Designating how payments are made to the IRS – When is it important? Hint…Statute of Limitations and Bankruptcy

Designating how payments are made to the IRS

If tax debt is owed to the IRS for more than one previous year or quarter, it is wise to tell the IRS how to apply the payment you are making to your tax bill. This is often called “designating” the payment.

If you don’t tell them where to apply the payment, they will apply it however they want.

Even more important, the payment will usually be applied to the oldest year or quarter that you owe money on.

This is important for two reasons:

a. The IRS is limited to 10 years to collect all the tax, penalty and interest.

If they apply to the oldest tax, penalty and interest, and that debt is close to the 10 year mark, you may be just throwing the money away. In essence, it would be much better to let the 10 year limit kill the old debt and your payment kill the newer debt, letting the two “work toward” each other until the debt is wiped about. This way you will likely pay much less in tax debt overall.

An Example:

Lets assume you owe for tax years 00 in the amount of $20,000.00 and 09 in the amount of $20,000.00. 00 was assessed on Sept 30, 2001. On Sept. 15, 2011, you want to make a payment to reduce your tax debt.

You send a check to the IRS for $20,000.00. The IRS applies the amount to the 00 tax year of course.

What if you had designated the payment to the 09 tax year. The IRS would have applied it to 09 zeroing that out and just two weeks later the statute of limitations would have zeroed out the 00 debt saving you $20,000.00

b. Bankruptcy

If you are considering bankruptcy and have old income tax debt, some of it may be old enough to be wiped out in the bankruptcy. You wouldn’t want to have payments applied to debts that are going to be wiped away anyway.

Making the designation

When you make an income tax payment with a check or money order it is a good idea  to write your social security number, tax period and the year you are pyaing in the lower left hand corner. If it is a business related tax than use the taxpayer id number instead of course.

Include with the check or money order a letter that states clearly what period and or year you want the payment to be applied to and reference the check or money order.

Send the letter and payment by certified mail and keep copies of all the documents. If the IRS ignores your request you can then later send proof of your request and payments to get it corrected.

Only the payments that are made voluntarily can be designated like this. If the IRS levies a wage or bank account or withholds the tax refund – no designation can be made.

IRS Levy – What it is and how you can stop it procedurally

taxes-man-being-shakenIRS Levy

Many taxpayers who contact my office are worried about the IRS lien. The recorded IRS lien is really just a big notice to the world that the IRS is owed money. The lien doesn’t cause an asset to be taken by the IRS on it’s own.

The law does provide the IRS the ability to sieze property and at least initially, this issue should be the one taxpayers are most concerned about.

Usually, an IRS levy is made against a paycheck or a bank account. They can also be issued and used to sieze property like cars, business equipment, and other items. In theory and with a few exceptions laid out below, the IRS can take just about anything you own including your home. It may be irrelevant as well how that property is held, i.e whether it is a community or jointly held asset – it may still be up for grabs.

A levy on a paycheck reduces the net income dramatically. Most income is taken by a wage levy. A few weeks of this and a typical taxpayer can lose their home, fall behind on other debts and end up in bankruptcy.

A levy on a bank account is a bit more “hit and miss” for the IRS. If there is a substantial sum of money in the account on the date the bank recieves the levy – that amount is frozen and held for 21 days before being distributed.

This gives the taxpayer a chance to work something out. Often, the bank account has a lower amount of funds or none at all and the bank levy has to be issued again in hopes that the taxpayer will use that account again and leave money in it.

Paychecks are a more reliable source of revenue for the IRS.

Thankfully, congress has placed a few procedural roadblocks in front of the levy power of the IRS. See IRC Section 6330.

In essence, before the IRS can take property or money, it must give the taxpayer a written notice of intent to levy with a letter that explains the taxpayer’s appeal rights.  This notice is called a “final notice of intent to levy”.

This letter has to be personally delivered, left at the home, or sent by certified mail to the last known address. If not, then subsequent levy is invalid and can be undone.

In almost every circumstance this notice has to be given more than 30 days before any siezure can be made.

