You owe the IRS money. You haven’t paid them, at least in full. You have a Collections problem.
Where to Start?
The IRS will most likely let you know, in increasingly harsher terms, when they want your money. They will likely send you letters, likely in the following order:
CP 14 Balance Due
Figure that each letter will be about a couple of months apart.
If you get to the last one (CP 90, 297), stop procrastinating and do something. This one means the IRS is taking steps to go after your assets – to levy your bank account, to garnish your paycheck, to do something. Unless you finished those night tax classes, passed an exam and worked in IRS representation for a while, please call a professional.
What is a Tax Lien?
A lien is a claim against your assets. They remain your assets, but the lien signals to your creditors that you owe money to the IRS. As you can imagine, this is not good for your credit rating. It may even block the sale or transfer of the asset as long as the tax debt exists.
By the way, the lien attaches to assets you acquire after the lien is filed. The lien attaches to all your property (like your car or your house) and to all your “rights to property” (such as accounts receivables, if you are in business).
What is a Tax Levy?
Let’s start by distinguishing a lien from a levy. Think of a lien as the barbarians encircling ancient Rome. Then think of a levy as the barbarians crashing through the gates, ransacking and looting.
The IRS prefers to levy cash or things quickly convertible to cash. Common levies include a bank account or a paycheck. Your employer cannot refuse. The bank has to put a 21-day hold on your account, at which time the money will be sent to the IRS. And yes, the IRS can go after your 401(k).
What Should You Do?
Here is the same advice your grandmother would give you: do open and read any correspondence from the IRS, do take seriously their “respond by” dates, and do get professional advice if possible. This problem is not likely going away on its own.
(1) If you owe $10,000 or less, you may be eligible for a “guaranteed” installment plan agreement if you are able to pay the entire amount within three years. The minimum monthly payment the IRS will want is the total of your balance due (including penalties and interest) divided by thirty.
NOTE: A key benefit of a guaranteed installment agreement is that the IRS will not file a federal tax lien.
(2) If you owe $25,000 or less, you may qualify for a “streamlined” installment agreement, if you can pay off the balance in 60 months or less. The minimum payment the IRS will want is the total of your balance due (including penalties and interest) divided by fifty.
NOTE: A key benefit of a streamlined installment agreement is that the IRS will not ask you to fill out a financial statement to analyze your current financial situation.
(3) If you owe more than $25,000, you will have to provide extensive financial information to the IRS in order to negotiate an installment plan. You will negotiate with an IRS agent. This will then require review and approval by the agent’s manager. The IRS will likely file a federal tax lien.
(4) If the minimum payments for either the guaranteed or streamlined agreements do not fit your budget, you may consider a “partial payment” installment agreement. Your monthly payment is based on what you can actually afford after taking into consideration your necessary living expenses. Unlike guaranteed or streamlined agreements, a partial payment plan can be set up to cover a term longer than 36 or 60 months. The IRS may file a federal tax lien to protect its interest. You will have to provide paystubs, bills and bank statements as supporting documentation. The IRS re-evaluates the terms of this agreement every couple of years to see if you can pay more.
(5) If circumstances are truly dire, you may be able to get your account placed in “currently not collectible” status. This means that you aren’t able to pay anything at all without incurring financial difficulties so tough that even the IRS wouldn’t chase you. Once you are considered CNC, the IRS will typically leave you alone for 18 months to 2 years. This allows you time to get into better financial shape. The IRS is not willing to completely write-off back taxes like they would through an Offer in Compromise, but at least you get some breathing room.
Offer in Compromise
This is “the pennies on the dollar” commercials you hear on late night television. We do not doubt that there are isolated cases where the IRS agrees to “pennies,” but the odds of you getting that deal is roughly that of being hit by a meteorite. Some of these advertisers are scams: they over-promise and under-deliver, charging you money along the way.
That said an OIC may be for you, but DO NOT HAVE UNREALISTIC EXPECTATIONS.
There is a process here. You can’t just call the IRS and say “Let’s make a deal.” You have to complete a form (Form 656, Offer in Compromise). There is a $150 fee. You have to submit financial information (Form 433-A Collection Information Statement). Be very careful completing this form. The IRS scrutinizes this form much more closely when considering an OIC than when you request an installment agreement. The IRS will ask you for financial documentation — pay stubs, bank records, etc.
