Podcast: IRS Debt Do's & Don'ts

How to Correct an IRS Substitute for Return

The IRS needs a tax return to start the tax assessment process. If the taxpayer does not file, the IRS will file a return for them. This is known as a ‘Substitute for Return’ or SFR in government parlance. The SFR is usually prepared by the IRS computers using all the information that they have on file for that taxpayer. Electronic information includes filings of documents like the 1099s and W-2s that we are all familiar with. The problem comes up when those documents are incorrect, bringing up the question ‘How do I fix this?”.

First of all, the taxpayer is under no obligation to correct an SFR that understates his or her tax. The taxpayer in these cases did not lie to the IRS or perjure themselves on their tax return.  The IRS filed it themselves using third-party information and it is on them to fix their own errors. If the taxpayer is happy with the return that was filed, they should just simply pay the tax bill and move on.

Sometimes that 3rd party information is wrong the other way. The result is that the IRS assesses a higher tax than it should have. How to fix it? The answer is simple. Just file the return that you should have filed showing the correct information.

Strategy 7 – Make your Business More Profitable

You owe the IRS a lot of money and you want a way out of this hole. Most people that get into this problem are business owners and they tend to overlook one of the best strategies available — make the business more profitable.

That is easier said than done, but now you have a large incentive to make real changes. Consider some of the following steps:

    1. Write up a one-page strategy statement that details your business purpose, vision, and values.
    2. Do a SWOT analysis and identify your strengths, weaknesses, opportunities, and threats.
    3. Using your strategy and SWOT analysis, write up an action plan that separates those steps that will produce a short-term vs. a long-term positive change.
    4. Implement. Planning is great, but actually doing it is what counts.

The change that can make the biggest impact on your profitability is your pricing policy. Marking up costs to produce a sales price is easy, but probably won’t get you where you need to go. Value pricing is a better way to go. Even a 1 or 2 percent change in pricing can have a major impact on your bottom line.

There are also the more traditional changes that will make a one-time jump in your cash flow such as collecting on your aged Accounts Receivable or reducing inventory levels. Be aware that unless you fix your systems to stay on top of these issues, the balances will tend to slip back to where they were before.

Improving your business profitability is hard work. After all, if it were easy, you would have already done it. The alternative is to shut it down and do something else to produce the money to get the IRS off your back.

Strategy 6 – Taxpayer Advocate Service

What do you do when you know the IRS is wrong and creating a financial hardship as a result? The cheapest answer is the Taxpayer Advocate Service also known as the TAS. You can file, an appropriately numbered form, Form 911 to explain the situation. A TAS representative will give you a call back within 48 hours to discuss your issues.

The TAS does require that you make every effort to resolve the situation before contacting them. This means you must have already done the following:

    1. Spoken with the Collection Division
    2. Spoken with the Group Manager
    3. Excised your appeals rights for a CDP or Equivalent Hearing
    4. Used the Collection Appeals Process

The best-case result from contacting the TAS is that they will cut through red tape and go straight to the right people. The worst-case result is that you will receive great advice on your options to proceed. This is an easy and worthwhile step when you can’t seem to get the IRS to recognize they are in error.

Strategy 5 – Innocent Spouse Claims

An Innocent Spouse Claim is worth considering in cases where the taxpayers jointly owe a lot of IRS debt. The downside is that the IRS does not generally approve these claims. Worse, most of the appeals to the courts have been IRS wins.

That said, it is still worth considering. Innocent spouse claims arise in cases where the tax understatement can be attributed to just one spouse. Additionally,  the other spouse must have no knowledge or benefit from that understatement. The strategic advantage is that you might get a better result on the Reasonable Collection Potential formula by removing the one spouse from the liability.

An Offer-in-Compromise will only work if the taxpayers can show that they do not have the financial means that will enable them to pay the debt in full. The IRS does not accept offers for less than full pay merely because someone throws a number at them. Instead, they do a financial analysis. The results are plugged into the Reasonable Collection Potential formula. Removing one of the spouses from the liability could change the formula results and make the other spouse eligible for an offer.

 

Strategy 4 – Audit Reconsideration

If your tax debt is the result of an IRS Audit, do not overlook the possibility of getting the IRS to reverse the audit assessment. The Audit Reconsideration as explained in Pub 3598 is a process to get some relief from audit results you do agree with or an assessment made by the IRS because you did not file a return.

You may request audit reconsideration if you:

    • Did not appear for your audit
    • Moved and did not receive correspondence from the IRS
    • Have additional information to present that you did not provide during your original audit
    • Disagree with the assessment from the audit

The IRS recommends you use form 12661 to explain your dispute. New information is the key to getting this process to work. It is critical that you provide all the documentation with the request.  Requests without documentation enclosed will be denied out of hand. You can use this process as long as the assessment is outstanding.

Your reconsideration request will be accepted if you:

    • submit information that has not been considered previously.
    • filed a return after the IRS completed a return for you.
    • believe the IRS made a computational or processing error in assessing your tax.
    • The liability is unpaid, or credits are denied.

This is a relatively cheap process to get rid of an IRS debt if you have the grounds to pursue it.

IRS Electronic Filing Systems Audit

The Treasury Inspector General released an audit report on the IRS electronic filing system. Some of the interesting facts in this report include:

  • The IRS destroyed an estimated 30 million paper 1099 type forms because of their processing backlog. Good thing we went through all the trouble to file them.
  • The percentage of business returns filed electronically is now up to 63 percent which is nowhere close to the 93% of the 1040s filed electronically.
  • The cost to process returns electronically is pennies vs multiple dollars. In the case of 1040s, it is 36 cents compared to $15.21 for example.

