If you had a serious illness like some form of Cancer, who would you want to consult with first?
Your Cousin Fred
A Family Doctor
A Doctor who specializes in Treating Your type of Cancer
You would want to speak with the Specialist right? Why? A Specialist has been trained for years to understand your illness and specifically treat it.
Go it alone
If you have a serious Tax Debt problem wouldn’t the same thought process apply?
I mean, you could go it alone right, talk to Fred a bit and do some research…
But if the problem were serious enough, would you take the chance that you had the time and ability to learn how to solve it and implement what you had learned?
Of course you are going to do some of your own reading on the subject, but reading some websites and downloading a few articles isn’t going to help you find and obtain the best solution to a serious tax problem. It wouldn’t help you solve your own serious illness either.
The IRS is trained and collects taxes every day – they are good at it. You will be doing it once…hopefully. You aren’t good at it and Fred probably isn’t either.
The IRS is trained to make you feel comfortable and to disclose things or provided thing that will hurt your case.
A Tax Attorney is specifically trained to research and zealously pursue his or her client’s best interests agains the IRS. A good Tax Attorney will make the IRS work hard, and
will often find ways to reduce or eliminate substantial amounts of tax debt using methods you may not know existed.
What about your Accountant?
Accountants do a lot of accounting like Preparing Financial Statements and balancing Books. Most Accountants spend very little time dealing with Tax Resolution issues, if any time at all. Accountants are great for planning ahead, preparing necessary items, calculating tax returns and helping you take advantage of legal tax breaks.
An accountant isn’t always equipped and doesn’t necessarily want to be equipped, to deal with the serious problems that arise from failing to file returns or failing to pay the tax debt.
Thats the job of a Tax Lawyer, someone who focuses on the law surrounding tax debt collection and tax controversy.
Tax problems are a legal issue. They are based on United States Laws that state that give the IRS the ability to seize money and property and charge you with a crime.
If you are really ill, you may visit your family Doctor first, I agree. A good family Doctor will recognize quickly that you need to see a specialist. A good Attorney will do the same and tell you to see another lawyer who focuses on dealing with Tax Debt. Attorneys who don’t focus their practice on Tax Problem Resolution are at a disadvantage primarily because they haven’t spent enough time dealing with the issues surrounding Tax Collection to know all of the ins and outs.
I don’t practice Family Law for the same reason.
You wouldn’t continue to see your Family Doctor if he or she didn’t deal with your type of Cancer on a regular basis either would you?
Serious Tax Debt
Serious IRS Debt requires the use of an Attorney who deals with the IRS directly and in Bankruptcy Court all the time. If you don’t use an Attorney with that type of practice you may very well miss out on a loophole in the law that will cure your problem.
Thousands of Americans have serious tax debt. They are often taken in by the promise of an easy solution via the IRS offer in compromise (OIC) program. The problem is that most people aren’t good candidates for the OIC program.
In an OIC the IRS is empowered to accept less than what they are owed if:
1. The debt amount is incorrect
2. The debt isn’t reasonably collectible
3. The debt is collectible but there is some other reason that would make it unfair for the IRS to collect the debt.
Most OIC cases are those that are based on #2 – the debt isn’t reasonably collectible. Most people don’t try an OIC and of those that try, most fail.
Reason 1 – The debt is collectible
The IRS is allowed to use a “formula” to determine whether a debt is collectible before the 10 year statute of limitations (SOL) on collection runs out. The formula is theoretically simple.
Average Income – “necessary” Budget = Excess Income
Excess income multiplied by time left in SOL + asset value = amount collectible over remaining time in SOL
If amount collectible over remaining SOL is less than the debt:
Cash Offer – Excess income x 12 plus asset value = OIC amount
Payment Offer – Excess income x 24 plus asset value = OIC Amount
The formula is simple on it’s face and for those that make little money and have few assets the formula often works well. The problem and the reason why so many OIC’s fail, is found in the details of the formula.
How does the IRS calculate income? If you have had a down year income wise, will the IRS limit it’s calculation of your income average to that year?
How does the IRS calculate your budget? It uses a standard budget with variations. Not your budget. If your house payment is $2500 per month and the standard for your household size is $1500 per month, it will usually use the lower number creating a larger excess income amount and phantom income.
The formula usually results in a failed OIC based on one of two things:
The IRS sees the ability to pay the entire debt before the statute of limitations runs out
The formula works but the taxpayer can’t afford to pay the settlement amount
Reason 2 – The process can be difficult
The IRS purposefully makes the process difficult. It initially rejects many cases and many do not have the funds or desire to continue the fight.
Reason 3 – Large amount paid upfront
The taxpayer must typically pay 20% of the debt with the offer (in a cash offer) or start making monthly payments equal to the offered monthly payment amount and loses those funds if the offer is unsuccessful.
Reason 4 – Full compliance is often a problem after acceptance
IF the offer is successful, the taxpayer must file tax returns and pay tax obligations for 5 years, if not, the offer is over, the money paid is lost, and the total original debt with it’s accrued interest, continues to be owed, minus what has been paid.
Reason 5 – Offer in Compromise is not a complete solution
Often, the taxpayer proposing the OIC has medical bills, credit card debt, personal loans, state tax debt etc. all of which must still be dealt with outside of the offer in compromise. The payments on these debts aren’t always allowed as part of the budget in calculating the reasonable collection potential of the taxpayer, making it difficult to comply with the requirements of the OIC.
OIC’s have other problems as well
1. When an OIC is rejected, the taxpayer still owes the entire debt with interest, while the statute of limitations period on the collection of the debt has been stopped. The taxpayer is right back where he or she began.
