Tax Debt left unattended will result in IRS collection activity…levies, liens and property seizures.
IRS collection activity just doesn’t stop on it’s own. It will happen after the tax debt has been:
a. Assessed (entered into the books as a debt)
b. You have been sent a notice of the debt and demand for payment and you don’t pay. AND:
c. You received a “final notice of the IRS intent to levy and a right to a hearing” at least 30 days before the levy actually occurs and to your last known address.
But even if you have a tax debt and are concerned about losing most of your paycheck, there are a number of situations in which the IRS collection activity can’t or won’t occur:
1. INSTALLMENT AGREEMENT IN EFFECT
If you have negotiated a formal payment plan (or non collectible status) with the IRS and you have been making timely payments, the IRS cannot collect.
2. 30 DAYS AFTER TERMINATION OF INSTALLMENT AGREEMENT
If the Installment Agreement is terminated for any reason, the IRS cannot collect for a 30 day period after it issues you it’s termination notice.
3. DURING APPEAL FILED WITHIN 30 DAYS OF INSTALLMENT AGREEMENT TERMINATION
If the Installment Agreement is terminated, and the IRS has provided you a 30 day notice AND you file a proper appeal within that 30 day period, the IRS can’t collect until the appeal is heard.
4. OFFER IN COMPROMISE IS PENDING
The IRS won’t collect while an properly filed Offer in Compromise is being considered.
5. DURING APPEAL OF REJECTED OFFER IN COMPROMISE
You have the right to appeal the rejected Offer in Compromise internally with the IRS. The IRS won’t collect during that period and until the hearing is complete.
6. DEBT ASSESSED BUT FINAL NOTICE OF INTENT TO LEVY HASN’T BEEN ISSUED
The IRS can’t collect until 30 days after it sends a “Final Notice of Intent to Levy” to your last known address.
7. DURING COLLECTION DUE PROCESS APPEAL FILED AS A RESULT OF RECEIVING THE FINAL NOTICE OF INTENT TO LEVY
The “Final Notice of Intent to Levy” provides the right to file an appeal. That appeal is called a “Collection Due Process Appeal”. If filed properly and you can prove the IRS received it, the IRS cannot collect until the hearing has been completed.
8. DURING A BANKRUPTCY PROCEEDING
Section 362 of the Bankruptcy Code creates an “automatic stay” that stops all creditors…yes even the IRS from collection activity. (Bankruptcy is helpful in other ways as well. It can even eliminate certain tax debt)
9. AFTER THE STATUTORY DEADLINE ON COLLECTION HAS RUN OUT
The IRS has a certain amount of time to collect a debt. 10 years to be precise, from the date the debt is assessed. Once that happens, the debt doesn’t exist. (Calculating the 10 year period isn’t always as easy as it seems)
10. NOT ENOUGH EQUITY IN AN ASSET
When the IRS is trying to grab an asset it must make sure that the asset has value above what is owed the bank on it. i.e. there must be “sufficient net proceeds” from the sale to apply some money to the debt. If you vacation home is worth $100,000.00 and you owe the bank $120,000.00, there is not equity and therefore no IRS collection.
11. IRS CONSIDERING THE SIEZURE OF YOUR PERSONAL RESIDENCE
The IRS won’t just slap locks on the door of your home. It must first file a case in the US District Court asking for formal approval. This is a relatively rare procedure.
12. IRS CAN’T SIEZE CERTAIN PERSONAL ASSETS
The IRS is barred from taking household goods and furniture worth up to $7900.00. It also can’t take child support, unemployment checks or clothing.
13. BUSINESS ASSETS OF AN INDIVIDUAL
The IRS won’t take your business assets if you have other assets that will pay the debt. Even if you don’t and it tries to take your business assets it must obtain approval from an IRS Area Director.
14. INNOCENT SPOUSE CLAIM
The IRS will stop collection when an Innocent Spouse Claim is properly filed and appealed.
15. DEBT IS INCORRECT
If you can provide some proof to the IRS Collection personnel that the debt is probably incorrect, it is supposed to slow down the collections process until the debt issue can be resolved (IRS Policy Statement 5-16)
16. IRS SUMMONS
If the IRS has issued a Summons, collection activity can’t occur on the date you appear to meet with the collection personnel.
The IRS will suspend collection activity if you can prove that the collection result will create a real hardship i.e. power will be turned off, kicked out of apartment, inability to eat etc. This suspension is only temporary if you can’t than provide additional required documentation within a certain time-frame.
