But be careful:  The time the IRS has to collect can be unknowingly extended by you. 

The decisions you make in attempting to resolve your tax problem can impact when it ends.  As your collection statute gets closer to expiring, carefully think through the benefits of taking any of the following actions that will extend it: 

(1)     Offer in compromise.  The filing of an offer in compromise will extend the statute of limitations on collection by the time it is pending plus 30 days.  The IRS can take six to twelve months to investigate an offer in compromise, and if it is accepted, the IRS will allow you up to two years to pay the settlement amount. Submitting an offer is not always in your best interest. 

(2)     Collection due process appeal.   Timely responding to an IRS Final Notice of Intent to Levy – known as a collection due process hearing  – will extend the time the IRS has to collect while your hearing is pending. 

A really good strategy:   A late-filed collection due process appeal – defined as filed within one year of the date of the Final Notice -  does not extend the collection statute but does entitle you to an appeals “equivalent” hearing.  See IRC 6330(e), IRM 5.1.9.3.6 and Treas. Reg. § 301.6330–1(g)(3), ex.1.

(3)     Bankruptcy.  Bankruptcy extends the statute of limitations on collection by the time you were in bankruptcy plus six months.  If you filed bankruptcy but did not eliminate all of your tax liabilities, the IRS will have more time to collect the non-discharged taxes from you.  See IRC 6503(h) and IRM 5.9.4.2.

(4)     Innocent spouse relief.  The collection period is suspended from the filing of the request for innocent spouse relief until the 90 day period for petitioning the Tax Court expires.  If a Tax Court petition is filed on an IRS denial, time is tolled until the Tax Court decision becomes final, plus 60 days.  See IRC 6015(e) and IRM 25.15.1.8.

(5)     Taxpayer Assistance Order (911).  If communications breakdown to the point of needing a Taxpayer Assistance Order to stop the IRS, the filing of Form 911 will suspend the statute of limitations on collection while your case is pending for review.  See IRC 7811(d) and IRM 13.1.14

(6)     Installment agreements.  If the IRS refuses or defaults an installment agreement, you have the right to appeal that decision.  If you do, the collection timeframe is extended during the appeal.  See IRC 6331(k)(2)(d).

The IRS gets more time because these actions prevent them from collecting from you.  What the IRS gives you – no enforced collection activity – they get back.  Before proceeding, always make sure the potential for success (i.e., high chance of offer acceptance) is greater than the risk of extending the collection timeframe and making your problem linger.

Mr. Levy – I hope you can help me.  I owe back taxes and filed a Chapter 13 to repay the IRS.  The Chapter 13 was dismissed because I could not keep up with the payments.  Now I would like to file a Chapter 7 to eliminate what I did not pay.  My attorney mentioned something about a stopwatch while I was in the Chapter 13.   What is this all about?

You are correct in recognizing that eliminating taxes in bankruptcy is all about timing - keeping an eye on the “stopwatch.”  You are referring to the requirement that taxes can be discharged in bankruptcy only if your return was due to be filed at least three years before your bankruptcy started and was actually filed at least two years before your bankruptcy. 

But if you file a bankruptcy before these timing rules are met (like you apparently did with your Chapter 13), does the “discharge clock” keep ticking?  Are taxes that were not eligible for a tax discharge when you entered the Chapter 13 now eligible when you come out of it and want to file a Chapter 7?  Was time on your side? 

The U.S. Supreme Court resolved this issue in 2002 in the case of Young v. U.S., 535 U.S. 43.  In that case, Cornelius and Suzanne Young filed a Chapter 13 bankruptcy to try to repay their debts, including $13,000 to the IRS.  The Chapter 13 was filed before the tax discharge timing rules were met. 

Unable to make their bankruptcy payments, the Youngs dismissed their Chapter 13 and filed a Chapter 7 instead.  By the time the Youngs had filed their Chapter 7, the taxes had aged to the point of being old enough for a discharge under the bankruptcy tax timing rules.  

