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According to the IRS, 15% of all taxpayers owe back taxes. And this figure includes only people who have actually filed tax returns. As mentioned in the article we wrote about filing tax returns, many people required to file tax returns haven’t.
There are several possible reasons you might owe the IRS back taxes:
No matter which of these categories you fit into, one thing is clear—you have a problem with the IRS. Let me tell you what passes for humor there: An auditor recently told me (with a straight face) that the IRS now requires a basic humanity test for all applicants. Those who flunk are hired by the collection division.
He may have been joking, but you won’t laugh if an IRS collector calls. He’ll probably be the toughest bill collector you’ll ever face, with the possible exception of Louie Loanshark’s boys.
Unlike other creditors, the IRS has no legal obligation to take you to court before seizing your car or paycheck. You can lose your business, your bank accounts, and even your pension. As far as the IRS is concerned, your tax obligation takes priority over all other debts. If the IRS records a notice of tax lien, your credit rating may be ruined for years.
Luckily, this doesn’t have to happen to you. If you deal with the IRS—in particular, if you intelligently respond to the IRS collector—chances are good that you’ll keep your property and survive the worst of what the IRS throws at you.
The IRS goal is to collect the maximum amount of taxes from you with the minimum amount of effort. The IRS starts by sending you computer-generated notices. Next, the IRS Automated Collection System, or ACS, kicks in, calling and sending you more threatening notices. Finally, if the IRS still doesn’t get its money, it assigns a human being from its collection division —a revenue officer—to get up close and personal with you.
You have six ways to deal with a tax bill you unquestionably owe:
All of these options are covered in this chapter.
While reducing your bill through an Offer in Compromise, going into bankruptcy, or having the IRS determine you are temporarily unable to pay may be the most attractive options, they are the most difficult to get. Paying in full is the only alternative for most working people with homes and other assets. For many taxpayers, however, paying in installments is the only way they can do it. Recently, more than 2.6 million taxpayers were on installment plans, paying collectively in excess of $4.5 billion.
In 2005, Congress radically changed the bankruptcy laws, making it harder to use this alternative for dealing with tax bills. See Nolo’s website at www.nolo.com for more on the bankruptcy law changes.
Don’t jump to the conclusion that paying your IRS debt over time (or paying it at all) is your best option. Read this entire section before making your decision on how to deal with the tax collector.
First, do you really owe all the IRS says you owe?
Before you agree to pay any amount to the IRS, make sure the bill is correct. You are entitled to a full explanation of why you owe any IRS bill. Here are some suggestions for making sure your bill is correct—or for possibly reducing it.
There is a little mercy in the tax code—it’s called the statute of limitations on the collection of a tax debt. In general, the IRS has ten years to collect. (Internal Revenue Code § 6502.) After ten years, the debt is wiped out. There are a number of ways the ten-year period can be extended:
These various rules are more complicated than this summary—see an experienced tax professional for more information.
Find out how the IRS calculated your bill and credited your account by requesting an account for the period in question. Call 800-829-1040 or your local IRS office. These printouts are not always easy to understand. If you need an explanation, call 800-829-1040, go to your local IRS office, or ask a tax professional for help. Compare your canceled checks, prior tax notices, tax refunds withheld, and bank and wage levies with the IRS printout. If it doesn’t match up—perhaps the IRS missed some credits you were due—immediately bring this to the attention of the IRS. Send copies of your proof of payment or other supporting documentation.
Almost all old tax bills include penalties and interest. It may be possible to have some or all of these unwanted additions canceled (or abated). See our article about penalties and interest to determine whether or not you qualify and how to go about asking the IRS for an abatement.
Despite its fierce image and extraordinary powers, the IRS, by its own admission, is a lousy bill collector. At last report, the amount of income taxes reported owed but uncollected exceeded $345 billion! The IRS collects only 85.5% of what it says it is owed by taxpayers. Add to that amount the taxes the IRS estimates are owed on unfiled returns and the total is even higher. The government calls this the tax gap.
The IRS claims it has neither the personnel nor the computer power to do better. Congress has responded with increased funding. When the IRS systems have been fully modernized, the IRS will be able to track down tax delinquents and seize their bank accounts and wages more quickly than it can now.
If you are coming up on a tax return filing date and owe a balance you can’t pay, file anyway. This avoids the hefty late-filing penalty (but not the smaller late payment penalty).
Send in as much as you can along with a completed Form 9465, Installment Agreement Request. (This one-page form can be completed and submitted online at the IRS website or can be obtained by calling 800-829-FORM.) If you’re sending in a hard copy of the form, include a copy of your tax return.
On Form 9465, tell the IRS how much you can pay monthly on the balance. The IRS should reply within 30 days to let you know if a plan has been approved, or to request more financial information from you before making the decision. During the rush of tax season (February to May), it will probably take longer for the IRS to reply. You may even receive a bill. Don’t assume that the IRS lost your installment request form. Chances are the IRS simply hasn’t processed it yet. Respond by sending in another copy of your completed Form 9465 along with the billing.
If you owe less than $25,000, your request should be granted. The IRS might bump up the amount required to be paid every month, however. If you are turned down, or you and the IRS cannot agree on an amount, you’ll have to furnish financial data and negotiate over the phone, via letter, or in person.
The IRS charges interest and a late payment penalty for each month you carry a tax balance. The initial late payment charge is H% per month, reduced to G% if you get a payment plan. The interest rate changes quarterly. Figure an additional 6%–8% average per year to the balance to get the full cost of doing business with the IRS. The IRS accepts payment by major credit card. Call 800-829-1040 for details.
If you didn’t pay your taxes or submit Form 9465—or it was ignored or rejected—call the IRS. Request an extension of time to pay a bill in full or a payment plan. You can do this without talking to IRS personnel. Call 800-829-7650 on a touch-tone phone. It should work if you owe less than $25,000 (including interest and penalties), are an individual or couple (not a business), and have no other balances due to the IRS.
You can get either an extension of up to 120 days to pay in full or a monthly payment plan. If you choose the payment plan, you’ll be asked how much you want to pay each month. Be sure to think about this before you call. If you need just a little time, request a 45-day extension. If you can’t pay at the end of the 45 days, you can request a payment plan or another extension.
If you don’t want to interact with an IRS computer, you can mail in a request for more time or another Form 9465, or call an IRS customer service representative at 800-829-1040.
IRS collection efforts begin—but don’t end—at the site where you filed your tax return. The IRS mission is to collect the tax using the least amount of human power possible. This accounts for the reams of computer-generated tax bill notices you will get long before ever hearing from a human being. No person is likely to even look at your account until your bill is at least six months overdue—often more like a year. And if you owe less than $1,000, no one may ever look at your account. You simply become a number in the IRS computer.
Once a balance due from a tax return has been posted to your account, a Computer Paragraph, or CP, notice is automatically sent to you. Your file is termed a Tax Delinquency Account, or TDA. The first letter is a nonthreatening CP-14 Balance Due.
If you don’t pay up within a month, you will receive a series of computer-generated notices. If you have other outstanding tax bills, the IRS may speed up the notices. By checking the number or type of notice you’ve received, you can figure out how close the IRS is to taking serious action.
Individual income taxes. About five weeks after sending the friendly bill, the IRS computer usually sends three “500 series” notices, identified by the number following the date in the upper right-hand corner: CP‑501, Reminder Notice – Balance Due, CP-504, Urgent Notice – Intent to Levy, and CP-503, Immediate Action Is Required. In four to eight months, you will get CP-207, Final Notice – Intent to Levy.
CP-207 usually means your case is going to another IRS department. So don’t panic just yet.
The total cycle, from the first notice to the last computer-generated letter, averages four to six months. This is the cushion before the IRS horror stories start coming true. At some point, the IRS will also send you Publication 594, The Collection Process.(available on the IRS’s website at www.irs.gov). It describes what the IRS can legally do to collect from you—which is plenty. Read it.