Bankruptcy is a process that takes place in Federal Court. The Bankruptcy Code governs the process and it is designed to provide debt and other relief to consumers and small businesses. Most consumers and small business people file a bankruptcy as a “liquidation” case called a Chapter 7, and some consumers and small business people file a “Reorganization” bankruptcy or Chapter 13. Very few Consumers or Small Business People file a Chapter 11 Bankruptcy, which is typically used for Corporate Reorganization of Debt.
In a Chapter 7 Bankruptcy you are asking the Court to wipe away as many debts as can be wiped out according to Bankruptcy Code. In a Chapter 13 Bankruptcy you are asking the Court to reorganize your financial life, pay some debts, wipe away others, primarily based on what you can afford and what types of debt you have.When you file a bankruptcy a Court Order automatically goes into affect. This is called the Automatic Stay and it stops most creditors from collecting during the case.
Certain types of debt survive a chapter 7 bankruptcy like child support, spousal maintenance, certain tax debt, most student loan debt and debts incurred fraudulently.
2. HOW DO I KNOW WHICH CHAPTER, CHAPTER 7 OR CHAPTER 13 I SHOULD FILE?
When you file a chapter 7 bankruptcy you are asking the Bankruptcy Court to sever your obligation to pay most of your debt. In exchange for that “discharge” of debt you have to give the Bankruptcy Trustee your assets or at least those that aren’t protected by various asset exemption laws in Arizona. The Trustee will take those non-exempt assets and divide them amongst your creditors.
A Chapter 13 Bankruptcy is not a liquidation case like a chapter 7 case. You don’t have to give up any assets. You do have to pay your creditors on a monthly basis a certain amount of money. The amount of money you pay your creditors depends on several factors. The most important are
a. Your income levy in the past and in the future.
b. Your budget
c. The amount of priority debt i.e. debt the bankruptcy code considers so important that it can’t be “discharged” and it must be paid in a chapter 13 in full.
d. The amount of secured debts you have like car loans
e. The value of your non-exempt assets: Again, those assets that aren’t protected by the Arizona Exemption Statutes.
With a good breakdown of the above information we can determine how large your plan payment will be in a chapter 13 case, whether that amount will protect your non exempt assets, and how much of your non priority debt will be wiped away after the case is over.
If you qualify to file a chapter 7 bankruptcy there are a number of reasons why you may choose to file a chapter 13 bankruptcy anyway: Some of the more common are:
a. You have assets that are not exempt that would be lost in a chapter 7 filing and that you consider important enough to keep that you are willing to pay their value to your creditors in a chapter 13 case.
b. You are about to lose your home to foreclosure and have no other way to bring it current. A chapter 13 case will allow you to spread the amount you are behind over 3-5 years and stop the foreclosure.
c. You have a car that is worth much less than you owe on it and/or that is about to be repossessed. The chapter 13 will stop the repossession and allow you to pay the market value of the car over 3-5 years at a reduced interest rate (in most cases) if you purchased the car more than 2.5 years ago.
d. You have non-support related debt obligations as a result of a divorce decree. These obligations are dischargeable in a chapter 7 but are in a chapter 13 Bankruptcy.
e. You feel the need to pay something back to your creditors and have a steady income.
3. SO I CAN JUST CHOOSE WHICH TYPE OF BANKRUPTCY TO FILE?
If you qualify to file both a chapter 7 Bankruptcy and a chapter 13 Bankruptcy than you can choose which one better suits your needs.
There are a number of ways a person doesn’t “qualify” to file a chapter 7 Bankruptcy or a chapter 13 Bankruptcy, but it is important to understand that even if you qualify for either, the choice you make could be a difficult one. An experienced Arizona Bankruptcy Attorney can help to make sure all of the issues are considered before making such an important decision.
4. WHEN AM I INELIGIBLE TO FILE A CHAPTER 7 OR A CHAPTER 13 BANKRUPTCY?
The most common situations that prevent a person from qualifying to file a chapter 7 Bankruptcy are:
a. Failed Means Test – Bankruptcy Law requires that each filer is “means tested”. In order to pass the test your disposable income after subtracting certain expenses and debt payments must result in less than a specific amount payable to your creditors over 5 years. This test can be complex in some cases and planning is often involved. If you fail it, you can’t file a chapter 7 bankruptcy UNLESS the majority of your debt is business or tax related.
b. Filed a Previous Bankruptcy – If you filed a chapter 7 bankruptcy within the last 8 years and received a Discharge you can’t file another. If you filed a Chapter 13 within the last 6 years and received a Discharge you can’t file a Chapter 7 Bankruptcy.
