing (there is that word again).  You have rights.

Those rights include having an IRS appeals officer review the auditor’s findings, and, if that is unsuccessful, to have an independent Tax Court judge do the same.

In other words, the audit is the first step in what can be a three-step process  (audit, appeal, Tax Court).  The goal, of course, is to resolve it with the auditor and get it right the first time, but if an agreement cannot be reached, it is important to know where to turn next.

After the audit is over, the IRS will send what is called an Examination Report.   The report will detail the auditor’s findings, the changes proposed to your tax return, and the amount proposed to be owed.  If you disagree, you have the option, within 30 days, to file an appeal with the IRS, disputing the auditor’s findings.  The appeal should be filed in writing, with proof of mailing, and timely sent back to the IRS auditor handling your case.  Your case will then be sent to an IRS appeals officer to listen and review why the audit report is incorrect. The appeals officer can erase incorrect findings.

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