The bottom line is that the IRS is going to require more and more electronic filing of business returns, especially payroll tax returns. This is a good and bad thing from my perspective. Processing returns electronically means that we get an almost immediate acknowledgment without the hassle of certified mail. Additionally, it significantly reduces the IRS keypunch error rates in inputting paper returns. On the bad side, the IRS’s attempts at preventing id theft continues to make it harder for taxpayers to file electronically.

 

Strategy 3 – Prove that you are Currently Not Collectable

The previous posts talked about the strategies of making an offer-in-compromise and payment agreements. These strategies work for people who can either fully or partially pay their IRS debt. But what about people whose financial picture is so bleak that they cannot make any payments? Are they doomed to forever harassment by government agents?

 

The answer is no, all is not lost. The government does not want to waste their resources chasing people who cannot pay when they have lots of cases for big bucks in inventory just waiting to get worked. The catch here is that you must prove to them that you are in the first group and not the second.

 

The way this works is that you must provide information about your equity in things you own and your cash flow. The IRS will review this information to verify that it is adequate and correct. The numbers are then plugged into a formula known as the “Reasonable Collection Potential”. If the result shows that you have no excess cash to contribute to the Treasury, the IRS changes your status to Currently Not Collectable and you get a pass from collection actions for approximately 2 years.

 

Besides getting the IRS off your back for 2 years or more, there is another huge benefit of proving your Currently Not Collectable status. The 10-year Statute of Limitations continues to run. Get across the 10-year line and the debt is no longer collectable by the IRS.

Strategy 2 – Make a Payment Agreement

There are several strategies to consider when it comes to dealing with IRS debt. Making an online Payment Agreement to full-pay the debt over time is the easiest way to get the IRS off your back.

Online Payment Plan Basics
  • Individuals, including sole practitioners and independent contractors, have two choices.
    • Long-term payment plan – total tax, penalties, and interest is $50,000 or less.
    • Short-term payment plan – total tax, penalties, and interest is $100,000 or less and can be paid in 180 days or less
  • Business Payment Plan comes in only one flavor – the total liability must be $25,000 or less.
  • The wonderful thing about these plans is that you do not have to submit financial information.
  • Approval or disapproval will be almost instantaneous.
  • Go to https://www.irs.gov/payments/online-payment-agreement-application
Paper Payment Plan Basics
  • These plans are a lot harder. You must submit financial information about assets that you own and your cash flow so that the IRS can determine what they think your monthly payments should be.
  • The IRS will suspend counting days on the 10-year Statute of Limitations while they consider the request. This process will probably add a minimum of six months to your time in purgatory.
  • The IRS will reluctantly accept payment plan requests that are less than full-pay provided your financial information supports the lower payment.
The Good and Bad of Payment Plans
  • IRS will suspend collection activities if the plan is approved.
  • A majority of payment agreements end up in default. The more plans that you default, the harder it gets to make future deals. The golden rule here is to call them if you can’t make your payments. Do not wait for them to call you.

Payment Agreements are great if you can afford to make payments. My next post will be about what to do when you cannot afford to pay anything.

Strategy 1 – Make an Offer

There are several strategies to consider when it comes to dealing with IRS debt. The Offer-in-Compromise is an option for taxpayers who are simply not in a financial position to pay their IRS debt in full. The IRS will accept less than full pay, but the process of getting that agreement is not easy. But, contrary to the ads on TV, most of the offers are rejected by the government. In fact, only 14,000 out of 45,000 offers were accepted in 2020 as per the IRS’s latest data book.

Offer-in-Compromise Basics:

    • You must be able to prove that your financial situation is such that you are not likely to be able to full-pay the debt.
    • All your tax returns due in the last 6 years must have been filed.
    • Your estimated tax payments and withholding for the current year must be adequate to cover your current year’s tax liability. The IRS will not make an agreement if you are still digging the hole deeper.
    • The offer amount must be adequate. The IRS uses a formula called the “Reasonable Collection Potential” to determine what they will accept.
    • Your offer must include a payment equal to 20% of the offer amount if you are offering a lump sum payment agreement.
    • Should the IRS reject your offer, the tax payments will not be returned.
    • Should the IRS accept your offer, you must stay in compliance for a period of five years. Failure to do this, by say not filing on time or making estimated tax payments, results in the Offer being void. And, no, the IRS will not be returning any tax payments made.
    • The 10-year Statute of Limitations is put on hold while the IRS is considering your offer.

The fact that most offers are rejected is undoubtedly the result of people making offers without understanding the process or the Reasonable Collection Potential formula. This is not helped by the TV ads promising ‘pennies on the dollar’ results without mentioning that you must prove your financial position.

IRS Gotchas – Foreign Bank Accounts

There is a question on your tax return about foreign bank accounts that trips people up, particularly immigrants. While the question seems to be aimed at bank accounts, it’s much broader. It includes brokerage and other financial accounts. Having signature or other authority over these accounts if they exceed $10,000 at any time during the year requires you to file an FBAR report with the IRS electronically.

 

The gotcha’s come in the form of penalties. Making an inadvertent mistake such as not realizing that the balance of the accounts came to $10,001 for only a single day results in a $13,481 penalty. If the IRS considers the omission willful, the penalty zooms to the greater of $100,000 or 50% of the balance. These penalties will wipe out most of the accumulated wealth in these accounts.

 

The FBAR report for 2021 is due today, 4/18. The good news for some is that there is an automatic 6-month extension until 10/15/22 if you do not file on time. This is a truly automatic extension that does not require you to file a form.

 

For those that may want to answer the question on their tax return as ‘no’ on the theory that the government cannot get the information, remember this. Even if the government cannot get this information now, that could change in less than a year.