Tax Debt as a result of IRS Audit? Do I have options?

samp01The result of an IRS audit is often a balance due.  We are often asked several questions at the end of an Audit as a result.  Questions like:

  • Will the IRS accept an amount less than what I owe and forgive the balance?
  • Will the IRS agree to a payment plan?
  • Will the IRS place a lien on my property if I am in a payment plan?
  • Can I use Bankruptcy to get rid of the debt?

Shortly after the audit related debt is placed in the IRS’ books it will start shooting letters to you.  “Balance Due” letters and “Final Notice” letters will issue over a period of several weeks.  You’ll receive a letter at the end of the string of letters called a “Final Notice of Intent to Levy”.  This letter is important because it provides you the ability to challenge collection action by the IRS and request an alternative solution IF you properly reply to it within 30 days of it’s mailing date.  The time between the assessment of the new debt and the date you get to discuss alternative solutions with the IRS usually provides enough time to analyze and plan your case.

Back to the common questions above:

Will the IRS accept an amount less than what I owe and forgive the balance?

The IRS will settle the debt IF you can prove that your “reasonable collection potential” (RCP) is less than the amount of the debt during an Offer in Compromise proceeding.  Proving your RCP isn’t done by discussing your situation with the IRS.  It is based on a formula.  The formula is simple in theory, but the majority of people who try and prove that their RCP is low enough to require settlement of the debt…fail.

They fail for all sorts of reasons, but primarily because the filers aren’t great candidates.  Or in other words, the RCP is high enough that the IRS believes it can collect all of the debt before the statute of limitations on collections runs out.

No matter what the IRS Offer in Compromise calculator you are seeing online says about your RCP, be skeptical, and get a second opinion from someone experienced with the process.

If you are a good candidate for an Offer in Compromise, then the answer to the question is yes, the IRS will likely settle the debt for less than what is owed and forgive the rest.

Will the IRS agree to a payment plan?

Yes in almost every case.  There are several types of payment plans and which type you request and end up getting will depend on the amount of the debt, the time left in the statute of limitations period, your income, your budget, the budget the IRS believes you should have and your assets.

The most common type of payment plan(s) we see are streamlined plans.  The debt in these types of plans are less than 50000.00 and the taxpayer can afford to pay the balance over 72 months.  These types of plan allow the taxpayer to avoid submitting a full financial statement and if done properly can even prevent the filing of an IRS lien.

If the taxpayer can’t afford to pay the debt over 72 months or if the debt is greater than 50000.00, than the solution becomes a bit more complex and the factors mentioned above become very important in determining how much a payment plan will be.

In some situations it is possible to convince the IRS to take very small amounts each month or even nothing each month even if the debt is very high.

Will the IRS place a lien on my property if I am in a payment plan?

If the debt is less than 25000.00 and you enter into a certain type of payment plan, the IRS won’t record a lien notice.  If they already have they will release it and even withdraw it from your credit report if you follow certain steps.

If the debt is less than 50000.00 and no lien notice has been recorded AND you enter into a streamlined payment plan that allows the IRS to take the payment from your bank or pay, the IRS won’t (or shouldn’t) file the notice of lien.

If the debt is above 50000.00 or one of the above two situations don’t apply, bets are off.  You can expect the lien and will have to formally request that the lien notice not be filed and have a very good reason why it shouldn’t be.

A successful Offer in Compromise will result in a lien release as will an eventual bankruptcy where the debt is paid or discharged and there are few assets for the lien to remain attached to.

Life after an IRS audit involves dealing with the IRS Collection Division.   In audits that result in money owed,  it is recommended to be pro-active and to understand the next step that awaits you – IRS collections.  There is no substitute for preparation.

Can I use bankruptcy to get rid of the tax debt?

A very strong…”it depends” applies here.  Bankruptcy will discharge an obligation to pay income tax debt, penalty on income tax debt and interest on penalty and income tax debt.  It will also discharge the obligation on certain other types of tax debt…but two things have to be true:

1.  The tax debt has to meet the criteria for discharge both date criteria and other criteria.  (Learn More)

2.  You need to be a good candidate for bankruptcy.

If you have new debt which is the result of an audit, the debt won’t be dischargeable in bankruptcy from a date standpoint for at least 3/4 of a year depending on how old the tax year is.  It may be 3+ years before it is dischargeable in bankruptcy from a debt standpoint.

We have many clients who use bankruptcy to deal with tax debt but these types of cases require real analysis, comparison to other options and usually some time spent in a payment plan before bankruptcy ends up making sense.