The taxpayer has that 30 days to file an appeal.   This Appeal is called a “collection due process appeal”  The appeal filing stops the process and provides a path for the taxpayer to challenge the levy activity in front of an appeals officer and than all the way to the U.S. Tax Court if necessary.

Penalty abatement request – how to and what you can do if it is rejected

Penalty Abatement – Reducing IRS Penalty

The key point in relation to penalty abatement requests and the IRS is that if you don’t ask you won’t get.  The following is a short review of the “asking” process.

If an IRS penalty is sent to you via the IRS mailed notice system, it is wise to start the penalty abatement process by mail.

When you get the tax bill in the mail that shows the penalties, write back to the address on the notice and ask for an abatement of the penalty. You can write a letter or use the IRS form 843. Attach to the letter or to the form the bill you recieved. You should also attach any copies of documents that back up your claims. If you do not provide proof, the request will likely fall on very deaf ears.

Paying the underlying part of the tax with the abatement letter and attached bill is also wise, if at all possible. Be certain to write on the check that the payment is for the tax debt only…not the penalty. If you pay the tax the interest on the underlying tax stops.

Keep copies of any letters or documents sent to the IRS and ideally send everything by certified mail. The IRS will often “lose” your letter and it’s attached documentation. Send the whole packet again if you get another bill before you receive confirmation of the receipt of your penalty abatement request.

If the penalty is added as the result of an audit, ask the auditor or a manager to abate them before you agree to the auditors report. If they won’t, than ask the appeals office to drop them.

If the IRS rejects the request, they should send a notice. (They often do matter how great the story) When you get the rejection notice you can do one of the following:

File an Appeal.

This is simply a letter sent to the IRS. This appeal will be handled all by mail or phone and there won’t be any in person meeting.

Request a transfer of your file.

Ask that your filed be transferred to the local office. When that happens, ask for a meeting with the revenue officer – convince the officer of your plight.

Pay and claim a refund.

You can always pay the penalty, file a form 843 or claim for refund and request for abatement. You can either attach a letter to explain or try to explain it on the form. Remember certified mail.

If your Form 843 claim is rejected, you can sue in a U.S. District Court or the court of claims. Penalties are not usually large enough to justify the cost of this.

Offer in Compromise

An Offer in Compromise is a formal procedure that can be used to negotiate or eliminate any tax, including penalties. There are some rules and these need to be carefully reviewed before filing.


In many circumstances, IRS penalties are dischargable in chapter 7 and chapter 13 bankruptcy. Get some good advice of course before heading down this path.

IRS penalty abatement and “reasonable cause” – what does that mean?

“Reasonable Cause”…could there be a more vague phrase? It makes sense than that this is the standard used by the IRS to determine whether a penalty should be forgiven or “abated”. It leaves some wiggle room.

Ridding yourself of an IRS penalty is all about this vague “reasonable cause” standard and the taxpayer has to be able to show “reasonable cause” in order to have the penalty wiped away.

So what is it? In essence it is any excuse that the IRS will accept.

The Internal Revenue Manual states: Any sound reason advanced by a taxpayer as the cause for delay in filing a return, making deposits…or paying tax when due will be carefully analyzed…

Some examples of reasonable cause that the IRS strongly considers:

  • The death or serious illness of the taxpayer or the immediate family.
  • Unavoidable absence of the taxpayer
  • Taxpayer unable to determine amount of the deposit of tax due for reasons beyond the taxpayer’s control
  • Destruction by fire or other casualty of the taxpayer’s place of business or records.
  • Lack of funds when a taxpayer can demonstrate the lack of funds occurred despite the exercise of ordinary business care and prudence

Other explanations are considered and almost any excuse can be provided. Many taxpayers simply argue that he or she exercised ordinary business care and prudence but was nevertheless unable to comply within the prescribed time.