The IRS argued that the bankruptcy discharge rules were “tolled” during the Young’s Chapter 13.   The government also argued that since it was prevented from collecting during the Chapter 13, the tax discharge stopwatch should be treated the same way – tolled.

The court agreed with the IRS, recognizing that any other ruling would create a loophole for taxpayers - filing a Chapter 13, getting time on the discharge rules without any risk of collection, and then filing a Chapter 7 when the time was right.   

The prior Chapter 13 never happened for purposes of bankruptcy discharge timing rules.

In 2005, Congress codified the Supreme Court’s ruling in Young  – see Bankruptcy Code 507(a)(8)(a)(i) - and added an additional 90 days to the tolling period.   

Summary:  If you filed a Chapter 13 too early to eliminate your taxes, had it dismissed and now want to try a Chapter 7, ou cannot add in the time the Chapter 13 was pending to your tax discharge calculations.

Here are five pointers to lower the value of your offer in compromise: 

(1)      Make sure you claim property the IRS cannot take from you as “exempt” on your IRS financial statement (Form 433A).  Exempt assets that the IRS cannot take includes everyday belongings in your house (Internal Revenue Code 6334(a)(1)).  It also includes certain tools from your business.  The value of these assets should not be included in the value of what you offer the IRS.   

(2)     Use the possibility of bankruptcy as leaverage.   Internal Revenue Manual 5.8.5.6(5) allows the IRS to consider the impact of a possible bankruptcy on the value of a compromise.  If your taxes are eligible to be discharged in bankruptcy, the IRS could get nothing if you chose that route over an offer in compromise.  Make sure you know how to use that leaverage to get an offer in compromise and avoid bankruptcy. 

(3)     Know how to properly utilize IRS living expense guidelines.  For example, if you car is over  six years old or has over 75,000 miles, the IRS can allow a $200 monthly replacement cost.  See Internal Revenue Manual 5.8.5.6.3.  Make sure you know the IRS guidelines in an offer in compromise and how to maximize the amount the IRS will allow you. 

(4)     Understand how to properly reduce the value of your property to quick sale value.  Start with what it would sell for at resale – that is fair market value.  IRS guidelines permit you to reduce fair market value by 20% to arrive a quick sale value.  If your house is worth $100,000, this can save you $20,000 ($100,000 x 20% reduction).  Make sure you take the “quick sale value” reduction on your property, including houses and cars. 

(5)     You may have income that the IRS cannot take.  If you do, request that it be excluded from offer calculations.  The IRS cannot seize workers compensation, unemployment benefits, supplemental social security for the disabled, blind or aged and service-connected disability benefits (Veterans).  If they cannot levy it, then it should not be considered as an income source.      

There are many factors that play a part in a offer in compromise negotiation.   The more knowledge you have about the IRS settlement process, the better.

Adding to the dilemma is an IRS request during the trust fund investigation for a personal financial statement (Form 433A) detailing your assets, income and living expenses.

If the IRS makes a request for a personal financial statement during a trust fund investigation, two questions must be answered:  (1) Is the IRS entitled to know your finances before its investigation is complete? and (2) How can an early disclosure of personal financial information help in defense of a trust fund assessment?

First, there is no legal requirement that the IRS is entitled to financial information from you during the trust fund investigation.  The Revenue Officer assigned to your case is making the request for financial disclosure BEFORE final assessment of the trust fund taxes against you.   Personal liability is still in the fact-finding phase.  

Unless there are other assessments against you already, the IRS has no ability to force a financial disclosure as part of a trust fund investigation.   Disclosing financials to the IRS in this manner is providing collection information before there is even a balance due.

Saying “no” to such a request must be done with balance:  respect as to an IRS investigation yet properly raising and protecting your rights as a taxpayer.

