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Fresh Start and Net Equity

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May 21, 2015

Gibson_New(1)By Dan Gibson, CPA

When submitting an offer-in-compromise with respect to settling amounts due to the IRS for a lower amount, the IRS focuses on a term known as “Reasonable Collection Potential.” In doing this calculation, the IRS reviews two key components: One is the net equity of assets that the taxpayer owns at the time of the offer and the other is the expected earning potential of the taxpayer. For this posting, we’ll focus on net equity.

At the sake of oversimplifying, net equity for OIC purposes is cash plus quick sale value of assets that you can “tap” into. For example, you may have an individual retirement account. An individual can usually cash out an IRA, less any early withdrawal penalties and related taxes. So this cash (less penalties and taxes) would be included in your net equity. On the other hand, if you had an interest in a retirement account with your employer that you currently have no access to, this would not be included.

A couple of other points to keep in mind when calculating your net equity for OIC purposes:

  1. Non-cash items (real estate, autos, etc.) are discounted by 20% of fair market value, which the IRS considers to be the quick sale value.
  2. Cash amount are calculated by using the average cash balance over the past 3 months, reduced by one month’s worth of allowable expenses and then further reduced by $1,000 (not to go below zero). We’ll talk about allowable expenses in a future posting.
  3. In addition to the 20% discount, auto values are reduced by debt on the vehicles. The net amount (auto value less debt) is then further reduced by a $3,450 exclusion (not to go below zero). The $3,450 exclusion can be used for 2 vehicles per household as long as the vehicles are used for work, production of income or family welfare.
  4. Business taxpayers can exclude income-producing assets. The thinking here was to eliminate the double-dip of the IRS getting both the value of the asset and the income in the calculation to come up with the reasonable collection potential. The IRS has been provided some discretion here to include the value of the asset and exclude the income it produces, if it so deems.
  5. As a general rule, the net equity of an asset cannot go below zero. So if you have real estate that is underwater with a mortgage greater than the quick sale value, you would report zero equity.
  6. Unsecured debt is normally not allowed as a reduction in determining your reportable net equity.

As you can probably tell, there are some planning opportunities that you can take advantage of when preparing an offer-in-compromise, so it is not just as simple as preparing a  form. Some thinking and strategizing can go a long way in saving dollars when submitting an OIC. 

Doesn’t Everyone Deserve a Fresh Start?

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May 14, 2015

Gibson_NewBy Dan Gibson, CPA

In doing tax collection work, the issue that needs to be addressed by practitioners and by revenue officers at the Internal Revenue Service is whether we can balance the need for the government to collect the tax against the ability of the taxpayer to pay the tax. Recognizing this, the IRS went through the process of easing the standards for troubled taxpayers in order to allow them to enter into what is known as an offer-in-compromise. This process of easing is known, in part, as the Fresh Start Initiative that was put into effect during 2012.

This OIC program is not for everyone. If the IRS believes that, based on the taxpayer assets and earning potential, they can receive a full payment within the time allowed by law (normally ten years), they will normally reject a submitted OIC application.

On the other hand, if there is enough uncertainty in collecting a full payment, the IRS can be persuaded to consider an OIC application. This will allow them to get the most payment in a shorter amount of time -- and enable them to clear the taxpayer debt from their inventory. Keep in mind, the IRS needs to be convinced that it is in their interest to accept this offer, not that of the taxpayer.

In summary, this is how the calculation goes.  The OIC is made up of 2 components: net equity and net income. Net equity consists of cash plus assets (normally discounted at 20% of their fair market value) less allowable debt. Added to that is net income, which consists of gross income less allowable monthly expenses. Depending on the method of payment, the net income is then multiplied by 12 or 24 (if the taxpayer wants to pay off the offer in 5 monthly installments or less, then the multiplier is 12; if the taxpayer wishes to do it with 6 to 24 monthly installments, the multiplier is 24).

Note: Prior to 2012, the multipliers were 48 and 60, respectively. A big difference!

There is much more to say on this topic -- and I’ll be saying it in future postings. Stay tuned.

Surprising Bankruptcy Case

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May 11, 2015

Gibson_New(1)By Dan Gibson, CPA

In the case Mallo v. IRS, the Tenth Circuit Court turned the bankruptcy world on its head.

The Bankruptcy Code states that personal taxes are dischargeable if all the following criteria are met:

  1. Due date of the return was more than 3 years prior to bankruptcy filing.
  2. Return was filed more than 2 years prior to bankruptcy filing.
  3. The tax must have been assessed 240 days or more prior to bankruptcy filing.
  4. The taxpayer must not have violated the fraud rule by filing a fraudulent return or willfully attempting to evade paying the tax.