Payroll taxes. If you owe business or payroll taxes, collection on your account may be accelerated. The IRS often shortens the notice cycle to as few as eight weeks, depending on the size of the delinquency.
Special circumstances. If you did not file a return or owe $100,000 or more, the IRS may go straight from the CP-501, Reminder Notice – Balance Due, to the CP-504, Notice – Intent to Levy. Or, the IRS may stop the notices if it determines that your account is currently uncollectible, or that you are deceased, filing for bankruptcy, or incarcerated.
If your goal is simply to buy more time, respond in writing to each IRS notice. Send a letter with the bill saying that you can’t pay right now. You don’t need to give an excuse; just ask for 45 more days to pay. This is the maximum time period that can be entered into the IRS computer to suspend the collection notice cycle. When the next CP notice comes, try responding by requesting another 45 days. If you are able, send a small payment with each of your request letters to show that you are trying. This should buy you an unofficial short-term payment plan, which might be all you need.
Sometimes, making 45-day delay requests throws a monkey wrench into the system. Taxpayers have been known not to hear from the IRS again for as long as a year. It all depends on the efficiency of your particular IRS campus and the priority your account is given.
Even if you ignore the first few notices, you can buy some time by responding to the CP series notices. After the IRS sends the CP-504 notice, it is required to send you a final notice, designated Letter 1058, before it can take any assets. This letter explains your rights to a hearing and requests an immediate response.
It you don’t respond, the IRS computer may send levy notices to any financial institution suspected of holding funds under your Social Security number or name, or to any employer or contractor who filed a W-2 or 1099 form showing they have paid you in the past. Levy notice recipients must then freeze your account or pay the IRS a portion of your wages or money owed to you. (Liens and levies are covered in our aticle about enforced tax collection by the IRS.) As discussed later in this chapter, you are entitled to appeal an IRS levy. The IRS could also issue Form CP-49, Overpaid Tax Applied to Other Taxes You Owe, and seize tax refunds that you are owed.
As mentioned above, if you don’t pay during the IRS campus computerized notice series, your file will be sent to the IRS Automated Collection System, or ACS. The ACS has the authority to collect most overdue tax bills, solicit tax returns from people who haven’t filed, and levy (seize) assets and wages.
The ACS is a staffed telecommunications system for collecting seriously delinquent accounts. The ACS operates by mail and phone only.
The ACS computer automatically analyzes accounts that require telephone contact and dials and redials your phone number automatically if the IRS gets no answer or a busy signal.
The ACS is the IRS’s primary mail dunning and telephone harassment apparatus. I have visited ACS facilities, although they are not open to the public, and have found 150 or more clerks sitting in front of computer monitors, wearing telephone headsets. They follow scripts demanding payment from tax debtors and respond to calls or faxes requesting payment plans or more time to pay. The ACS mails collection letters and issues levies to third parties such as banks and employers.
Unless your case has enough “points” to be assigned to a field collector—under a secret IRS scoring system—it can stay with the ACS for as long as the IRS still has to collect (generally ten years from the date the tax was first assessed). The chief factor is the amount you owe—most importantly, whether it’s over or under $25,000. Other point factors are your past history of tax delinquencies and the number of years of taxes you owe.
As your case gets near the end of the ten-year statute of limitations for collection, even small balances may be sent to the local office for handling by a revenue officer.
ACS computer data is often inaccurate. For example, the ACS frequently requests tax returns from women who have filed under a new name after getting married or from deceased taxpayers.
If you want to slow down the ACS, ask for more time to pay. To suspend the computerized collection process, a collector must enter an appropriate freeze code into the computer. There are many freeze codes, but the precise details—such as the code designations, the exact number of codes, and when they can be used by ACS collectors—are not public information. Requesting more time to pay, filing for bankruptcy, or asking for a suspension of collection due to a hardship all have different freeze codes.
When a freeze code is entered into the computer, collection activity on your account is put on hold for the time specified for that code number—up to one year or even longer. No action will be taken on your case during that period, but you may still get tax bills. And, any tax refunds you are owed will be held by the IRS. After the time period elapses, the computer automatically pulls the case back up for further review and contact by the IRS.
Short-term hold. You can get a short-term hold—up to 45 or more days—usually by just asking for it. First, make your request over the telephone. Also, follow up with a written response to the ACS. Just photocopy the notice you were sent, write on it that you need up to 45 days to get the money to pay, and send the notice back—a separate letter is not necessary.
Long-term hold. If you really can’t afford any monthly payment amount, ask the collector to classify your account as “currently not collectible” or a “significant hardship case” and to suspend collection activities for 12 months or more. You must convince the collector you are truly down and out—no assets, no job, or very meager income and you survive mostly through welfare or the kindness of others. If you keep giving excuses, you may come up with one that convinces the collector to enter a long-term hold code. But, ACS collectors are on short leashes and not known for being sympathetic.
If asking for a hold doesn’t delay the tax collector for long, you can try one of these tactics:
If you owe less than $25,000, you should get a payment plan for up to 60 months by asking for it. You can be denied a payment plan if you have unfiled tax returns. If you owe more than $25,000, you may have to negotiate with the ACS collector.
Before dealing with an ACS collector, first have a plan of action. If the ACS collector calls you and you’re not ready to speak with her, give a polite excuse, such as you’re late for a doctor’s appointment, the baby is playing with matches, or you work nights and are sleeping now, and promise to call back. Don’t answer any questions asked by an ACS collector, other than your name, until you are ready with your facts and figures.
You need to make a comprehensive list of your assets, debts, income, and—most importantly—your living expenses. The collector will be looking for information similar to that requested on IRS Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, Form 433-F, a shorter version of Form 433-A, or Form 433-B, Collection Information Statement for Businesses. Use the appropriate form to organize the information, especially your expenses. Your goal is usually to convince the collector to give you time to pay your taxes. Her goal, however, is getting you to pay the full tax bill as soon as possible.
Once you’ve compiled your financial data, call the ACS. Have a notepad, pencil, the tax bill, and your Form 433-A or 433-F, or 433-B information. ACS offices are open from the early morning to the late evening. Of course, getting through may be a different story. The best times seem to be Tuesdays, Wednesdays, and Thursdays, early morning or lunchtime. Expect to be put on hold, and be prepared for a long wait—set aside snacks, the remote control, reading material, or your knitting.
When a collector finally comes on the phone, write down her name and ID number. You may get only a first name or a pseudonym. The collectors often do not give their real names out of fear of retaliation. This person may be on an ACS collection team of five to seven members. Make notes of important points throughout the conversation. If you ever have to call back, you probably will not be able to talk to the same person—the ACS system is nationwide, with thousands of employees. The IRS claims that you will get the same result no matter who you speak to, but don’t believe it. If you don’t like a particular ACS collector, politely end the call and try back the next day. You will likely get a different, and hopefully more reasonable, collector.
ACS collectors sit all day long listening to every excuse in the book—and some that aren’t. They hear so many lies that they become cynical and unsympathetic. Without lying, accent the negative—how hard your life is, your large expenses and low income, and the like. If the collector becomes rude or bullying, ask to speak to her supervisor. If all else fails, try begging or crying. You may be assigned another collector, or the supervisor may personally handle your case.
The telephone collector’s purpose is to identify assets, called levy sources, that the IRS can seize if you do not voluntarily pay the tax bill. Don’t lie—about your assets or anything else. If you’re asked a question you don’t want to get into with the ACS, such as whether or not you have any sideline income, gracefully end the conversation—use a prepared excuse, such as you are running late for work. Call back later. You may not be asked the question again.
The IRS telephone collector will also ask about bank balances and equity in your home or other real estate. She may ask about your cash borrowing power, but you can’t be forced to take out a loan. Remember—her goal is to get you to pay the full tax bill at once. If she thinks that you can pay, she will demand payment immediately.