It is always wise to submit the penalty abatement request based on one of the items listed above if possible. There are many other excuses that have been provided to the IRS that have succeeded like:

  • If the tax had been paid on time the taxpayer would have suffered an undue hardship. This means that, had you paid the tax on time, you would not have been able to put food on the table or been taken care of medically. Proof is important here.
  • Reliance on a tax professional that led you down the wrong path. If your’e accountant caused the problem by giving you bad advice or filing the wrong form for instance.
  • Employer submitted the wrong 1099 or w-2 form.
  • The IRS wouldn’t help you figure it out when you asked.

IRS Audit – How long do I have to worry about it?

As a general rule, your tax return can’t be audited after three years from it’s original filing date. If you filed before the due date of April 15, the 3 years starts to run from April 15 of the year it was due.

There are some exceptions of course:

1. If you understate your income by 25% or more on the return the audit deadline is extended to 6 years. It is not a good idea to under report income though and hang on for six years.

2. If you file a fraudulent return, there is no time limit on the audit. Tax fraud is any conduct that was meant to deceive the IRS. The mistake has to be purposeful. The common belief is that the IRS doesn’t audit returns after three years even if there is some fraud indication if the amount of the debt is not above certain levels. I don’t suggest clients rely on these claims.

3. The time limit only starts to run when the taxpayer files the tax return. Unfiled tax returns are always open to being audited. If six years have gone by and no return has been filed by you or the IRS than you may be safe because the IRS typically is not interested in personal returns unfiled for more than six years both from a civil and a criminal standpoint.

Audit notices are typically sent out about 12 to 18 months after the filing of the tax return, and the IRM or internal revenue manual instructs that audits are to be completed within 28 months after the return has been filed. This 28 month rule of course is just an internal deadline.

Time limits are a good thing for the taxpayer. The IRS has it’s own set of problems that cause delays and the older the return is the more anxious they are to put it away.

Important IRC Sections for those with Tax Debt, Late Tax Returns and an Audit Phobia

There are three sections of the Internal Revenue Code that are of special significance for taxpayers who are late in filing the tax return, late in paying the tax return or who are concerned about an audit.

Section 6511 of the IRC

The 3 year refund statute. This statute allows the IRS to keep your tax refund if you file a tax return more than 3 years after it’s due date. A moneymaker for them I am sure.

Section 6502 of the IRC

The 10 year debt collection statute. This statute says that after 10 years have passed (with some exceptions) from the date the debt was “assessed” the debt is no longer valid. i.e. gone…poof…etc. This also means that the underlying lien is gone as well.

Section 6501 of the IRC

This is the 3 year audit statute. The correct tax return enjoys the protection of this statute. i.e. the IRS cannot audit the return if more than 3 years have passed since filing.

To read more about these statutes theInternal Revenue Manual 25.6.1, is a good place to start.

Independent Contractor designation and the problems it can cause for your small business

Footba12Employment tax law requires the employer to withhold the employees’ fica tax, unemployment tax and income tax from the paycheck, throw it in a pot, mix some more money into the pot equal to the employee’s fica tax and shoot the whole thing over to the IRS each quarter.

This process requires a lot of work and a lot of money, especially when the business has a lot of employees.

So, the employer has a natural incentive or really a “dis-incentive” to do this work and pay this tax. The investment comes with no reward, reduces profits and reduces the number of employees the business can hire and products it can sell.

This incentive leads the small business to find ways in which it can avoid the burden by treating workers as independent contractors instead of as employees.  By doing this, the business avoids the tax reporting, the bookkeeping and the withholding tax and save’s itself a lot of money and headache.

The problem?

If the business treats workers as Independent Contractors when it should be treating them as employees, the headache can be much larger.

If the IRS gets involved and determines that an independent contractor should have been treated as an employee, the business can get stuck with penalties/costs up to 35% of the payments made to the wrongly classified worker…plus interest.

This misclassification is a priority problem in the IRS’ world. It targets businesses it suspects, like building contractors, doctors, sales organizations and beauty shops among others.  Often the IRS will make the determination without fully analyzing the status of the business’ work situation and leave it to the owner to prove that the workers deserve the independent contractor determination.

So – how to follow the IRS’s rules and classify/treat the worker appropriately in order to avoid a mess is the question and the topic of future posts.

