Podcast: IRS Debt Do's & Don'ts

IRS Data Book

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:

 

Type of tax and type of penalty Civil penalties assessed Civil penalties abated % of # % of $ abated
Number Amount Number Amount
Civil penalties, total 33,393,194       17,132,623       3,069,510       2,702,606       9% 16%
Accuracy 788,243 1,821,183 37,241 230,451 5% 13%
Bad check 1,041,858 96,592 55,027 18,976 5% 20%
Delinquency 3,404,985 4,568,266 430,604 1,081,078 13% 24%
Estimated tax 11,103,032 2,165,917 336,758 432,405 3% 20%
Failure to pay 17,048,457 8,028,212 2,209,541 903,366 13% 11%
Fraud 1,296 403,787 150 33,184 12% 8%
Other [5] 5,323 48,665 189 3,145 4% 6%

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.

How do you prove a negative to the IRS?

One of the hardest and most irritating problems to work with the IRS is when someone has issued a W-2 or 1099 with an incorrect social security number on it. Generally, what happens is that you receive an IRS notice of proposed changes to your tax return for unreported income. The notice includes a list of 3rd party 1099s and W-2s issued to your social security number. One of those 1099’s, for say $20,000, is from some company that is not even in your part of the country.

Calling up the IRS and complaining about this does nothing. The IRS’s position is that it is up to you to prove that the 1099 is in error.  Several people I have known over the years have given up at this point and just paid the additional taxes.

However, there are better options:

    1. Call the company on the form and try to get them to amend it.
    2. Fill out IRS Form 2624 giving the IRS permission to contact the payor. The IRS will race at a snail’s pace to contact them, but this is usually enough of a prompt to get it fixed.
    3. If this does not work, it’s possible that you are a victim of identity theft. You should call the IRS and request an IP PIN.
    4. The next step is to file a Form 911 with the Taxpayer Advocate Service. One of their primary purposes is to get the bureaucracy to correct errors when its processes fail.
    5. Finally, if it’s enough money, consider an Offer-in-Compromise due to Doubt as to Liability. Make an offer of $150 to cover the processing costs and hopefully, the IRS will let it go at that.

What is so irritating about this issue is its unfairness and the IRS response that this is your problem, not theirs. Luckily, most of the millions of 1099s and W-2s are issued with correct id numbers.

What can you do about a Federal Tax Lien?

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. 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.

IRS Liens are “Self-Releasing”

The IRS issues millions of liens on tax debtor property every year. Unlike other creditors, IRS liens are “self-releasing”. There is a highlighted box on each Notice of Federal Tax Lien that states that this notice will also operate as a lien release one day after the Last Date for Refiling. The problem is that most people, including financial professionals, do not read this and keep looking for a formal release that is not coming.

 

The easiest way I have found to handle the problem with bankers and closing agents expecting a formal withdrawal is to send them a copy of the lien notice and highlight in red the already highlighted box. You can also send them IRS Publication 1468 which explains the self-releasing nature on page 4.

 

The IRS will formally withdraw the lien notice if the debt is cleared prior to the Statute of Limitations. This is usually done automatically within 30 days after the debt has been paid off with money or an Offer-in-Compromise. There are also other reasons they will issue a withdrawal if the government can be convinced it is in their best interest.

What Can Non-Filers Do About Missing Records?

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. 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.

IRS Form 1099-A vs. Form 1099-C

One of the more confusing issues in reporting taxable income is what to do when there is a 1099-A or 1099-C involved. Sometimes both the A and the C refer to the same property, other times not. Here is a simple way to think about the issue.

    1. The 1099-A is required from any creditor when a borrower abandons real or personal property. This is not a taxable event. The purpose of the form seems to be only to alert the IRS that a taxable event is likely coming.
    2. The 1099-C on the hand is issued by a financial institution whenever it cancels debts of more than $600. This usually means that the finance company has given up on collecting the debt and written it off.

The 1099-C is what the IRS is going to attempt to match to the related tax return. The problem is that just because there is an amount on a 1099-C, it is not necessarily all taxable. There are several exceptions that the taxability of debt cancellation including:

    1. Cancellation of debt in a title 11 bankruptcy case. Use Form 982 to report the reduction in tax attributes for canceled debt.
    2. The amount that the taxpayer is insolvent immediately after the discharge. See Pub 4681 for their nifty worksheet to calculate solvency.
    3. A discharge that is characterized as a gift.
    4. A discharge that would produce an offsetting deduction.
    5. A purchase price reduction that reduces the asset basis.
    6. Certain student debts.