If she concludes that you can’t pay now, she will ask questions to see if you qualify for a monthly payment plan, called an installment agreement, or IA. You will be asked about your family’s size, income, and living expenses.
Then, the collector may ask you to send substantiating documentation, such as rent receipts or pay stubs. She may demand that you fill out an IRS financial statement form. Follow the instructions below for advice on completing the form, called a Collection Information Statement.
Be prepared to negotiate a monthly amount with the ACS collector. Tell her the amount you can afford. Start low, as the ACS collector may well ask for a higher amount. She may insist that you cut back on some of your expenses. Be firm if the expenses are really necessary to your survival, and not luxuries.
The ACS collector questioned Yung’s assertion that his family’s monthly grocery bill totaled $600, saying it was beyond IRS allowances for a family of four. Yung explained that his two children were lactose-intolerant diabetics on special costly diets.
If you verbally agree to a payment plan, the IRS will send monthly statements and payment vouchers. Start making payments on the date you and the ACS collector agreed you would start. If you haven’t yet received the IRS monthly billing, send in a payment, enclose a letter stating that you are paying “per a telephone conversation with Carol, ID# 123456, on 12/29/xx, in which I agreed to pay $350 per month beginning 1/15/xx.” Send your payment to the ACS office. Write your Social Security number or federal ID number and tax period on the check or money order.
Interest and late payment penalties are running while you are in an installment plan.
If you are ever unable to make a monthly payment when it is due, see “Installment Payment Plan,” below.
If you can’t get anywhere with the ACS, or you don’t want to deal with them—for example, the bill is wrong—request that your file be transferred to your local IRS office. There, your case will be handled by a revenue officer. There are several other reasons why you might want your file transferred from the ACS:
How do you get your case out of the ACS? ACS collectors do not grant transfer requests without a good reason. Just asking probably won’t do it. Reasons that may work include telling the ACS collector that you don’t agree with the tax the IRS claims you owe and that you want to meet with the IRS to discuss it. Very few of us understand tax notices, so you won’t be lying. ACS staff are supposed to transfer a file whenever a taxpayer questions the correctness of taxes on a notice.
If the collector refuses to send your file to your local IRS office, ask for her supervisor. Unless your complaint is clearly phony, you should get your way. Keep asking for a transfer if you don’t first succeed. The more you owe, the easier it will be to get a transfer—that is, the ACS will grant transfers to people owing $50,000 more readily than to those owing $5,000.
Make the same transfer request in writing in response to the ACS notices you receive in the mail. Write that you don’t understand how the tax bill was computed and therefore don’t agree with it. Ask to meet with someone from your local IRS office for an explanation and to discuss payment.
If you owe more than $25,000 and the IRS notices have failed to get you to pay, or if you’ve requested that your file be transferred to your local IRS office, your case will end up with a revenue officer. These tax collectors follow a four-step process.
These steps are all discussed in detail below.
Some revenue officers try to catch delinquent taxpayers off guard by what I call the ambush. The officer simply comes to your home or work, usually between 8 a.m. and 6 p.m. If you aren’t there, he’ll leave a card requesting that you call back within a few days.
If he finds you at home or work, or if you call back, he will start asking financial questions or set a time for you to be interviewed at the IRS office. Don’t lie, but avoid giving financial information unless you are completely prepared. Say that you have to check your records. Then he’ll ask if you’ve filed your tax returns. If you have, no problem. If you haven’t, don’t lie. Say you need to check your records or with a tax professional, but don’t say yes if you haven’t filed.
Assuming you clearly owe the IRS, begin your first conversation with a revenue officer by acknowledging your responsibility and stating that you have every intention of cooperating. You don’t have to offer details on how you plan to pay. Don’t launch into the problems of your life, complain about the unfairness of the tax law, or be generally defensive. Being positive—even if you have to grit your teeth the entire time—will send a signal that you are not unreasonable. Considering how much discretion collectors have to make your life miserable, this is a wise approach.
The revenue officer will set an in-person or telephone appointment for a collection interview. He may, however, want to talk to you in person or on the phone before the interview. Before giving him any information, ask him if he intends to get financial data from you at the meeting.
After he says yes—and he will say yes because that is the purpose of the meeting—request that he send you a copy of the collection form. It will be Form 433-A or 433-F, Collection Information Statement. He will go over the form with you during the interview. (For the most current form, check the IRS website at www.irs.gov.)
By requesting the IRS form before the interview, you can delay the collection process a bit. Explain that you want the form ahead of time so that you can be as accurate as possible during the interview. He can’t argue with that. Fill in the form before you go to the meeting.
According to the Internal Revenue Manual, the first taxpayer interview is the most important event in the IRS’s collection process. The revenue officer plays detective. He is trained to first act sympathetic to gain your confidence and cooperation. But after the honey often comes the vinegar.
Legally, you can’t be forced to answer any of his questions. But if you don’t, you risk rapid “enforced collection” action—seizure of your assets and wages. What you say at the collection interview often will determine how successful you will be in resolving your problem. Be on your best behavior.
The IRS purpose for the interview is to gather information for the Collection Information Statement, which details your finances.
The IRS has several versions for its financial statement:
To negotiate with a revenue officer, all individual and self-employed persons must complete Form 433-A or 433-F. Business entities, such as corporations, or those who owe payroll taxes for their employees must submit Form 433-B.
A revenue officer will push hard to get all questions on the 433 forms answered. All 433 forms are divided into two main parts—assets and liabilities, and income and expenses. You will probably know the figures for your assets, debts, and income. The expense part is where problems usually arise. Most of us know exactly how much our car and house payments are, but not how much we spend on other living expenses. The IRS expects you to know these costs when it comes time to fill out the forms.
After the interview, the revenue officer will ask you to immediately sign the financial disclosure forms. Don’t be coerced into signing, even if you are desperate to get out of the IRS office. If you haven’t prepared your figures ahead of time, you will probably underestimate your living expenses by 10% to 40%. (Precise instructions for completing this form are given below.) In turn, this gives the IRS the false impression that you have a lot of money left over after paying your monthly expenses. Then the revenue officer will demand you pay the IRS all of this leftover money plus whatever amount he deems as “unnecessary” living expenses listed on your 433-A or 433-F.
Tell the revenue officer you want to go over the forms in your home or office with your records at hand. Make this request even if you got the forms in advance and filled them out before the meeting—if nothing else, you can buy a little time. This is far less nerve-wracking than coming up with figures at the IRS office. If he gives you a hard time or asks what part is incorrect, tell him that you want to go over your records or talk with your tax adviser first. If he still balks, tell him you want to discuss the matter with his supervisor. He probably will relent without calling in the boss.
If it’s too late—you’ve already signed the 433 form without the chance to review your expenses—you may still be able to revise it. Tell the revenue officer that some of your original figures were incorrect and you have further information to make them right. Then show him the correct numbers.
In general, you don’t have to give the IRS financial information about yourself. While lying to a collector is a crime, refusing to give information is not. (Internal Revenue Code § 7206.) If you don’t cooperate or you only partially cooperate, the IRS has three options:
The IRS allows only “reasonable necessary and proven living expenses for a tax debtor and his dependent family members.” Be prepared to defend your expenses to a tax collector. Bring your canceled checks, rent, or mortgage receipts, apartment leases, repair bills, insurance notices, medical bills, and paid receipts to the interview. The 433-F form is similar so the following applies to both versions
For the IRS, the key parts of 433 forms are assets and monthly expenses. Let’s go over these. Also, thumb a few pages ahead to view the sample filled-in Form 433-A. The 433-F form is similar so the following applies to both.
The form asks you to reveal your assets and their value. The IRS wants this information to determine your ability to pay and to seize your property or request you to sell it or borrow against it. Some assets are easy to value, like bank accounts and stocks. Other asset values can be estimated, like your home, furniture, boats, and banjos. The lower the value you place on your property, the less interested the IRS will be in seizing it or requiring you to sell or borrow on it.