NOTE: The IRS uses national or regional standards for expenses such as food, clothing and transportation. If your expenses exceed the standard, expect the IRS to disallow the excess unless you can provide very persuasive reasons why they shouldn’t. The nasty surprise is that the IRS may “see” disposable income in your budget that you do not have. This is intentional.
There’s a drawback to submitting an OIC. If your OIC is rejected, the disclosures you made give the IRS a roadmap for collection efforts against you. For this reason, we recommend you not submit an offer unless it is likely to be accepted.
Do You Qualify for OIC Consideration?
Merely wanting to make a deal is not enough. We all want a deal. To qualify, you must show that one of the following conditions exists:
- There is some doubt as to whether the IRS can collect the tax bill from you — now or in the foreseeable future. The IRS calls this “doubt as to collectability.”
- There is some doubt as to whether you owe the tax bill. The IRS calls this “doubt as to liability.” This condition is unusual.
- Due to exceptional circumstances, payment of your full tax bill would cause an “economic hardship” or would be “unfair” or “inequitable.”
How Much Should You Offer?
According to the IRS, the amount of an OIC must be equal to the “realizable value” of your assets plus the amount of money the IRS could take from your future income. Needless to say, you and the IRS are likely to disagree on these two amounts.
The amount you offer may depend on how quickly you can pay.
(1) If the installments will be paid in 5 months or less, you should offer the realizable value of your assets plus (roughly) 48 months of disposable income.
NOTE: 20% of the total amount of this offer must be paid with the application.
(2) If the installments will be paid over more than 5 but less than 24 months, you should offer the realizable value of your assets plus (roughly) 60 months of disposable income.
(3) If the installments will be paid over more than 24 months, you should offer the realizable value of your assets plus the number of months remaining on the statutory period for collection.
NOTE: For both (2) and (3), the first payment must be submitted with the application. You must continue to make regular payments while your offer is being reviewed. Failure to make regular payments – even if the IRS hems and haws – is likely fatal. The good news is that, if you continue payments and the IRS unreasonably delays, the OIC is deemed to be accepted.
Very often, what makes or breaks an OIC is the monthly budget. That’s because the monthly disposable income is multiplied by 48 or 60, so even small adjustments to the monthly budget can have big consequences.
The IRS classifies expenses as either necessary or conditional. Necessary expenses are for health and welfare or for the production of income, such as food, housing, health care, taxes and transportation. All other expenses are conditional and may be disallowed if you cannot pay the IRS over three years. Goodbye to private school tuition and 401(k) contributions, for example.
If Your Offer Is Rejected — Keep Trying
The IRS will give you a written explanation if they reject your offer. If your offer is too low, they will state what amount is acceptable. You can also request a copy of the report listing the factors that caused the rejection.
After finding out why your offer was rejected, resubmit the offer. The revenue officer might help you come up with a way to make your offer acceptable. You won’t need to submit a new Form 656 if you submit a new offer within a month, if your financial circumstances have not appreciably changed and if the new offer is not “radically” different from the old one. Instead, write a letter. State that you wish to change your offer by increasing the payment amount.
Appealing a Rejected Offer in Compromise
You can formally appeal a rejected offer in compromise. You have to appeal within 30 days of the date of the rejection letter, though.
You may not know this, but federal income taxes can be discharged in a Chapter 7 bankruptcy. There are very specific timing rules, though:
- More than 3 years have passed since the due date of the return, and
- More than 2 years have passed since the return was actually filed
Confusing, isn’t it? Consider an example where taxpayer files his 2005 return (extended and therefore due October 15, 2006) on May 12, 2008. Normally the three years would run out on October 15, 2009. However, two years from the filing (May 12, 2010) is later, so that date controls. Taxpayer will not discharge his income taxes unless he delays his Chapter 7 filing until after May12, 2010.
There is a special rule if the return was audited. The discharge date is the later of
- The later of the above
- More than 240 days after the audit assessment date
Now this can really spin the wheel! Say that the 2005 return was audited. The final assessment was on October 14, 2009. The new target date is October 14, 2009 plus 240 days which would be June 11, 2010. Since this is later than May 12, 2010, the new date of June 11, 2010 is the winner.
Statute of Limitations on Collection
The IRS has 10 years to collect unpaid taxes – starting from when the IRS puts the tax liability on its books. Frankly, some of the planning and work by accountants working with Collections is getting to the 10 years.