The IRS wants your money! We all know this but what happens when taxpayers either don’t file tax returns or don’t make payments with filed returns?
You diligently gather all your tax information and prepare a tax return. Unfortunately the returns show a balance due and you don’t have the money to make a payment. So you do nothing… Now the next year rolls around - this time you don’t even prepare a tax return - you’re worried that filing a return this year will highlight the fact that no return was filed last year. And the cycle repeats…
Then the IRS contacts you because it has information from third parties that show that you should have filed a return - a W-2 from your employer, a 1099 from your client, a 1099 from your bank.
Now full blown panic sets in - what do you do?
First things first - stay calm - the primary goal of the IRS is to encourage voluntary compliance - i.e. filing your tax return and making payments. Surprising to most taxpayers is that the IRS will work with you even if returns are missing or payments have not been made. However most taxpayers in these situations, understandably, do nothing - “why bother to file my tax return if I can’t make payment”, “why contact the IRS if I can’t pay them”. So IRS correspondence usually ends up in the trash.
The IRS has number of programs available for taxpayers unable to make payment. Two of the most used programs are Installment Agreements (IA) and Offers In Compromise (OIC).
Before we discuss these programs we need to discuss what the IRS considers “table stakes” - specifically “compliance”. This means getting current with all missing tax returns and be in the process of making tax payments for the current year. For un-filed tax returns the IRS goes back six years. Although these tax returns are required to be filed payment is not required. Regarding the current year the IRS requires payment against your current year tax obligations - for employees this means current tax withholding on your wages and for self-employed individuals this means payment of current year estimated taxes. What we stress to our clients is that before we even consider payment plans or compromising tax debts we need to ensure compliance. This is absolutely required in order to approach the IRS with an offer to deal with your tax debt.
In order to discuss your debt the taxes need to be “assessed”. This typically involves taxpayers voluntarily preparing and filing tax returns. In limited circumstances the IRS may prepare what is know as a “substituted return”. This is a return prepared by the IRS with information available to them - i.e. W-2s and 1099s. Upon assessment the IRS typically has ten years to collect the debt. Once tax has been assessed and you can show that you’re not falling further behind the IRS will actually work with you to resolve your debt. The IRS certainly has a reputation for being harsh and unforgiving - in many situations this reputation is earned. However for cooperating taxpayers they will work on resolving issues.
Once your tax has been assessed the IRS Collections division is charged with collection of the tax (of course this assumes that any tax withholding or estimated tax payments do not cover the assessed tax). The job of Collections officers is to settle outstanding tax debt - this can be done by way of full payment, payment over time (IA), or compromising the debt - i.e. reducing the debt and arranging for payment (OIC).
What happens if you do nothing? For the most part you can’t entirely avoid the IRS. In this digital age we all leave footprints and eventually the IRS will catch up with you. If you’ve filed tax returns the IRS will attempt to collect the unpaid amount reflected on the tax return. If you haven’t filed tax returns the IRS will prepare one for you and then attempt collection.
Collection efforts typically begin with friendly correspondence “we noticed you owe us money please send in payment”. The notices then take on an increasingly hostile approach “we have sent you several notices, you haven’t responded, and we intend to force payment”.
Enforced payment methods include liens and levies. Once tax has been assessed the IRS automatically acquires a lien on all of your assets. This is done as a matter of law - no action is required by the IRS. However at this point there is no public notice of the lien. When payment of assessed tax is not made the IRS will make a public filing - the most common among homeowners being a “Notice of Federal Tax Lien” that is filed with the government agency that maintains real estate records. While this action alone won’t result in the IRS seizing your house it will prevent you from refinancing your mortgage or selling the house without dealing with your tax debt - a situation that should definitely be avoided.
A levy does result in the immediate taking of your property. There are two types of levies: a one-time levy and a continuing levy. Typically a one time levy is made against a bank account. It results in the seizure of all funds in the account on a particular day. A continuing levy is usually made against wages - it’s a legal requirement for your employer to send a portion of your pay directly to the IRS. The payment amount represents a significant portion of your pay.
These methods of enforcing collection are severe - they are designed to be since they are used as a collection means of last resort - typically where the IRS has made numerous requests for payment and taxpayers have been unresponsive. However even at this point payment deals can be made. However the earlier you deal with the issue the less painful the process.
Let’s back up a bit - what is an IA and OIC? In order to approach the IRS with any payment offer you’ll first need to prepare a summary of your income and expenses - not taxable income but cash income. Determination of this amount is a mix of actual figures and IRS allowed amounts (to be covered in a future blog post). The net income determined by this process is used to compute what is referred to as “Reasonable Collection Potential” or RCP. This amount uses projected income for the remaining period of time for collection (the ten year period previously discussed). If the RCP is greater than your tax debt the IRS will not compromise the debt but will allow for it to be paid over time under an IA. This doesn’t settle your tax debt but it puts a hold on collection activity - as long as you are making agreed upon payments!
If the RCP is less than the debt the IRS will consider an OIC. In this arrangement the IRS actually compromises your tax debt - allowing for payment of an amount less than owed. Remember the IRS has every legal right to enforce full collection of all amounts owed (tax, interest, and penalties) - through liens, levies, and asset seizures.
Entering into an IA or OIC is an accommodation to the taxpayer. As such compliance with the IRS rules is essential in ensuring relief - even when some rules may not make sense. Remember the government has extraordinary power to take your assets to satisfy your debts - but they are usually reasonable if you work within their rules. The IRS does not set out to seize assets but will do so when no other avenues are available to enforce collection.
Stay tuned to this blog for future discussions where we’ll delve into the topics discussed in this post. We’ll also discuss other less used programs including “Currently Not Collectable” and “Innocent Spouse”.
Link to outline slides: Collections Outline
Link to video: Collections Video
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