Consider prepaying some expenses. Because the tax collector may pressure you to pay the IRS from any existing liquid assets revealed on a Form 433—like cash, stocks, or CDs—you can beat the IRS to the punch by prepaying some of your future expenses—like your mortgage, rent, or insurance. This will reduce your collectible assets and make sure you have a roof over your head. Or, use your liquid assets to pay past-due debts. Wouldn’t you rather repay your best friend the $10,000 loan she made three years ago than give that money to the IRS?
Here are some suggestions for valuing specific items.
Vehicles (Questions 18, 19). List and value your vehicles, whether owned or leased. Start with the lowest wholesale value shown in the Kelley Blue Book, which the IRS follows. This book is at your local library, at car dealerships, and online at www.kbb.com. Reduce the book value substantially if the car has a lot of miles on it or needs work.
Marcia drives her Honda to work. It has a Blue Book value of $10,000. She enters that in the first column. She owes her credit union $9,000, which goes into column two. But the car needs $700 of transmission work. The amount for column three, equity in asset, would be $300.
|Repairs needed||– 700|
The IRS would not seize Marcia’s car under these circumstances. First, the $300 equity would be wiped out by the costs of seizure and sale. Second, IRS policy discourages seizing vehicles needed for work transportation.
Real estate (Question 17). Call several real estate agents. They’ll be happy to tell you the fair market value of your property if they think there is any chance you might list it for sale. Or check ads in the paper for similar properties. Discount that value by 20% and list it on Forms 433-A or 433-B. This is realistic, as you would have to pay closing costs, sales commissions, fix-up fees, and other expenses if you were forced to sell the property. Also, real estate agents tend to be overly optimistic in their valuations, hoping you will list the property for sale with them.
Personal items (Question 19). Value your appliances, furniture, and fixtures at garage sale or thrift shop prices, which are extremely low. A sofa you bought five years ago for $1,000, for instance, would probably be worth only $100 or less today. On the form, you can group items. For example, furniture—$250 total is sufficient.
The IRS rarely verifies the values you list for personal items like household goods or wearing apparel. And the IRS can’t get into your home to see these items unless you invite them in—which you don’t have to do.
If you have trouble getting a fair installment agreement from the IRS, the problem is likely to be over what constitutes your necessary living expenses.
Most tax debtors owing more than $25,000 are put on a budget if they want an IRS payment plan. In effect, the IRS dictates how much you can spend on living expenses. Collectors follow specific national, regional, and local published guidelines on how much money they believe is necessary to sustain a family. The IRS uses these guidelines regardless of your actual living expenses.
The Internal Revenue Manual establishes national standards for reasonable expenses in six IRS-established categories:
Except for miscellaneous, the standards are derived from the annual Bureau of Labor Statistics Consumer Expenditure Survey. The allowances are updated annually and can be found at the IRS website (www.irs.gov). The allowances take into account the size of your family. But the government moves pretty slowly, so it is no surprise that the figures used are always a year behind. Because the cost of living always rises, the IRS standards don’t reflect reality, and tax debtors usually must argue that their actual expenses are higher than the national standards.
The IRS also establishes local expense allowances for:
The allowances for transportation expenses do not take into account the size of your family (unlike the national standards above). Whether you are single and childless or married with ten kids, the IRS allows you the same amount for transportation.
Also, local housing standards don’t take into account disparities in living expenses within the same locale. If you live in a better part of town, you probably spend more than the IRS local standard.
Court-ordered child support and alimony may be deducted as living expenses in addition to the above items.
The IRS considers many types of expenses conditional, meaning they aren’t absolutely necessary for your well-being. The general rules are:
In addition to expenses that exceed the national and local allowances described above, the following are examples of conditional expenses:
Conditional expenses are usually not allowed when you submit an Offer in Compromise or try to get your tax debt declared to be currently not collectible.
The standards are not chiseled in stone. The Internal Revenue Manual lets a revenue officer allow greater expenses in all categories. You must convince her that the additional amounts are necessary for you or your family’s health and welfare, or are needed to produce income. Revenue officers are reluctant to permit greater expenses, however, because they must justify their actions to their managers. You may have a fight on your hands, so be prepared with good reasons and documents.
If you didn’t prepare Form 433-A or 433-F in advance of your IRS interview, don’t let the IRS rush you into it at the meeting. Instead, take the forms home and complete them. This gives you time to remember all your expenses. Ask the revenue officer if you can mail it back or bring it to your next meeting.
You went through a collection interview, telling the IRS everything. Now the IRS collectors know where you work, bank, live, and more. In short, the IRS is in great shape to seize your wages and assets. What can you do to protect yourself if you are worried about an aggressive revenue officer?
Financial information must be true on the date that you give it, whether orally or on an IRS form. Do not commit to the IRS that you won’t change jobs, sell assets, or switch banks the next day. In fact, switching banks is good self-defense if you fear the IRS may levy upon your account. Alternatively, reduce the known bank balances to a minimum. Take the excess funds and open a new account at a different bank. Bank account moving is only a short-term solution to dealing with IRS collectors or IRS computers, which might freeze and seize your accounts.
Contrary to what many people think, banks do not automatically report your account information to the IRS. If you have an interest-bearing account, however, the interest is reported to the IRS annually after the end of each year. If you live in a small town, open the account outside the area or in another state. If you don’t, a local bank canvass by a revenue officer might find your account. In large metropolitan areas with many banks, this is not as likely to happen.
Deposit all further income into the new account. If and when you start paying taxes, pay the IRS out of the old account or with money orders. The reason is that whenever you pay the IRS, the agency records your bank account number in its computer. Don’t give the IRS your new account number by using the new account.
If the collector requests an updated Form 433-A or 433-B, you must disclose the new accounts. Updates usually aren’t requested more than once a year. Then you can begin the account-moving process over again.
After reviewing your financial disclosures on Form 433-A (and possibly Form 433-B), the revenue officer will proceed in one or more of the following ways:
Don’t expect a collector to take your word for anything. It is his job to verify what you tell him and the information on a 433 form. Revenue officers are alerted for transfers of your assets or assets held by members of your family. In such a situation, a revenue officer will treat you harshly—and may try to get the property back under a law that prohibits fraudulent transfers. The revenue officer will also check public records, such as DMV files and real property recordings. He may ask for past tax returns for clues to stocks, real estate, and businesses you previously owned. You don’t have to turn these over, but the officer can retrieve some tax filing data through the IRS computer system.
The most widely used method for paying an old IRS debt is the monthly installment agreement, or IA. If you owe $25,000 or less, an IA is usually easy to get. If you owe over $25,000, an IA requires negotiation. As mentioned above, if you have money or assets available beyond the amount of the IRS calculation of your allowable expenses, the IRS isn’t required to grant a payment plan, but it may do so.
Don’t assume that a payment plan is your best option—there are definite drawbacks. The biggest is that interest and penalties continue to accrue while you pay. Interest is adjusted by law quarterly. Combined with late payment penalties, recently the rate has averaged between 6% and 8% per year (less than your credit card). It’s possible to pay for years and still owe more than when you started because of the compounding of principal and interest.
Rodney and Rebecca owe the IRS $40,000 in back taxes. They enter into a $300 per month payment plan at a time when interest and penalties total 10% a year, adding $4,000 to their balance. But 12 months’ worth of $300 payments add up to only $3,600, and so they will owe $40,400 at the end of the year ($40,000 minus $3,600 paid plus $4,000 in interest).
You can set up an IA by calling the number on the IRS bill, or you can do it online using IRS Form 9465, Request for Installment Agreement.
You must be current on your tax filings. If IRS computers show that you haven’t filed all past due tax returns, you will not get an IA until you are current. Likewise, if you are self-employed, you must be making your quarterly estimated tax payments for the current year. If you are an employer, you must be current on your payroll tax deposits as well.