c. Dismissal – If your Bankruptcy case was dismissed within the last 180 days in certain circumstances.
d. Fraud – You defrauded your Creditors
The most common situations that prevent a person from qualifying to file a Chapter 13 Bankruptcy are:
a. Filed a Previous Bankruptcy – If you filed a chapter 7 Bankruptcy and received a discharge within the last 4 years you are ineligible to file a chapter 13 Bankruptcy and receive a discharge.
b. Too Much Debt – Chapter 13 bankruptcy is limited to those who have less than $1,184,200.00 in secured debt and unsecured debt of $394,725.00.
c. Business – Business Entities can’t file a chapter 13 Bankruptcy. (Self employed individuals can)
d. Disposable Income – You must have income that is high enough to pay your basic living expenses and a payment to the Bankruptcy Trustee that will pay car loans, mortgage arrears, priority debt, fees, value of non-exempt assets, and an amount to unsecured creditors required by the means test.
e. Haven’t Filed Tax Returns – You must file at least the last 4 years and continue to file during the case.
5. WHAT CAN BANKRUPTCY DO FOR ME?
Bankruptcy can do a number of things for you if you are having serious debt problems. The most common are:
a. Eliminate your obligation to pay most of your debt.
b. Eliminate the obligation to pay tax on the eliminated debt as you may have to if it were forgiven outside of bankruptcy
c. Stop a foreclosure on a home and allow you to pay the arrears over time
d. Stop the repossession of your car and even force the return of it in certain circumstances.
e. Stop wage garnishment, debt collection calls.
f. Restore or prevent termination of utility service.
g. Allow you to challenge creditor claims
h. Allow you to pay less per month on your debt obligation than you may have had to pay the IRS directly.
6. BANKRUPTCY CAN DISCHARGE DEBT, SAVE MY HOME FROM FORECLOSURE, PROTECT CERTAIN ASSETS AND SOME OTHER GREAT THINGS, BUT, WHAT CAN’T IT DO
a. It can’t eliminate certain debt obligations
Certain debt obligations aren’t discharged in Bankruptcy. The most common are: Child Support/Spousal Maintenance, Property Settlement Debt related to divorce (chapter 7 only), Certain taxes, Most student loan debt, debt you forget to list (there are exceptions in a chapter 7 bankruptcy), debts related to drunk driving or criminal activity and fraudulently incurred debt
b. It can’t prevent a creditor whose debt is secured with property from taking the property. Bankruptcy can eliminate the obligation to pay the debt, but it doesn’t eliminate most liens. So if you don’t continue to pay for your car, you won’t be obligated to pay for it but the bank can take it.
c. It can’t protect co-signers. When a relative or friend has co-signed a loan, and you discharge the loan obligation in your bankruptcy, the co-signer may still be on the hook. (This may not be true in Arizona re: your spouse)
d. Discharge debts that you incur after Bankruptcy
7. CAN BANKRUPTCY ELIMINATE MY TAX OBLIGATION?
The most common type of tax debt obligation eliminated in bankruptcy is income tax. There are some basic requirements for this type of debt obligation to be eliminated in Bankruptcy.
a. The Tax Return must have been due more than three years before you file the bankruptcy.
b. The Tax Return must have been filed by you more than two years before you file the bankruptcy
c. The Tax Debt must have been assessed by the IRS more than 240 day before you file the bankruptcy case
d. You cannot have filed a fraudulent tax return or otherwise willfully tried to evade paying tax.
We have helped hundreds of clients discharge millions of dollars in income tax debt using bankruptcy and the rules although simple on their face can get confusing and an experienced tax and bankruptcy attorney is often necessary to sort them out.
There are other benefits that bankruptcy can provide in relation to tax debt as well like:
a. A chapter 7 bankruptcy will discharge the obligation on most income tax penalties and interest on the penalty older than 3 years
b. A chapter 13 bankruptcy will allow you to treat most income tax penalty and interest on the penalty as dischargeable debt no matter how old the tax debt is
c. The non trust fund portion of employment tax if owed by the individual business owner is dischargeable in bankruptcy if it meets the date requirements.
d. Arizona Sales Tax (Transaction Privilege Tax) is dischargeable in bankruptcy if it meets the date requirements, as it is not a trust fund tax.
8. WILL BANKRUPTCY ALLOW ME TO GET RID OF MY SECOND MORTGAGE?
In Arizona, a Bankruptcy can be used to “get rid” of your obligation on the second mortgage if:
a. The home is worth less than the 1st mortgage is owed making the second mortgage fully unsecured
b. You file a chapter 13 Bankruptcy and follow the local rules in filing certain documents and following certain procedures
c. You complete the chapter 13 Bankruptcy and obtain a discharge.
