Author: Jim Payne

Jim Payne, a Florida Certified Public Accountant (CPA) since 1976, offers candid insights on getting square with the IRS — with the least pain, and at the lowest cost — with (or without) the help of a tax representative. Mr. Payne is a former IRS agent and expert in business profitability, IRS audits, IRS payroll tax, and IRS non-filer issues. As a Tax Representative, his goal is clear: " I will speak on your behalf to all IRS agents, so you never have to, and I'll guide you in executing a strategy to resolve your IRS problem so you can get back to enjoying life."

The Real Issue Behind Payroll Tax Problems: Fixing Profitability First

You’re not alone if you’re struggling to keep up with payroll taxes. It’s a problem many small business owners face, especially when cash is tight, and profits aren’t where they need to be. But here’s the thing: payroll tax issues usually aren’t the main problem—they’re a symptom of something bigger. At the heart of it, the real challenge is profitability.

It’s easy to feel overwhelmed when the IRS sends notices or punishes you. But instead of focusing only on the payroll tax deadlines, it’s essential to take a step back and look at the bigger picture. Why is it that these taxes are burdensome to pay? More often than not, it’s because your business isn’t generating enough profit to cover your obligations comfortably.

What’s Going On?

Cash flow becomes a juggling act when a business isn’t consistently profitable. Sure, you’re making sales, but when you look at what’s left after paying your bills, suppliers, and employees, there’s often insufficient to cover everything—including those payroll taxes. It’s a vicious cycle: the less profit you have, the harder it becomes to stay on top of obligations like taxes, and the penalties keep adding up.

If your profit margins are tight, any small hiccup—a slow month, an unexpected expense—can throw everything off balance. Payroll taxes, because they’re not always front-of-mind day-to-day, become something that gets delayed, and that’s where trouble with the IRS starts.

Turning It Around: Focus on Profitability

So, what’s the solution? It comes down to increasing profitability so that paying your payroll taxes and other bills becomes less of a strain. Here are a few practical steps to help you get started:

Take a Hard Look at Your Pricing: Are you charging enough for your products or services? Sometimes, businesses underprice to stay competitive, which could hurt your bottom line. Make sure your pricing reflects the true value of what you offer.
Trim Unnecessary Costs: It’s incredible how small expenses can add up. Review your expenses and cut anything that isn’t necessary. Whether it’s unused subscriptions or overpriced services, reducing these costs can free up much-needed cash.
Improve Cash Flow: A profitable business needs steady cash flow. Speed up how quickly customers pay you, negotiate longer payment terms with suppliers or offer discounts for early payments. These small changes can make a big difference.
Focus on Your Best Sellers: Every business has products or services that are more profitable than others. Putting more energy into what makes you the most money can improve profitability without increasing your workload.

The Long-Term Benefits

Once you get a handle on profitability, you’ll find it’s much easier to stay on top of payroll taxes. Instead of scrambling every quarter to find the money, you’ll have a cushion to meet your financial obligations comfortably. Even better, you’ll have peace of mind knowing the IRS won’t be sending you any surprise letters.

Ultimately, payroll tax problems are often just the tip of the iceberg. The real issue is profitability; once you fix that, everything else—including taxes—falls into place. So, take the time to focus on increasing your profits, and you’ll not only avoid IRS trouble but build a more substantial, more stable business.

By addressing profitability, you’re not just solving one problem—you’re setting your business up for long-term success.

How to Correct Unreasonable Compensation Before an IRS Audit Hits

As a business owner, figuring out how much to pay yourself can be tricky. Paying too little or too much can lead to issues with the IRS if your compensation is deemed “unreasonable.” The good news? You can correct unreasonable compensation before an IRS audit, and in some cases, it may even make sense to amend prior years’ returns—but only in specific situations.

What Is “Unreasonable Compensation”?

In closely held corporations, particularly S corporations, the IRS monitors how much you pay yourself as an officer. If your salary is too low (or zero), and you take most income through dividends, the IRS may see this as an attempt to avoid payroll taxes. They might reclassify those dividends as wages and hit you with back payroll taxes and penalties. On the other hand, if you overpay yourself, the IRS could disallow part of your salary as a deductible business expense, increasing your corporate tax bill.

