Offer in Compromise

    401k and bankruptcy: Will the IRS seize my retirement account after my bankruptcy is over?

    by Michael S. Anderson, P.C. on January 19, 2012

    Scenario

    • You hire a bankruptcy attorney who has explained that the $100,000.00  in your 401k plan is safe from creditors, and therefore safe from everyone inside of a chapter 7 bankruptcy.
    • You also owe the IRS $150,000.00 in back income tax.  The income tax debt meets the criteria to be discharged in the bankruptcy filing.  In other words, when the chapter 7 bankruptcy is over, you won’t owe the IRS the debt. Your legal obligation to pay it will be wiped out along with your credit card and other unsecured debt.
    • Several months prior to the bankruptcy filing,  the IRS recorded a number of “Notices of Federal Tax Lien” documents in the local County Recorder’s office.
    • You file the bankruptcy case.
    • The case goes well, discharge is entered and the case is closed.
    • Six months after the bankruptcy case is closed, you receive a letter from the IRS.  The letter states that the tax debt was discharged, but that the IRS is enforcing it’s tax lien on your retirement account and is taking action to seize the account.
    • You are confused as you believed that the retirement account was safe and that the tax debt was wiped out.   Sleepless nights ensue.
    Explanation
    If you have serious tax debt and/or consumer debt and a retirement plan, this scenario may be important to you.  There are a few things about the law that you need to understand as a result:
    • Most retirement accounts i.e. 401k, IRA, 403B funds are safe or exempt in bankruptcy.  Actually, certain “ERISA” accounts aren’t even part of the bankruptcy estate.   The bankruptcy trustee has no interest in them from the outset.
    • Unlike other creditors, the IRS isn’t subject to exemption rules i.e. social security checks and retirement accounts are theoretically fair game.
    • IRS liens properly recorded, survive a chapter 7 bankruptcy filing even if the underlying tax debt, the tax debt that was the basis for the lien was wiped out.  That tax lien survives and it is worth whatever you were worth on the date of the bankruptcy filing.  If you owned one asset worth $5000.00, like a car, and the discharged tax debt was $100,000.00, the lien is worth $5,000.00.
    • In a way, the IRS is like the lender on a car.  If you file a chapter 7 bankruptcy and you want to quit paying on the car, the chapter 7 bankruptcy will discharge your obligation to do so.  You will not be legally required to make the payment to the car lender.  The car lender however, still has a relationship with the car i.e. a security interest in it and that security interest is worth whatever the car is worth.  When the case is closed, the secured lender can take the car as a result.  It cannot sue you for the balance or deficiency if one exists.
    • The retirement account is like the car.  In our scenario above it is worth however far more than $5000.00.  If it were worth only $5000.00, it is highly likely that the IRS would agree to simply release the tax lien.  The amount of the tax debt was quite high though and more than the value of the retirement account, so the IRS could seize the account based on the lien.
    Solutions
    Some solutions to this problem include:
    • If possible,  file the bankruptcy before the tax lien is recorded.  This can be tricky of course.  The tax debt won’t become dischargeable in the bankruptcy case for a period of time.  (See bankruptcy discharge date requirements). The IRS will try to record that tax lien notice as soon as it can where the debt is relatively large.  There are defenses to the recording of the lien, but their application is fairly narrow if the debt is over $25,000.00
    • Remind the IRS that internal policy requires it to consider collection alternatives before levying or seizing assets.  (Although this may be changing)  Alternatives include IRS installment agreements and IRS offers in compromise.  The fact that you may have been saving money in the 401k plan while ignoring the tax may not bode well for you in this regard.
    • Prove to the IRS that you need the retirement account funds to survive or will need them in the near future.  It may be sensitive to the fact that the proceeds are paying your basic living expenses perhaps for the remainder of your life.
    • Make an offer.  Try to get the IRS to accept a smaller amount than the tax lien is worth in exchange for leaving the account in place.
    If the above scenario is familiar or you think it will be in the near future, the wisest thing to do initially is to speak with an attorney experienced in bankruptcy and tax debt matters as soon as possible.

    Tax Resolution Companies – Are they over-promising solutions?

    by Michael S. Anderson, P.C. on January 12, 2012

    I met with a person recently who has a six figure IRS income tax debt.  Many of my clients do.  As is common, he had been talking to several “Tax Resolution” Companies about his options.  There are hundreds if not thousands to choose from, so finding several isn’t hard to do.

    This person is single, no children and earns a six figure income.  All of his tax returns have been filed.  These facts about him are important because without knowing anything more, they probably mean that he is NOT a good candidate for an IRS Offer In Compromise, i.e. he is not likely a good candidate to reach a settlement with the IRS for less than is owed.

    A quick review of the realities that exist in regards to the offer in compromise program is in order here,  before I get to my point.

    1. Standard Allowances are usually applied

    The IRS will disagree with this person’s amount of living expenses.  It will review his expenses closely in order to calculate how much money he SHOULD have at the end of each month to pay toward his tax debt.  I emphasized the word should on purpose.

    The IRS doesn’t have to pay much attention to what he actually spends each month.  It can rely primarily on some “standard allowances” which have been created to tell it what the “average joe”  lives on each month.  Applying these standards will leave this person with fake or phantom income.  That income will be the basis of the amount the IRS thinks he can afford to pay.  Typically they won’t allow for his payments of credit card debt, retirement investment, vacation, Christmas, birthday, eating out, etc. etc. etc.  If a single person in Maricopa county earns $6500.00 per month after tax withholding, the IRS will probably see an ability to pay a few thousand per month toward the debt.  These standards can be challenged to some degree, but it is not easy to do.

