By Robert B. Teuber, Weiss Berzowski Brady LLP, Milwaukee

Dec. 15, 2010 – In the three previous articles concerning IRS procedure, I discussed tax audits, tax appeals and the Tax Court process. Absent a full victory at one of these stages, a tax liability will exist and the case will be transferred to the IRS Collections Division. Once in the Collections Division, the IRS is no longer concerned with the accuracy of the liability but, rather, how it will be paid.

To “encourage” payment of a tax liability, the IRS has the ability to place liens on a taxpayer’s property, levy bank accounts or receivables, garnish wages, and seize assets.

Before doing so, however, the IRS must give notice of the debt and demand that payment be made. This is accomplished through a series of notices that become increasingly threatening. Where the IRS has filed a lien or threatens to levy on assets, a taxpayer can challenge the lien or intended collection action through the Collection Due Process (CDP) procedures.

The conduct of a CDP hearing is not unlike the appeals process discussed in part 2 of this series but do involve different rules and procedures.

When a substantial tax liability exists, the filing of a lien is almost automatic. The lien attaches both to existing assets and assets acquired after the lien has been filed. Moreover, a tax lien can take priority over other creditors even if a debt has already been reduced to judgment.

The IRS views a lien simply as a means by which to secure a debt. Yet, in some instances, the filing of a lien itself can create such hardship or impact a taxpayer’s ability to pay the debt in the long run. In these instances, the IRS has the discretion to choose not to file a tax lien. Convincing the IRS that such a hardship exists can, however, be difficult.

Where the IRS has levied on a taxpayer’s assets (for example, a bank account), a taxpayer may argue for the return of the levied funds based on hardship. Preferably, however, your clients will never find themselves in this position.

Installment agreements

When the IRS threatens to levy, a taxpayer has the right to challenge that action before the levy takes place. If the client is paying attention to its financial concerns, the client ordinarily would not have to ask for a return of levied funds.

IRS agents will typically not levy on bank accounts, receivables, or seize assets if a taxpayer is working towards a resolution with the government. Such a resolution might take the form of: (1) an installment agreement; (2) an offer in compromise or; (3) temporary uncollectible status.

Where a taxpayer seeks to resolve a debt by installment agreement, the work involved in doing so may depend on the size of the liability. If the debt is under $10,000, the taxpayer has been in compliance with the tax laws, no recent installment agreements exist, and the taxpayer will pay off the debt in three years, the installment agreement will not be turned down.

Where the debt exceeds $25,000, financial statements will be required to accomplish the installment agreement. The amount of the monthly installment payments will be determined by the IRS and the taxpayer through an analysis of the financial statement. Where the debt is more than $10,000, but less than $25,000, no financial statements are required; however, the proposed payment plan may not be accepted.

Offer in compromise

Another option for resolving an outstanding tax obligation is the offer in compromise. An offer in compromise may be entered into between a taxpayer and the government to resolve a tax debt for less than the total amount due provided that the taxpayer qualifies under one of three tests: (1) doubt as to liability; (2) doubt as to collectability or; (3) effective tax administration.

A doubt as to liability offer in compromise will be submitted where a taxpayer is in the collection division, yet believes there is some basis for asserting that the person is not liable for the taxes asserted. Even though this type of offer is based on a question of liability, a compromise payment must still be made. The question of liability is simply the basis for reaching the compromise.

An offer based on doubt as to collectability involves the assertion (backed up by facts) that the taxpayer will not be able to pay the tax liability in full within the remaining statute of limitations on collection.

The taxpayer will be required to submit financial statements that will undergo detailed scrutiny. The financial statements require information concerning financial assets, equity in property, income, and expenses.

The IRS uses certain national standards to limit the expenses that a taxpayer may claim. The IRS sticks to these expense limitations rather firmly; however, an expense may exceed the national standards provided an adequate justification is accepted by the IRS.

Once a taxpayer’s equity and net monthly income is determined, the amount of the compromise can be established. Most often, however, the IRS will assert that a greater payment can be made than what was originally suggested by the taxpayer.

The IRS may also compromise a tax debt based on effective tax administration (ETA). This method is used where a taxpayer has the financial resources to pay the liability in full; however, other special circumstances exist that make a compromise equitable. The Treasury Regulations provide an example of an ETA offer where elderly taxpayers will not be able to meet their necessary living expenses in future years if they are required to drain their savings to pay a past due tax debt.

Other special circumstances that may also justify an ETA offer include medical issues of a taxpayer or loved one and erroneous advice from the IRS. ETA compromises are rare.

This is, in part, because such compromises do not have a formulaic analysis that is as easy to apply as do offers based on collectability. This does not mean, however, that a taxpayer should shy away from an ETA offer when appropriate.

Uncollectible status

If an installment agreement is not possible and, for one reason or another, an offer in compromise cannot be obtained, a taxpayer may be classified as uncollectible.

This temporary status can allow a taxpayer a reprieve from forced collection action and any payment requirements if it can be established that the taxpayer is currently unable to make any payments against the debts.

Placing your client into an uncollectible status, however, should not be considered a permanent resolution to a tax case because the debt is preserved for later. While the statute of limitations on collections (typically ten years) continues to run, interest also continues to accrue.

Classifying a taxpayer as uncollectible does little to resolve the debt. The IRS may also have motivations for placing taxpayers in uncollectible status instead of accepting a compromise. Given the current economic times, more taxpayers are facing difficulties paying past due taxes. As a result, they can use offers in compromise to permanently reduce the total amount of the tax debt.

If, however, these taxpayers are placed into uncollectible status, the full amount of the debt is preserved, interest continues to accrue and the IRS can revisit the collection of the full liability in a later year when the taxpayer’s financial status has improved. It is possible in such a later year, that the taxpayer will no longer qualify for a compromise.

Conclusion

Choosing which solution to use should be based on the facts and circumstances facing your client. Often those facts will dictate which alternative is available. However, where several alternatives are available, a representative should work with the taxpayer and the IRS to find the best possible resolution for their client.

A one-size-fits-all approach is never appropriate for resolving a tax problem. A client should be wary of anyone that proposes a course of action without having evaluated the facts and financial statements that will be reviewed by the IRS.

About the author

Robert B. Teuber is a tax attorney with Weiss Berzowski Brady LLP in Milwaukee. He works with individuals and businesses in resolving tax audits, appeals, litigation and collection actions brought by the IRS and Department of Revenue. Rob can be reached at 414/270-2538 or at rbt@wbb-law.com. 

Related:

• Don’t panic: The who, what, when, and where of IRS tax audits (Part 1) – InsideTrack, Nov. 3, 2010
• Don’t panic: The who, what, when, and where of the IRS tax appeals process (Part 2) – InsideTrack, Nov. 17, 2010
• Don’t panic: The who, what, when, and where of challenges in tax court (Part 3) – InsideTrack, Dec. 1, 2010