How to Correct Unreasonable Compensation

If your compensation seems out of line, here’s how you can fix it:

Research Industry Standards: Look into what similar business owners in your field are paying themselves. Industry reports and salary databases are good places to start. Make sure your salary fits within that range.
Document Your Role and Hours: Your compensation should match your duties. A higher salary is justified if you’re working long hours and wearing many hats. If your involvement is minimal, a lower wage makes sense. Keep records of your responsibilities to support your salary.
Adjust Your Salary Going Forward: If your salary is too low and you rely on distributions, start paying yourself more. If it’s too high, adjust it to a reasonable level that aligns with your duties and industry norms.

Should You Amend Prior Year Returns?

Amending prior years’ returns to correct unreasonable compensation can be costly and complex. It would be best if you only considered this option in specific cases.

If your officer salary was reported as zero in past years, amending those returns might be necessary. Taking no salary while drawing dividends is a major red flag for the IRS. By amending, you can report a reasonable salary, pay the required payroll taxes, and potentially avoid larger penalties in an audit.

However, if your past salary was just a bit low, amending might not be worth the expense. In these cases, correcting your salary for future years is often sufficient to avoid issues.

Take Action Now

It’s better to correct unreasonable compensation before the IRS audits you. If your officer salary was zero in prior years, amending returns could help you avoid penalties. But if the difference is minor, adjusting your salary in the future is often enough to get back in line. Taking action now can save you stress and trouble later.

The Cohen Rule: Still Helping Taxpayers Nearly 100 Years Later

There’s good news if you’ve ever been stressed about not having every receipt for your tax deductions. Almost 100 years ago, a principle was established that still benefits taxpayers today—it’s called the “Cohen Rule.” Born out of the 1930 Cohen v. Commissioner case, this rule remains a powerful tool, saving taxpayers from being unfairly penalized when documentation is missing or incomplete. And believe me, it’s still relevant—even though some may have thought it had faded into obscurity.

My Experience as an IRS Agent: Is the Cohen Rule Dead?

When I was an IRS Agent decades ago, my Group Manager often claimed the Cohen Rule was dead. I heard it all the time. But even then, I knew better. In practice, the Cohen Rule was still quietly applied in cases where taxpayers couldn’t produce every receipt but had reasonable, credible deductible estimates. And today, it’s still doing exactly that—protecting taxpayers who may not have a perfect paper trail.

The Origins of the Cohen Rule

The rule originated when George M. Cohen, a famous Broadway producer and performer, faced a challenge we all can relate to: he claimed deductions for business expenses. Still, he didn’t have every receipt on hand. The IRS disallowed those deductions, but Cohen argued that the expenses were reasonable and ordinary for his line of work. The court ruled that if a taxpayer could provide reasonable estimates for legitimate expenses, the deductions could still be allowed, even without perfect documentation.

How the Cohen Rule Helps Taxpayers Today

Fast forward nearly 100 years, and the Cohen Rule remains vital, especially for non-filers trying to get back on track. When you’ve fallen behind on filing taxes, tracking down every bit of paperwork can feel impossible. The IRS typically requires documentation for expenses, but if you don’t have all your records, the Cohen Rule can help. It allows taxpayers to estimate certain expenses as long as they’re reasonable and supported by other evidence, like bank statements or testimony.

Impact on Non-Filers

This flexibility is crucial for non-filers. Imagine trying to catch up on several years of taxes but missing essential receipts for legitimate expenses. Without the Cohen Rule, you could face hefty penalties, interest, and additional taxes just for not having every document. But the rule provides some much-needed breathing room, recognizing that life isn’t always perfect, and neither is paperwork.

Conclusion: The Cohen Rule Still Offers Relief

In a world where tax compliance can feel overwhelming, the Cohen Rule is still quietly offering taxpayers a fair chance—even decades after my manager claimed it was dead. For those behind on their taxes or who don’t have every receipt in hand, it’s a reminder that reasonable, honest efforts to comply are still respected.