    2.  The Offer in Compromise process isn’t informal

    The taxpayer has to disclose his entire financial life to the IRS.  Bank accounts, work history, paystubs, proof of payment of bills, asset values etc.  This isn’t done based on a chat over the phone.  It is a formal process much like filing a lawsuit, that comes with some rights but mostly responsibilities.  Often, while the taxpayer is in the process of submitting items to the IRS, things change.  Income increases, someone dies and leaves money or property.  The chances that the offer as submitted are accepted are reduced as a result.

    3.  The IRS isn’t interested in settling with most

    On average, the IRS agrees to settle about 20-25% of offers in compromise that are submitted.  When I explain this to people though they still get the impression that this is random.  It isn’t.  The offers that are accepted are those that meet the formal criteria.  What constitutes a good offer varies as well.  One person may have a $100,000.00 tax debt and be able to obtain an agreement to settle for $50,000.00, but have no way to pay it.  Another with the same set of facts may have a rich uncle.  Trying to reach some sort of conclusion about the IRS’ willingness to settle these cases based on their average acceptance rate is almost meaningless as a result.

    4.  Not a quick process

    Most Offers in Compromise take 6-12 months from filing.  Sometimes many more months are spent on the front end getting things right and on the back end appealing a negative result.  If the offer is accepted, the taxpayer either needs to pay the amount now, or spread it out typically over two years adding to the already long time frame.

    5.  Statute of Limitations on collection is extended

    The offer in compromise filing stops the clock.  It extends the timeframe the IRS has to collect the debt from you.  This timeframe is called the “statute of limitations” and it lasts ten years.  If you spend 15 months trying to get the offer in compromise accepted and it doesn’t work,  you will add 15 months to the timeframe.  If there was only a relatively short period of time left on the statute of collection when the offer is filed, filing the offer may have been a big mistake.

    So, the point…(finally).  

    This person had decided to hire a tax resolution company he had heard on the radio before speaking to me.  The company promised to “solve” his problem and requested $10,000.00 + as a flat fee to do so.  What he didn’t understand is what I have laid out above.  He is not going to “solve” the problem with an offer in compromise.  In reality, he will solve the problem with some sort of IRS installment plan in combination with the statute of limitations period or bankruptcy.

    Of course, the tax resolution company isn’t a law firm and has no ethical duty to really explain this…and didn’t. In fact, it probably uses a commissioned salesperson whose main objective is to close the “deal”.

    The company is hoping that it can arrange a payment plan with the IRS, and pocket the $11,000.00 for “solving” the problem.  It is really a play on words.  ”Solving” doesn’t mean reducing via an offer in compromise necessarily. The potential client doesn’t fully get this until it is too late.  He ends up paying  3 times or more than what he should, for the end result…a partial solution.

    Tax resolution companies are not law firms.  They can’t practice in Bankruptcy Court, they have no duty to tell the truth, and for most taxpayers the offer in compromise just doesn’t work.  What these companies are left with are subtle sales pitches that leave the wrong impression.  A very expensive wrong impression.

    If you have serious tax debt, your situation has to be fully reviewed/analyzed, bankruptcy and the statute of limitations must be considered AND a period of planning and adjusting should probably take place as well, before an offer in compromise is filed.  Don’t pay a large fee to someone on the promise of a “solution” until this work is done.

    Tax Debt – Why can’t I pay the original balance and receive a waiver of the penalty and interest?

    by Michael S. Anderson, P.C. on December 1, 2011

    A common  question my clients ask is “why won’t the IRS just accept a check for the original tax amount and waive all the penalty and interest”.

    This question makes alot of sense and in the real world most creditors will consider making a deal that pays the original balance and waives interest.  In the current economic situation many would be happy

    to the original amount back.

    But..this is the IRS’ world we are talking about.  So some things you need to understand:

    Tax, penalties and interest are all the same to the IRS

    The IRS considers the tax, penalty and interest to be all the same once assessed.  It is all principal debt at that moment.

    Settling tax debt with the IRS isn’t “horsetrading”

    The Free Dictionary defines “horsetrading” as “negotiation characterized by hard bargaining and shrewd exchange”

    This type of negotiation works well when discussing a credit card debt, or the price of a car, but at the outset of the discussion with the IRS there is no bargaining.  The process is not informal.

    The formal process is called an “offer in compromise“.  In an offer in compromise, rules are followed and at least in theory if the taxpayer fits into and follows those rules, the IRS has to settle the debt…formally.

    IRS penalty reduction has it’s own set of rules

    If the taxpayer wants to challenge the penalty and try to strip it from the overall debt outside of the offer in compromise process, there is another legal process typically called “penalty abatement”.

    This process is administrative and the IRS can forgive penalties that have already been assessed if the taxpayer meets certain formal criteria as well.

    No horsetrading at the outset here either.

    Bankruptcy must be seriously considered in most cases

    From a financial standpoint and because of the formality that exists in relation to trying to “settle” the debt, bankruptcy is often the best long term solution for those with serious tax debt.  If a taxpayer has serious tax debt, bankruptcy has to be considered.