9. CAN I FILE THE BANKRUPTCY WITHOUT MY SPOUSE?
In Arizona you may be entitled to what is called a “community discharge” of your debt. This means that even if your spouse doesn’t file with you he or she may protect community assets and income from creditors as long as you are married.
10. HOW WILL BANKRUPTCY AFFECT MY CREDIT?
The affect on your credit score as a result of bankruptcy is difficult to determine. Generally, if you have bad credit now and bankruptcy will wipe out the obligation on a number of debts listed on your credit report, your credit should improve. Bankruptcy should be considered a last resort and if the decision between filing and not filing is being made based solely on the effect the bankruptcy will have on the credit report, you may not be a good bankruptcy candidate.
In Arizona, a person or married couple is allowed to protect the first $150,000.00 equity in their personal residence from creditors. This rule applies in bankruptcy as well.For example, if you own a home, you live in it, and it is worth $200,000.00 and your only mortgage is $50,000.00, you have $150,000.00 in equity. That equity is safe.
What if you don’t make your mortgage payment? That’s a different story.
2. TAXES CAN’T BE DISCHARGED IN BANKRUPTCY
Income tax debt is dischargeable in bankruptcy if it meets certain criteria. It is the most common type of tax debt dealt with in bankruptcy. Certain other tax debts are as well like:
a. The non-trust fund portion of the self employed payroll tax. If you own a small business and run it as a sole proprietor using your social security number and you have employees… you must withhold their income taxes, their portion of social security and medicare taxes, and you must match a certain portion of that payroll tax and send it all in. (6.2% social security tax and 1.45% medicare tax) If you don’t, you will owe the entire amount. The employee portion is trust fund i.e. it is never dischargeable in bankruptcy, but the employer portion may be dischargeable in bankruptcy if:
– More than 3 years between the date the 941 return was due and the date the bankruptcy is filed
– More than two years have elapsed between the date the returns were filed and the bankruptcy filing and;
– No willful evasion of the obligation to pay the tax occurred.
b. Arizona Transaction Privilege Tax: The Arizona Transaction Privilege Tax is a sales tax but it isn’t collected from the customer. It is tax on the privilege of doing business paid based on a percentage of sales. It is not trust fund. If it meets criteria similar to the criteria mentioned above under Non Trust Portion of Payroll Tax, it may also be discharged in Bankruptcy.
c. Tax Penalty: The IRS hits you with all kinds of penalties related to income tax. The most common are failure to file a tax return on time and failure to pay the debt. These two penalties really add up and with interest can actually double the debt over time. In a chapter 7 bankruptcy these two common penalties are dischargeable if they meet the three basic date rules.
– 3 years between due date of return and filing date of bankruptcy
– 2 years between actual filing date and filing date of bankruptcy
– 240 days between assessment date and bankruptcy filing date
What if the underlying debt didn’t meet one of these rules? The debt and the penalty would survive the bankruptcy. In a chapter 13 bankruptcy, the penalty and the interest on the penalty is treated as non priority dischargeable debt no matter it’s age.
3. YOU GET TO CHOOSE WHICH CREDITORS TO “INCLUDE”
This is a very common misconception and a dangerous one. The failure to list a creditor in the bankruptcy schedules is a serious matter. One purpose of the bankruptcy code is to treat all similarly situated creditors alike. When you leave one out and pay it, the others are getting shortchanged. When you file bankruptcy make sure and tell the attorney every debt you have.
4. AN AGREEMENT THAT SAYS THE DEBT IS NON DISCHARGEABLE MAKES THE DEBT NON DISCHARGEABLE
For the most part these types of clauses in contracts are not enforceable and are just a tactic used by creditors to scare them away from bankruptcy.
The bankruptcy filing severs obligations with most creditors. It severs the obligation that was the original result of the contract you signed that contained the non-discharge language.
5. YOU CAN LOSE YOUR JOB IF YOU FILE FOR BANKRUPTCY
There is a law for most everything and there is a law for this as well. That law says that if you can prove that the employer fired you because you filed for bankruptcy, the employee can sue the employer. However, if you are looking for a job, that new potential employer may be able to use the bankruptcy filing as a factor in deciding whether to hire you.
