How many offers in compromise does the IRS really accept?

Posted on November 17, 2008
Filed Under IRS Enforcement Statistics, Offer in compromise | Leave a Comment

The IRS offer in compromise program has been promoted endlessly over the last several years. Turn on your television, open up the newspaper, or listen to the radio, and there it is.  

My clients usually are very interested in the compromise program, but the first thing I do is set them straight that this is not a “freebie” program.

The numbers speak for themselves.  Compare:

-     In 2001, the IRS accepted 38,643 offers.

-     In 2007, the IRS accepted 11,618 offers.  

That is a 70% decline.  Pretty significant.  

With over 2 million active balance due accounts in 2007, the IRS arguably should be as welcoming as the advertisements lead one to believe.    

Think about it:  2 million balance due accounts, 11,618 offers accepted.  

The reality is that this is anything but a “loose” program.  In certain situations it can be very helpful, but a hard analysis of income and expenses under the strict IRS financial guidelines is essential to success. 

What if I am audited by the IRS but my recordkeeping is poor or my records are lost?

Posted on November 9, 2008
Filed Under Audits, Notice of Deficiency, Tax Court | 2 Comments

Since I often help clients close out IRS audits when their records are lacking, I thought it was time to answer this question: 

I recieved a letter to meet an auditor from the IRS to audit my 2005 - 2007 taxes. My house was broken into several times, and I don’t have any of my paperwork to show deductions. My computer was also taken the first time, and I did fill out a police report. What will happen if I don’t go to the audit, or if I go without anything?

There are many issues raised here, all important.  

1.     Poor records/lost records for the audit.  Of course, the best case for an IRS audit is to have perfect records.  Few people do.  And that, believe it or not, is okay.

There is a well-recognized U.S. Tax Court case that permits recreating expenses when direct records do not exist.  The case is Cohan v. Commissioner, 39 F. 2d 540 (2d Cir. 1930).  Cohan established a rule that permits estimates to be made of paid expenses when direct proof does not exist. To make the estimate, a foundation has to be laid that the expenses were actually incurred.  Here is a real life example:

Over-the-road truck driver hauls furniture for individuals moving cross country.   He subcontracts in each city with laborers to load and unload the personal belongings of his clients.  He cannot load and unload the furniture by himself.  But he pays in cash, no receipts.  Over $80,000 in expenses for this were being questioned by the IRS, a significant amount.

As a beginning premise, we knew he incurred the expense - couches and refrigerators do not move by themselves.  So, we recreated from his travel log and calendar each job he did.  He knew that if he moved 10,000 pounds of furniture, it would take two men a total of 8 hours to complete the job, and the going rate was $150/day.  He recreated a spreadsheet for each day, listing the city he was in, his recollection of the weight of the load, how many men he used and the time it took to complete the job.  

This took some work, but an $80,000 deduction was on the line.

The IRS allowed everything he recreated.  We were able to establish that the amounts were actually paid, and a reliable method was used to prove it. 

I have had similar cases, for example, for an owner of a landscaping company, who paid his subcontractors in cash and kept no receipts.  Those lawns were not mowed by themselves.  Jobs and customers were recreated, detailing how many workers were used per job.  This Cohan method of recreating expenses has been applied to have the IRS allow other expenses like charitable contributions, or business miles driven by a real estate agent (recreating a mileage logbook).  Cohan is an important rule that should be used to alleviate a harsh result in cases where perfect records do not exist to prove expenses that were clearly paid.      

2.     Understand who you are dealing with.  IRS auditors sometimes take very narrow views of substantiation cases.  But if you cannot reach an agreement in audit, you have the right to have an appeals hearing or to take your case to U.S. Tax Court.  In appeals, there is a broader view of your case.  The question appeals officers ask themselves is “If this case went to court, what would happen?”  If you can testify to a reasonable basis to the expenses being incurred, appeals officers will likely allow a portion of the expenses. Appeals officers try to replicate what a Tax Court judge would do.  Auditors are often too distant from that reality, and usually do not allow enough leeway.   See my prior post “Tax Court - proving a level playing field in audits.”

3.     Do not ignore the audit.  If you do, the IRS will send you what is called a “Notice of Deficiency.”  This is your notice that the IRS has found a “deficiency” in your taxes, and calculates the tax, interest and penalties they are charging.  If you ignore this notice, the amount becomes final and the IRS will start collection activities.  Participate in the audit to the extent that you can determine if the auditor is open to application of the Cohan rule (they should be).  If the audit is not going your way, exercise your rights to have an appeals hearing, and if necessary to have your expenses reviewed by the Tax Court.  If you are entitled to it, you will be allowed expenses equal to the level of your credibility.   