     

     

    IRS Interest – limited circumstances under which IRS interest can be abated

    by Michael S. Anderson, P.C. on September 12, 2011

    The law allows the IRS to charge interest on tax debt. Even on tax penalties. Of course, if the underlying debt or penalty is wiped out as a result of an offer in compromise, bankruptcy, penalty abatement or other, the interest attached to that debt or penalty goes away with it.

    To get rid of interest all by itself i.e. unattached to an underlying debt or penalty is difficult and limited to just a few circumstances:

    1. If the IRS is incorrect in charging the interest

    This arises when the taxpayer has paid the tax when it was due or just didn’t owed the tax in the first place. If this has occurred, you can:

    a. Write the IRS, explain the situation and ask for abatement of the interest.

    b. If writing doesn’t work, get the taxpayer advocate service involved.

    c. Sue the IRS in U.S. District Court or the Federal Court of claims to recover the interest you already sent in.

    2. The interest is a result of delays of the IRS in performing it’s own “ministerial” acts.

    A very common example is the time delay while the taxpayer waits for the IRS to send the tax bill after a final audit report is agreed upon. The taxpayer is entitled to an interest abatement for all but the first 30 days of delay. (see revenue procedure 87-42; IRS Regulation 301.6404-2T)

    If the bill arrives 120 days later you can ask that 90 days of interest be wiped away.

    There is a “ministerial” act exception. Interest that accrues while you challenge the bill, while you appeal and or go to tax court, or while the IRS is auditing you, cannot be wiped away under this theory unless…you win your case.

    3. The IRS sent you a refund that was incorrect and has asked for it’s money back plus all the interest from the date the check was issued

    You are entitled to abate the interest in this circumstance as long as your own actions didn’t cause the refund.

    4. Any interest that has accrued more than 18 months after the original due date of a tax return or the date the return was filed and the IRS didn’t notify you that the additional tax was due during that period. (IRC Sect 6404)

    5. The interest that accrued on a return you filed late because you were living in a federally declared disaster area when the return was done.

    Of course, if one of the above doesn’t apply, and as indicated in number 1 above, a bankruptcy or offer in compromise that wipes out the underlying debt will also wipe out the interest attached to it.

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    Does the IRS charge interest on the tax I owe? How much? Can I get rid of it?

    by Michael S. Anderson, P.C. on September 3, 2011

    The Government thinks that money you earn is it’s money. This is why politicians call tax cuts…“costs”.

    This is why politicians also think that when you don’t pay your tax bill you are borrowing from the Government. It was their money first to lend to you. Get it?

    As a result of this, the world’s “biggest bank”, charges interest on the unpaid tax. It lends money interest free of course to certain countries AND businesses that have paid or promised sufficient political contributions, but not to you.

    The interest rate it charges is decided upon by congress, it compounds daily and adjusted 4 times per year. It is typically somewhere between 4% and 8% and it is computed on BOTH the underlying tax owed or that you have “borrowed” and on the penalties due.

    Interest is rarely “abated” upon request. It can only be canceled as part of an abatement request if it was erroneously applied or if it was as a result of IRS delay.

    The good news?

    Interest can be reduced via the penalty abatement process, an offer in compromise, bankruptcy and it goes away when the statute of limitations on collection runs out.

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    Offer In Compromise -12 Facts

    by Michael S. Anderson, P.C. on May 17, 2011

    12 Important Facts about the Offer in Compromise Program

    1. Tax Returns

    All tax returns that are required to be filed must be filed. They don’t have to be paid (although some payments toward the account may help). For those self employed, this may mean filing and payment for two quarters in a row that are most recent.

    2. The amount of the settlement isn’t about debt amount

    During the Offer in Compromise process, The IRS looks at income, budget and assets to determine the amount that will be the settlement. The debt could be $100,000.00 or $1,000,000.00, the settlement should be the same.

    3. The IRS can use a budget that isn’t your actual budget in determining settlement amount

    When the IRS looks at income and budget it can subtract from the average income a budget that is considered reasonable and necessary. This number is based on averages that the IRS has arrived at presumably from the otherwise private info we all provide each year. This budget, at least to start, is rarely your actual budget.

    4. The IRS will reduce value of property

    The IRS will reduce the value of assets to “quick sale” value, which is usually a 20% reduction. This means that when calculating your offer in compromise amount most assets will be considered worth 20% less than market value.

    5. You can appeal

    If the IRS determines that the offer in compromise number you propose is no good, you can appeal the decision. The appeals hearing is “informal” and you can’t appeal it further if the offer wasn’t filed in relation to a collection due process appeal request.

    6. Collection Due Process Appeal – Allows you to make offer request and stop collection

    The collection due process appeal request is made after you recieve a final notice of intent levy, lien or garnish. This stops collection activity on the year or years in question and allows you to propose an offer in compromise or some other alternative. It is a smart thing to do because as mentioned above, the appeal hearing can be appealed further to Tax Court.

    7. All Types of Tax Debt can be compromised

    All tax debt be it individual or business can be compromised. This includes debt based on substitute tax returns prepared by the IRS.

    8. Effective Tax Administration

    The IRS doesn’t always have to compromise a tax debt just based on assets, income and budget. It can also compromise the debt if taxpayer has “special circumstances”. These may be possible even if the taxpayer can afford to pay it.