6. YOU HAVE TO BE REALLY BROKE TO FILE FOR BANKRUPTCY
The bankruptcy code doesn’t have a “really, really broke” provision. It does allow you to protect certain assets so that you have a place to live, a chair to sit on, a car to drive and some retirement money. It does this so that you don’t file for bankruptcy and than become a “ward” of the state. In Arizona the most common assets that are safe from the Bankruptcy Trustee and most of your creditors outside of Bankruptcy are:
Home – Equity to 150,000.00
Tax Qualified Retirement Accounts
Certain Whole Life Insurance Policy Cash Value Amounts
1 Car per person up to $6000.00 in equity
Most household Furniture
Clothing, Wedding Rings, Gun
Six Months of Food Fuel and Provisions
Also, many people file for bankruptcy and have steady and “good” incomes. If the majority of all your debt is tax or business debt, it may not matter what you earn, you may still qualify to file a chapter 7 bankruptcy.
7. YOUR EMPLOYER WILL BE NOTIFIED WHEN YOU FILE FOR BANKRUPTCY
Filing for Bankruptcy doesn’t carry with it the requirement that you notify your employer. Bankruptcy filings are placed in the public record, most employers don’t go searching the public bankruptcy record on a regular basis.
8. MY CREDIT WILL BE TERRIBLE FOR TEN YEARS
Most bankruptcy filers see some improvement after a relatively short period of time 1 to 2 years, especially if they apply some effort after the case is over to rebuild the credit score. We take the position that if the deciding factor in choosing to file bankruptcy is just your credit score hit, you really should re-think the decision to file anyway. Your situation may not be serious enough to warrant using bankruptcy.
9. I CAN JUST SELL THE MY BOAT, HOUSE, FANCY CAR TO MY COUSIN FOR 1 DOLLAR AND PROTECT IT FROM BEING LOST TO THE BANKRUPTCY TRUSTEE
Any transfer for less than market value made within 2 years prior to the bankruptcy case has to be disclosed to the court. It is considered fraud for bankruptcy purposes and can be reversed. It can also end up causing your to lose your bankruptcy discharge. There are other ways to deal with non-exempt assets that may be more beneficial.
10. I HAVE TO FILE BANKRUPTCY WITH MY SPOUSE
You may be able to file alone and in Arizona still give your marital community the benefit of the bankruptcy discharge i.e. protection from creditors. It is called the community discharge and you will need to talk to an experienced bankruptcy lawyer about it.
The following is a list of the most common legal ways to deal with large IRS 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 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 you are 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.
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.
This seems like a long time, but you would be surprised at how many people 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)
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 the collection, would stop the statute from running. So some serious thought would be required before doing so.
There are other statutes that limit time periods in which the IRS may act:
Assessment: The IRS has only three years to assess a tax from the date a return is filed in most circumstances.
Liens: 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.
Payroll Tax Assessment: Only three years again to assess payroll tax withholding amounts from the date of the filing of the return or the date the return was due whichever later.
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.
IRS 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 IRS 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 a tax that can result in incorrect debt amounts, like the assessment of the trust fund recovery penalty against a responsible party.
Where the business has withheld the employee portion of the payroll 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 about innocent spouses.
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 called installment agreements or plans.
A guaranteed 3 year plan if the debt is less than $10,000.00
A streamlined plan for debts less than $100,000.00/$50,000.00/$25,000.00 that is typically paid over 6 to 7 years and doesn’t require the submission of detailed financial information.
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 6 years and;
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. (see above)
Installment agreements stop levies as well, but they don’t necessarily prevent the recording of the notice of federal tax lien (unless the debt is less than $50,000 and the payment plan is set up in a certain way) or stop the assessment of penalties or accrual of interest. They also don’t prevent the IRS from demanding the 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 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 criterion 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 or 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, then 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
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.
b. 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 and that is that 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.
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:
a. Innocent Spouse Relief – Where your former spouse filed to report income correctly or claimed improper credits or deductions.
b. 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.
c. 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:
a. The taxpayer filed a joint return which has an understatement of tax due to erroneous items.
b. 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.
c. 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 are 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 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 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 (or a portion of it in district court) 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 within a certain time period after the rejection of the claim.
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.
In most bankruptcy cases, a powerful tool called the “automatic stay” comes into existence the moment the case is filed. This “stay” prevents almost every type of debt collection from continuing. A home foreclosure, car repossession, and garnishments all end by operation of law. The automatic stay applies to the “debtor” or “debtors” who actually file the bankruptcy case.
But sometimes the debtor filing the bankruptcy has a co-debtor (someone who owes the debt jointly) who can’t or won’t file bankruptcy. In those cases, the question becomes whether the automatic stay will stop debt collection activity for them as well. In certain situations, it will via the “co-debtor stay”.