Sometimes, however, disclosing the financial information early can help resolve the trust fund investigation in your favor.   If your financials shows that the IRS could never collect from you if you were held personally liable for the employment taxes, the IRS has discretion to not assess the trust fund recovery penalty against you.

Internal Revenue Manual 5.7.5.3.1, Nonassertion Based on Collectibility, provides that “After reviewing and verifying the financial information, if the present and future collection potential is minimal, do not recommend assertion of the TFRP.”

It is not guaranteed that every Revenue Officer will drop a trust fund assessment due to uncollectability.  It is important to know your Revenue Officer if collectability is a defense to the trust fund recovery penalty.   Collectability is a valid consideration in investigations of the trust fund recovery penalty – know when to let the cat out of the bag.

You have rights to defend the filing of a lien, and prevent the issuance of a levy.  To be able to assert your rights and protect your property, it is important to  understand and recognize the tools the IRS uses.

Here is what you need to know about the IRS tax lien and IRS tax levy:

IRS TAX LIEN

An IRS tax lien protects and secures the IRS’s rights to your property.  The lien attaches to property you own when it is filed, and property you purchase later.  A Federal tax lien most commonly impacts real estate.

If you own a house, and the IRS files a tax lien against you, the lien would give the IRS an interest your home similar to that of your mortgage company.

Example:  Your house is worth $100,000, and you have a mortgage of $75,000 on it.   There is $25,000 of equity in your house.  Before the IRS filed its tax lien, that equity would be yours.  Now that the lien has been filed, the equity belongs to the IRS.   If you want to sell your house, the IRS gets your equity at closing, not you.

The IRS usually files its Federal tax lien with county recorder or clerk of courts in the county where you residethe property is located.   For the tax lien to affect real estate, it must be filed in the county where the property is located.  It would then encumber all of your real estate in that county.  A federal tax lien does not name the property it attaches to – it automatically encumbers all your real estate in the county it is filed and all of your other personal property.

If the IRS files a lien against you, you have a 30 day window to file an adminsitrative appeal to request reconsideration of the filing.  This is called a collection due process appeal.

The lien expires when the IRS statute of limitations on collection expires – in most cases, 10 years.

IRS TAX LEVY

The purpose of an IRS levy is to take your property.  An IRS levy is the same as a seizure, or garnishment.  The IRS can levy on your wages, bank accounts, subcontractor pay, accounts receivable, even retirement accounts.  The IRS can seize your house, car or your business equipment (although those are rare).   For most people, it is the levy, not the lien, that hurts.

There are only a few things the IRS cannot levy  – these “exemptions” are listed in Internal Revenue Code 6334.   The exemptions you can claim include the right to keep unemployment benefits, workers compensation, most household goods and some tools of your trade from the IRS.

Before the IRS can levy on your property, they must first send you a Final Notice of Intent to Levy.  This is your notice of that the IRS intends to start enforcement against you.  After you receive the Final Notice of Intent to Levy, you have 30 days to file an appeal of the proposed IRS collection action. If you file the appeal, the IRS is prevented from taking action until your hearing is completed.  The purpose of the hearing is to reach a resoluton to levy action before it occurs – offer in compromise, installment agreement, uncollectible, for example.

The IRS does not need to file a Federal tax lien as a prerequisite to levying your wages, bank accounts, etc. - just the Final Notice of Intent to Levy.

In the rare cases of seizure of a house, the IRS must get court approval first.  To do this, the Department of Justice will usually file a lawsuit against you in Federal District Court seeking approval to foreclose and take your house.  Again, this is not a preference of the government.

The Federal tax lien and tax levy gives the IRS different rights against you – the lien as to security in your property, the levy to take it.  Together or apart, the lien and levy are powerful tools for the IRS.

No matter what the IRS may tell you or what you may have heard, it is very unlikely the IRS will levy on your house, car or furniture.  The assets you may be most concerned about the IRS taking are the one’s the IRS is least likely to take from you.  This is important to know in negotiating with the IRS.