Statute Of Limitations: The IRS Is Wrong Many Times

When it comes to dealing with the IRS, many taxpayers feel a sense of dread—and for good reason. The IRS, while powerful, does not have a reputation for precision. In fact, the agency is often wrong, and taxpayers can be left sorting through the mess. One critical area where the IRS often stumbles is in applying the Statute of Limitations (SOL), the time limit for certain IRS actions, such as audits or collections. Understanding how the IRS frequently miscalculates the SOL could help you protect your rights and push back when they overstep.

What is the Statute of Limitations (SOL)?

The Statute of Limitations essentially places a deadline on how long the IRS can take certain actions:

Audits – The IRS generally has three years from when you file your return to audit it. However, if you underreport your income by 25% or more, that window extends to six years. If you fail to file a return or commit fraud, there’s no limit—the IRS can audit anytime.
Collections – For unpaid taxes, the IRS has 10 years from the date they assess the tax to collect it. After that, they are supposed to stop all collection efforts.

Sounds simple, right? Not so fast. The IRS often messes up when calculating these deadlines.

How Does the IRS Get the SOL Wrong?

One of the most common errors involves “tolling events,” which pause or extend the SOL. These events include filing for bankruptcy, submitting an Offer in Compromise (OIC), or requesting a Collection Due Process (CDP) hearing. Each of these can temporarily stop the clock, but the IRS can (and does) miscalculate how long the pause lasts, incorrectly extending the SOL.

Another frequent mistake happens when the IRS doesn’t correctly record when a return was filed or tax was assessed. This could lead to the IRS attempting to collect taxes or audit a return long after the deadline. For taxpayers, this can feel like being chased for a debt that should have been closed years ago.

What Can You Do When the IRS Makes Mistakes?

If you think the IRS is acting outside the SOL, you have options:

Request your account transcripts using IRS Form 4506-T. This will give you a breakdown of your tax history and show how the IRS calculates dates.
You can challenge the IRS’s actions by appealing or disputing their calculation. Working with the Taxpayer Advocate Service (TAS) can sometimes help resolve complex issues.
Know your rights – Familiarizing yourself with IRS procedures in the Internal Revenue Manual (IRM) can give you the upper hand when dealing with SOL miscalculations.

The IRS might not always be right, but it’s up to taxpayers to hold them accountable. Knowing the limits of what the IRS can do—and when they’ve gone too far—can save you from unnecessary headaches and stress.

How the IRS Uses Indirect Methods to Calculate Taxable Income for Non-Filers Without Records

When a taxpayer fails to file a return or keeps inadequate records, the IRS doesn’t just shrug and give up on assessing tax. Instead, it has a range of tools at its disposal to estimate a person’s taxable income through what’s known as “indirect methods.” These techniques help the IRS reconstruct income when accurate records are unavailable, ensuring that non-filers are held accountable.

What Are Indirect Methods?

Indirect methods refer to various approaches the IRS can use to estimate an individual’s or business’s income when direct evidence, like bank statements or tax returns, is incomplete or missing. These methods rely on external sources of information and lifestyle indicators to paint a picture of the taxpayer’s financial situation.

Some of the most commonly used indirect methods include:

Bank Deposits Method: This involves analyzing taxpayers’ bank accounts to identify deposits. The IRS assumes that most bank deposits reflect income unless proven otherwise, such as loan repayments or gifts. The IRS adjusts for known non-taxable deposits, but unexplained amounts are generally considered taxable.
Net Worth Method: The IRS assesses changes in a taxpayer’s net worth over time by examining assets, liabilities, and expenditures. If a taxpayer’s wealth significantly increases without a corresponding explanation (like inheritance or gifts), the IRS may attribute that growth to unreported income.
Expenditures Method: This method assumes that a person’s income must cover expenses. The IRS can estimate income levels by evaluating a taxpayer’s spending patterns. For example, if someone is living a high-cost lifestyle but there’s no evidence of reported income, the IRS may assume that unreported income is financing those expenses.
Markup Method: Typically used for businesses, this method calculates income based on the cost of goods sold and expected profit margins. Suppose a business doesn’t have records or reports less income than seems plausible. In that case, the IRS uses industry standards to estimate the revenue based on purchases and standard markup rates.
Cash-T Analysis: This approach looks at taxpayers’ cash on hand and spending. If someone spends more money than they could reasonably withdraw or earn based on their reported income, the IRS may infer additional unreported cash income.