The Co-Debtor Stay and How it Works
Imagine a husband and wife who have jointly financed the purchase of some nice furniture for the family room. They are both on the hook to pay the loan for the furniture either or both of them sign the loan documents. (Arizona is a community state so what binds one spouse binds the other).
The couple later has financial problems and the wife decides to use chapter 13 bankruptcy to deal with the debt. The husband doesn’t file the case with her. The wife is protected by the bankruptcy filing’s automatic stay…but is the husband as well? Can the bank that lent the money on the furniture sue the non-filing husband who is outside the bankruptcy case? No, the creditor can’t sue the Husband.
In a chapter 13 case, the automatic stay applies twice. Once for the filer of the case and once to the co-debtor on a specific debt.
Even though we used a husband and wife example, the co-debtor stay applies to non-spouses as well in a chapter 13 bankruptcy. It will protect anyone jointly responsible.
The Co-Debtor Stay has Some Limits
Not in Chapter 7 Bankruptcy
The first limitation on the co-debtor stay is that it never applies in a chapter 7 case. Some people use chapter 13 bankruptcy just for the purpose of protecting a co-debtor even when chapter 7 makes more sense for other reasons.
Only Consumer Debt
The second limitation is that the co-debtor stay only applies to consumer debts. A consumer debt according to the bankruptcy code is a debt incurred primarily for a personal, family or household benefit. The co-debtor stay doesn’t apply to tax or business related debt.
Under section 1301(c) of the bankruptcy code the Bankruptcy Judge can lift the co-debtor stay and allow the creditor to continue collection if the creditor files a motion and one of three circumstances are true. First, if the co-debtor was the party that actually received the benefit of the loan as opposed the bankruptcy filer. Second, if the chapter 13 filer’s plan doesn’t propose 100% payment on the creditor’s claim. Third, if the creditor would be irreparably harmed by the co-debtor stay.
Once a motion to lift or remove the co-debtor stay is filed, a hearing is held. If the creditor is alleging that 100% of the debt won’t be paid, the stay is lifted automatically after 20 days if no objection is filed by the debtor or co-debtor.
Creditors like to issue 1099-c documents if they’ve worked out a settlement and decided to forgive the debt entirely. Creditors also issue 1099 forms when bankruptcy is filed and it discharges the obligation to pay the debt. These forms also show the IRS that the debt forgiven matches the amount written off in their own tax return.
Avoiding tax on forgiven debt
If the debt obligation is discharged in bankruptcy and the creditor issues a 1099 form, the law requires the bankruptcy filer to show the amount forgiven on the tax return. However, debt forgiven as a result of a bankruptcy discharge doesn’t cause “cancellation” of debt income and on IRS Form 982 the bankruptcy filer can make clear to the IRS that the forgiven debt isn’t taxable, by simply marking the box.
If the debt was forgiven outside of bankruptcy, then the amount of the debt that counts as income depends on how “insolvent” you were on the day before the forgiveness took place. Form 982 is used again to show the IRS that the included debt forgiveness amount should be reduced as income based on the insolvency amount. Talk to your Accountant about this.
If the debt was forgiven outside of bankruptcy, then the amount of the debt that counts as income depends on how “insolvent” the person was on the day before the forgiveness took place. Form 982 is used again to show the IRS that the included debt forgiveness amount should be reduced as income based on the insolvency amount. Talk to your Accountant about this.
But what happens if the 1099-C is incorrectly issued
Sometimes a creditor will issue a 1099-C to someone who hasn’t actually filed for bankruptcy or settled the debt. This tends to happen to a joint debtor whose partner on the debt has negotiated a settlement or filed for bankruptcy. Usually, the partner is an ex-spouse but it can be a business partner or other family member.
Post-bankruptcy, the partner shouldn’t be receiving the 1099-c as the bankruptcy discharge doesn’t apply to the personal liability of that spouse, ex-spouse or other.
If this happens, the first step is to contact the creditor and ask them to correct the 1099 form. The creditor issues the form to the individual several weeks before it sends the form to the IRS. This provides enough time to make the contact and try to get the problem fixed.
If the form has already reached the IRS, a form 982 may need to be filed with the 1040 and an explanation attached containing the reason why the debt wasn’t actually forgiven, i.e. didn’t file for bankruptcy and no personal liability discharge occurred as a result.
Debt Settlement Versus Bankruptcy
For someone struggling with credit card debt, settling for less than the amount owed can be a real blessing until the 1099 form is received. If money is being saved for the purpose of settling a debt, forgiven debt as income should be taken into account before a settlement is reached. An advisor should be mapping out whether insolvency will be a way to avoid tax on the forgiven amount or not.