    9. Bankruptcy may play a role

    If you have tax debt that could legally be “wiped” away in a bankruptcy and you are otherwise a candidate for bankruptcy, this may be important in convincing the IRS to settle the tax debt.

    10. The Offer can be submitted anytime

    The offer can be submitted anytime after the tax is assessed unlike in bankruptcy which requires a waiting period for discharge.

    11. Debt can be compromised before assessment

    The tax debt can be compromised even before the tax assessment in an audit situation. Before agreeing to an amount with the IRS auditor, the offer might be used to determine the amount of the accepted offer and then compared to the costs of tax court ltigation for the IRS and the taxpayer.

    12. An Offer can be filed more than once

    An offer in compromise can be filed more than once. Each filing probably makes success more difficult but a poorly done and rejected Offer in compromise can be reworked and resubmitted.

    Also read:

    Some Negatives About the OIC Program

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    Tax Debt – 6 Common Reasons Bankruptcy is Used

    by Michael S. Anderson, P.C. on May 15, 2011

    No matter what you have heard, a bankruptcy filing, motivated by serious income tax debt, is a common occurrence.

    The reason is obvious. There can be significant benefits to filing bankruptcy.

    6 of the most important potential benefits are as follows:

    1. The Automatic Stay

    “Automatic Stay” is the common term used to describe that section of the bankruptcy code that governs what creditors must do or stop doing, once a bankruptcy is filed. It applies in every bankruptcy case. This law requires that almost every creditor in almost every situation, stop collection activity once the case is filed. This includes the IRS.

    If the IRS has proper notice of the bankruptcy, the filer can actually sue the IRS for violation of the Automatic Stay Provision and recover actual damages including court costs and attorney fees, if the automatic stay provision is violated.

    2. Elimination of Tax Debt after Discharge

    The most obvious reason to file the bankruptcy, is the ability to get rid of the debt. As I often say, “believe it or not” certain income tax debts can be wiped away in bankruptcy along with accumulated penalty and interest. Determining “dischargeability” can be more complicated than it seems. Use of experienced legal counsel is a must.

    3. Threat of Bankruptcy in an Offer in Compromise

    A good bankruptcy candidate may be able to use threat of bankruptcy to obtain a better offer in compromise without ever having to file. The key? A good bankruptcy candidate and experienced legal counsel.

    4. Force payment plan

    In a chapter 13 bankruptcy a payment plan can be forced on the IRS, if the IRS won’t agree to a better and more reasonable payment plan outside of bankruptcy

    Whether the plan is approved is not up to the IRS, but decided by bankruptcy law and the bankruptcy judge.

    5. Deal with all other debt at same time

    Most with serious tax debt have other debt problems as well. Credit card debt, medical bill debt, foreclosure issues, business related debt etc. etc.

    A bankruptcy, chapter 7 or 13 depending on which best fits, can deal not only with the tax debt but also with these other problems, via discharge, cramdown, or payment.

    6. Re-determination of Taxes Due

    The bankruptcy code allows the Bankruptcy Court to redetermine the amount of tax owed.
    Bankruptcy can be used to determine the amount of the debt even if you lost the argument in tax court.

    If you have serious tax debt, you must talk to an attorney experienced in the relationship between tax debt and bankruptcy in order to find the best solution to the problem.

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    Serious tax debt in Arizona – Why Offers Often Fail and Why Bankruptcy Often Makes Sense

    by Michael S. Anderson, P.C. on April 6, 2011

    Offer in Compromise Versus Bankruptcy?

    The tax solution providing hope to thousands of Americans is the IRS’ “offer in compromise” program (“oic”). Savvy salespeople have realized that there are lots of Americans with tax debt who don’t sleep well. They offer the offer in compromise as a solution thousands of times every day on tv and radio.

    The promise: Settle your IRS tax debt for far less than what you owe…easilyandoften guaranteed.

    The problem: most taxpayers with serious tax debt aren’t good candidates for the program.

    Via the oic program, the IRS is statutorily empowered to accept less than what they are owed if there is:

    1. a doubt that they are actually owed the money
    2. if there is a doubt about whether the debt that is owed is actually collectible from the taxpayer, or
    3. the taxpayer can afford to pay the debt and taxpayer owes the debt, but there is some other circumstance about the taxpayers life that should be taken into account in settling the debt.

    Most taxpayers pay various “sales” organizations to file an oic based on a doubt as to the taxpayer’s ability to pay.

    So why is an offer in compromise so often a failure?

    1.The formula results in too large of a number – Taxpayers can’t afford

    The IRS is allowed to force each taxpayer who applies to settle their tax debt, to use a standardized budget in determining how much they have to pay.

    In other words, everyone who files has to pretend that they live on the same budget as someone who possibly earns much less then them. This budget can, with the help of an experienced attorney, be planned for, added to, enlarged, but it is difficult to make it match the actual budget of many with serious tax debt.

    The result is that when the taxpayers actual net income is compared to this budget, there appears to be some large excess income left to pay the tax debt with each month.

    The IRS then multiplies this “excess” by a pre-ordained number and then adds that number to the taxpayer’s assets to arrive at a collection potential for the taxpayer.

    If the “excess” number is 500 and the asset value is $5000.00, the IRS will claim that the taxpayer can afford to cough up $29,000.00

    The problem is that the 500 is usually being used in real life to pay the taxpayer’s actual mortgage, credit card bills, or the 20 year old son’s car payment and insurance.