Are Indirect Methods Likely to Overstate Income?

Indirect methods rely heavily on assumptions, which means the IRS could overestimate taxable income. For instance, if the IRS mistakenly classifies a non-taxable deposit as income or overlooks legitimate expenses, the taxpayer’s income could be overstated. However, taxpayers can challenge these estimates by providing evidence to the contrary. Proper documentation is crucial to avoid this scenario.

The Takeaway

Indirect methods are essential tools in the IRS’s arsenal, allowing them to estimate taxable income even when non-filers try to evade detection. Anyone in this situation should understand that the IRS can and will find ways to calculate your income. If you’re concerned about unfiled returns or incomplete records, it’s always better to voluntarily file and communicate with the IRS before they contact you with these indirect techniques.

Record Keeping 101: Essential Tips for Non-Filers

Keeping good financial records is important even if you haven’t filed taxes in a while. Non-filers still need to track income and expenses in case the IRS contacts them. This guide covers what records to keep, how long to keep them, and why it’s important.

Why Record-Keeping Matters

You might think you don’t need to keep records if you haven’t filed taxes. However, the IRS can pursue unfiled returns for up to six years (longer if fraud is involved). Organized records can help you file past-due returns, avoid penalties, and correct any mistakes the IRS may make in estimating your tax liability.

Accurate records are essential to qualify for IRS programs like Offer in Compromise (OIC) or Currently Not Collectible (CNC) status. These require proof of financial hardship, which you can’t show without the proper documents.

Record Keeping for Small Business Owners

Small business owners and self-employed individuals are likelier to fall behind on tax filings. Record keeping is even more important for these individuals, as their income and expenses are often complex.

If you’re a small business owner who hasn’t filed, be sure to keep:

Income Records: Keep sales receipts, invoices, 1099 forms, and payment platform records (PayPal, Stripe, etc.).
Expense Receipts: Save receipts for business expenses like office supplies, advertising, or vehicle costs.
Business Bank Statements: Keep business bank and credit card statements to verify income and expenses.
Payroll and Contractor Records: Maintain payroll records and Forms 1099 for contractors.
Asset and Inventory Records: Track inventory and equipment depreciation for tax deductions.

How Long to Keep Records

The IRS recommends keeping records for at least three years after filing, but the clock doesn’t start until the return is filed for non-filers. To be safe, hold on to records for at least six years.

Conclusion

Good record-keeping is essential for non-filers, especially small business owners. Whether you need to file past-due returns or prove financial hardship, organized records will help you get back on track with the IRS. Take the time to sort through your receipts and statements now—it will save you stress later.

IRS Notice of Determination…Now What?

Receiving an IRS Notice of Determination can be intimidating, but don’t panic—it’s just a step in the IRS process that requires your attention. This notice typically means the IRS has decided on a tax matter you’ve been involved in, such as a request for an Offer in Compromise, a Collection Due Process (CDP) hearing, or another dispute resolution. Let’s walk through what it means and what steps you can take.

1. What is an IRS Notice of Determination?

An IRS Notice of Determination is a formal letter to inform you of the agency’s decision after reviewing a tax-related issue. It commonly follows an appeal or request for review, often related to collections, levies, or liens. In a Collection Due Process hearing, for example, the notice signifies the conclusion of your appeal. The IRS outlines whether they’ll continue with collection actions or if you have some relief, such as a new payment arrangement.

2. What’s in the Notice?

The Notice of Determination will summarize the IRS’s findings and explain their decision regarding your case. It will also include information about your rights and what steps you can take next, whether accepting their decision, appealing it further, or taking action to prevent enforcement measures like levies or liens.