Bankruptcy avoids the issue entirely as debts discharged in bankruptcy aren’t treated as taxable income and the IRS won’t try to treat them this way as long as the 1040 form is accompanied by the 982 form and the correct box is checked.
In September of last year, the IRS issued a notice indicating an intent to use private debt collection services. This is going to become reality when the collectors begin handling old accounts within a few months.
The IRS will send a notice explaining the details and the private debt collection agencies will also send a notice out explaining that it will not be enforcing debt collection.
These debt collectors will be subject to the Federal Fair Debt Collection Practices Actthat imposes a penalty on collectors that don’t follow specific noticing rules, “abuse” the debtor, call the debtor’s friends and family etc. The IRS isn’t subject to this act of course. These collectors will have to identify themselves as contractors for the IRS and not as the IRS itself. They also won’t be able to issue levies or take any time of affirmative action to collect the money other than to make contact.
Nonetheless, I anticipate a great deal of confusion as a result of the legitimate fears we all have of identity theft and other related problems. Tax debtors will not be sure who to trust when receiving a call or a letter and criminals will likely find a way to take advantage of this.
If you receive a call or letter from a collection agency for the IRS, be careful about the information you provide.
If you own a business and that business has value, many people would assume that it should be included as an asset in calculating the amount of settlement. As a result, many offers are calculated much higher than they should be.
Income producing assets in an IRS Offer in Compromise shouldn’t always be fully included in the calculation of “reasonable collection potential”.
When an Offer in Compromise is submitted to the IRS and that taxpayer owns business assets that produce income, it’s correct to adjust the income or the expense calculation to account for any loss of income if the asset were liquidated or used as collateral to secure a loan for purposes of funding the offer.
This analysis may even include a rental property.
The Internal Revenue Code defines rental property as a real estate trade or business. Rental property is important to the production of income where it is actually being rented. If the IRS were to treat the equity in the rental property as an asset for Offer in Compromise calculation purposes, it would then need to reduce the income from that rental property as well.
The reason so many people get this calculation incorrect is because the IRS forms 433A and 656 don’t specifically ask if any business assets are essential to the production of income. Most offer in compromise “filers” simply add both the asset value and the income stream from the asset to the disclosures in 433A and to the calculation in the 656 form as a result.
When they do this, the IRS gladly accepts. It won’t catch the mistake and fix it. It definitely won’t make the argument for the taxpayer either.
If you own rental property or a business and have significant tax debt, keep in mind that the Offer in Compromise must take the above into account. The documents should contain and the argument must be made that either the equity should be excluded or the stream of income should be excluded from the income producing business asset when calculating a settlement amount in an Offer in Compromise.
The recorded document puts the world on notice that the IRS has a lien on your stuff and makes it impossible to sell your home without obtaining the Government’s “permission”.
We’ve reviewed IRS liens and the options that exist to deal with them several times inside this blog. Start here to read more about how liens are dealt with outside of bankruptcy.
When a bankruptcy case is filed, and the Filer has equity in a home and/or other substantial assets, another layer of complexity is added to the mix. There are 3 problems IRS liens create if a bankruptcy case is filedafter the lien notice has been recorded
IRS LIENS POST-DISCHARGE – CHAPTER 7
If the IRS has recorded it’s lien prior to filing the chapter 7 bankruptcy case, and the underlying obligation to pay the debt is removed, the lien itself isn’t removed. Bankruptcy exemption laws don’t apply to IRS Liens.
If the bankruptcy filer has equity in a home or other assets that were subject to the lien prior to the bankruptcy filing, those same assets will be subject to the lien after the bankruptcy case is over.
In certain situations this isn’t a terrible thing. Where the equity value in the assets is low, the IRS will sometimes just release the lien or agree to release the lien just because you asked. Sometimes an amount offered that is less than the value of the asset(s) is paid in exchange for a release.
Even when the equity is large, it will make sense in certain situations to file the chapter 7. As an example:
Mr. F owed the IRS $250,000.00 and his home had an equity value of $75,000.00 at the time of filing. That equity was exempt in bankruptcy and safe from creditors, but not the IRS’ lien. He also owed other creditors $50,000.00. He wasn’t a great candidate for an offer in compromise but he did qualify to file a chapter 7 and was able to discharge his tax obligation and credit card debt. Post bankruptcy, the equity in the home had climbed to $85,000.00 making the lien more valuable. The IRS approached him and he agreed to pay them $50,000.00 in exchange for a release of the lien.