    Items either limited or not allowed in the IRS’s standard budget.

    2.The process can be difficult
    The IRS purposefully makes the process difficult. It initially rejects the vast majority of offers. Many do not have the funds or desire to continue the fight.

    3.Large amount paid upfront makes it more risky
    The taxpayer must typically pay a large percentage of the debt with the offer or start making monthly payments equal to the offered monthly payment amount and loses those funds if the offer is unsuccessful.

    4.If rejected, the debt comes back in full with interest
    When rejected, the taxpayer still owes the entire debt with interest, while the statute of limitations period on the collection of the debt has been stayed.

    5.Failure makes it easier for the IRS to collect
    The taxpayer who has been rejected, has provided every detail about his financial life to the IRS making it easy for them to collect the debt.

    6.Full compliance is often a problem after acceptance
    IF the offer is successful, the taxpayer must file tax returns and pay tax obligations for 5 years, if not, the offer is over, the money paid is lost, and the total original debt with it’s accrued interest, continues to be owed, minus what has been paid.

    7.Offer in Compromise is not a complete solution
    Often, the taxpayer proposing the offer in compromise has medical bills, credit card debt, personal loans, state tax debt etc. all of which must still be dealt with outside of the offer in compromise. The payments on these debts aren’t typically allowed as part of the budget in calculating the reasonable collection potential of the taxpayer. The offer, at it’s best becomes only a partial solution as a result.

    For these reasons and many others, the vast majority of oic’s fail.In a given year, less than 30% of offers submitted are successful.In 2007, it was closer to 25%.

    There is another solution to serious tax debt, that if used properly can be successful…

    Bankruptcy.

    A quick review of bankruptcy in relation to tax debt will help to explain why.

    There are two types of bankruptcy that pertain primarily to consumers. Chapter 7 and chapter 13.

    A chapter 7 bankruptcy is the more commonly filed, and is a liquidation case. In a chapter 7 bankruptcy, the debtor loses all assets not protected by statute and is forgiven his or her dischargeable debt.

    Chapter 13 bankruptcy is a “reorganization” bankruptcy. The debtor attempts to keep his or her assets and paysomeor all of the debt depending on income and budget amounts. The plan length varies between 3 and 5 years depending on a number of factors.

    Tax debts as alluded to above, are classified in either a chapter 7 or chapter 13 as either dischargeable or non dischargeable on the date the bankruptcy petition is filed.

    Non dischargeable tax debts include:
    1. collected and unpaid sales tax (of the trust fund nature)
    2. trust fund recovery penalty (employment tax unpaid by a business assessed against a “responsible party”).
    3. Trust fund tax
    4. Income tax related to a return that was not filed or filed but within 2 years of filing the bankruptcy.
    5. Income tax related to a return that was due including extensions within the last three years
    6. Income tax related to a return for which fraud was involved
    7. Income tax for a tax liability that was assessed by the taxing authority within 240 days prior to the date of the bankruptcy filing.

    Dischargeable tax debt includes:
    1. Those income taxes that meet the following criteria:
    A “return” was filed
    It was filed more than two years ago
    It was due more than three years ago including extensions
    The tax was assessed more than 240 days ago
    There was no civil or criminal fraud nor did the taxpayer willfully evade or defeat the payment of the tax debt.

    In essence, a tax motivated bankruptcy is a bankruptcy case that takes into account filing issues, timing and taxpayer history in a way to take maximum advantage of bankruptcy law in relation to the tax debt.

    Or in other words, what may be a nondischargeable tax debt today may become a dischargeable tax debt tomorrow.

    The other benefits in comparison to an offer in compromise are as follows:

    1. OIC’s factor in the taxpayer’s income while chapter 7 bankruptcies usually don’t. In a chapter 7 if the majority of the taxpayer’s debt is tax debt, then the income is irrelevant as to whether the taxpayer qualifies to file a chapter 7. The bankruptcy means testing shouldn’t apply.

    2. OIC’s factor in future income potential while most bankruptcies don’t. It may not matter in bankruptcy that the taxpayermaybe making more next year. Many offers are rejected on that basis alone.

    3. OICs factor in asset equity. Bankruptcies do not. Equity in bankruptcy has little to do with ability to file or the dischargeability of the debt itself. Certain assets may be liquidated in a chapter 7, most consumer assets are safe.

    4. The largest benefit of bankruptcy over the Offer in Compromise is that a bankruptcy can be crafted to deal with all of the other taxpayers debts at once. State tax, credit card, medical bill, personal loans and other consumer debt.

     

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    IRS Offer In Compromise – 4 Reasons Most Offers Fail

    by Michael S. Anderson, P.C. on April 3, 2011

    Background

    An “offer in compromise” is simply an offer to settle tax debt made by the taxpayer to the IRS that may result in a settlement agreement between the two. (As if you didn’t already know that)

    The real driving force behind the process is that…like most creditors, the IRS is smart enough to know when a “bird in the hand” is worth more than “two in the bush”, i.e. if it really believes that it will get less in the end, it will agree to take what it can now, and call it a day.

    The initial standard used to determine the “bird in the hand” value is whether the amount being offered by the taxpayer to settle the debt once and for all, is greater than or equal to the “reasonable collection potential” of that taxpayer. (RCP)

    So…first question:

    How Does The IRS Determine One’s “RCP”?