2. The taxpayer who has been rejected, has provided every detail about his or her financial life to the IRS making it easy for it to collect the debt. They’ve provided a detailed roadmap.
3. The OIC stops certain time-period(s) from running for purposes of bankruptcy requiring a payment plan to be negotiated post rejection in order to run out the time.
BANKRUPTCY – is it really an alternative?
Believe it or not many people with tax debt use bankruptcy to reduce, eliminate or control tax debt.
A quick review of bankruptcy in relation to tax debt will help to explain why:
There are two types of bankruptcy that pertain primarily to consumers. Chapter 7 and chapter 13.
A chapter 7 bankruptcy is the more commonly filed, and is a liquidation case. In a chapter 7 bankruptcy, the debtor loses all assets not protected by statute and is forgiven his or her dischargeable debt.
Chapter 13 bankruptcy is a “reorganization” bankruptcy. The debtor attempts to keep his or her assets and pay some or all of the debt depending on income and budget amounts. The plan length varies between 3 and 5 years depending on a number of factors.
Tax debts as alluded to above, are classified in either a chapter 7 or chapter 13 as either dischargeable or non dischargeable on the date the bankruptcy petition is filed.
Non-dischargeable tax debts include:
1. collected and unpaid sales tax (of the trust fund nature)
2. trust fund recovery penalty (employment tax unpaid by a business assessed against a “responsible party”).
3. Trust fund tax
4. Income tax related to a return that was not filed or filed but within 2 years of filing the bankruptcy.
5. Income tax related to a return that was due including extensions within the last three years
6. Income tax related to a return for which fraud was involved
7. Income tax for a tax liability that was assessed by the taxing authority within 240 days prior to the date of the bankruptcy filing.
Dischargeable tax debt includes:
1. Those income and certain other non “trust-fund” taxes that meet the following criteria:
A “return” was filed
It was filed more than two years ago
It was due more than three years ago including extensions
The tax was assessed more than 240 days ago
There was no civil or criminal fraud nor did the taxpayer willfully evade or defeat the payment of the tax debt.
In essence, a tax motivated bankruptcy is a bankruptcy case that takes into account filing issues, timing and taxpayer history in a way to take maximum advantage of bankruptcy law in relation to the tax debt.
Or in other words, what may be a non-dischargeable tax debt today may become a dischargeable tax debt tomorrow.
The other benefits in comparison to an offer in compromise are as follows:
1. OIC’s factor in the taxpayer’s income while chapter 7 bankruptcies usually don’t. In a chapter 7 if the majority of the taxpayer’s debt is tax debt, then the income is irrelevant as to whether the taxpayer qualifies to file a chapter 7. The bankruptcy means testing shouldn’t apply.
2. OIC’s factor in future income potential while most bankruptcies don’t. It may not matter in bankruptcy that the taxpayer may be making more next year. Many offers are rejected on that basis alone.
3. OICs factor in asset equity. Bankruptcies do not. Equity in bankruptcy has little to do with ability to file or the dischargeability of the debt itself. Certain assets may be liquidated in a chapter 7, most consumer assets are safe.
4. The largest benefit of bankruptcy over the Offer in Compromise is that a bankruptcy can be crafted to deal with all of the other taxpayers debts at once. State tax, credit card, medical bill, personal loans and other consumer debt.
The IRS audit or the creation of tax returns by the IRS are uncomfortable propositions no matter your circumstance. The Cohan Rule may help.
Why so scary? An audit is just an attempt by the government to grade your homework right? A simple review of the documents you used to create your income and deduction disclosures. No big deal.
For many, the above is true. Of course, they are the ones that sat in the front of the class.
For most of us, a review of documents used to create income and deduction disclosures is scary. Why? Bad recordkeeping.
Now, I am just trying to be funny by over-generalizing. In reality, many of those who sat in the back of the class , are good record-keepers and vice versa. No matter our personalities, we should all be aware of the following:
The IRS can ask for documents and other proof to substantiate income and deductions claims on the tax return.
The IRS can review bank statements and lifestyle clues for signs of unreported income.
The IRS can expand an audit from one year to multiple years
The lack of substantiation can turn a civil audit into a criminal referral.
An attorney is needed to deal with the sensitive areas of the audit to try and prevent audit expansion and criminal referral.
The Good News:
Despite the above, “holes” in your record keeping i.e. missing receipts, checks etc. can be filled in legally.
Thanks to an old case called Cohan v. Commissioner, 39 F 2nd 540 (2nd Cir. 1930), the IRS will allow proof of expenses, even if receipts and checks are missing.
The catch is that the taxpayer must have a “reasonable basis” for the claim made on the return.
What is “reasonable basis” then? An example.
Imagine a realtor that drove many miles over hill and dale, night and day in her attempt to sell homes. She maintained a calendar of her workday all year, but didn’t keep a mileage log.
When audited she reconstructs the mileage log using the calendar. She submits the new mileage log along with an affidavit in which she swears that she drove that many miles.
What if the audit has already completed and the realtor did not recreate her mileage log. She knows the new bill is too high but doesn’t know what to do.
If the audit has been completed and the bill is too high, the audit may be reopened and the IRS can review the created mileage log. This process is called “”audit reconsideration“.
The Cohan rule still stands for the proposition that direct records aren’t necessary to verify an IRS expense deduction if a “reasonable basis” estimate can be reconstructed. If you have unfiled returns or are being audited and are concerned about missing documents, you are welcome to call me to discuss.