If you incurred the expenses, do not walk away from the audit.  There are methods to recreate the expenses and reach the correct result.  

If I file bankruptcy on the IRS, but my spouse does not, will the filing stop the IRS to both of us?

Posted on October 26, 2008
Filed Under Bankruptcy, Chapter 13, Chapter 7 | Leave a Comment

When a bankruptcy is filed on the IRS, Section 362 of the Bankruptcy Code imposes what is called an “automatic stay” on collection activity by creditors, including the IRS.  The automatic stay requires the IRS to release any levys and to cease any further collection action.

But what if a husband and wife owe back taxes on joint returns, and only the husband files bankruptcy?  Will the bankruptcy cause the IRS to stop collecting on the whole amount or just the husband’s portion?

The bankruptcy will stop the IRS from collecting against the spouse who filed the bankruptcy (husband in this case), but it will not stop the government from collecting against the non-filing spouse (here, the wife) on a joint liability. 

This question refers to what is known as a “co-debtor stay.”  In most Chapter 13 bankruptcy cases, a co-debtor stay protects both the filing and non-filing spouse against all collections on joint debts during the bankruptcy.  The catch is that co-debtor stays apply only to consumer debt.  Most courts define consumer debt to mean extenstions of credit, like loans and credit cards, not taxes.  So, taxes are not consumer debt, and are not subject to the co-debtor stay in Chapter 13 cases.  As to Chapter 7 cases, there are no co-debtor stays regardless of the type of debt involved. 

That being said, bankruptcy can be a very effective way to eliminate taxes.  Learn a little more in this post, or read an article I recently wrote on the topic for the Journal of the National Association of Enrolled Agents (NAEA). 

Can the IRS conduct a collection interview at your house or business?

Posted on October 18, 2008
Filed Under Audits, IRS Financial Statements, IRS collection letters, Revenue Officers, Summons | 2 Comments

IRS Revenue Officers continue to become more aggressive in the field. Here is a new approach to look for:

I had a recent case in which a Revenue Officer sent my client a notice stating that that there would be an interview at my client’s house.  These meetings usually take place at an IRS office.  It was a somewhat bold move to request access to a personal residence for an interview in a collection case, especially because my client lived with her mother.  This made my client very uncomfortable, for good reason (then again, wasn’t that the point of the IRS request?).

Here is my response:

     1.     The IRS has no right to access a taxpayer’s private living quarters or business without the permission of the taxpayer or a court ordered writ of entry.   Sometimes it makes sense to grant permission or access, but not this time.

     2.     Under Internal Revenue Code 7521(c), the IRS cannot compel the presence of a taxpayer at a meeting if the taxpayer has representation. 

     The relevant parts of Section 7521 state as follows:

Any attorney, certified public accountant, enrolled agent, enrolled actuary or any other person permitted to represent the taxpayer before the Internal Revenue Service… who has a written power of attorney executed by the taxpayer may be authorized by such taxpayer to represent the taxpayer in any interview…(a)n employee of the IRS may not require a taxpayer to accompany the representative in the absence of an administrative summons issued to the taxpayer.

The taxpayer is not required to meet with the IRS if there is representation.  If the representative is not going to be at the client’s house or place of business, then there is no meeting.  The Revenue Officer is required to meet with the representative, and that would either be at the representative’s office or at the IRS. Compelling the taxpayer’s attendance can only be done with a summons, which was not present in this case. The IRS was testing the waters on this one.  

There can be circumstances where access to a personal residence or business can be beneficial.  A Revenue Officer once drove by my client’s mobile home and stated afterwards that she believed (correctly, I might add) the case would be uncollectible.  

As a general rule, cooperation and good communication is essential in dealings with the IRS, but that must be tempered with knowing when to say no.

Go back six years to get current on unfiled returns.

Posted on October 15, 2008
Filed Under Criminal investigation, Substitute returns, Unfiled returns | Leave a Comment

In most cases, the IRS will require the past six years of unfiled tax returns for an account to be considered current.  This is a written directive of the IRS, found in IRS Policy Statement 5-133, “Delinquent Returns - Enforcement of Filing Requirements”.  

