Keith Fogg, at the terrific tax blog “Procedurally Taxing” has provided a short review of the Martin v. United States Case wherein the 9th Circuit Bankruptcy Panel (BAP) rejects the literal interpretation of Bankruptcy Code Section 523(a)(*). You can read his review here.
If you have tax debt, and have been following the issue of whether it can be discharged in bankruptcy… if the underlying return was filed late, or filed after the IRS files a “substitute return”, this BAP case will be of interest to you.
As you recall, there are three circuit courts, the 1st, 5th and the 10th that have ruled that a return filed even one day late can never meet the requirements of a return filing for bankruptcy discharge purposes. These Courts have primarily based their decisions on the literal reading of the language found in 523 (a)(*).
The 9th Circuit BAP rejects the literal interpretation regarding whether a return is still a return if it is filed late, and does a good job in explaining why courts that have ruled that timeliness is an issue, make little sense.
The 9th circuit hasn’t ruled on the issue of tardiness, and in 2015 we were able to help our clients discharge several hundred thousand dollars of tax debt as a result.
Right now in Arizona, a late filed return is still a return for purposes of calculating the discharge dates and a return filed after the IRS has filed a substitute return will still be considered “not-discharged” by the IRS.
I expect a 9th circuit ruling in a case similar to the Martin case, within a few months. That case is called Smith vs. United States. The 9th Circuit may come to some of the same conclusions as the 9th Circuit BAP, potentially setting the issue up for the Supreme Court. Or, it may side with the 1st, 5th, and 10th, and stick it to late-filers.
Almost every person who contacts me asks about getting rid of IRS penalties. There are two reasons I think this happens:
1. Many Americans believe in paying debt and see tax as a debt. But they regard penalties as just unwarranted punishment.
2. Many people have been falsely led to believe the IRS’s Fresh Start Program allows for some new, magical way to reduce or eliminate IRS penalties.
As for the second reason, I blame the tax resolution “experts” who use the veiled promise of penalty relief to take advantage of people who aren’t sleeping well and are desperate to hear good news. These “experts” will use a subtle tongue slip to take money. There is no such thing as IRS penalty relief under the IRS Fresh Start Program.
Unfortunately, penalty abatement almost never happens the way that it is portrayed. You must still qualify for penalty relief using one of the legal remedies that existed before the Fresh Start program existed as follows:
Even though I have helped hundreds of people with tax debt problems use the bankruptcy code to find relief, I consider it to be a last resort. For certain people with IRS penalties bankruptcy can provide penalty relief. Most penalties that meet the date requirements for tax debt discharge will be discharged in a chapter 7 bankruptcy. In a chapter 13 bankruptcy almost all penalties are treated as dischargeable no matter the age.
Don’t run out and file a bankruptcy though. Alot of thought and planning has to go into a decision to file a bankruptcy case.
First Time Penalty Abatement
The IRS will usually give a first time offender a free pass and waive a late filing or late payment penalty. In order to get this abatement though, you have to be in current compliance with tax return filings, making any estimated tax payments, have no penalties assessed during the previous 3 year period, meaning paid and filed on time.
First time penalty abatement doesn’t apply to the failure to pay taxes through the Electronic Federal Tax Payment System, or to one-time filing for gift or state tax returns.
Reasonable Cause. You will hear this phrase being thrown around alot by tax professionals but if you think about it…the phrase is reasonably meaningless. The IRS determines what is reasonable or not and even though it tries to treat these requests uniformly, it doesn’t.
Generally, the IRS considers reasonable cause to be when you have done everything else right but despite those efforts you weren’t able to comply. Most people have failure to file and failure to pay penalties so the argument usually revolves around why you were late and/or broke.
Serious illnesses, death in the family, caught in a hurricane, and things like this are often the best arguments to make but really just about any argument can be posed if it is based on reality and and the situation was really beyond your control.