Review

After the IRS Audit – A Basic Guide

IRS Audit – Some Background

In order to make sure that Arizona taxpayers follow the law, the IRS conducts audits on a certain percentage of us each year.  The IRS has several methods to determine who gets selected.  The most common are:

The Discriminate Information Function – A computerized scoring system

Infection Audits – The practice of auditing returns that are related to another audited return

Issue Related Audits – The incorrect calculation of the Earned Income Tax Credit, is an example of an issue-related cause for an audit.

Despite what you may think, the IRS audit isn’t focused necessarily on the “well to-do”.  The U.S. General Accounting Office has reported over the last few years that as much as forty percent of all audits conducted are done to people who are in the lowest tax bracket.

There are several types of IRS examinations:

  • Correspondence Exams – Examinations done by mail
  • Office Exams – Examinations done at the IRS’ office
  • Field Exams – Examinations done at the Taxpayer’s place of Business or Home
  • Employment Tax Audits – Examinations focused on business employment tax withholdings

By far the most common audit is the Correspondence Exam.  These are conducted via mail and begin with an IRS letter requesting an explanation and/or supporting documents to substantiate certain items on the return.  Many people contact our office after the audit stage is over as they have ignored the IRS notices or they didn’t provide the IRS with enough evidence to resolve the problem.

Audits reach a resolution in only one of three ways:

  • The taxpayer will agree with the IRS’ findings
  • The taxpayer will disagree with the IRS’ finding
  • The taxpayer will ignore the findings

The “30 Day” Letter

When the taxpayer disagrees with or ignores the audit findings the IRS will issue a notice commonly called a 30 day letter.  The 30-day Letter will review the findings made by the IRS examiner and provide an explanation about the taxpayer’s appeal rights.  The taxpayer will have 30 days from the date on this Letter to request a conference with the IRS Appeals Office.  Most taxpayers ignore the 30 day Letter.  This is usually a mistake because the taxpayer loses one of the chances available to challenge an incorrect result.  The 30-day Letter is not a “statutory” letter, so extensions can be granted to request the appeals conference.

If time is short and the statute of limitations deadline for the IRS to finalize the Audit is close to expiration, the IRS will  not always send the 30-day letter.  It will instead skip to the 90 day letter.  (See Below)

Protest

The “protest” is sent with the request for a conference with an IRS Appeals Officer as a result of receiving the 30 Day Letter.  What form the protest must take depends on the circumstances and the amounts involved.  If the total amount of the additional tax, claimed refunds or over-assessment is over $10,000.00 for any one period, than a written protest that lays out the facts, the law, and the arguments the taxpayer is relying on, must be submitted under penalty of perjury.  If the amount is between $2500.00 and $10,000.00, a short written protest that lays out the disputed issues is required.  If the amount is only $2500.00 or less, and it is a field audit case, an office interview or correspondence exam, an oral protest should be enough.  The taxpayer should make a written protest anyway.

The protest should include name, social security number, a copy of the Power of Attorney form if the taxpayer is represented, a copy of the 30-day Letter and the Audit Report that lays out the years involved and the changes that are being proposed.  The protest should also include:

  • A statement that the protest has been timely provided
  • A request for an Appeals conference
  • A detailed list of the changes made by the IRS to the return that the Taxpayer disagrees with and specific reasons
  • A list of the facts supporting the taxpayer’s position
  • The legal basis supporting the position
  • The taxpayer’s signature or a statement by the Representative that he or she prepared the protest and knows the facts alleged to be true (to the best of his or her knowledge)
  • The Attachment of supporting documents

 The “90 Day” Letter

If the 30 day letter is ignored or if it is responded to timely, but Appeals and the taxpayer don’t end up reaching an agreement, the IRS will issue a “90-day Letter” or a Final Notice and Right to CDP Hearing.

This Statutory 90-Day letter shouldn’t be confused with any other letters that may provide for a 90 day response… especially not the letter required when an innocent spouse relief request is denied. See IRC § 6015.

The taxpayer also receives the 90 Day Letter if the Office of Appeals issues a finding after a protest is provided and the taxpayer doesn’t agree with those findings.

The 90-day letter gives the taxpayer 90 days of course… during which a Tax Court Petition can be filed and thereby a request for the US Tax Court to re-determine the liability that is being proposed by the IRS’ Examiner.  If the issue is only one of filing status, the taxpayer should consider whether a joint return should be filed before the petition is filed.  See IRC § 6013(b)(2)(B).  Once a Tax Court petition is filed, a joint return is no longer permitted to be filed.

