It often starts with a letter from the IRS.
“It might be an LT11, generated by computer, or an LT 1058,” explained Bill Nemeth, immediate past president of the Georgia Society of Enrolled Agents. “They both say they haven’t received your payment for overdue taxes, and intend to seize your property or rights to property. The LT11 is an [Automated Collection Systems] letter, while the LT 1058 has a real person associated with it. Neither should be ignored.”
All too often, of course, the taxpayer does ignore the notice, out of fear or confusion or pure wishful thinking that maybe the IRS will go away. They won’t, of course.
“The Letter 1058 is serious,” according to Nemeth. “It is your final notice of intent to levy for unpaid taxes. If you don’t take action within 30 days, the IRS has the right to levy or seize your assets.”
Smart taxpayers will turn to their tax preparer, but while preparers can often help with more run-of-the-mill audits, when it comes to situations where the taxpayer clearly owes and can’t pay, even highly qualified preparers aren’t always up on how to handle the situation, and may not be aware of all the options available or how to pursue them.
“The possible responses are to pay in full immediately, set up an installment agreement for full pay or partial payments, or ask for ‘currently not collectible’ due to financial hardship,” Nemeth explained. “The noncollectible due to financial hardship is supposed to be reviewed every year, but generally the IRS will not review it if the taxpayers continue to file returns and pay any balance due every year.”
Navigating these complicated waters is one of the key elements of a tax controversy practice, and it starts with mastering the basics.
For instance, the timeline for addressing a tax controversy matter varies significantly depending on the type of matter being addressed and the underlying unique facts surrounding the case, according to Robbin Caruso, a partner and co-manager of the tax controversy practice at Top 100 Firm Prager Metis.
She offered some common factors:
How large the audit or tax liability is in dollars;The taxpayers’ overall ability to pay;The availability of documents and records to substantiate facts;If the matter will require substantial financial disclosure; and,Whether liens or levies will create hardships.
“Another important factor is the procedural status of the taxpayer’s matter when they first contact us for representation,” Caruso continued. “Many matters are more easily resolved when addressed early in the process and prior to requiring the filing of an appeal or petition in the Tax Court or federal court. We can resolve some payment collection matters or first-time penalty abatements relatively quickly, but matters such as a reasonable cause penalty abatement or an OIC can easily take anywhere from six to nine months or significantly longer.”
The windmill’s point of view
Next up is knowing exactly how far the IRS is willing to go, and the qualifications they’re looking for.
“The service looks at two things,” said David Klasing, a tax attorney and CPA who specializes in helping taxpayers in trouble with meeting their federal tax obligations. “The net worth of the person who owes, and then their earning capacity. A person may have a net worth of zero and no earning capacity if they’re in a car wreck that they caused. They’re basically destitute — that’s the type the government might give an OIC to, and not because they ‘like’ that person or that person is represented by someone who is very good at what they do. They grant an OIC because they don’t want to spend their collection resources on a situation they won’t be able to capitalize on. When the government realizes that they’re trying to squeeze blood out of a turnip, that’s when they might be willing to grant an OIC.”
Klasing makes sure to let clients know that the government has the right to force them to live at the poverty level while they’re trying to collect. “Their attitude is that anything you make beyond this belongs to the government,” he explained. “The attitude of the average revenue officer is that anything beyond that level belongs to the government.”
(Read more: “Giving OICs a bad name.”)
Moreover, the government doesn’t have to accept an installment agreement, he warned: “The best terms you will get is a seven-year spread, because the government has a 10-year period to collect and they don’t want to lose anything. With California, the best spread you can get is three years. Both California and the IRS don’t want the negative press that they took your primary home, so in most cases they will not be trying to push a taxpayer out of their home. It’s not written down; it’s just my experience over 30 years.”
“If you own a vacation home, they can try to get you to sell it,” he continued. “The same goes for a stamp collection or anything else of value. But if you own your primary residence, they can try to get you to refinance and get a loan against it to pay off your debt.”
“People like to get creative when they owe money to the government,” Klasing cautioned. “They should understand that there are two flavors of income tax evasion: The first is cheating on your return to understate your tax liability, while the second is evasion of payment. If someone says to put your assets in someone else’s account, or move them into an account that the government doesn’t know about, lying on your collection information statement or to a revenue officer, these actions are crimes. So be cautious whose advice you listen to and act upon. You can go to jail for these crimes.”
The one they see on TV
Clients frequently labor under the delusion that the IRS is perfectly happy to negotiate tax debt down to almost nothing, and is willing to accept pennies on the dollar — a delusion fed by disreputable players.