The IRS will also look at and should grant penalty abatement requests based on the law. If for instance you can prove you mailed your return on time, or if there was a government slowdown etc. than the law sometimes orders the IRS to remove the penalty.
Administration Based Abatement
The IRS will often change the way it is doing something and it will realize that changing the process may confuse some people. When this happens there is usually some kind of administrative waiver that it put in place to forgive penalties out the outset for a certain period of time.
IRS Makes an Error
The IRS messes up all the time. They apply penalties when they shouldn’t, lose returns, misplace payments, fail to make notes etc. etc. etc.
They will remove penalties or they should…if the penalty was based on the IRS’ error and you can prove it.
IRS Offer in Compromise
Much like a bankruptcy a successful offer in compromise will reduce IRS debt. This includes the debt that has accrued as a result of penalty.
NO FRESH START BUT…..
There isn’t such a thing as IRS Fresh Start Penalty Relief…sorry. Don’t believe people who try and tell you there is. But there are ways to eliminate penalties in certain circumstances and sometimes with the right help.
Releasing an IRS levy when tax returns aren’t filed
The IRS likes to get attention. It doesn’t take “selfies” to get it, but once it issues a wage garnishment or a bank levy on your account, you will wish that it just used a camera instead.
It doesn’t use a camera because it wants something from you that sometimes it can only get by inflicting pain. It wants missing returns, a disclosure of your finances or some missing estimated tax payments typically.
The IRS can condition the release of the wage garnishment or bank account levy on receipt of what it wants. So if you have one or several years of missing returns… it can literally say “too bad, that wage levy will remain in place until those returns are filed”.
This is true with a few exceptions. One exception is the filing of a bankruptcy which will stop the levy by operation of law. The other exception is based on a U.S. Tax Court Case from 2009 called Vinatieri v. Commissioner (See Office of Chief Counsel Notice re: Vinatieri here cc-2011-005).
In Vinatieri v. Commissioner, the Tax Court found that the appeals office had abused it’s discretion when it upheld a levy after the officer decided that the levy would be an economic hardship for the taxpayer but left the levy in place anyway because of missing returns. The Tax Court based it’s decision on section 6343(1) of the IRC which requires that the IRS release a levy if it will cause the taxpayer economic hardship. The Court reminded everyone that the statute contained no wording conditioning the release on the filing of any missing tax returns.
After the Vinatieri decision the IRS issued a Chief Counsel Notice cc-2011-005 in order to try and ensure that appeals officer would follow the Tax Court Decision.
There are a few issues to be aware of if you think you are in a hardship, the IRS has levied or garnished and you have un-filed returns:
1. You will probably need to point out the Vinatieri decision and the Chief Counsel notice to the collection personnel you are dealing with. They won’t want to follow it and may not be aware of it even several years after the fact.
2. “Economic Hardship” isn’t going to be defined by you. The IRS has a set of budget standards that help it determine whether you are truly a hardship case and it will try and apply those standards to your situation. If after it applies those standards, it sees “excess” income, Vinatieri won’t apply.
3. In order to finalize the case and be placed on “non-collectible status” , you will need to prepare and file the missing returns. Vinatieri says that levy can’t take place if you are in a hardship but the case file can’t be closed and a determination made without those missing returns. The IRS will set a deadline for the missing returns and if you don’t meet it – it will try to collect again based on your non-cooperation.
If you are being levied or garnished and think that you qualify for hardship status but have missing returns, review the links in this article before proceeding. Make sure you qualify for hardship status, find out which returns need to be filed, and start working on those asap.
I haven’t filed a tax return in a long time – what should I know?
If you haven’t filed a tax return for a while – you’re not alone. There are literally thousands of people and small business owners who haven’t filed a tax return in several years. The IRS is actively searching for millions of missing tax returns at any given time. The following are eight things you should know if you fall into this category:
First – Don’t Lose Sleep About Jail Time
Willfully failing to file a tax return is a federal crime BUT there are only 3000 or so IRS indictments filed each year. Most people charged with failure to file a tax return have been charged with other criminal offenses and the un-filed return issue just gets dragged into the mix. The IRS just doesn’t prosecute these cases very often. It takes the position as well… that if you file your returns before it begins the criminal process, they won’t proceed.