3. What Are Your Next Steps?

Depending on your situation, you may have several options:

Accept the Determination: If you agree with the IRS’s findings, you can accept the outcome and follow any instructions. For example, if the IRS approves a payment plan, you would begin making those payments.
File a Petition in Tax Court: If you disagree with the IRS decision, you can petition the U.S. Tax Court. You have 30 days from the date of the notice to file, so time is of the essence. Tax Court offers an independent review of your case, possibly leading to a different outcome.
Negotiate or Take Action: Depending on your situation, you may want to negotiate further with the IRS or submit additional documentation to support your case. This could include applying for another IRS collection option, such as an Offer in Compromise, Installment Agreement, or Currently Not Collectible (CNC) status.

4. Why Timing Matters

Timing is critical when dealing with a Notice of Determination. The IRS gives you a limited window to respond—usually 30 days—to either comply with their decision or challenge it. Failing to act in time could result in enforced collection actions, like wage garnishments or bank levies.

Bottom Line

Getting an IRS Notice of Determination doesn’t have to be overwhelming. It’s a crucial step in the process, and knowing your options—whether to accept, appeal, or negotiate—can help you make the right move. Remember to act quickly and keep all communications with the IRS in writing to protect your rights.

Differences Between RCP Type OIC and ETA OIC: Actual Negotiation Required

I recently represented a woman in her 80s who had been defrauded from most of her life savings. She was forced to liquidate her brokerage and retirement accounts, which created a large tax bill due to income and capital gains. Although she had enough left to pay the taxes, doing so would have left her financially unstable for the rest of her life.

Our only option was an Offer in Compromise (OIC) based on Effective Tax Administration (ETA OIC). A Reasonable Collection Potential (RCP) OIC wasn’t an option because she could technically afford to pay full taxes. After lengthy negotiations, the IRS settled for about half of the taxes owed. The process, however, was far more complicated and subjective than a typical RCP offer. In the end, neither my client nor the IRS was particularly happy, but it was a compromise that allowed her some financial security.

This case highlighted the key differences between an RCP OIC and an ETA OIC—especially during negotiations.

RCP Type OIC (Doubt as to Collectibility)

An RCP-type OIC is for taxpayers who cannot fully pay their tax debt. The IRS calculates its Reasonable Collection Potential (RCP) by looking at income, assets, liabilities, and living expenses. If the taxpayer’s financial situation shows they can’t afford to pay, the IRS may agree to settle for less.

RCP OIC Negotiation:

Numbers-Driven: The IRS relies on strict calculations to determine how much the taxpayer can afford to pay.
Little Room for Subjectivity: It’s about the numbers. If the offer matches the taxpayer’s RCP, it’s likely to be accepted.
Rigid Process: If the IRS determines taxpayers can afford to pay, they likely won’t accept a lower offer.

ETA OIC (Effective Tax Administration)

An ETA OIC is different. It’s for taxpayers who can technically pay their debt but would find it difficult to do so. In my client’s case, paying the full amount would have left her financially vulnerable for the rest of her life.

ETA OIC Negotiation:

Focus on Hardship: This type of offer considers personal circumstances, such as age, health, and future financial needs.
More Subjective: I had to argue that even though she could full-pay, it would have been unfair. This type of negotiation requires a narrative backed by facts, showing why paying the debt would be unjust.
Longer and More Complex: The IRS takes more time to review these cases and has more back-and-forth than RCP offers.

Key Differences in Negotiation

The main difference between an RCP OIC and an ETA OIC is the negotiation focus. With RCP offers, the numbers drive the decision. If taxpayers can’t afford to pay, the IRS will accept less. The process is straightforward and primarily based on financial data.

With an ETA OIC, it’s more about fairness. I needed to show that paying in full would cause undue hardship, even if the taxpayer could technically afford it. These negotiations are more subjective and can be drawn out as both sides work through the details.

In my client’s case, the ETA OIC allowed her to avoid full payment, giving her a chance to live out her final years with some financial peace of mind. While the process was complicated, and neither side was thrilled with the outcome, it was a fair resolution for her situation.