The tax code imposes a ten-year time limit on the IRS to collect taxes. (Internal Revenue Code § 6502.) This period starts on the date the tax was officially assessed. If you were audited, the ten years runs from the date the IRS assessed additional taxes, if any.
Sometimes, as a condition of granting an IA, the IRS will require that you allow the ten-year period to be extended. You will be asked to sign Form 900, Tax Collection Waiver. Generally, the extension period requested is five years beyond the time left on the statute of limitations for collection (normally ten years). When the revenue officer hands you Form 900, tell him that you want to talk to your tax adviser before signing. This stalling tactic may work. Often the IRS forgets to ask for the form later, and you are home free. If the IRS insists (and doesn’t forget), go ahead and sign. The IRS has you over a barrel—no waiver, no installment agreement.
Getting an IA if you owe more than $25,000 means dealing with an IRS collector. It can be done either in person at the local IRS office, or by phone or mail. The IRS makes this choice, not you.
The collector starts by taking information from you for an IRS Collection Information Statement, Form 433-A or 433-F. Based on this data, the collector determines the amount you should pay monthly. If you believe the amount is greater than your ability to pay (almost always the case), then you may be able to negotiate for a lower amount.
Here are some strategies for negotiating an installment plan:
A collector doesn’t have sole authority to grant a payment plan for amounts over $25,000. He can only recommend it to his manager for approval. Most of the time approval is given, but not always.
If an Installment Agreement is verbally agreed upon with the collector, it may take a few weeks for the IRS to notify you in writing that it has been formally approved.
There’s no free lunch with an IRS payment plan. The IRS now charges a “user fee” of $105 to set up an IA. Cut this to $52 if you agree to a Direct Debit arrangement with your bank to make monthly withdrawals. Or, it can be as low as $43 if your income is below the IRS poverty level. (The IRS looks at your most recent tax return to see if you qualify.) If you miss a payment and the IA is revoked, it will cost you $45 if the IRS agrees to reinstate the payment plan.
Send payments under your IA to the IRS using the payment vouchers and bar-coded envelopes mailed to you each month. Write your name, Social Security number, type of tax (income, payroll), and tax periods (years or quarters) covered by the IA in the lower left-hand corner of your check, and make a photocopy for your records. If you don’t want the IRS to know where you bank, use a money order or cashier’s check from another financial institution.
You have two other options for making payments once your IA is approved:
Before the IRS will accept an IA, the IRS officer must believe that the information on your 433-F form is truthful, your living expenses are “necessary” and the IRS is getting the maximum amount you can pay.
When the IRS won’t agree to installment payments, it is for one of three reasons:
If your IA proposal is first rejected, you can keep negotiating. Ask to speak to the revenue officer’s manager. Just making this request is sometimes enough to soften the officer up. But, if you talk to the manager, don’t criticize her employee or start yelling. Keep your cool and if the manager believes you are trying to be reasonable, she may take over the case or ask the revenue officer to reconsider.
If you get nowhere with the manager, you can go to the IRS Appeals Office (see “If the IRS Records a Tax Lien,” in our article about IRS enforced collection and Form 9423), or contact a taxpayer advocate.
Once you receive written approval of your IA, you and the IRS are bound by the terms of the agreement, unless:
If the IRS intends to revoke your installment agreement, you will receive CP-523, Notice of Default of Installment Agreement. You can appeal the revocation of an IA. The procedure is explained in our IRS enforced tax collection article. You must use Form 9423.
If you can’t make a monthly IA payment, call the taxpayer assistance number at 800-829-1040. If you negotiated with a revenue officer, call her, too.
Explain your problem. Ask for more time to pay and that collections be suspended. You’ll need a good excuse, like losing your job, becoming disabled, or a similar mishap. If you don’t get anywhere and the IRS says your IA is in default—meaning the IRS can begin grabbing your property—call the Taxpayer Advocate Service. A taxpayer advocate can keep your agreement from being revoked if it would result in a significant hardship.
If your IA is revoked and your appeal fails, you can start negotiations over from scratch. The IRS may grant a reinstatement, but don’t count on it. Remember, unless you owe less than $10,000, installment agreements are discretionary with the IRS. If the IRS is willing to grant a new IA, you’ll need a good excuse for defaulting and likely have to furnish updated documentation of your income and living expenses. And while you are trying to get a new IA, the IRS may start seizing your bank accounts and wages.
Often you will owe both the IRS and your state. If you do, negotiate payment plans with both agencies at the same time. Otherwise, any deal you make with one may not leave you with anything to pacify the other. Read our post on state income taxes for information on negotiating installment plans with both taxing authorities.
Would you like to wipe your tax slate clean at an enormous discount? The IRS has accepted less than 1% of a tax bill and called it even. There is no legal right to ever have a valid tax bill reduced by the IRS. It is entirely a matter of government discretion whether or not you qualify for an Offer in Compromise, referred to as an Offer or OIC. (Internal Revenue Code § 7122.) In all but a few instances, the IRS must give a properly submitted OIC its fair consideration. You even have the right to take a rejected OIC to the IRS Appeals Office.
The IRS occasionally makes deals—but be aware that there is no “tax debt fire sale” happening in Washington. Nevertheless, fewer than one in ten Offers in Compromise are eventually negotiated with the IRS. This doesn’t mean that the IRS accepted the original Offer; typically the IRS and the taxpayer do some bargaining.
Make sure you qualify. Read the IRS Form 656 booklet (44 pages) and this section before you make an offer to the IRS. If you find out early that you don’t qualify, you can save yourself a great deal of time and avoid frustration.
Submitting an Offer to the IRS is a very formal process—you can’t simply call the IRS and say “Let’s make a deal.” You start by completing IRS Form 656. The form is deceptively simple. Read and carefully follow the instructions that accompany the form.
Along with Form 656, submit Form 433-A and, for certain business owners, Form 433-B. There is an application fee and an initial payment required. The IRS scrutinizes your Forms 433-A and 433-B much more closely when considering an OIC than when you request an installment agreement. If you are married, the IRS may request that your Form 433-A include financial data on your spouse—even if you alone owe the IRS.
Completing Forms 656 and 433-A (and 433-B for business entities) is just the beginning. After receiving your OIC documents, the IRS will ask for rafts of written proof and backup—paystubs, bank records, vehicle registrations, and myriad other items. Expect a long and time-consuming process, unless you are quickly rejected, which happens too.
Wanting to make a deal with the IRS is not enough—everyone would like to have his tax bill reduced. To qualify, you must check the right box on Form 656 and show the IRS that one or more of the following conditions exists:
In addition, you must not be in bankruptcy.
The amount of an OIC must be equal to (a) the net realizable value of your assets, plus (b) the present value of the total sum the IRS could collect under a monthly payment plan. For example, if the first number is $7,200 and the second $14,800, the minimum offer must be $22,000. Let’s look at how these numbers are calculated by the IRS.
Net realizable value of your assets. The net realizable value of your assets is the amount the IRS could collect if it seized your assets and sold them today—after paying off any debts associated with the property, such as a mortgage. To figure out the net value or equity in real estate, the IRS allows a “quick sale value,” or QSV, generally 20% less than the fair market value. In a depressed real estate market, you can argue for a greater discount.
Darlene owes the IRS $47,850 for back taxes resulting from the failure of her Beanie Baby Bazaar venture. Darlene has $1,500 in cash and a house, which has a fair market value of $150,000 and a quick sale value of $120,000. She owes $77,000 on her first mortgage, $33,000 on a home equity loan and $4,000 in back property taxes.
|Fair market value (home)||$150,000|
|Quick sale value||$120,000|
|Home equity loan||(33,000)|
|Unpaid property taxes||(4,000)|
|Total debt on property||($114,000)|
|Net realizable value (home)||$6,000|
|Realizable value (cash)||1,500|
|Total Net Realizable Value||$7,500|
When totaling up your assets for an OIC, you can exclude most household property and personal effects, such as clothing, furniture, and appliances, as long as they are not luxurious. List luxury items like your sable coat and Louis XIV dining room set. In the example above, Darlene’s stuff was pretty much from Levitz and Wal-Mart, so it didn’t have to be figured in.