    The most common way is as follows:

    The equity value of taxpayer assets PLUS The difference between the taxpayer’s income and budget when multiplied by 48.

    An example: Fanny Fictitious

    Fanny has the following:
    $30,000.00 Equity in home (“Market value” of home – loan amount)
    $5000.00 Equity in car (“Market value” of car – loan amount)
    $10,000.00 “Value” of Retirement Fund
    $45,000.00 Total Equity
    $5,500.00 (gross monthly income)
    $5,300.00 (gross monthly living expenses including proper tax withholding)
    $200.00 (Remainder) X 48
    $9,600.00 Ability to pay from income
    $45,000.00 PLUS $9600.00 = $54600.00
    $54,600.00 = Reasonable Collection Potential

    Fanny’s RCP would be $54,600.00 assuming that she could prove up the case.

    If she owes more than $54,600.00, than in theory, it’s a good settlement, i.e. the IRS is getting…the bird… and Fanny is paying less than she owes.

    Great right? Now a catch.

    The payment would have to be made by sending 20% of it as a lump sum with the filing of the offer proposal and the remainder within a very short period of time following the agreement. (by the way if the offer doesn’t pan out, the IRS keeps the 20%)

    What…? Yes, this type of offer in compromise requires the amount to be paid in full, very quickly following acceptance.

    So what if Fanny doesn’t have access to such a large sum of money?

    She could convince the IRS to try and calculate the RCP another way. She would multiply the remainder number by 60 instead of 48 thereby increasing the RCP but also thereby creating a payment plan of sorts. A payment plan that requires the RCP be paid over what is typically a two year period.

    There are exceptions, but you are getting the idea.

    This RCP thing seems simple enough…

    So, Why Do So Many Offers In Compromise Fail?

    How many? Nationwide you can count on about a 80% failure rate each year.

    A few reasons:

    1. The Relationship Between 48 and Fannie’s Lifestyle

    It’s a bad one. The IRS is able to “impose” a budget on Fanny, at least to start. That budget is typically not the same as Fannie’s actual budget. It is lower. Every dollar that the IRS can remove from the budget is 48 dollars added to the cash offer and at least 60 to a “payment plan” offer.

    Many people that file offers in compromise don’t fully understand this relationship and the IRS’ ability to use budget numbers different than their own.

    Of course, this basic budget can be challenged in different ways, and an experienced practitioner will understand some of the ins and outs related to convincing the IRS to agree to a more reasonable number.

    2. Inability to Pay Offer Amount

    Assume that Fanny owes the IRS 1 million dollars. The above RCP is only $54,600.00. A savings of…$945,400.00.

    Holy smokes. That is really a fantastic settlement. Amazing.

    Fanny doesn’t have $54,600.00 though. She can’t borrow it because no one she knows has that kind of dough. (An uncle in Newark maybe, but she’s afraid to talk to him)

    She switches to the payment plan but the monthly amount needed to pay the settlement over a limited period of time leaves her too little income to pay her actual bills.

    3. Unclear Standards

    The law surrounding what constitutes an acceptable offer in compromise is a bit..fickle. You know, uncertain, flighty, gray etc.

    An example of this is found in a 2008 Tax Court Case,Leslie B. Bennett v. Commissioner.

    Ms. Bennett owed some money to the IRS. She calculated her RCP using the standards mentioned above and submitted the offer.

    Although the IRS admitted that the offer amount she submitted was more than “ten times” the RCP based on it’s own calculations,they rejected the offer.

    Some of the reasoning:

    1. Internal Revenue Manual (IRM) Part 5.8.7.6(5)(Sept. 1, 2005), says that a rejection can be based on a determination that an acceptance of the offer is simply not in the government’s best interests.
    2. In other parts of the IRM the IRS is allowed to reject the offer if the taxpayer had a bad history for filing returns on time and there was some belief that she would continue in that manner.
    3. The doubt as to collectability i.e. the RCP amount above only determines whether the offer should be “considered for acceptance”.

    Quoting from the case. “This language…doesn’t require that the Commissioner accept an offer in compromise whenever the amount exceeds the collection potential. Rather, it only establishes grounds for winning consideration”.

    What this case really stands for is that RCP is really just the beginning. You don’t have the right to appeal the denial of the offer and win just because the numbers make sense. The IRS can deny the offer for a whole host of reasons including quite possibly…just because.

    4. I Just Can’t Hack It

    It takes an organized and dedicated person to put together the information necessary to submit with a compromise offer.

    In the more complicated case, the amount of paperwork kills a few trees. Sometimes, multiple submissions must be made and more trees meet their doom.

    Not only that, but in order to make the RCP work to the taxpayer’s best advantage, some planning i.e. changes must often be made.

    Many bail out during this process. It is just too much work, and the inability to keep up, dooms the case from the start.

    If you have serious tax debt, talk to experienced tax professionals who will explain all of your options. You can call our office at 480 507 5985 and ask for me as well. I will discuss your tax debt and some options for free over the phone.

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    Serious Tax Debt? 12 Options

    by Michael S. Anderson, P.C. on April 2, 2011

    The following is a list of the most common legal ways to deal with large tax debt. Some are obvious, some are difficult and require extensive planning, and some only work best in combination with another option.

    Despite the fact that a review of the list alone won’t solve the problem, it should provide you some additional knowledge about existing options and some hope that there may be a solution.