The 90 day period is statutory.  This means the date the Tax Court petition is due can’t be extended for any reason.  It is very important not to miss the 90-day deadline as a result.

The 90-day period is calculated from the date the Notice of Deficiency is mailed to the taxpayer’s last known address. The IRS is required to include directly on the notice the last day the Tax Court Petition can be filed.  SeeIRC § 6213.

During the 90-day period and until the Tax Court reaches a decision, the IRS can’t make a tax assessment or engage in collection activity.  See IRC § 6503(a)(1)


Failure to file a Tax Court Petition Timely

If the taxpayer files the tax court petition late, the IRS will assess the proposed amount.  The IRS must assess the debt before the collection process can begin.  Again… the date the Tax Court petition is due can’t be extended for any reason, so if the taxpayer files the petition late, the assessment will take place and collection activity will begin.

Collection Action 

IRS Lien

Once the debt is assessed the IRS will begin sending the taxpayer a series of collection notices demanding payment.  An automatic lien under IRC § 6321 in favor of the United States on all property and any rights to property that belong to the taxpayer will exist if after the IRS provides a notice of the assessment and a demand for payment the taxpayer doesn’t pay the tax.

This lien isn’t good against any purchaser, holder of a security interest, judgment lien creditor, or mechanic’s lien until an actual notice of the lien is recorded with the County Recorder’s Office.  That notice of lien is recorded where the taxpayer lives or where he or she owns property. See IRC § 6321

IRS Collection

The final letter in a series of letters that the IRS sends the taxpayer is a “Final Notice” at least 30 days before it issues a a Notice of Levy.  See IRC §6330   This statutorily required notice must provide the amount of the tax and contain language explaining that the taxpayer has a right to request a CDP or Collection Due Process hearing within 30 days.  The notice also provides the administrative appeals rights and the procedures to follow in order to obtain the release of the levy or lien.  Any decision of an Appeals Officer following a CDP hearing is subject to judicial review in Tax Court. If the taxpayer wants to challenge the IRS’s proposed action, a Form 12153 must be used.

The Form and an alternative to the proposed collection of the proposed collection is sent to the IRS office that sent the notice.  A taxpayer has this right to appeal attached to the first collection due process notice for each year. In some cases, the CDP notice is a second or third notice issued over a number of years. If the taxpayer fails to submit a Form 12153 within the 30 day period, the IRS will continue with it’s proposed collection activity which is typically a wage garnishment or a bank levy or both.

IRS Audit? How long does the IRS have to complete an audit once started?

The IRS cannot assess additional debt based on a tax return if three years have passed from the Tax Return’s original filing date.  See 26 USC Section 6501 – Limitations on assessment and collection

“Except as otherwise provided in this section, the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed”

This means that the IRS cannot start an audit and than change the tax amount or “assess” the additional tax against you if 3 years have passed since you have filed your return.  If you filed the return before April 15 in the year it was due, the three year time starts to run on the due date or April 15th.

Some exceptions exist to this rule…of course:

Exception One

If you have understated your income by more than 25% this 3 year deadline can be extended to 6 years.

Exception Two

If you filed a fraudulent return, there isn’t a time limit for the IRS to finish the assessment.

Exception Three

Really a repeat of the general rule stated differently…the audit time limit period only starts to run when you file your return.  Un-filed tax returns are always subject to assessment by the IRS.

Exception Four

A partial exception exists in that the IRS Manual instructs the auditor to complete the adjusted assessment or close the audit within 28 months.  It sets this internal deadline to provide itself time to deal with any appeal you may file to the assessment.

If you are being audited, look backwards to the date you filed the tax return and than count forward 3 years.  The Auditor technically has that much time to make a decision and enter an assessment of the new amount the IRS thinks you should owe.

Michael Anderson, Tax Lawyer In ArizonaWritten By:

Anderson Tax Law
2158 N. Gilbert Rd. Ste 101
Mesa, Arizona 85203

Phone: (480) 507-5985
Fax: (480) 507-5988
Email: [email protected]
Website: https://taxlawyeraz.com

IRS AUDIT? LOST RECORDS AND RECEIPTS? Don’t Lose Hope. The Cohan Rule May Be Your Hero

If you are self employed, you probably don’t like the process of maintaining receipts and other proof that you bills-thumb-375x325-49437actually paid the business expenses.

Bookwork is no fun.