If the unfiled returns have a balance due, the amount you owe will double every five years from the interest and penalties charged by the IRS (more about the time limitations to collect here.  Since IRS billing notices will start after the returns are filed, an early financial analysis is always recommended to determine the collection approach (offer in compromise? bankruptcy? installment agreement?).  You will receive refunds, but only for returns that were to be filed within the last three years.  

Exceptions to the six year rule may apply in cases involving a prior history of noncompliance, false statements, existence of income from illegal sources, or the class or industry the taxpayer is in (a physician with advanced education may be held to a higher standards of awareness).  These cases could involve criminal elements and must be handled very delicately, although the vast majority of nonfiling cases are civil matters, not criminal.

How does the IRS value retirement accounts in an offer in compromise?

Posted on October 12, 2008
Filed Under IRS Levies, Offer in compromise | Leave a Comment

I recently received a email question inquiring about how the IRS values retirement assets in an offer in compromise.

If you do not have the right to access the retirement money, then neither does the IRS, and it is not included in the value of a compromise. In other words, the IRS steps into your shoes. This rule is incorporated into Internal Revenue Manual Section 5.11.6.2 (a levy on a retirement plan only reaches the taxpayer’s present rights) and recognized in law (U.S. v. General Motors, 929 F.2d 249 (6th Circuit 1991). This applies to both a collection case and the value of an offer in compromise.

With that background, the handling of retirement plans in an offer in compromise is outlined in Section 5.8.5.3.8 of the Internal Revenue Manual, summarized as follows:  

1.     Cannot liquidate, cannot borrow.  If the account is tied to your employment, and you cannot liquidate the account or borrow against it until separation from employment (or you are not vested), then the account will not be included in the value of a compromise. If you cannot get to it, neither can the IRS. However, if you will be retiring before the statute of limitations on collection expires, the IRS has discretion to include the account value in the compromise as part of the future collection potential. 

Here is an good example from the Internal Revenue Manual 5.11.6.2(7):

The taxpayer has money in a plan. The terms of the plan do not allow for any lump sum withdrawal. The plan provides a right in the future to receive monthly payments, but the taxpayer has not paid into it long enough yet to qualify for any future payments. A notice of levy attaches nothing, because the taxpayer has no present property rights

2.     Cannot liquidate, can borrow.  If you cannot liquidate the account, but can borrow against it, the Internal Revenue Manual provides that the amount available as a loan is included in the value of the compromise.  However, in situations where borrowing is permitted but not liquidation, the IRS would not be able to immediately seize the account and get to it (the IRS cannot “borrow” for you, and has no rights to liquidation since you do not). Yet the government includes ability to borrow in the value of the compromise. This appears to skewer the compromise collection potential in the government’s favor.  In “cannot liquidate, can borrow” cases, this rule on borrowing should be respectfully disputed. 

3.     Can liquidate.  If there are no restrictions on access to the account and it can be liquidated, then the account value will be included in the compromise, less expenses of liquidation (taxes and penalties).  

IRS levies on Social Security benefits - enforced collection on those who can least afford it

Posted on September 15, 2008
Filed Under IRS Collection Problems, IRS Levies | 3 Comments

I have seen an increase in calls to my office from retirees who have received an IRS levy on their Social Security benefits.  In most every case, the levy (1) relates to conduct from self-employment when they were younger, and that conduct has long ago ended and (2) creates a substantial hardship for the retiree, who needs the levied money for to pay for prescriptions, food, utilities and rent.  

The IRS is authorized to levy on Social Security benefits under section 6331(h) of the Internal Revenue Code.  These levies are continuous and take 15% of Social Security benefit, a real hardship to those on a fixed budget.  

The IRS makes the levy by matching its records against those of the government’s Financial Management Service.  Once a match is made, the IRS will send a Final Notice Before Levy on Social Security Benefits (CP 91).  If no action is taken within 30 days as to the notice (i.e, collection appeal), the IRS electronically transmits the levy to FMS for a reduction in the benefit.    

The IRS had previously used a income filter to systemically exclude those with income below a specified threshold.  The Government Accountability Office (GAO) found the filter flawed, and in 2006 the IRS eliminated it.   

The IRS Taxpayer Advocate reports what I have seen:  Their case intake from the Federal Levy Program, which includes Social Security benefits, increased from 525 cases in fiscal year 2004 to nearly 3,500 cases in fiscal year 2007.  

Can the IRS take my stuff?

