IRS Late Tax Returns

Tax Advice – Does your Dentist know the answer?

by Michael S. Anderson, P.C. on January 18, 2012

Earlier this month the First Circuit Court of Appeals upheld the conviction of a couple who based their actions on some bad advice from their dentist. (See United States V. Allen) Apparantly, the dentist convinced the couple that tax return filing and tax payment weren’t legally required.

So in 1998, they began to claim exemptions from withholding for federal income taxes and their employer stopped withholding income tax from their paychecks. They then classified themselves as independent contractors and as a result the employer stopped withholding FICA i.e. social security and medicare. In 2000, they stopped filing tax returns. They also closed all bank accounts, had checks written to them made payable to cash or directly to their creditors and transferred title on the home into a trust.

In 2009, the Government charged them with one count of conspiracy to commit fraud on the United States, one count of attempted tax evasion, and four counts of willful failure to file income taxes.

At trial, the primary defense was a good faith reliance on the prior advice they received from this dentist. There is a basis to argue that a taxpayer lacks the “willfulness” necessary for a tax evasion conviction, if he or she honestly (not necessarily reasonably) believed, based on a misreading of the tax law, that no tax is owed, [See Cheek v. United states, 498 U.S. 192 (1991)] The Jury didn’t buy it though. The pair were convicted and each ended up recieving three years in prison.

To some, the moral of this story is that you should file your tax returns, disclose your income, and pay the tax.

For others, the outtake from this case, is to be extra careful when picking one of the many tax advice dispensing dentists in your area.

image credit: popular-pics.com

Debt forgiven by creditor? Three options exist to avoid the tax

by Michael S. Anderson, P.C. on January 17, 2012

When a creditor cancels or “forgives” a debt, it is deciding not to collect that debt. It does this for various reasons, none of which are for the purpose of helping you.

When the debt is forgiven following a settlement negotiation, a short sale, or a foreclosure, the creditor must report the amount of the cancelled debt to the IRS on a form 1099-c.

Under Section 108 of the Internal Revenue Code, the IRS than treats that cancelled amount as income.

If, for example, you earn $75,000.00 per year and a home sold at short sale for $100,000.00 less than the lender was owed, the IRS will treat you as having earned $175,000.00 in income.

UNLESS:

1. The debt was discharged in bankruptcy

If the obligation on the debt was included in and than discharged in a bankruptcy proceeding, it isn’t attributable to you as income. If you received a bankruptcy discharge on the obligation, and a 1099c document from the lender, you will need to file a form 982 with the tax return. This form tells the IRS how the forgiven debt is being treated and why it is not being included in the income disclosure on the return.

2. If the cancelled debt occurred while you were insolvent

If you were “insolvent” you can reduce the amount of the cancelled debt from your income. See U.S.C. Section 108(a)(1)(B). Unlike bankruptcy, a determination of your asset value for insolvency purposes includes all of your assets, including retirement funds like IRA and 401k funds. In Bankruptcy, these assets are generally out of reach.

3. If you qualify under the Mortgage Forgiveness Debt Relief Act of 2007

President Bush signed this act into law and it is in place through the end of this year 2012. In essence it protects those who have cancelled debt related to a principal residence. It doesn’t apply to second mortgages used to buy a boat or pay off debt, nor does it apply to second homes.

Losing a home, whether as a result of forced sale, short sale or foreclosure is traumatic. I speak with many people who have made the experience more traumatic than necessary by ignoring the consequences of the 1099c. If a debt is going to be forgiven and it is relatively large, you will need to determine whether an insolvency or the 2007 act will apply to reduce or eliminate taxation on the amount. If not, bankruptcy as an option should be reviewed before the debt is forgiven if possible.

McCoy V. Mississipi – The end of late filed tax returns? Probably not

by Michael S. Anderson, P.C. on January 13, 2012

About a week ago on January 4, the 5th Circuit Court of appeals in the case “McCoy v. Mississippi State Tax Commission” ruled that a debtor wasn’t entitled to a discharge of state taxes where the tax return was filed late even though it was filed by the taxpayer. In essence, they ruled that a late filed state tax return filed by the taxpayer/debtor is not a “return” for purposes of satisfying the “two year rule” in bankruptcy.

Specifically, the State argued that the debt wasn’t discharged because the return was filed late. The Appeals Court agreed and added that unless a late filed return is filed under a “safe-harbor” provision of the bankruptcy code, a late filed state income tax return is not a return for discharge purposes under Section 523(a) of the bankruptcy code.

This case has raised the interest of many who deal with tax debts and bankruptcy, because to some…it stands for the proposition that a tax return filed one day late i.e. one day after it was legally required to be filed, can never be discharged in a bankruptcy unless it was filed with the aid of the State taxing Agency i.e. IRS.