Small business and IRS audits – What they are looking for and how to prevent problems

IRS Audit and Your Small Business

Face it…The Government is at odds with small businesses in America.  Money “belongs” to the government first right?…and small businesses move around alot of it. This makes the government uncomfortable, just like you would be if you asked your small child to watch your stash of bills.

Thus, the sour relationship.

The IRS doesn’t really care whether our tax policy is right or wrong, it just “enforces” the policy. It has indicated that most “cheating” is done by small business and as a result it watches small business owners more closely than wage earners.

This is partially evidenced by the number of IRS employees (more than 45,000) dedicated solely to squeezing the small businessperson where it hurts the most

As a result, small businesses are at great risk for an audit. We know though what the IRS is typically looking for when they conduct a small business audit, and the most common items are:

  • Personal living expenses written off as business expenses
  • Auto expenses written off for travel that was not business related
  • Large business entertainment expense
  • Failure to report all business related income
  • Whether workers are being classified as independent contractors when they should be classified as employees
  • Whether the business is making all of it’s payroll tax deposits.

I always make four suggestions to small business owners as a result:

1. Use a reputable payroll company – this helps prevent the use of payroll withholding to keep the business afloat during down times. The most dangerous problem is when the small business owes a lot of payroll tax. It won’t go away. It will stay with the business until it dies and a large portion of it will stay with the responsible owner etc. until it’s paid.

2. Use someone else to do the tax return – i.e. don’t do it yourself – a third party cpa or tax lawyer can look at the big picture and make sure the return makes sense, spot missed deductions, and apply tax law to the facts of your situation. This reduces the chances that income is missed and increases the odds that all legal deductions are taken. It is worth the dough in the end.

3. Plan ahead – talk to a cpa or tax attorney about what you can do in coming year(s) to take advantage of the tax code. Talk to them especially when you plan on taking on employees and paying them as independent contractors, or leasing a private jet.

4. Treat the business as a separate entity – set the business up properly, keep a separate set of books, use separate checking accounts, don’t use business accounts to pay for movie tickets and trips to the zoo.

What are the most common IRS penalties and how do I get rid of them?

suspiciousIRS Penalties are a fact of life unfortunately.  They are a revenue “stream” for the IRS and not one that it will give up easily.

When the IRS sends you a bill from the negative results of an audit, it will add a penalty or two to the bill. Interest is also conveniently attached to the underlying new debt and the penalty as well.

These penalties were originally designed to be a punishment. A punishment meant to deter bad conduct. They are now a dependable source of income for our ever expanding government. Many tax experts consider the billions a year assessed as penalties to just be a tax and not a real deterrent.

Let’s look at some of these penalties just to give you an idea what you are facing.

Failure to Pay Penalty

The IRS gets to tack on ¼% to 1% each month of the amount you didn’t pay on time, ½% to start and drops to ¼% once you arrange a payment plan. If you fail to pay and a notice of intent to levy is issued – the penalty can be raised to 1%. It is imposed monthly.

Failure to File Timely Penalty

If you filed the return late – the penalty is 5% per month on the balance due up to 25% of the total debt. This penalty tops out if 5 months and 1 day after the return was originally due you still have filed the tax return. If you file but no debt is owed – there is no penalty. Some non income tax/personal returns have other rates.

Accuracy Penalty

The IRS gets to stick an additional 20% penalty to the tax bill if the IRS auditor decides that you understated your tax liability. This is very common.

Fraud Penalty

If the IRS decides that you omitted income on purpose i.e with fraudulent intent it can add a fraud penalty. This is a big one – 75% of the underreported amount.

Also if it decides that you fraudulently failed to file tax returns, it can penalize you 15% for every month you didn’t file for five months. This one is relatively rare.

The good news – if there is some to be found….

The IRS can remove a penalty if the taxpayer can prove that the failure to comply was due to some “reasonable cause”.

You can make the reasonable cause argument before the penalty is imposed or after it is imposed. If accepted, the penalty be removed or never added in the first place.

Penalties can be reduced in an offer in compromise, discharged in a bankruptcy or eliminated via the statute of limitations period as well.