Second – Beware the Automated Substitute Return Program
For most late filers, the real issue is the Automated Substitute Return Program (ASFR). The IRS “system” gathers information that has been reported about you from 1099s, w-2s, k-1s and create a rough return. The return contains just the reported income and a standard deduction for a single person. That rough return is sent to you with a warning. The warning essentially says that if you don’t file the correct return within a certain period of time, the IRS will use the rough return as a determination of how much you owe and then start collection proceedings. Many late filers get these bills in the mail but don’t open them out of fear, and then they wake up one day and a bank account has been frozen.
Third – The ASFR Will Almost Always Result in More Debt Than You Owe
You read above about how they do these returns and for most people, especially the self-employed, this process results in debts that are much larger than you actually owe. Sometimes it matches the correct amount but this is usually only when you are a w-2 wage earner with no itemized deductions, or family members. As a result of these very high and very fictitious numbers, many people can’t even open the envelopes from the IRS – they get physically sick, can’t sleep and lose the ability to move forward with the problem.
Fourth – You Can Challenge and Reduce the Amount Owed by Completing Correct Returns and Taking Some Other Steps
We have helped literally hundreds of individuals and self-employed complete corrected returns for years the IRS has already assessed ASFRs and convince the IRS to replace the ASFR with the correct return(s). This has resulted in millions of dollars in savings.
The IRS will almost always agree to replace the ASFR with the corrected return and in most cases it makes sense to do this.
Fifth – Sometimes it Makes No Sense to Challenge the ASFR
What? It may make no sense to try and reduce the debt? Follow me on this:
a. Statute of Limitations
It is possible that on a particular tax year the 10 year statute of limitations is going to be applied by the IRS. If the IRS assessed an incorrect debt based on it’s ASFR in January of 2006 and it is going to apply the 10 year statute of limitations on collection to the debt in January of 2016 – it may not make any sense to spend your time, energy and money on the creation of corrected returns even if those returns would reduce the debt substantially.
b. Offer in Compromise
An IRS Offer in Compromise is a formal process that allows certain qualifying individuals and businesses to settle the debt for less than is “owed”. One of the factors in the IRS formula is the amount of the debt and strangely, the higher the debt…the better in most cases.
Sixth – The ASFR Once Assessed, Can Ruin Your Ability to Discharge the Debt in Bankruptcy
Right now the IRS treats debt from a return filed AFTER the IRS has filed and “assessed” one of these ASFRs as non-dischargeable in bankruptcy – ever, and right now the 9th Circuit Court of Appeals doesn’t disagree. So imagine a realtor or other self employed person who had a string of good years and didn’t file their returns. Imagine the ASFRs were created and assessed for those years and the debt with interest an penalty totaled the nice, round, large, sum of $400,000. Now suppose the person created correct returns that reduced the overall debt to $200,000.00.
Imagine that this person made too much money to qualify for an IRS offer in compromise BUT that the tax debt was the largest portion of his or her overall debt and as a result, they could use chapter 7 bankruptcy to discharge it after certain time periods and other factors were taken into account. (Grammar Police needed?)
Good scenario for them. Right? Not so fast.
ASFR assessed before he or she filed returns – the principal tax debt balance won’t ever be discharged in bankruptcy at least in the 9th circuit. (Assuming the law doesn’t change)
Seventh – If You Haven’t Filed for More Than Six Years – It’s Possible That You Won’t Need to File More than Six Years
The IRS isn’t going to deal with you if you have missing returns. It won’t negotiate a payment plan or an offer in compromise and in bankruptcy certain years must be filed as well. The mistake people make is that they assume that if they haven’t filed for 10 years, all 10 have to be filed. This isn’t typically the case because in most cases the IRS only requires 6 years of missing returns if they haven’t already done them for you.