This line of reasoning has been attempted to some degree before, and in response, the IRS issued at least one notice ( irs-cc-2010-016-late-filed-tax-return) indicating that “form 1040 is not disqualified as a “return” under section 523(a) solely because it was filed late.” The IRS doesn’t agree that a late filed return should be considered a non return.

So…for now, and at least in the 9th Circuit, the late filed return still qualifies as a return for purposes of discharge in bankruptcy if filed by the taxpayer more than two years before the filing of the bankruptcy case and before the IRS assesses a debt. I don’t think this will change in the future, but just in case…file your tax return on time.

Late Tax Returns and IRS Debt? Yes…the IRS can do bad things as a result

by Michael S. Anderson, P.C. on January 11, 2012

Everyone who has either missed the filing of tax returns or owes the IRS significant tax debt wonders, at least once or twice, what it is the IRS can actually do to them…?

Unfortunately, it can do a number of things…mostly bad. Well…all bad really.

I am providing this list of the most common actions I see that the IRS takes against individual Americans.

Substitute Tax Return

Internal Revenue Code Section 6020(b) (1) states:

“If any person fails to make any return required by an internal revenue law or regulation made thereunder at the time prescribed therefor, or makes, willfully or otherwise, a false or fraudulent return, the Secretary, shall make such return from his own knowledge and from such information as he can obtain through testimony or otherwise”

This means that the IRS can prepare a return based on information it has at it’s disposal or that it can find otherwise. It doesn’t have to report deductions, expenses etc. So the return is done as a single person, with a standard deduction and it’s creation usually results in a debt that is overstated, sometimes by tens of thousands of dollars.

It than uses this return to do some of the other bad things mentioned below.

The good news…if the return is wrong it can usually be “challenged” and fixed. We have saved clients literally millions of dollars in tax debt by simply doing the correct returns and “challenging” the IRS return during an audit reconsideration process.

Levy

The IRS has the authority to take wages, federal payments, state tax refunds, bank account funds, and monies owed to independent contractors.

They don’t need a court order, all they need is the “assessment of the tax debt” and some time to provide written warnings or final notices of intent to levy, that go unheeded.

If wages or federal payments are levied, the levy won’t stop until of course it is released, you pay the debt or the statute of limitations on collection ends.

If the IRS levies your bank account, your bank must hold funds up to the amount that is owed for 21 days. This is done to give the bank a chance to make sure you own the account. After the 21 day period is up, the bank must send money with any accrued interest to the IRS.

Lien

A recorded Notice of Federal Tax Lien provides the IRS a legal claim to your property as security for payment of the debt. Before this notice can be filed though it must “assess” the debt, (see above), send a notice and demand for payment and you must refuse to pay or neglect to pay within 10 days of that notice. This process creates the lien and the notice of lien makes other creditors legally aware that the IRS is first in line.

The lien attaches to property even if is acquired after the lien is noticed out.

Releasing a lien can be very difficult.

Sell Property

Yes the IRS can sell your property. Recently, it has become more aggressive about seizing retirement accounts and homes as well.

The process as it is related to seized property under IRC sections 6335 and 6336, is as follows:

The IRS will post a public notice of sale in a local newspaper and deliver a copy to you or send it certified.

After placing it, the IRS has to wait ten days before holding the sale, unless the items are perishable.

Before the sale, a minimum bid price is created. This is usually 80% of the forced sale value of the property, after liens are taken into account. This value can be appealed and sometimes needs to be as the more money that can be brought from the sale the less debt the taxpayer will have in the end.

Trust Fund Recovery Penalty

Where a business has held employment taxes from employee checks and hasn’t sent the funds in to the IRS, the IRS can assess a penalty against the “responsible parties” called a “trust fund recovery penalty“. That penalty consists primarily of the employees portion of the tax withheld and not the matching portion. This means that individuals become liable for the businesses debt. It is a difficult penalty to deal with as it isn’t dischargeable in bankruptcy and the IRS will often assess it against everyone involved and let the chips fall “where the may”.

If I can’t pay the amount of tax shown on my tax return, should I file the tax return?

by Michael S. Anderson, P.C. on January 9, 2012

Choosing to leave a tax return unfiled because you can’t afford to pay the debt associated with it, is a mistake. For some, just a small one. For others…a big one.

There are a few important reasons why this is true. The most common that I see are as follows:

1. Failure to file penalty

Not only can the IRS assess a civil penalty for the failure to pay the tax debt but it can also assess one for a failure to file. This penalty is calculated based on the time from the deadline to file your tax return (including extensions) to the date you actually filed it. It is 5% for each month the return is late, up to a total of 25%. This percentage is based on the amount of the tax due as it is shown on the tax return. So..if the amount you owe is quite high, the penalty will be as well. Filing it on time avoids the penalty entirely.