Retirement plan balances, SEPs, IRAs, and 401(k)s, must be included in the asset calculations for an OIC. But you can discount their values by any income tax and any penalties for early distribution you would owe after cashing them in. Attach a written explanation of how you arrived at the discounted value.
Excluded assets. A list of the relatively few items that may be excluded from your asset calculation is in IRS Publication 594, The IRS Collection Process—a copy is available on the IRS’s website at www.irs.gov. The list is titled “Some property cannot be levied or seized.”
Future income less living expenses. This calculation is made by subtracting your necessary living expenses from your total monthly income (see Form 433-A). This is your monthly disposable income which is the amount you could be expected to pay if you were on a monthly payment plan with the IRS.
After you determine the monthly disposable income amount, you must multiply it by a number according to the type of offer you propose. There are three types of offers:
Let’s continue with Darlene. Using Form 433-A, she calculates that she could pay a maximum of $150 per month.
Be ready for a tax lien. If the IRS accepts either type of periodic payment Offer in Compromise (for payments over two years or longer), it may record a Notice of Federal Tax Lien showing your tax debt. The lien will remain on the public record until every last penny has been paid or the statute of limitations for collection has expired, whichever occurs first.
What if you calculate the minimum amount required for an OIC and it shows you have too many assets? However, selling those assets would cause an economic hardship to you or your family. For example, tax payment would mean losing your retirement account income or your home. IRS personnel have leeway to accept less than required under strict application of the normal rules, under the “effective tax administration” (hardship) condition.
The IRS favors offers from people with bleak financial prospects due to advanced age—over 60 in particular. And the IRS gives special consideration to people with physical or psychological infirmities, including HIV or drug- or alcohol-related problems. The problem could even be related to a family member if it has a detrimental financial effect on you. For medical conditions, get statements from doctors and medical records to prove it. If the medical data doesn’t make the point clear, then explain how the condition prevents you from earning much of a living now or in the foreseeable future. As the Rolling Stones sang, “Paint It Black.” The best way to bring special circumstances to the IRS’s attention is through a letter attached to your Forms 656 and 433. It doesn’t have to be formal or fancy, just one or two pages telling your tale of woe.
If you follow the IRS’s OIC instructions in the Form 656 booklet and the suggestions here, your chances of success should be as good as if you had hired a tax professional. My advice though: Run your 656 and 433 completed forms and documents by an offer-experienced tax professional before sending them to the IRS.
Or, if you just can’t stomach dealing with the IRS, hire a tax professional to prepare and submit your OIC. Expect to pay her between $1,500 and $7,500. While the IRS won’t give special consideration to an OIC submitted by a tax professional, she is much less likely to make a fatal mistake in the process than you are.
Making an Offer in Compromise has its advantages and disadvantages.
The obvious advantage is that if your Offer in Compromise is accepted, you’ll save a heap of money. If your offer includes deferred payments, interest continues to accrue, but only on the amount you’re paying under the Offer in Compromise—not on the original amount owed.
Also, even if your offer is ultimately rejected, your stress level will be reduced while the offer is pending. This is because the IRS normally doesn’t seize your wages or property during this period.
Finally, once an Offer in Compromise is accepted and paid in full, the IRS must release tax liens within 30 days— as explained in the enforced collection procedure. Your credit rating will improve as soon as a Certificate of Release of Federal Tax Lien is filed on the public record.
There are eight potential disadvantages to an OIC, as follows:
Offers must be presented on Form 656, Offer in Compromise. You also must submit a completed Form 433-A and, for certain business owners, a Form 433-B as well.
Make sure your Offer in Compromise and 433-A and 433-B forms are the latest versions. Call the IRS at 800-829-1040 or check the IRS website for the correct form (www.irs.gov).
Call the IRS (800-829-1040) to tell them you intend to submit an OIC, and ask that no collection action be taken while you prepare the offer. Your request should be granted, depending on your history of problems with the IRS. Then file your offer within 45 days.
If you live in Alaska, Alabama, Arizona, California, Colorado, Hawaii, Idaho, Kentucky, Louisiana, Mississippi, Montana, Nevada, New Mexico, Oregon, Tennessee, Texas, Utah, Washington, Wisconsin, or Wyoming, send your completed OIC forms and attachments to:
Memphis IRS Service Center
P.O. Box 30803 AMC
Memphis, TN 38130-0803
If you live in another state or in a foreign country, send your OIC materials to:
Brookhaven IRS Service Center
P.O. Box 9007
Holtsville, NY 11742-9007
When your packet arrives at one of these processing units, it will first get a quick review to make sure you filled in the forms correctly and attached the proper supporting documents. After that, the unit will formally open your case and either contact you directly or assign it to your local IRS office for investigation. The processing unit or a local IRS offer specialist will likely contact you for follow-up information and questioning.
Suggestions for completing Forms 433-A and 433-B are in “Filling in IRS Collection Statements” and “How Much Should You Offer?” above.
A completed sample of Form 656 is below. Also see the IRS website for a worksheet. Here are some additional tips, by the paragraph numbers on Form 656.
Section II. Check the box or boxes specifically by year and type of tax—such as income taxes.
Section IV. Study your options carefully and enter the amount you propose to pay and how you intend to pay it—in a lump sum, installment payments, or a combination of a down payment and installments.
After you have filed your Form 656 Offer, the IRS will want evidence supporting the information on your Forms 433-A and 433-B, if applicable. Be prepared to submit copies, (but not the originals) of:
The IRS is always impressed by paper, so lay it on.
According to the IRS, the most common errors taxpayers make when submitting an Offer in Compromise are:
All of these mistakes are easily corrected—you can fix the problem and resubmit your offer. This will cause weeks or months of delays, however.
Lump Sum Offers (5 payments or fewer). A 20% deposit is required if your offer is to be paid in five months or less. So, if your total offer is $10,000, you must make a payment of $2,000 with your initial offer forms. The payment is nonrefundable if the IRS rejects your offer, but is applied to your bill.
Installment Payment Offers (more than 5 months). If your offer is to be paid periodically, you must include the first installment payment with your forms. You must also make all subsequent payments as proposed while your offer is pending. So, if you are offering to pay $12,000 over 24 months, you must submit $500 (1 ÷ 24) with the offer and continue that every month thereafter.
Application fee. Payments are nonrefundable but are applied to your bill if the IRS rejects your offer. You must include an application fee of $150, payable to the U.S. Treasury. You may request that it be waived by submitting the Application Fee Worksheet in the IRS Form 656 booklet. The application fee does not get applied to the offer amount and is not refundable.
All payments should be by check or money order payable to “United States Treasury,” not the IRS.
If the IRS finds your offer defective (or non-processable, in IRS-speak), it will send your offer paperwork back to you. Simply make the corrections and refile. Don’t get discouraged, as this is very common.
If the IRS deems your offer legitimate and processable, it usually takes between four and 18 months to review and investigate it and make a decision. You must continue to make payments under an existing installment agreement unless you get permission from the IRS to stop. When it’s time to file your next return, do so or make sure you file an extension, and pay whatever taxes are due. Otherwise, the IRS can reject your OIC. If the IRS doesn’t make a decision within 24 months, the offer is automatically accepted.
The IRS works in mysterious ways. Sometimes, offers to pay 5% of the tax bill are accepted, while 80% payment offers are turned down. Consider the following two cases.
