Delayed filing of returns only increases penalties
Do you or your business owe taxes you can’t pay? Have you received a collection notice from the IRS or had your bank accounts garnished? First, file all your tax returns. People often delay filing tax returns if it will result in a tax bill they are unable to pay, which increases the penalties and interest. Plus, all returns must be filed before utilizing the IRS’ resolution options.
If taxes are not paid right away, the IRS will begin collections by mailing a series of four to six collection notices, each one more threatening than the last. The final notice comes with a 30-day appeal right. Except in special circumstances, the IRS cannot begin forced collection efforts until that appeal right expires or while the appeal is pending.
If no appeal is filed, the taxpayer becomes a target for liens, levies and garnishments. I almost always recommend filing an appeal because it provides protection against collection efforts, gives the taxpayer more time to develop a plan and is often the most efficient way to resolve an outstanding tax liability. It is important to bring in a tax professional as soon as possible.
Once collection starts, assuming you cannot pay the tax in full, there are only five resolution options:
– 1. Do Nothing. Very few people can get away with doing absolutely nothing. These individuals are otherwise collection-proof or the business has already shut its doors with no remaining assets. Taxpayers are collection-proof if they have no equity in assets and no income. For taxpayers with regular income or equity in assets, doing nothing comes with grave consequences.
– 2. Uncollectable Status. The IRS sometimes agrees to place certain taxpayers in uncollectable status, which means that the IRS will put a collection hold on the taxpayer’s account. To qualify, taxpayers must have little to no equity in assets and earn income at or below the amount required to meet their ordinary and necessary living expenses (as determined by the IRS). Uncollectable status can be achieved by filling out financial statements and providing support documentation for the lack of assets and income. This status can last up to two years, at which time the IRS will require the taxpayer to submit new financials.
– 3. Installment Agreement. An installment agreement to pay the tax over time is the most common resolution option. It is a formal agreement between the taxpayer and IRS to make regular, monthly payments over time. While the IRS has 10 years to collect a tax, it typically wants the tax debt paid in less than six years. The taxpayer must make timely payments and stay in current tax compliance during the entire installment agreement. Current tax compliance means filing all tax returns and paying the tax on time, including making all estimated deposits.
The IRS will evaluate the taxpayer’s ability to pay and make a demand for what it believes the taxpayer can afford to pay. There are certain expenses that the IRS must allow and there are others that are negotiable. A tax attorney can often negotiate a lower payment.
– 4. Offers in Compromise/Settlement. You’ve probably heard the phrase “settle your tax debt for pennies on the dollar” on radio and TV commercials. This settlement process is called an “offer in compromise.” It can be a good resolution option, but only under certain conditions.
If the IRS would never be able to collect enough to pay the tax in full, it may agree to settle for less than the total owed. The IRS analyzes the taxpayer’s income, reasonable expenses and equity in assets to determine what it will accept. The offer process can take up to 30 months. However, there is a collection hold while the offer is under review.
The valuation of assets and determination of disposable income can often be difficult but it is crucial to calculating the lowest acceptable offer. A tax attorney can prepare the offer in compromise, assert valuations and negotiate on your behalf. If an offer is accepted, the taxpayer has between five months and two years to pay in full. Importantly, the taxpayer must remain in tax compliance for five years after the offer has been accepted (plus other conditions).
– 5. Bankruptcy. Individual income tax liabilities may be dischargeable in bankruptcy. Exceptions to discharge include: taxes from a fraudulent return; situations where no return was filed at all; if the IRS filed a substituted return for you; and taxes relating to attempts to evade or defeat a tax. Generally, a taxpayer can discharge a tax when more than three years have lapsed since the due date of a timely filed tax return or two years from a late filed return, whichever is later. There are additional circumstances that may impact this time frame. It is essential to consult with a tax or bankruptcy attorney if you have tax debts you may wish to discharge in bankruptcy.
Withholding tax liabilities such as sales tax and employment taxes are non-dischargeable. Certain excise taxes are also non-dischargeable in bankruptcy.
Jessica McConnell is of counsel in the Portland office of Williams Kastner Greene & Markley (www.williamskastner.com). Her practice concentrates on federal, state and local tax controversies, including tax audits, offers in compromise and tax collection matters. She excels at complex audits, offers in compromise, employment tax liabilities and protecting her clients against unwanted and unexpected collection efforts. Williams Kastner publications should not be construed as legal advice.