Many people who are self employed find it so boring to keep records that they haven’t done it for years.

The problem with this “rears” it’s head in two circumstances:

1. When the returns haven’t been filed and need to be re-created.

2. When a return has been filed and is being audited.

Lets look at the second problem and ask whether the small business owner can prove business expenses during the audit even if there are no receipts or even cancelled checks?

There is an old case called Cohan V. Commissioner, 39 F. 2d 540 (2d Cir. 1930) that states that the IRS will accept most expenses despite the fact that the receipts are missing.

The catch?

The business owner needs to present a reasonable basis upon which he or she recreated the expense.

So if you have very few records and you are being audited, here are two examples where this “Cohan Rule” may help you:

a. Mileage Log – This can be recreated using anything that creates a reasonable basis for the miles. A calendar along with a signed affidavit is a good example. If you keep a calendar of which job site you visited each day – this would work even though you didn’t keep a mileage log.

b. Subs or employee cost – recreating what is necessary to have performed the individual jobs can form a reasonable basis for the expense. Carpet doesn’t get laid by itself.

In recreating a reasonable basis for expenses it is important to understand how critical the business owner’s testimony can be. If the business owner is willing to swear under oath about the expenses and how they were arrived at despite a lack of documents, that can be powerful.

So..what happens if you lose the audit because you have few records and you failed to appeal timely?

You can ask the IRS to reopen the audit to re consider the expenses. This is called an audit reconsideration.

Conclusion:

If you own a small business and you haven’t kept records, it won’t devastating if an audit takes place as long you can logically estimate the expenses using some reasonable basis. Calendars, Memory, Comparables from other businesses and Affidavits will help.

If you have lost an audit but know that the IRS didn’t get the numbers right, you may want to consider asking the IRS to re-open the Audit so that you can provide a “reasonable basis” for the items that were disallowed.

IRS Adjusted Your Return? – You may only have 90 days to challenge it

Our Mesa Tax Lawyer Can Help You When The IRS Adjusts Your ReturnIRS adjusted your return? If so, 90 is an important number. It is the time frame i.e. the number of days the law thinks you should be given to respond to an IRS Notice of Deficiency.

The IRS Notice of Deficiency is issued as a result of the IRS making an adjustment to your return that you either didn’t respond to or didn’t agree with. It is the invitation to the taxpayer to take it up with the US Tax Court and see what it has to say about the adjustment.

The required legal method to do this is the filing of a Tax Court Petition.

90 days. That seems like a long time. Three months to get a Tax Court Petition figured out and filed correctly. When the 90th day arrives though, many taxpayers are surprised by how quickly the time passed and the petition is filed late.

If the Tax Court Petition isn’t filed timely, the taxpayer receives a bill for the total amount of the debt including the adjustment and the “fun” begins. This is the type of fun that you want to avoid.

Here are some important things to understand about this 90-day letter.

1. The 90-day period is final. There is not ability to extend it. If you don’t file the Tax Court Petition on time, your right to appeal the adjustment to Tax Court will be lost…forever and a day.

2. If you file the Petition timely, it doesn’t go straight to the Judge. It goes first to the Appeals office and they will call you to try to work something out. Probably what you were trying to do, when you filed the Petition in the first place.

3. Some people file Tax Court Petitions without the aid of an attorney. Actually, a lot of people do. You can go to the Tax Court’s Website at www.ustaxcourt.gov to find procedures and get access to some forms.

4. If you missed the appeal date and you have no Tax Court in your future you may want to think about:

a. Filing an Audit Reconsideration Request. Publication 3598 tells you all about it. A few things about audit reconsiderations. You must supply information that the IRS has never seen before and you don’t have the ability to appeal its decision.

b. File an offer in compromise based on a doubt as to a liability. Yes another bite at the apple.

c. You can also just bite bullet, pay the tax and file a claim for a refund of the tax paid or at least the adjusted amount. If and when the IRS disallows the claim for the refund, you can appeal to a different court.

Conclusion

If you are being audited i.e. if the IRS is threatening to change your return in any significant way, pay close attention to your options to appeal their decision. When they issue the 90-day letter, don’t dilly-dally. 90 days goes by quickly.

Michael Anderson, Tax Lawyer In ArizonaWritten By:

Anderson Tax Law
2158 N. Gilbert Rd. Ste 101
Mesa, Arizona 85203

Phone: (480) 507-5985
Fax: (480) 507-5988
Email: [email protected]
Website: https://taxlawyeraz.com

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.

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.