Leroy and Mary were in their late sixties and had filed for Chapter 7 bankruptcy (liquidation) several years before. Their income tax debts did not qualify for discharge, and they still owed the IRS $35,000. They were now retired and living modestly on Social Security. The IRS collection notices and threats kept on coming. This was particularly upsetting to Leroy, who had a bad heart. Their free credit score check at www.freescore.com came back with a low rating and they couldn’t get a loan from a bank.
Leroy and Mary submitted an Offer in Compromise to pay $3,500 cash, with a $700 deposit, which Mary’s sister promised to give them. The IRS accepted their offer for processing and assigned it to an offer specialist, who contacted them. The couple emphasized to the offer specialist their frugality and Leroy’s health problems. Almost a year later, they received a letter saying that the offer had been accepted. Leroy and Mary paid the IRS and the IRS released its $35,000 tax lien. A very happy ending.
Louis and Juanita owed the IRS $51,000 as a result of a failed business venture. Louis worked sporadically in the Merchant Marine and Juanita was a nursing home attendant. Together they earned $42,000 per year. An aggressive IRS revenue officer demanded payments of $1,500 per month. This was clearly impossible, as they had four children.
Louis and Juanita made an offer of $15,000 cash on Form 656. The IRS rejected the offer because Louis and Juanita had $59,000 of equity in their home.
The IRS must give a written explanation if your offer is not accepted. The IRS usually rejects Offers in Compromise:
If the offer is too low, the IRS letter will state what amount would be acceptable.
You should automatically get a copy of the report which lists the factors that caused the rejection. If they won’t give it to you, make a request under the Freedom of Information Act. (Appealing a Tax Audit.)
After finding out why your offer was rejected, you can try again without a new 656 form if you resubmit it within 30 days. Instead, write a letter if the new offer is not substantially more favorable to the IRS than your old one and if your financial circumstances have not appreciably changed. For example, state that you wish to change your offer by increasing the amount of cash offered from $10,000 to $15,000, or whatever is appropriate.
To submit a significantly different offer, complete another Form 656. The IRS offer specialist might help make your offer acceptable.
Looking at Offers in Compromise that were accepted might give you an idea of what kinds of proposals the IRS goes for. Call the IRS at 800-829-1040 for an appointment to see offers that were accepted. These are available to the public for one year, although not all personal details are revealed. You will have to go into an IRS office to view these documents.
If your Offer in Compromise is turned down, you can either call the person who signed the letter and try to get her to change her mind, or you can formally appeal. (Here’s more information on how to appeal a tax audit.) This administrative appeal goes to a division separate from the one that turned down your offer.
An appeal is your last chance; you cannot take the IRS to court for rejecting your offer.
An appeal begins with your letter following a format laid out by the IRS. Follow the tax appeal letter, “Protest Letter for Appeals Over $25,000 (Large Case),” but substitute the following for the first three paragraphs.
I wish to appeal the rejection of an Offer in Compromise submitted June 20, 2005, and rejected on January 7, 2006. I request a conference.
The IRS must receive your appeal within 30 days of the date of the rejection letter. Otherwise, you have to submit a new offer and appeal it if it’s rejected. The IRS frowns on offers submitted within six months of the first rejection unless there’s been a significant change of your circumstances or you offer substantially more.
An appeal will not be seriously considered unless all of the following are true:
My experience with appealing offers has been mixed. Sometimes, instead of forwarding cases to the appeals office, the IRS will reconsider and invite further negotiation. An appeal further delays the collection process—but interest and penalties keep accruing if you don’t eventually make a deal.
[The following section was written with the assistance of two bankruptcy experts: John Raymond, J.D., and Alan Rosenthal of the law offices of John Raymond, San Francisco, California.]
Filing a petition under the bankruptcy code can often reduce or erase tax debts. Alternatively, using bankruptcy can buy time and force a repayment plan on the IRS. Bankruptcy might be just the answer to your tax debt prayers.
For more information on bankruptcy, including recent changes to bankruptcy law, see Nolo’s website at www.nolo.com and The New Bankruptcy: Will It Work for You? by Stephen Elias (Nolo); How to File for Chapter 7 Bankruptcy, by Stephen Elias, Albin Renauer, and Robin Leonard (Nolo); and Chapter 13 Bankruptcy: Keep Your Property & Repay Debts Over Time, by Robin Leonard (Nolo).
Bankruptcy is a legal procedure for sorting out your debt problems, including your tax debts, by filing a petition in federal bankruptcy court. There are two basic types of bankruptcies:
One of bankruptcy’s most alluring features is a legal refuge called the automatic stay. The moment you file for bankruptcy, the automatic stay stops all creditors and bill collectors—including the taxman—cold.
The only way a creditor can collect while your bankruptcy case is open is to ask the bankruptcy judge to remove, or lift, the stay. The IRS rarely applies to have a stay lifted.
There are several negatives to consider before deciding to take the plunge into bankruptcy.
Before filing for bankruptcy, you must complete credit counseling with a government approved agency. This doesn’t stop an IRS action to collect.
If you go into bankruptcy and emerge still owing the IRS—meaning that not all of your taxes were erased in bankruptcy—the IRS gains extra time to collect the balance.
The IRS normally has ten years to collect tax bills, penalties, and interest from you. Once your bankruptcy case is over, the IRS gets whatever time remains on the original ten years to collect, plus the time your bankruptcy case was pending plus another 180 days.
A bankruptcy filing is a matter of public record and it usually remains on your credit record for ten years.
If the IRS or state taxing authority recorded a tax lien notice, the harm to your credit has already been done. A bankruptcy filing at least shows that you are making a positive effort to deal with your debt problem.
Not all tax debts can be wiped out in a Chapter 7 bankruptcy. For example, you must have filed the past four years’ tax returns before filing for bankruptcy. You’ll need to read some mind-bending rules to determine if bankruptcy can help you with your tax debt. (See the Nolo books listed at the beginning of this section.)
In Chapter 7 bankruptcy, the court can erase or discharge an individual or married couple’s taxes in certain circumstances.
Federal tax bills can be discharged in a Chapter 7 bankruptcy only if all of the following are true.
Taxes must be income taxes. Other taxes, such as most payroll taxes, Trust Fund Recovery Penalty, or fraud penalties, can never be eliminated in bankruptcy.
No fraud or willful evasion. You must not have filed a fraudulent tax return or otherwise willfully attempted to evade paying taxes. This usually applies only if you’ve been assessed a fraud penalty.
Three-year rule. The taxes were due at least three years before you file for bankruptcy. This usually means three years from April 15 of the year the return was due. But, if you filed a request for an extension, it could be October 15. If the 15th fell on a Saturday or Sunday, your return wasn’t due until the following Monday. That is the date you start counting from for this rule.
Two-year rule. You actually filed all tax returns at least two years before filing the bankruptcy—having the IRS file a substitute return for you doesn’t count. If you don’t file a tax return, you can never discharge the taxes you owe for that year in bankruptcy. You can, however, include the taxes in a repayment plan.
240-day rule. The income taxes were assessed by the IRS at least 240 days before you file your bankruptcy petition. Normally, this applies only if you’ve been audited within 240 days before the petition is filed.
If any of the following apply, you will have to add time to the three-year, two-year or 240-day rules for your debts to qualify for discharge in bankruptcy:
Before filing bankruptcy for tax debts, call the IRS to obtain a record of your filing dates. This is called an account transcript. Specify each tax year or other period on which you might owe. This free computer printout lists important tax dates—when the returns were filed, when the taxes were assessed, and the various dates of any tolling or time-extending events. Check the dates from the IRS transcript before filing bankruptcy. This is very important, so get it right.
If your taxes qualify for discharge in a Chapter 7 bankruptcy case, you still may have a problem. This is because previously recorded tax liens are still on your record. A Chapter 7 discharge will wipe out only your personal obligation to pay the tax. Any lien recorded before you file for bankruptcy survives the discharge to the extent your property has equity to which the lien can attach.
