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A retired couple decides to liquidate some of their stock investments because they are no longer able to handle the ups and downs of the market. This action puts them into a strong and safe cash position but also produces a large tax bill. Paying that bill significantly reduces the savings they have built and depend upon for their retirement years.

They decide to make an Offer-in-Compromise with the IRS instead. The offer is rejected by the IRS because the analysis of their financial position shows that they could full-pay the debt. Is it a lost cause for this couple?

Not necessarily. The IRS can accept the Offer under Special Circumstances where the collection of the debt in full would create an “Economic Hardship”.  This would be the case for the retired couple depending upon their savings for the rest of their lives.

The big factor for taxpayers hoping to have an Offer with Special Circumstances accepted is a history of compliance. Investing in dubious tax shelter schemes, repeated non-filing penalties, or failure to pay on a regular basis are all factors that will work against the offer.  Most of these offers are in fact initially rejected by the IRS, so you can expect that a trip to Appeals is going to be part of the process.

I will discuss the meaning of “Economic Hardship” in more detail in my next post.

The IRS does have the power to have the State Department revoke your passport for owing back taxes is YES. Recently the Fifth Circuit upheld the constitutionality of the government restricting international travel for James Franklin due to back tax debts of $55,000. Mr. Franklin had claimed that revoking his passport had violated his 5^th Amendment rights to due process. Luckily, the US is a big country, so you can still have some places to go while all those IRS notices are building up in your mailbox.

Revoking your passport is not the only tool in the IRS toolkit that goes beyond liens and levies. In 2014 Congress passed the Consolidated and Further Continuing Appropriations Act that prohibited federal agencies from awarding contracts or grants to contractors with any amount of delinquency in federal taxes. This law does not get used consistently, but it is another good reason to avoid getting in the hole with the IRS.

Companies that fail to make their payroll tax deposits will eventually be faced with dealing with IRS Collections. One of the tools that the IRS has in its arsenal is the Trust Fund Recovery Penalty which is assessed on the people responsible for not making the payments. Defending against this assessment starts with understanding who the IRS will consider to be a responsible person.

The IRS considers a responsible person to be anybody who is accountable for collecting OR paying the payroll taxes and who then willfully fails to do so.  “Willful” sounds like a possible out if your cash flow is in the toilet, but it’s not. Paying other bills before the IRS is considered evidence of willfulness.

Typically, the IRS will assess people in the following positions:

1. 1. The owner/operator – There is no out for anybody in this position. Even if you did not know the taxes were not being paid, the courts have held that you should have.
   2. Other officers of the corporation if they had signature authority on bank accounts and knew that the payroll taxes were not being paid.
   3. Accountants that had signature authority on bank accounts and signed the payroll tax returns.
   4. Lenders who have funded payrolls in the amount that only covers the employees’ net paycheck. The theory here is that they knew the company owed the funds and could have required them to borrow enough to pay the taxes.

The best defense for anybody in these positions, other than the owner, is to not have signature authority on any business bank accounts. The ultimate responsible person is always the top guy or gal. Business owners and CEOs cannot delegate this responsibility away.

My next post will cover some strategies for dealing with a potential Trust Fund Recovery Penalty.

The IRS recently released their Data Book for 10/1/19 – 9/30/20. This publication is a compilation of various statistics for the fiscal year ended 9/30/20. You can find some interesting information that might be useful in dealing with the IRS.

For example, ever wonder which penalties are the easiest to abate? Table 26 shows penalties assessed vs. penalties abated. I did a little spreadsheet work and compiled the following table for individual penalties:

The failure-to-file penalty is the most likely penalty to be abated. The accuracy penalty is the one that causes taxpayers the most angst and is one of the hardest to get relief.

The bad check penalty is interesting. It’s one of the easiest penalties to have abated since it requires someone to knowingly issue an insufficient funds check. Most of the corporate bad check penalties are abated, but only 5% of the assessments on individuals get removed presumably because the amounts are too small to bother with.

The most effective IRS tool for getting paid is the Federal Tax Lien Notice. Should you sell your real estate, they are virtually guaranteed to get your share of the proceeds to cover your tax debt. Most payment plans on the other hand end up in default. As a result, they will not remove the lien notice simply because you start making monthly payments.

There are some options open to you when it comes to Federal Tax Lien Notices:

1. 1. They will usually issue a Subordination of Federal Tax Lien to allow a bank refinancing of a mortgage provided they get a significant chunk of any cash coming out of the deal.
   2. They will also remove a particular property from their lien provided they get some cash. This is called a Certificate of Discharge from a Federal Tax Lien.
   3. You can get a Lien Withdrawal if you are on a Direct Debit Installment Agreement and your debt balance is $25,000 or less. The catch on this one is that the agreement must lead to full payment in less than 60 months or before the Statute of Limitations runs.

Of course, the option the IRS likes the best is for the taxpayer to just pay off the debt balance. Should that happy day happen, the Lien Withdrawal will be automatically issued within 30 days.

Lien Notices are usually not very disruptive to your life like a levy of your wages or bank account. They do affect your credit score and will result in you getting umpteen letters from people offering to get you out of your problem for “pennies on the dollar.” However, most closing agents have experience in dealing with these when it comes to selling real estate making them a minor complexity in the deal.

Non-Filers have a particular problem when they decide to come in from the cold and rejoin the tax system. That is nonexistent records. Non-Filers are most likely to be people with small businesses that can dodge the 1099/W2 reporting systems. Coming clean with the IRS requires them to report their net income for any returns missing in the last 6 years. What should they do if those records do not exist?

First, you must realize that records do exist. They are just not in the possession of the taxpayer. Here is a list of places to start to rebuild those resources:

1. 1. The IRS transcripts are the first place to start. You can download these from the irs.gov website. Life is a lot easier if late filed returns agree to the 1099s in IRS possession.
   2. Bank statements are still on file at the various banks. There may be some cost to get them depending upon their age.
   3. Credit card statements are also available from the various banks that issue them.
   4. Vendors have records of their billings and collections from their customers. This is particularly important if the transactions were primarily in cash.

Finally, there is the Cohen Rule. Cohen was a 1930 case in which the Court allowed the use of estimates if there is a reasonable basis to assume that the expenses had occurred. This won’t work with travel and entertainment expenses but is still better than nothing when it comes to other costs.

Yes, the fees for cobbling all this stuff together are going to be higher than they would have if you had never gone out of compliance. Think of it as a motivation to avoid this situation in the future.