All 1099-Cs should be reported to avoid problems with the IRS matching program. Use a disclosure note to explain your reductions when one of the exceptions applies.

The Pros & Cons of IRS Voluntary Disclosure for Nonfilers

The IRS has been building a list of millions of nonfilers who have significant income. The names on this list have been prioritized and their people are starting to work on those cases. One of the options for someone who thinks their time is running out is the Voluntary Disclosure Practice.

The idea here is that by making disclosures before the IRS catches up with you, you demonstrate your goodwill by coming clean. This saves the government investigation time and money.  There are two steps to the process. First, you need to make sure that an investigation is not already underway. This is called ‘Preclearance’ and takes 4 to 8 months before you receive an IRS letter welcoming you to the program or not. Once you have your preclearance letter in hand the next step is the actual disclosure followed by making arrangements to pay the taxes and penalties due.

The Pros of joining the program:

    • Acceptance means jail time is most likely out.
    • Penalties can be negotiated down.

There are some Cons to think about also:

    • You must tell them everything and cooperate fully. Messing this up will result in you having provided evidence to the IRS to be used against you in a likely criminal case.
    • Nonfilers with illegal income, even if legal under state law, are not eligible to participate.

How to Get Back into the Tax System without going to Jail

The common scenario is somebody who has not filed for years but finds themselves wishing they had. Perhaps they have seen articles about the IRS’s claim to have identified millions of non-filers with significant income. Or maybe they realize that in this world of interconnected databases there is simply no place to hide.

Whatever their reasoning, the next question is “how do I get back into the tax system without invoking a criminal investigation?”  There are three approaches to consider:

    1. Simply start filing and hope enough time goes by that the non-filing periods drop off the IRS radar.
    2. Then there is the “Quiet Disclosure” technique.  Basically, you prepare returns for the last three years and mail them in separately every week or two, hopefully with a check. The idea here is that no one return processor will connect the dots that something significant is happening.
    3. Finally, there is Voluntary Disclosure. You file a letter with the IRS requesting preclearance for voluntary disclosure. The preclearance process is so that the IRS can check their records to determine if you are already under investigation and not eligible for the “Voluntary Disclosure” process. Once you are cleared to proceed, you confess all and begin negotiating the penalties without fear of criminal actions.

Which is the right approach? Depends upon the situation and money owed.  Acceptance into the Voluntary Disclosure Program is the safest approach if you owe lots and a criminal investigation is likely. Run-of-the-mill cases are usually safe with the Quiet Disclosure approach.

Non-filers are in the IRS Crosshairs

The IRS claims to have built a list of millions of non-filers with substantial income. They were ready to pull the trigger on a program to begin investigations of the people on that list when COVID hit. Everything went on hold. The IRS is now officially back in the office and picking up where it left off.

 

What should you do if you think you might be on this list? Your number one priority should be to keep your case from going criminal. If you think the past due taxes are substantial, talk to a tax attorney with experience in criminal tax matters. Attorneys have confidentiality privileges that CPAs and other tax preparers do not, so do not go blabbing to them about your problem.

 

The next step is to prepare the missing returns. If you have not filed for decades, there is some good news. IRS Policy Statement 5-133 only requires that you catch up the last 6 years of returns. Don’t have the records? Not a problem for the IRS. They will happily compute the highest tax possible with the information they have. Reconstructing the records using a forensic accountant is costly, but more likely than not, worth it.

 

Once you have the missing returns prepared and the scope of the problem identified, it’s time to work on the strategy. If criminal action is likely, listen to your attorney. Jail time is a real bummer. If it’s not a criminal case, then you need to work with someone who knows how the IRS Reasonable Collection Potential formula works to determine which path to follow to clear the debt. Most people in this situation do not have the assets and income that will allow them to pay the debt in full. An Offer-in-Compromise is the best bet in these cases.

 

Timing is everything in getting out of this mess. The best outcomes happen when you come forward voluntarily, with returns in hand, and a strategy to clear the debt. Waiting for the IRS investigation to start means you will be facing hard deadlines throughout the process along with an unsympathetic Revenue Officer.

Yes, you can do a Wire Transfer to the IRS

Occasionally you really need to pay the IRS on a single day without fail. This can happen in cases with real estate closings in which the IRS is a lien holder. The safest way to make this happen is a bank-to-bank wire transfer.

The IRS Same-Day Wire Federal Tax Payments at https://www.irs.gov/payments/same-day-wire-federal-tax-payments has a downloadable worksheet that you can fill out and take to your bank. There are of course fees involved.

There is one big caveat to keep in mind in using wire transfers. If your wire comes in after 5:00 PM ET, it will be returned to the bank.