Last year, the IRS made only 600 seizures of houses, cars and other personal property.  In case you are wondering, 600 seizures across the country is a very low number (compare to the 2 million levies the IRS sends on bank accounts and wages – now that is a concern worthy of attention).

The reason?  If you do not have any “equity” in your property the IRS will not levy it.

Internal Revenue Manual 5.10.1.2 states that seizures are prohibited  “where the taxpayer has insufficient equity in the property.”  Internal Revenue Code 6331(f) prevents the IRS from making an “uneconomical levy” – meaning there must be an economic recovery to the IRS to do it.

Examples:

Your car? If your car is worth $7,500, and you owe $7,500 on it, you are protected.

Your house? Take the value, subtract your mortgage, and reduce it further by the costs of sale.  There has to be a fairly substantial amount left afterwards for the IRS to be interested under the equity rules.

Even if there is equity, a seizure is still generally something the IRS does not desire to do.  You will need to force them – meaning a lack of cooperation after repeated attempts by the IRS to work it out.  Most seizures need managerial approval before being sent to an IRS property liquidation specialist.  Some, like a personal residence, require outside court approval (See IRC 6334(e((1)).

In most cases, the IRS is prohibited by tax law and their own internal guidelines from making a seizure when there is no recovery.  Because of that, the IRS focuses the most on levying wages and bank accounts.  Knowing the difference allows you to put your energy into protecting what really matters to the IRS.

Your installment agreement may keep the IRS at bay, but your tax liability does not get paid off.

The tax code and the IRS offers no real way of stopping interest and penalty accruals.  That is frustrating, but there are solutions.

The solution for many is in the bankruptcy code.  An IRS repayment plan made through a Chapter 13 bankruptcy can stop IRS interest and eliminate penalties. Chapter 13 can even reduce the amount of tax you pay.  This often results in a shortening the time it will take you to repay the IRS.

No one really wants to file bankruptcy, but making your installment payments by bankruptcy law, not tax law, can result in substantial benefits to you.

A Chapter 13 bankruptcy repayment plan can help you with the IRS.  Here’s how:

(1)     Interest stops.  Chapter 13 stops the IRS from charging you interest while you make your payments.  The interest you already owe the IRS can also be reduced by bankruptcy law.

(2)     Penalties can be reduced.  Chapter 13 can stop the accrual of IRS penalties.  Bankruptcy law can also force the IRS to accept a reduction in the penalties already charged.

(3)     Repay a percentage of what you owe to the IRS.   The amount of tax, interest and penalties repaid to the IRS can be as little as 1% by Chapter 13 bankruptcy law (vs. 100% in IRS installment agreements).  This is accomplished by use of the Chapter 13 bankruptcy “cramdown” rules.  You pay back olny what you can afford on older income tax debts in a Chapter 13.  Anything you cannot afford to repay on the older taxes is eliminated.

(4)     IRS collections stop.  Once you file a Chapter 13, the IRS is prevented from levying your property.  Bankruptcy creates a “stay” on the IRS.  You keep everything in a Chapter 13 tax bankruptcy.

(5)     Your budget.  If the IRS will not allow some of your expenses in an installment agreement, bankruptcy law could.  A Chapter 13 tax bankruptcy means you pay the IRS what your reasonable budget permits under bankruptcy law standards.  You eliminate much of the use of IRS “living expense standards.”

In most cases, the Chapter 13 bankruptcy results in you paying back much less than what you would in an IRS installment agreement.  What you pay does not double by tax law, but can be reduced by bankruptcy law.  Comparison of a Chapter 13 repayment plan vs. IRS installment agreement can save you time and money.

The Final Notice of Intent to Levy gives you very important rights to stop the levy and resolve your case.