Posted on September 9, 2008
Filed Under Form 433A, IRS Financial Statements, IRS Seizures, Offer in compromise, Property Exempt from Collection | 3 Comments

In the vast majority of cases, you will not lose any of your stuff to the IRS.  Most clothing and personal household belongings are beyond the scope of the IRS collection power.  Here’s why:

Section 6334(a)(1) of the Internal Revenue Code allows you to keep all of your clothing.  Bear in mind that the tax code uses the words “necessary” in describing the clothing that is exempt from IRS collections, meaning that the IRS can technically take clothing that is not necessary, like designer shoes, handbags, etc. (click here for some fancy clothing that the IRS did see fit to seize, and note that this is type of activity is highly unusual). 

Section 6334(a)(2) of the tax code protects your furniture and household effects up to $7,900 in value from the IRS.  The IRS is not taking your television, or your bed, or lawnmower.

The Internal Revenue Manual, at Section 5.17.3.4.7, Property Exempt from Levy, restates these exemptions in guidance to IRS employees.

It is important to remember these exemptions when completing IRS financial statements, like Form 433A. Claim the value of these everyday items as exempt.  And in an offer in compromise, make sure that these assets are not included in the value of the offer as they are off limits to the IRS - again, claim it as exempt. 

IRS steps it up on pursuit of unpaid employment taxes

Posted on August 31, 2008
Filed Under Employee Withholding Taxes, Employment taxes, Trust fund recovery penalty | Leave a Comment

In tough economic times, hard-working entrepreneurs protect their business by first paying the vendors, suppliers and employees that are necessary to operations, and delaying payment to the IRS.   This is because the vendors and employees are at the door, waiting for payment, and there can be no tomorrow without them. The IRS is more distant.  The plan is to catch up later with the government.  

This year, I have seen the IRS take significant steps to get more aggressive on employment taxes. Revenue Officers are appearing at my clients’ place of business earlier than ever, after only a quarter or two of employment tax delinquencies. Many of the cases in involve balances due -  $15,000 and under - that are relatively small compared to other accounts the IRS is carrying and would usually be more focused on.  The message I am getting is clear:  The IRS is seeking to stop employment tax problems earlier than in the past, and it is a priority.

Final Notices of Intent to Levy, which must be issued by the IRS before assets can be garnished or seized, are being issued upfront, immediately, and upon first contact in employment tax cases.  In the past, Revenue Officers would often use some discretion to see if the case could be solved before turning to possible enforced collection measures.  This aggression is forcing quick appeals of the Final Notice of Intent to Levy.  The appeal stops IRS collection action and puts negotiations in the hands of an Appeals Officer, without risk of IRS collection action.       

Employment taxes pose a significant threat not only to the business, but to owners and management.  Even if the business is incorporated, the owners and key employees who control financial decision making will be pursued individually by the IRS for the part of the unpaid employment taxes.  This is called a trust fund recovery penalty, and puts the personal assets of management into play for collection of the unpaid taxes.

The new IRS approach is actually somewhat of a benefit to business owners.  The early wake-up call makes recovery for the business more possible as the employment tax liability is not yet at the point of no return. And it minimizes the extent of personal liability of management.  I have seen employment tax cases go out of control to where the business cannot recover from it, must close, and management is saddled with the trust fund penalty.

The IRS is forcing a harsh reality, but it is a good reality nonetheless.  But great care needs to be taken in defending the aggression of the IRS in these cases against the business and its management.  

5 things to always do when talking to the IRS.

Posted on August 19, 2008
Filed Under Automated Collection Service, IRS Collection Problems, IRS collection letters, Installment agreements, Revenue Officers | Leave a Comment

1.     Be courteous and respectful.  You will get nowhere with an angry or condescending attitude, and will just give the IRS reason to come down harder on you.  When your head is in the mouth of the bear, say nice bear.

2.     Abide by deadlines, or call for more time if one can’t be met.  Don’t let it pass.  The IRS will assume the worst if there is no contact, but usually will be forgiving if a call is placed with a reasonable explanation. 

3.     Do not give false or misleading information.  Hard questions may require some thought for good answers that are both correct and in your best interest, but false information is always a no-no.  It is not worth turning a civil collection or audit matter into a potential criminal one.

4.     Open your mail.  It is intimidating to get IRS letters in the mail.  But those letters are often very important, and give you legal rights that will lapse if not attended to.  Ignorance to what the IRS is sending you is not a defense.  It will only complicate matters and make it harder to dig out later.

5.     Stay current on your taxes.  File and pay on time while you are negotiating and thereafter.  There will be no negotiations if you are not current, and any success in the negotiations will ultimately fail if you later default. 

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