2. Criminal Failure to File

Failing to file a tax return on time is a crime. However, it is the IRS’ internal policy not to recommend prosecution for failure to file if the return is voluntarily filed or arrangements are made to file before the taxpayer is notified of a criminal investigation. The vast majority of people with late tax returns are not prosecuted but this is probably true because the eventually file and do so before the IRS begins the criminal investigation.

3. Substitute Returns

The IRS will commonly do a tax return for a non filer. When it does this, it doesn’t do the return correctly. No credit for deductions and exemptions etc. These returns almost always overstate the debt. They are always used as a basis for the filing of the notice of tax lien and to start the collection process. They can be fixed but it is often much more difficult to fix them years after the fact. There are circumstances where an old substitute shouldn’t be replaced by a correct return. It is wise to get advice before every corrected return is filed.

4. Lose ability to bankrupt debt

If a substitute tax return is assessed – the debt associated with that tax year whether based on that return or the taxpayer’s later filed correct return is likely never going to be considered dischargeable in a bankruptcy. This is often a very bad result, as bankruptcy can be the best way for many to remove the debt and get a fresh start.

5. Lost Refunds

If you are owed a tax refund and you wait more than three years from the date the return is due to file the return, you will lose the refund. This applies to the earned income tax credit as well. I have seen taxpayers lose tens of thousands of dollars as a result.

Used an extension before filing tax return? This may negatively impact the discharge in bankruptcy

by Michael S. Anderson, P.C. on December 28, 2011

Several rules exist that govern whether an income tax debt is dischargeable in a bankruptcy case. They are all important, but the first one typically mentioned is often given the least amount of thought. That is the “three year rule”.

The bankruptcy code, specifically section 523, disallows the discharge of income tax based on a tax return that was due to be filed less than 3 years before the filing of the bk case.

If, for example, the case was filed on Oct 14, 2011, and the tax debt was from the year 2007, the 2007 tax return should have been filed or was due to be filed April 15, 2008. This would satisfy the 3 year rule.

But…what is often missed is when the return was actually due to be filed.

As stated above, the 2007 tax return would have been due to be filed on April 15th 2008. This would be more than three years prior to the filing date of the bankruptcy and the debt would meet the first requirement in obtaining a discharge of the debt.

BUT…what if the taxpayer filed an extension to file the tax return on April 14th, 2008. The due date for that return would have been moved to October 15, of that same year. Given the above filing date of the bankruptcy of October 14, 2011, the bankruptcy would have been filed a day too soon to meet the 3 year rule and the debt wouldn’t be discharged in the bankruptcy.

This extended time period adds an equal amount of time to the calculation of the three year rule for purposes of discharging the income tax debt. Taxpayers with serious tax debt and their counselors need to be aware of this glitch in the law. I have been contacted often by many filers after the fact, who didn’t understand why their tax debt wasn’t wiped away. Often, it is because they filed three years after the April 15th due date and not three years after the extension date.

IRS Substitute Returns: Overstated tax debt that can be solved

by Michael S. Anderson, P.C. on December 27, 2011

The IRS substitute tax return is based on the reported gross income…only. It doesn’t take into account:

mortgage interest
children (dependency exemptions)
business expenses
basis amounts – sale of property and stock
charitable contributions
marriage situation
depreciation

In essence, it doesn’t take anything into account that would reduce the tax on the gross reported income. Therefore, the amount is almost always substantially overstated. The IRS knows it is substantially overstated and it is hoping that the threat of such a return will cause the taxpayer to supply the correct return. Unfortunately, many taxpayers don’t file on time to beat the ssessment and feel they are stuck with the incorrect assessment amount.

Fortunately, these returns can be “challenged” via the audit reconsideration process. The taxpayer can create a correct return and submit it as a challenge to the substitute return. As a general rule the IRS will replace the incorrect substitute tax return with the more correct taxpayer created return.

I have prepared many actual returns after the substitute return has been assessed, and have often been able to get rid of many thousands of dollars for clients. I recently finalized a return for a client and reduced his debt related to one tax year from $100,000.00 to less than $5000.00. In many cases the reduction results in a refund to the client if the return is filed within 3 years of it’s due date.

In most cases, it is best to get the return filed before they do. Doing so preserves the ability to use bankruptcy to discharge the debt later. Where they have beaten you to the punch, there may be a way to correct it in any event. If there isn’t… there may be a way to reduce or eliminate the debt.

