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

IRS Audit?  Pay close attention to deadlines, they mean something

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

Late IRS Tax Returns

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 Internal3409012-i-think-i-m-being-watched-0 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.

Arizona Bankruptcy Filing? Will you lose your home?

Arizona Bankruptcy Filing?  Will you lose your home?

The equity in most residential homes i.e. the home you live in, is safe in a chapter 7 bankruptcy up to $150,000.00 if Arizona exemptions can be used.  Even if the equity is greater than the exemption amount, there will be costs associated with liquidating the home.  The chapter 7 trustee will take those costs into account before attempting to take the home.

In the current economic climate, I see very few homes with more than the exemption amount in equity.

The more common issue is that the chapter 7 bankruptcy doesn’t relieve the property of liability for a voluntary liens, like a deed of trust or for a tax lien.  The lender has the right to foreclose if the payment isn’t made.  (In a chapter 13 bankruptcy, a wholly unsecured 2nd mortgage may be removed from the residence).  If the equity amount is safe as a result of the exemption and the payment is made to the bank on time each month, everyone is happy.

If the value of the equity is greater than the exemption amount, a chapter 13 bankruptcy would allow you to pay the value of that non exempt portion of the home to your creditors, thereby paying them what they would have received had you filed a chapter 7 bankruptcy case and given the non exempt portion up.

So…if there is equity in your residence, first determine how much and than determine whether the bankruptcy exemptions that are available to you equal or exceed the equity in the home.  Again, if the equity is exempt and you pay the mortgage, the home is safe.  If the exemption is insufficient, consider a chapter 13 case.

If the home is upside down substantially, you should speak to your attorney about the opposite problem…whether you should keep the home at all.

Arizona Bankruptcy Disclosure – Will the Bankruptcy Trustee pay a visit to my home?

Arizona Bankruptcy Disclosure

A bankruptcy filing requires a large amount of disclosure.  The bankruptcy code requires that you tell the Arizona bankruptcy court about your current assets, debts, income and budget.  It also requires that you tell the Court about assets you may have had in the past that you sold or gave away.  Assets that you may have in the future like an inheritance or a personal injury settlement must also be disclosed.

When I explain the need for full disclosure and start to ask about items in the home as small as furniture and silverware, the common response is…will they actually come to my home and search it to find out if I disclosed everything?

The answer is… not in most cases, a visit is very rare.

Visits to the home may occur if the bankruptcy trustee believes that you have hidden something or that you have substantially undervalued what you own.  The system assumes that you are telling the truth.    But…don’t let this lull you into a sense of security and a decision to be sloppy about disclosure.

The penalties related to failure to disclose can be severe.  They include the loss of the discharge, loss of assets and even jail in extreme cases.

I am often surprised by the desire of those in debt to attempt a purposeful and partial disclosure to the court in order to try and protect some asset worth a fraction of the overall debt being discharged in the bankruptcy.  Doing so is dishonest and illegal, and is just not worth the risk in any event.

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

Unfiled Tax Returns

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.


(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.

Arizona Bankruptcy Exemptions – Can you keep any assets if you file for bankruptcy

Arizona Bankruptcy Exemptions

The Bankruptcy Code attempts to strike a balance between the debtor’s interests and those of the creditors.   It is a difficult thing to do of course and what is considered “balanced” can change with the political winds.  One thing that the code has always attempted to do despite politics, is to leave the bankruptcy debtor some assets after the case is over.   Most in the “know” feel that this has been done to prevent the debtor from becoming destitute and potentially a burden on the Government’s welfare systems.

The law surrounding what assets are safe or “exempt” from attachment in a bankruptcy case can be complex.  There are exceptions and hidden traps that may be difficult to find and apply.  Generally though, each state is allowed to determine what property is safe and what property isn’t.    The state of Arizona property exemptions are applied to most Arizona bankruptcy filings and the basic and most recent list can be found at the U.S. Bankruptcy Court’s website here.

If the bankruptcy filer qualifies to use the Arizona bankruptcy exemptions than the following major items are typically safe:

– $150,000.00 equity in principal residence (may be limited)

– $4000.00 equity in household furnishings per adult filer

– 6 months food, fuel, provisions

– $500.00 in clothing

– $1000.00 in engagement/wedding ring value

– Funds in ERISA qualified retirement plans (with some limitations)

There are other items that are safe from creditors and therefore safe in a bankruptcy filing in Arizona as well, but the above are probably the most common.

There are a number of issues that crop up in relation to whether individual exemptions apply to assets including the fact that none of the exemptions protect the asset from back child support or spousal maintenance, but one of the most difficult issues can be whether or not the Arizona bankruptcy exemptions apply at all to the Arizona bankruptcy filer.

The rule is as follows:

You can only use exemptions for the state that you lived in for at least 730 days (2 years) before the date you will be filing the bankruptcy case.  If you didn’t live in one state for that previous 2 year period than you have to use the state’s exemptions where you lived the majority of the 180 day period preceding the 2 year period.  If that renders you ineligible to use any that state’s exemptions, (some states limit use of their exemptions to current residents), than you may be able to use the federal bankruptcy exemptions.  Arizona filers i.e. those that qualify to use Arizona exemptions can’t choose the federal exemptions under any circumstance.  See A.R.S. Sect. 33-1133.

Once you have determined the correct exemptions to use, you can also determine with some certainty which assets aren’t exempt.  If the asset is not exempt you have to assume that you will lose it if you file a chapter 7 bankruptcy or that you will have to pay it’s value to your creditors if you file a chapter 13 bankruptcy,  Of course, in the chapter 7 bankruptcy, the chapter 7 trustee may not be interested in the asset because it isn’t worth very much,  but if the trustee is interested….

A common question potential bankruptcy filers have once they realize that an asset isn’t going to be protected in a bankruptcy filing is “can they give the asset away” prior to filing.  The answer to that is the topic of another blog entry, but the answer is yes.   Assets can be given away prior to bankruptcy.  However… if an asset is transferred for less than market value within a certain period of time prior to filing the bankruptcy,  a number of other issues will arise…all negative for the filer and/or the transferee.

In any event, if you have assets and you think you may need a bankruptcy to deal with debts, you need to speak with experienced counsel to obtain a fuller understanding of your rights and duties in a bankruptcy filing as they pertain to bankruptcy exemptions.

Fail to File Tax Returns? Is the IRS ever barred from bringing criminal charges?

Fail to File Tax Returns?

The tax code limits the time the IRS has to chase late tax return filers on a criminal basis.

It must bring a criminal charge against the non filer for failure to file within 6 years of the date the return was originally due.

So, if the return was due April 15 of 2003,  the IRS cannot prosecute for the failure to file that return after April 15 of 2009.

This criminal prosecution deadline is important in relation to civil penalty assessments for failure to file returns.

There is no deadline for the IRS to impose these civil penalties in addition to any tax owed.  So while you can’t go to jail for not filing the 7 year old return, you will always be required to file the return if you had an obligation to do so.  In theory, the government could assess the tax, penalty and interest forever.


The IRS’ internal policy is that old returns – beyond six years should generally (not always) be ignored.

Read the Internal Revenue Manual 0021 and IRS policy statement P-5-133 for more.