After your bankruptcy is over, the IRS can seize many of the assets you owned at the time the bankruptcy was filed. (It may be possible to reduce the amount of the tax lien. See a bankruptcy attorney for more information.) Unless you owned real estate or have an IRA or pension plan, the IRS lien probably won’t harm you.
If you or your tax debts do not all qualify for Chapter 7, consider a Chapter 13 repayment plan. This can be the next-best solution to a tax bill problem.
For more information on bankruptcy, including recent changes to bankruptcy law, see the following resources:
Chapter 13 is the most widely used bankruptcy option for people with tax debts. In Chapter 13, you propose a payment plan for the bankruptcy court’s approval. You make monthly payments to a court-appointed trustee, who divides up the money among your creditors, including the IRS. This repayment plan runs for five years.
Secured taxes—those for which a lien was recorded and you own property whose current value is equal to the tax lien—must be paid in full in a Chapter 13 case. Once you pay off your secured taxes in Chapter 13, the tax lien is satisfied. The lien no longer attaches to property you own or may acquire in the future.
Chapter 13 can still be beneficial, for many reasons, including:
To file for Chapter 13 bankruptcy, much like Chapter 7, you must complete a rather imposing set of forms disclosing your assets, liabilities, income, and expenses and you must have filed all your tax returns for four years prior to filing. You must also submit a proposed payment plan to the court. See Chapter 13 Bankruptcy: Keep Your Property & Repay Debts Over Time, by Robin Leonard (Nolo), or consult a bankruptcy attorney before tackling the forms.
If you qualify under these rules, submit a Chapter 13 payment plan to the bankruptcy judge. She reviews your petition and appoints a trustee to oversee your case. The trustee holds a hearing in which your creditors can come and object to your plan. The IRS rarely ever contests a Chapter 13 plan—so don’t worry.
The judge might make adjustments to the plan, but will normally approve it if the forms are right. You make 60 monthly payments to the trustee, who in turn pays your creditors on a pro rata basis.
Chapter 11 bankruptcy is primarily for troubled businesses. It gives businesses protection from their creditors while attempting to make a profit and reorganize their debts. Individuals can file for Chapter 11 bankruptcy, but it is rarely done.
Chapter 11s require the help of a knowledgeable (and expensive) bankruptcy attorney. Fees start upwards of $10,000. Chapter 11 bankruptcies may last many years. Eventually, the business either becomes healthy or fails. If it fails, the bankruptcy may be converted to a Chapter 7.
In a Chapter 11 bankruptcy, the automatic stay stops all IRS collection efforts, but interest continues to accrue. (By contrast, in Chapter 13, interest usually stops accruing on your tax bills.)
The bankruptcy code only talks about taxes—not just federal income taxes. But there are three areas of special concern with state taxes and bankruptcy.
First, some states send out interim, not final, notices of a tax assessment. In California, for example, the final date for bankruptcy counting is no less than 60 days after the issuance of the proposed additional tax. The result is that the waiting time to discharge California state income taxes is 300 days from assessment, not 240 days.
Second, many states require a taxpayer to file an amended return after an IRS assessment based on audit or examination. The three-year rule is measured from when the original return was due, and the two-year rule from when it was filed.
Finally, state sales taxes are usually not dischargeable in Chapter 7 or Chapter 13, so they must be paid in full. In a few states, however, including Hawaii, California, and Illinois, unpaid sales taxes can be discharged the same as income taxes if they meet the 240 day, three-year, and two-year rules. Again, see a bankruptcy attorney in your state if this might be an issue.
Chapter 12 bankruptcy is for debts arising from the operation of a family farm. Its rules are similar to Chapter 13 but there are some differences not discussed here.
It is illegal to transfer assets to defeat the IRS once it has started trying to collect a tax debt. It is possible to protect some assets through entities or family members. The key is advance planning and timing the transfers.
Before moving your property beyond the reach of the IRS, consider the following:
Protect yourself. See an attorney to make sure you do a transfer legally and do not commit fraud on the IRS or any other creditors.
Here are a few of the most common ways people attempt to protect their assets from their creditors, including the IRS:
Transfer assets to a corporation with a friendly owner. You can also work for a corporation owned by your spouse or child. If you keep the salary low, you may be able to negotiate an IRS installment agreement that you can live with. The IRS could seize corporate assets if it deems the corporation a sham, but it seldom does so.
Put assets into a family limited partnership. See an attorney if this sounds promising. Don’t simply put property into joint tenancy with family members—that won’t stop the IRS.
Transfer assets to a trust for a spouse or other family members. A children’s trust, for example, can own assets used in your business. Again, see an attorney. Putting property into a revocable living trust won’t offer any protection, because you maintain control over the asset. And the IRS considers the use of offshore trusts very suspiciously.
Put life insurance policies into an insurance trust. This generally safeguards them from IRS seizures if done in advance of tax problems.
Fully fund your retirement plans and 401(k) accounts. The IRS can legally take non-ERISA qualified plans, but IRS policy discourages it. You can borrow from a 401(k) plan to reduce the amount that could be seized by the IRS. This is your safest bet.
Transfer assets to family members outright. If you are going to leave property to your children on your death, and you fear a future IRS tax bill, this might be a way to save the property from the IRS.
File separate tax returns. Married couples who file jointly and owe the IRS have their refunds automatically grabbed by the IRS. One way to get around this may be to file separate tax returns if only one spouse owes the IRS. If you reside in a community property state, however, this may not work.
How far does the reach of the tax collector extend? Many countries have treaties with the IRS allowing them to collect U.S. taxes due from our taxpayers on their soil. As a practical matter, even our strongest allies don’t pursue our tax deadbeats. You may be able to beat the IRS by leaving the country and taking all of your property with you. And you may have to stay away permanently, as the IRS computer is linked to the U.S. Citizenship and Immigration Services computer. And, one more thing: The ten-year statute of limitations on collections is suspended while you’re out of the country and for 180 days after your return.
There are also ways to protect your assets by sophisticated estate planning devices. See an attorney if you want to learn more.
If your prospects are bleak—no job, little or no money, and pressing creditors—ask an IRS collector to “53” your case. If he agrees, the collector recommends to his supervisors that your tax account balance be classified as “currently not collectible.”
The collector then fills in IRS Form 53. If approved, it is entered into the IRS computer. Once you’re declared a 53, you shouldn’t hear from the IRS again for six months or longer. The IRS stops bothering you, but interest (and late payment penalties) still accrue. At the end of your 53 grace period, the computer brings your account back up and the process starts over again.
The IRS doesn’t grant 53 status lightly. A collector may agree to 53 your account over the telephone, but first you may be required to submit one or more of the 433 series forms showing your assets, liabilities, income, and expenses. The IRS may want other documentation, too, such as doctors’ statements showing you are disabled and cannot work.
Being classified as currently not collectible doesn’t solve your IRS problem. It only gives you more time for dealing with it.
The 53 process buys time. It can be helpful if you’re hoping to beat the IRS by filing for bankruptcy or waiting out the ten-year collection statute. Even when your debt is in 53 status, IRS time limits for collecting are running in your favor.
A taxpayer may sue the IRS for up to $1 million if an IRS collector willfully disregards the law. For example, the collector seizes your assets after you filed for bankruptcy, or the IRS seizes your home without a court order. Be aware that taxpayers rarely win lawsuits against the IRS, and not many lawyers are willing to take IRS cases on a contingency basis.
For further information, consult the following resources.
IRS Bills? The Internal Revenue Service can wreak havoc on your life. This book has the information and strategies you need to confront America’s most intimidating agency.View on amazon
Create a business tax strategy that will save you time, energy and money. Getting your tax on track will free time to do what really counts - running a profitable business.View on amazon
Worried about escaping an audit intact? Then you need Surviving an IRS Tax Audit. This book explains what to say, what to do, even what to wear, so that a visit from the auditor doesn't turn into a disaster.View on amazon