BANKRUPTCY TRUSTEE AND SECTION 724(b) OF THE BANKRUPTCY CODE – CHAPTER 7
I mentioned above that the exemption law that might protect home equity during a bankruptcy, doesn’t protect that home’s equity from a tax lien. This problem shows up post bankruptcy when the IRS tries to collect on the assets as described above.
That same lien however does something that would surprise most bankruptcy filers. It gives the Bankruptcy Trustee the ability to snatch the equity in the home under Bankruptcy Code Section 724(b).
The Bankruptcy Trustee rarely uses this power because it tends only to benefit the IRS and the IRS can collect it’s own equity post bankruptcy.
What needs to be understood though, is that many people file bankruptcy to discharge IRS debt and they understand that the lien will survive. They’re taking the calculated risk that the IRS won’t try to collect the assets subject to the lien before the 10 year statute runs on collection post bankruptcy discharge.
Section 724(b) adds another layer of complexity to that decision, because the Trustee can use the lien to take the home, the filer has to assume the additional risk that the home equity may be grabbed before the bankruptcy case ever ends.
PAYING LIEN VALUE IN CHAPTER 13 BANKRUPTCY
A chapter 13 bankruptcy isn’t a “liquidation” case like a chapter 7 bankruptcy. Nobody is taking anything in a chapter 13 unless you ask them to. The trade-off is that certain debts have to be paid over time to the Trustee for distribution to creditors in order to obtain a confirmed plan and an eventual discharge. Most secured debts have to paid to the Trustee through the plan.
If the IRS has recorded it’s lien and you have equity in assets, the IRS is a secured creditor as well. In order to receive a confirmed plan and eventual discharge in the bankruptcy case, that lien’s value as of the filing date, has to be paid to the IRS with interest during the plan period.
Despite the fact that this sounds awful, it’s often the case that the overall situation lends itself to a chapter 13 filing. Chapter 13 Bankruptcy and it’s potential value has to be viewed with the big picture in mind.
If you have a large IRS debt and assets that would normally be exempt or safe in bankruptcy AND the IRS debt would potentially be discharged in bankruptcy, you will want to file a bankruptcy before the IRS records it’s lien notice if you were going to file a bankruptcy at all. This would remove all 3 of the above problems.
Talking to an attorney who is experienced in bankruptcy and IRS debt sooner rather than later is absolutely necessary.
Just because you are in an IRS Installment Plan with the IRS doesn’t mean that your work is done. One of the common questions I get is “why did the IRS terminate my installment plan?”.
The following are the most common reasons why this happens.
Your Income Changed
When you file a tax return the IRS reviews it to determine whether you income has changed i.e. increase. If they see this and you are in a partial pay installment plan or a plan based on your income and budget, they will send you a letter indicating that the plan will end unless you provide updated financial information. Unless your payment plan is guaranteed or streamlined, the IRS will request new financials when it sees the increase in income.
You Didn’t File a Return
Installment plans are contingent on compliance. If you late file a future tax return….it will send you a notice of intent to terminate your agreement and send you back to collection. You will have to file any missing returns, and negotiate a new plan.
You Didn’t Pay a Future Debt
If you file a subsequent return on time and it has a balance due but you don’t pay it, the IRS will do the same thing as if you didn’t file the return on time. It will send a notice terminating the agreement and force you to re-supply your financials.
You are in a Partial Pay Installment Agreement
Many people with tax debt are either in non-collectible status arrangement or they are in a partial payment installment agreement with the IRS. In a partial payment agreement, you aren’t paying enough to the IRS to pay the debt owed before the 10 year clock on collection runs out. (IRS Statute of Limitations on Collection) This type of arrangement is allowed, but the law requires that the IRS review the arrangement every few years.
You owe the IRS $75,000, and have convinced them to accept $100.00 per month toward it. The Statute of Limitations period has 4 years or 48 months remaining to collect the debt of the 10 year total time-frame it has to do so. Six years have elapsed. About 2 years into that 4 year remaining period, the IRS should send you a letter asking you to supply updated financial information.
If you make a late payment, the IRS will typically warn you, but if not caught up, it will sever the installment agreement and you will have to re-negotiate it.
Contact the IRS as soon as you are having one of the problems above. If you are having trouble, don’t ignore the situation. Call the IRS and ask for a month off. Review any changes in your financial situation and re-think whether some other option may now make more sense like Non-Collectible Status, a Lower Installment Agreement, Bankruptcy, or an Offer in Compromise.