On rare occasion it makes sense to file beyond the 6 year mark other than to challenge an ASFR. If you never file a tax return for a particular year, no statute of limitations period begins to run. The IRS can file that return for you forever, or charge you with a crime for failure to file…forever. Also, if you don’t file it, you can’t ever get the clock running for bankruptcy purposes.
I can’t tell you how many times someone calls me who just filed 10+ years of missing tax returns creating thousands of dollars of unnecessary debt. If you are about to do this – talk to me first…please.
Eighth – Self Employed During Those Years and Don’t Have Good Documentation? The Returns Can Be “Pieced” Together
The IRS has income histories for you several years back. The document that needs to be ordered is called a “Wage and Income Transcript” and it will show you everything reported income wise, mortgage interest wise and a few other items. You can use that and your old bank statements to re-create income.
Figuring out the missing information about expenses, especially small business expenses ,is often the more difficult problem. But if we know your income, we can often piece together your business budget from old bank statements and comparable expenses from similar businesses. The law requires a best guess based on a reasonable foundation. That can be built.
Search around our blog for more information, or simply call and ask for me directly. I will speak with you for about 15 minutes for free and answer your questions.
Millions of Americans fail to file tax returns each year for various reasons. The most common reason we see is simply procrastination combined with a dash of fear. Every late tax return filer worries about what the consequences might be. Some think about it every day of their lives. If this sounds familiar, here are nine things you need to know.
1. Lost Refunds In order to receive a refund if you are owed one, the return must be filed within three years of the due date. Yes ¦they will keep it no matter how large it is, and yes it is often a very large windfall for the government.
2. Lost Earned Income Credit
The 3 year rule strikes again. Failure to file within that time period means that your “Earned Income Credit” will be lost as well.
3. Lost Social Security Benefits
If you are self employed, you have to file returns reporting self employment income within three years of the due date in order to receive social security credits toward retirement.
Income is reported to the IRS both from employers and from others. So, even if you are self employed, the IRS may have information about how much your clients paid you in a given year. At some point, the IRS will use that information to create a tax return for you. It won’t be correct, as it won’t contain correct deductions. It can be used to assess a debt and begin the collection process however. The assessment of the tax based on a substitute return can also create other serious problems related to future tax debt options like bankruptcy.
The IRS is starting to catch up to the computer age. As a result, it has ramped up it\’s pursuit of non-filers. It can charge non-filers with a crime. The willful failure to file is a misdemeanor and can result in a sentence of up to one year in prison for each tax year not filed.
7. Avoiding Prosecution
Most people with unfiled returns will avoid criminal prosecution for three reasons.
Numbers: It is difficult for the IRS to get to everyone right now. There are just too many non-filers and too few employees in relation.
The Voluntary Compliance Program: If the non-filer attempts to come forward before an IRS investigation or examination ensues, he or she will usually avoid prosecution related to the failure to file the returns.
IRS can’t prosecute after six years: The IRS is barred from prosecuting the failure to file a tax return if the return twas due to be filed more than 6 years ago.
8. The substitute return can be challenged
The substitute return mentioned above can be challenged via the audit reconsideration process. This means that even though the IRS has filed the return with incorrect numbers, it will consider and usually accept your correct return even if filed much later. Whether it makes sense to use this process to deal with the debt, depends on the individual circumstances of the case.
9. If the IRS files Substitute Returns First – You can probably forget using Bankruptcy later to discharge the debt.
In most Jurisdictions, the filing and assessment of a substitute return by the IRS before you file the correct return makes it difficult to treat the tax debt as dischargeable in bankruptcy. If you suspect that you may owe a large amount of income tax debt and want to preserve the ability to discharge it in bankruptcy later, your returns should be filed before the IRS gets a chance to do it for you.