    Here they are:

    PAY THE DEBT

    If the funds exist to pay the irs debt in full, it often makes sense to do so, paying the debt off at once or in a few payments, stops liens, levies and interest. Borrowing to pay it off at once or in a few payments, stops liens, levies and will often reduce interest.

    However, if the taxpayer is considering the use of retirement funds or home equity to pay the debt off or to borrow against in order to do so, some additional thought may be in order.

    For most, doing so isn’t possible right now and if it were, they probably wouldn’t be visiting this site. Nonetheless, the option does exist.

    For others the means exist to pay the debt in full, but there is a need for legal representation to help “smooth” the path.

    USE THE STATUTE OF LIMITATIONS TO YOUR ADVANTAGE

    Congress decided at some point, that it would make sense to limit the time the IRS has to figure out how to get paid. It does things right once in a while.

    26 U.S.C Section 6502 provides the limit and as a result, the IRS has ten years to get it done.

    This seems like a long time, but you would be surprised at how many of those with serious tax debt are able to use this law to their advantage. In fact, the wise use of the Installment Agreement/Non Collectible Status option combined with the statute is what I often call the “poor man’s” offer in compromise. (see below for more about installment agreements and offers in compromise)

    An example:

    Imagine a tax debt of $100,000.00. Imagine that the IRS has let 7 years pass without attempting to collect the debt, but they are now at the doorstep. The debt has grown to $300,000.00 with penalty and interest over time, but the taxpayer can only afford to pay $100.00 per month toward the balance. If the taxpayer were able to negotiate such a payment, only $3600.00 of the $300,000.00 would be paid before the debt disappeared.

    Filing an offer in compromise, bankruptcy or pursuing some other legal remedy in an attempt to slow down collection, would stop the statute from running. So some serious thought would be required before doing so.

    There are other statutes as well that limit time periods in which the IRS may act:

    1. Assessment: The IRS has only three years to assess a tax from the date a return is filed in most circumstances.
    2. Liens: IRS Liens have the same 10 year statute as debt collection. I.e. if the IRS has not reduced the debt to judgment, the lien is no good once the statute on collection runs out.
    3. Trust Fund Recovery Penalty Assessment: The IRS has three years to assess personal responsibility for corporate payroll withholding amounts from the filing of the applicable return.

    CHALLENGE THE TAX DEBT

    The IRS screwed up. They assessed a debt against you that you know isn’t correct. Typically, this is the result of an audit gone bad or the creation of a tax return by the IRS, because you didn’t file it yourself. They don’t use correct deductions when they do that by the way.

    Audits that go badly can be appealed.If done right, they can be appealed all the way to tax court and beyond. If your audit result is wrong, you have a limited amount of time to bring the appeal, so call someone…now.

    Tax returns filed by the IRS come with appeal rights as well. Most people don’t respond in time and lose them however. Thankfully, the assessment of the tax from the incorrect return can be challenged using the “audit reconsideration” process.

    In english… you can file the correct return and use it to try and replace the incorrect return.

    The ability to do this isn’t guaranteed and doesn’t come with appeal rights. Also, failing to file your own return before the IRS files a return can cause another big problem. Namely, the potential inability to discharge the debt in bankruptcy if necessary.

    There are other things the IRS does to assess tax that can result in an incorrect debt amounts, like the assessment of the trust fund recovery penalty against a “responsible” party.

    Where the business has withheld the employee portion ofpayroll tax, but used the money for advertising and rent payments instead of sending it in, the IRS can add the amount up and stick it as a penalty on the individual person who they consider to have been responsible for the diversion of the money.

    There are defenses to this however, and the assessment of the debt can be challenged as a result.

    Sometimes the tax is correct but it just isn’t fair that the spouse should be stuck with it. The law provides the ability to challenge the debt based on some theories aboutinnocent spouses.

    INSTALLMENT AGREEMENT

    26 U.S.C. Section 6159 allows the taxpayer under various and specific circumstances to pay the debt over time. These types of agreements are commonly call “installment” agreements or plans.

    There are various types of installment agreements including:

    1. A guaranteed 3 year plan if the debt is less than $10,000.00
    2. A “streamlined” plan for debts less than $25,000.00 that is typically paid over 5 years and doesn’t require the submission of financial details.
    3. A one year plan that allows the tax payer to use an actual and “reasonable” budget to determine the plan payment amount for one year to provide opportunity to make changes to budget
    4. A full pay plan that allows the taxpayer to use his or her actual/reasonable budget to determine ability to pay if the debt is paid over 5 years and;
    5. A “partial pay” installment agreement.

    The “partial pay” plan allows the taxpayer to pay only what he or she can “afford” each month even if the amount paid doesn’t pay the debt in full before the statute of limitations runs out on the collection of the debt. Again, a “poor man’s” offer in compromise.

    Installment agreements stop irs levies as well, but they don’t necessarily prevent the recording of the notice of irs tax lien, or stop the assessment of penalties or accrual of interest. They also don’t prevent the IRS from demanding use of assets to pay down the debt.

    OFFER IN COMPROMISE

    26 U.S.C Section 7122 provides the basis for the settlement or one time reduction of the tax debt. In essence you would be making an irs offer to compromise and settle the back tax liability. But…this isn’t “horse-trading”.

    The amount that the law requires the IRS to settle for is based on objective criteria. This “criteria” is called the “reasonable collection potential” or the “RCP”.