You should also read:

Reasons why you should file your return now

When the IRS audits, adjusts or files a substitute tax return, pay close attention to deadlines

by Michael S. Anderson, P.C. on November 30, 2011

A great number of Americans owe the IRS at any given time. Some estimates are as many as 10-15% of all taxpayers owe…right now. The most common reason I see a consumer owing tax, is the most obvious one; the taxpayer just didn’t withhold enough or pay enough during the year or at the time the return was filed. There are other reasons though that cause the tax bill to be a surprise to many like:

The IRS audits the return and the taxpayer ends up signing the audit report and agreeing to the amount
The IRS audits the return, the taxpayer appeals the audit assessment and loses the appeal but doesn’t file tax court petition. The tax bill then becomes a final bill.
The IRS audits the return, the taxpayer doesn’t agree but also doesn’t appeal or file a tax court petition.
The IRS audits the return, the taxpayer appeals, files a tax court petition and still loses and therefore owes.
The taxpayer files what he believes is a correct return but the IRS later adjusts the return as a result of missing income.
The IRS filed a tax return for the taxpayer called a substitute return, the taxpayer doesn’t appeal timely, and sent the taxpayer the bill.

The problem with every one of these scenarios is that at the end… the tax debt is set in stone. I.E. challenging the amount internally becomes very difficult if not impossible. Also, once the debt is assessed and a notice period passes, the IRS doesn’t need court approval to take a paycheck or bank account. It can seize assets, record a notice of tax lien that will destroy a credit rating, and tack on penalties and interest to the debt.

The point of this post is to show you how tax debt is created, so that you can take to heart the following advice if any of the above happens to you:

Don’t allow deadlines to pass. The failure to respond timely and properly can result in a debt that may not actually be correct. I see this constantly and am dismayed about how often it could have been avoided.

Late IRS Tax Returns – We are being watched by the IRS

by Michael S. Anderson, P.C. on November 29, 2011

Timothy J. Patton and his wife Dawn of Big Sandy Texas were sentenced on September 30, 2011, to 40 months and 36 months in prison, respectively. They were also ordered to pay $571,734 in restitution to the Internal Revenue Service. The Pattons were found guilty in July, of “conspiracy to attempt to evade federal income tax” and five counts of “attempting to evade federal income tax”.

Apparently, the Pattons stopped filing federal income tax returns in the year 2000 amongst other things. These other things included lying in order to avoid having taxes withheld from paychecks.

The point in letting you know about Mr. and Mrs. Patton is to remind you that the system is set up to watch us. If you have been working, and that income is being reported to the IRS as is required, the IRS knows the amount, when it was paid, and whether you have disclosed it via a tax return filing. If you haven’t filed properly or at all, the system is churning and spitting out notices and reminders to let you know they are onto you.

Eventually, they will do the work for you, via a substitute return, and/or charge you with a crime. It is just the way it is. There is no escape. You have to join the collective, gather enough friends to vote in a new tax system or go into hiding.

The good news is…it usually takes quite a bit of evading and non filing for the system to charge you with a crime. Lots of years unfiled, high income, prominent or interesting person? The odds and speed will increase.

If you have unfiled returns and want to avoid future entanglements with the IRS, I suggest that you talk to an attorney about your tax return situation. There are other reasons to get the returns filed as well. Read more here.

Unfiled Tax Returns – Two problems IRC Section 6020(b) can cause

by Michael S. Anderson, P.C. on November 28, 2011

What can the IRS do if you don’t file a tax return?

IRC Section 6020(b) provides the IRS the authority to create the tax return for you.

Specifically:

(b) Execution of return by secretary

(1) Authority of Secretary to execute return

If any person fails to make any return required by any internal revenue law or regulation made thereunder at the time prescribed therefor, or makes, willfully or otherwise, a false or fraudulent return, the Secretary shall make such return from his own knowledge and from such information as he can obtain through testimony or otherwise.

The primary problem with this code section is that it provides the IRS the authority to create the return for you from information it has on hand. In most cases this means that it will use the income reported and that is all. No deductions are used in creating the returns other than the standard deduction for the individual filer. No mortgage interest, no basis amounts, no business expenses, no children, no charitable contributions, nothing, nada.

This usually results in tax returns that grossly overestimate the amount of the tax due. The assessment of this overestimated tax is than used to levy wages and bank accounts.

The secondary problem…if the tax debt is assessed prior to the date the taxpayer files his or her own correct returns, any debt from the return, whether the correct amount or not, is likely never dischargeable in bankruptcy. That was a long “run on” sentence that really stood for the idea that the taxpayer needs to file their own returns before the IRS does. This must be done where bankruptcy may end up being the best solution.

The good news is that in many cases the incorrect substitute return can be “challenged” via the audit reconsideration process with the correct tax return.

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