“A lot of people advertise that the offer in compromise is a route that works, and it is something that a professional can help the taxpayer with,” said David King, chief executive officer of one of the largest tax resolution services, Optima Tax Relief. “But if you’re honestly trying to help a taxpayer resolve their liabilities through the offer in compromise route, you would be honest and upfront and tell them that it can be a fairly rigorous review process by the IRS. Inform them that ‘You’re going to submit a statement about your income, your assets, the expenses, and it’s reviewed by the IRS and signed under penalty of perjury.’ The IRS doesn’t just eyeball this. Per statutes and regulations, they cannoli compromise if the compromise is based on either collectability or a doubt as to liability. And in this case, they’re solely looking at collectability. The goal of the IRS is to maximize its recovery, taking into account your income, your expenses, your assets, and the tax liability at issue.”
Some tax resolution services are good at being honest and upfront with taxpayers, according to Curt Smith, a senior manager on the tax team at Top 10 Firm Baker Tilly, and formerly a trial attorney with the Department of Justice Tax Division: “But there are some places that give the perception that you can just give the IRS an offer and they’re going to take it. And they give examples of five people who settled for a fraction of what they owed.”
But the reality is very different, according to Smith: “Some people find that the little money they do have of disposable income goes to pay these large upfront fees, instead of going to legitimately try and settle their debt.”
OICs can be either lump sum, or periodic payments, and they’re governed by slightly different rules, he explained. A lump sum payment can be between one and five payments, and requires a payment of 20% of the lump sum payment with the offer. “To be even considered for an offer in compromise, you must be current on your tax filings. If you have unfiled returns, the IRS won’t even process your offer,” he added. “If you’re in bankruptcy, the IRS lets bankruptcy law handle the kind of relief you get. Likewise, if your case has been referred to the Department of Justice, the IRS can’t compromise your liability because they have transferred that authority to the DOJ.”
Smith recommends using the pre-qualifier tool available on the IRS website to educate prospective applicants regarding their eligibility. “It will tell you if you even qualify for an OIC, but you need to make sure you’re using the official IRS website,” he cautioned.
The IRS won’t consider or acknowledge frivolous offers, Smith cautioned. The process of submitting an offer is more detailed and exhaustive than some taxpayers are led to believe.
But there are other options, he said: “The IRS has an installment agreement procedure that allows you to pay your liability over time, depending on the amount at issue and the time that you need. If you really don’t have anything that’s collectible right away, the IRS can put you in a status that they call ‘CNC — currently not collectible.’ It doesn’t take care of your liability, but it keeps them away from your door.”
A lot of these liabilities have significant penalties, Smith noted. “In lieu of an offer in compromise, they can get penalties abated if they can show reasonable cause,” he said. “If it’s the first time they’ve had a penalty, a lot of penalties can be abated under first-time abatement. That can significantly affect the amount that a person is paying. And the IRS can compromise a liability if there’s a doubt as to liability. This wouldn’t fall under offer in compromise; this would be, ‘The IRS audited me and I don’t actually owe the tax.’ For this situation, there are several options. You can request an audit consideration, you can go to IRS Appeals or you can contest the tax in either Tax Court or Federal District Court … . There’s technically a third prong of when the IRS can compromise a liability. It’s called ‘promoting effective tax administration,’ but it’s given in exceptional circumstances to promote public policy, and it’s a rather difficult prong to fall under.”
(Read more: “IRS leveraging AI for audits amid layoffs.”)
It’s important to remember that the government sets most of the ground rules, down to which programs and types of cases they plan to focus on. With reduced staffing, the IRS will have to prioritize where their efforts will be expended, according to Caruso: “We anticipate that there may be stricter enforcement in some cases as they work to close matters as efficiently as possible. For instance, they may not provide additional holds on collection activity or may provide shorter timeframes to address audit matters. Also, the IRS is constantly working to utilize technology to increase efficiency, expanding online tools and functionality, and self-help capability to offset the impacts from reduced staffing and budget limitations.”
Tax pros need to make sure their clients understand that the government really is in charge. “If you owe money to the federal government, the federal government writes their own laws about how and when they get paid, and how they can collect that money,” said Baker Tilly’s Smith. “And it’s no surprise that the federal government is generally very good to themselves.”
“The public should know that tax attorneys and CPAs are not the ones with the power in this situation; the government is,” said attorney and CPA Klasing. “You’re not dealing with Walmart; you’re dealing with the government about a tax debt that people voluntarily reported on their return. Offers in compromise are not routinely accepted. It’s very rare that the government comes in and says, ‘You’re a nice guy, I like you.'”