    In theory, the RCP is the amount that the IRS could collect from you before the statute of limitations period on collection runs out.

    The vast majority of offers filed with the IRS fail primarily because the RCP calculation is rigged a bit in the IRS’ favor. They are allowed to use as a starting point for calculation purposes a budget that is based on averages they have created.

    For instance, they may have pre-determined that a family of four only needs $1650.00 per month to pay for all housing and utilities expenses. That family may be actually spending $2100.00 per month. If in the end, the IRS is able to use the $1650.00 figure to determine the RCP, than the amount of “extra” income per month by their calculation would be at least $450.00 per month.

    If the statute of limitations period remaining on collections is 8 years than the RCP, just based on this number could be as high as $43,200.00

    Typically, the IRS must use a smaller multiplier than the statute period, but even then, you can see how quickly the RCP can grow.

    Successful Offers in Compromise, require much thought and planning as a result. They shouldn’t be entered into lightly.

    There are two other types of Offers. One is used to dispute the underlying debt typically called an Offer in Compromise based on a doubt as to the liability. The other is made when the taxpayer may be able to afford the tax debt payment but it would be unfair to make him or her do so.

    Some side notes about the Offer Process:

    1. It usually stops irs levy and other seizures.
    2. The taxpayer is on “probation” for 5 years following the acceptance of the Offer. He or she must file all returns timely and pay all the tax due or else the offer is revoked.

    CURRENTLY NON COLLECTIBLE STATUS

    If the IRS is levying or otherwise, and the collection is causing an actual hardship on the taxpayer, the collection activity is supposed to stop. If the taxpayer can convince the IRS of the hardship status, a code can be placed on the account to designate the account as “non-collectible”.

    The main benefit is obvious. There is a secondary benefit that is less obvious.  Specifically,  the statute of limitations period on collections continues to run while the status is in place.

    The downsides of non collectible status are that interest continues to accrue and if the change in circumstance is to the taxpayer’s benefit, i.e. income goes up, the status can be revoked.

    INNOCENT SPOUSE

    If you filed a return jointly with your spouse or ex-spouse, and a large tax debt exists as a result, you need to be at least aware of your potential rights as an “innocent spouse”.

    There are three types of relief:

    1. Innocent Spouse Relief – Where your spouse or former spouse filed to report income correctly or claimed improper credits or deductions.
    2. Separation of Liability – The additional tax that exists as a result of the spouse or ex-spouse’s decision to not report something properly on the return may be allocated to that spouse.
    3. Equitable Relief – If you do not qualify under one of the theories above, the IRS may agree to relieve you of the debt based on “fairness” and equity.

    The basic requirements to file for innocent spouse relief are these:

    1. The taxpayer filed a joint return which has an understatement of tax due to erroneous items.
    2. The taxpayer can establish that at the time he or she signed the return he or she did not know, and had no reason to know that there was an understatement of the tax.
    3. Taking into account all of the facts and circumstances, it would be unfair to hold the taxpayer liable for the understatement of the tax.

    COLLECTION DUE PROCESS

    When a tax debt is “assessed” or entered into the government’s records as a debt, the IRS doesn’t need a Judge’s permission to collect. They can simply start the collection process. However, there are some limits on this ability. The most important is that you are entitled to “due process”. Therefore, the IRS must send you a notice of it’s intent to levy and give you thirty days to appeal it and ask for some alternate arrangement.

    This “appeal” is called a collection due process appeal and using it stops the collection process. Although the statute of limitations on collections stops running while the appeal is pending, the appeal typically provides the taxpayer the time to find a solution to the tax debt.

    An offer in compromise can be made via this process and judicial review attaches to the process as well.

    COLLECTION APPEALS PROCESS (CAP)

    Collection activities can be “appealed” at any time. These types of appeals have different names like “equivalency” hearing, and can in less powerful ways forestall the collection process. They do not come with the right to seek judicial review.

    BANKRUPTCY

    Bankruptcy and it’s relation to tax debt is misunderstood. Many people including attorneys believe that bankruptcy can’t resolve tax debt. Nothing could be further from the truth.

    In fact, unless the IRS is able to prove that a taxpayer attempted to “evade” a tax or filed a false return, the treatment of the tax debt is not up to them. It is governed by the Bankruptcy Code.

    Filing a bankruptcy petition will stop all tax collection activity by the IRS and erase taxes that meet the Bankruptcy Code’s definition of “dischargeability”.

    I have helped many taxpayers rid themselves of tax debt and other debt, through bankruptcy especially where one of the other solutions in this article didn’t make complete sense.

    PAY AND SUE FOR REFUND

    The U.S. District Court and the Court of Federal Claims hear tax cases only after the taxpayer has paid the tax and filed a claim for a refund.

    A taxpayer can file a claim for a refund if he or she believes that the tax paid was incorrect. Once the claim is disallowed by the IRS, the taxpayer can bring the suit.

    The suit must be brought no later than 2 years after the rejection of the claim.

    PENALTY ABATEMENT

    As a taxpayer you have the right to request the cancellation of any IRS penalty. There are more than 140 penalty provisions and they all have a “good faith” exception.

    If you have been penalized for something like a failure to pay the tax on time, but you acted in good faith and there exists some “reasonable” basis for the failure then the penalty can be removed along with interest. This removal often makes it easier for you to deal with the underlying debt.

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