Here is what you need to know:

(1)     If the IRS has not sent the Final Notice of Intent to Levy to you, you are protected.  If you are unsure if you have received it, the IRS can be contacted to determine if it has been sent and what action needs to be taken.  Here is what the IRS final notice looks like.

(2)     If the IRS has sent you the final notice, they have to wait 30 days after the letter is sent to start collection.  During this 30 day window, you have the right to file a request for an administrative meeting with an IRS appeals officer.  The purpose of the meeting is to discuss alternatives with the IRS to property seizure.  This is known as a collection due process appeal.

(3)     The IRS is legally prohibited from taking your property until your appeal is completed. Typically, it takes the IRS about four to six months to have your case assigned to appeals officer and for your conference.

(4)     IRS appeals officers tend to be best equipped to resolve your case in a manner that is fair to you. You will have one person assigned to your case and can have a face-to-face meeting if you request.  This is impossible if you go through the IRS automated collection 1-800 systems for resolution.  Meeting with an IRS appeals officer usually gives you the best chance at reaching a fair resolution – that is their job.

(5)     Solutions you can request from appeals include an installment agreement, hardship “uncollectible status,” offer in compromise or innocent spouse claim.

(6)     If you cannot agree with IRS appeals over how to resolve your case, you have the right to have an independent Tax Court judge review your case. If you have a strong case and can show that the IRS is being unreasonable, the hold on collection will continue while your Tax Court case is pending and decided.

If it has been more than 30 days since the IRS sent you the Final Notice of Intent to Levy, you still have options. IRS administrative policy (see Internal Revenue Manual 5.1.9.3.2.3) is to process a late-filed collection due process appeal if it is filed within one year after the final notice is sent.  Filing your appeal late gives you the same administrative rights as filing timely – a hold on collection and meeting with an appeals officer.  You lose the right to go to Tax Court by filing late.

Exercising your rights to a collection due process hearing allows you to achieve a solution with an IRS appeals officer without the threat of collection.  This levels the playing field during negotiations – no IRS  levy or seizure – and puts you in the best place for resolution.

Tax refunds increase the amount you pay to the IRS in an offer in compromise.   

Here’s why:  The terms of an offer in compromise requires the IRS to keep your tax refund for the year in which the offer is accepted.  This means if your offer is accepted in 2010, the IRS will keep your refund from your 2010 tax return. 

It may get worse.  The IRS will also keep your refund in any year in which the offer is under investigation.  So if you submit your offer in late 2008 but it is accepted in early 2010, you will lose the refunds on your 2008, 2009 and 2010 tax returns.

The solution is simple:  Always check how much your tax withholdings are before submitting an offer in compromise.  If a refund is on the horizon, request that your employer reduce the IRS withholdings so no refund is available.  The cash will be in your pocket, not the governments.         

Your tax refunds can easily double the amount the IRS accepts in an IRS offer in compromise.  Planning ahead of time will ensure that the amount you pay is equal to the amount the IRS accepts.

A centerpiece of bankruptcy law is the concept of an “automatic stay.”    The automatic stay stops creditors from calling and writing to enforce or collect a debt from you.  The “stay” on your creditors – including the IRS – starts the minute you file bankruptcy. 

The automatic stay is why the IRS will immediately release a levy if you file for bankruptcy protection. 

But can bankruptcy stop the IRS from conducting an audit?

Bad news first:  Although bankruptcy can be pretty absolute on the IRS, it falls short of being able to slow down an IRS audit.  The bankruptcy stay does not apply to IRS audits and will not stop them (Bankruptcy Code section 362(b)(9)). 

Here’s the good news:  Bankruptcy can, however, eliminate any taxes, interest and penalties you might end up owing after an audit is completed.  The timing of the filing of the bankruptcy is important – among other conditions, you have to wait 240 days after the audit is final to be able to bankrupt an audit result.  

IRS audits are often painstaking, but there can be light at the end of the tunnel.  You may not be able to stop the machine, but bankruptcy can clean up the damage.