Understanding the Different Types of Offer-in-Compromise: A Path to Tax Relief

An Offer-in-Compromise (OIC) can be a lifeline for taxpayers with overwhelming tax debt. It lets individuals settle their tax liabilities for less than what they owe, but only if they meet specific criteria. This isn’t a free pass. The IRS closely reviews each application, considering your ability to pay, income, expenses, and assets. There are three main types of OICs: Doubt as to Collectibility, Doubt as to Liability, and Effective Tax Administration. Each one applies to different situations. Knowing which one fits your case can help improve your chances of approval.

1. Doubt as to Collectibility (DATC)

This is the most common type of OIC. It applies when you can’t afford to pay the total tax debt. The IRS looks at your income, assets, and allowable expenses to see if you can’t pay the total amount. You must provide detailed financial documents like bank statements and pay stubs to qualify. If the IRS determines that you won’t be able to pay off the debt within the remaining collection period (usually ten years), they may accept your offer for a lower amount.

Given your current financial situation, your offer must be the most the IRS could reasonably expect to collect from you.

2. Doubt as to Liability (DATL)

This type of OIC applies when you disagree with the tax debt or believe it’s incorrect. You might submit a DATL offer if you think there was a mistake in the audit process or if you have new evidence that reduces your liability.

To succeed with this offer, you’ll need robust documentation showing why the IRS’s assessment is wrong or why the amount should be lower.

3. Effective Tax Administration (ETA)

An Effective Tax Administration offer is used when paying the full tax would cause serious hardship. This type of offer is rare. It’s for people who can technically pay the debt, but doing so would leave them unable to meet basic living expenses. For example, an ETA offer might apply if you liquidated a brokerage or IRA account due to fraud and now face high taxes on top of the loss. Even though the debt is valid, the IRS may accept less if collecting the total amount would cause undue financial strain.

Conclusion

Choosing the right Offer-in-Compromise is crucial to improving your chances of acceptance. The OIC process offers a possible solution, whether you’re facing financial difficulties, disputing the tax, or dealing with hardship. Be sure to meet the eligibility requirements and provide the necessary documentation to back your case.

How to Calculate Reasonable Compensation for S Corporation Owners

One of S corporation owners’ most crucial tax considerations is determining “reasonable compensation.” The IRS scrutinizes S corporation shareholders’ compensation because it impacts how income is taxed. While S corporation shareholders can take salary and distributions, only the salary is subject to payroll taxes. Distributions are not, making it tempting to underpay salaries. However, doing so can lead to IRS penalties if the salary is deemed unreasonably low.

What is Reasonable Compensation?

Reasonable compensation is the salary an S corporation owner must pay themselves for the services they provide to the business. The IRS expects this salary to reflect what someone in a similar role with similar experience would earn in the market.

The IRS looks at factors such as:

The shareholder’s duties and skills
Time and effort spent on the business
Comparable salaries in the industry
The company’s gross revenue and profits

How to Calculate Reasonable Compensation

1. Research Comparable Salaries
Use resources like the Bureau of Labor Statistics (BLS) or salary surveys to find salary data in your industry and region. For example, if the owner is both a CEO and performs technical work, combine salaries for those roles.

2. Consider Hours Worked
Estimate the time spent on each role and calculate compensation based on that split.

3. Factor in Company Financials
Your compensation should also reflect the financial health of your business. Higher profits may justify a higher salary while struggling businesses might opt for more modest compensation.

The Importance of Documentation

Maintaining documentation or a study to support your salary calculation is crucial. Without this, you leave the determination of what is “reasonable” to an IRS auditor if you’re ever examined. This could result in the auditor setting a higher salary than you paid yourself, leading to back payroll taxes, penalties, and interest.

If the IRS determines underreported wages, they will likely apply the adjustment to all three open tax years, increasing your liabilities.

Conclusion

Determining reasonable compensation for S corporation owners is critical to avoiding payroll taxes and penalties. To protect yourself in the event of an audit, be sure to document your approach based on industry standards, duties, and financial performance.