In the Mallo case, the taxpayers failed to file their 2000 and 2001 returns and the IRS eventually prepared returns for them by filing what is called a Substitute for Return (SFR). Subsequently, the Mallos replace the SFRs by filing returns for those non-filed years.

Then in 2010, the Mallos decided to file Chapter 13 in the Bankruptcy Court. The case eventually converted over to a Chapter 7 liquidation case. Upon the discharge of their debt, the taxpayers inquired about their 2000 and 2001 income tax debt. The IRS claimed, not surprisingly, that the taxes were not dischargeable.

The IRS and the Taxpayers ended up before the Tenth Circuit, United States Appeals Court. The Court determined that neither the SFRs nor the late-filed 2000 and 2001 returns were dischargeable in bankruptcy. The Court’s decision hung on language in the bankruptcy code which states that a return means one which meets the “applicable filing requirements.” The Court interpreted applicable filing requirements to mean that the return must be filed timely.

A loud warning should go out to all who are in this type of a situation. Many taxpayers may be surprised to learn that they may be responsible for income tax that they thought would otherwise be discharged in bankruptcy.

Lions, Tigers, Bears, Liens and Levies!

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April 30, 2015

Gibson_New(1)By Dan Gibson, CPA

When taxpayers find themselves deep in the woods and being hunted down by the most effective collection agency in the world, the Internal Revenue Service, the threats of liens and levies are always menacing weapons that must be dealt with. However, there are strategies for avoiding these IRS actions. Keep in mind that these IRS enforcement actions can have a devastating effect on one’s credit rating.

Be Proactive

Quite frankly, this is not a trait found in most delinquent taxpayers, but dealing with the situation up front can go a long way in avoiding the IRS’ lien and levy action. If upon filing a return, the complete amount of tax cannot be paid, file a Form 1127 – Extension of Time for Payment of Tax. When asked, the IRS will state that there is no such form; but it’s there. The extension is not automatic; you’ll need to provide information demonstrating that you do not have the means to pay the entire amount and that paying that amount would cause a financial hardship. However, it is a means to go on the offensive to buy yourself six months to sort things out.

Managing Your Balance Owed

Normally, if your balance is under $10,000, the IRS, as a practical matter, will not file a lien. So if you have a balance slightly over this amount, you may want to consider paying down enough balance to get it under the $10,000.

If you have a balance up to $50,000 or can pay down the balance to get it under $50,000, the streamlined installment agreement is available as long as the balance can be paid down within six years (72 months) or before the expiration of the statute of limitation on collection expires, whichever is shorter. In most case, installment agreements for amounts under $25,000 are automatic, with very little administrative fuss. For balances between $25,000 and $50,000, you’ll likely have to make payments by direct debit from your bank account. However, in any event, you should be able to avoid having a lien filed against your property by the IRS.

The Deed is Done

Once a lien has been filed and a balance remains outstanding, it is nearly impossible to release or withdraw it. Once the lien is in place, the next step for the IRS is to levy (or take away) your property.     

The IRS starts this process by issuing five letters, starting with a CP14 and then ending with a L1058/LT11. It’s a letter campaign that gradually turns up the pressure on the taxpayer, with the final letter basically stating: “This is the final notice. The next time you hear from us will be after we clear out your bank account!” However, in this final letter, the IRS does offer one final olive branch known as the Collection Due Process Hearing. From the date of the final letter, you have 30 days to request this hearing by way of a Form 12153.    If filed in a timely fashion, this will cause all collection actions to cease and allow you time to discuss your situation with a settlement officer within the Appeals Division of the IRS.

If you find yourself needing someone to assist you with balances owed to the IRS or have specific questions on the above, please do not hesitate to contact your tax professional.

Collection Action -- The Proper Balance

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April 22, 2015

Gibson_New(1)By Dan Gibson, CPA

In speaking to most IRS collection officers, you would be under the impression that the IRS can file a lien against a taxpayer’s property whenever the taxpayer owes money to the government. However, a recent Tax Court decision, James B Budish v. Commissioner, showed that may not always be the case.

Mr. Budish owed the Service over $200,000. He attempted to enter into an installment agreement. However, as a condition of the agreement, the IRS insisted on filing a lien based on their interpretation of the Internal Revenue Manual (IRM) Section This section states that the IRS “In general, should” file a notice of lien when there is a balance of $5,000 or more.

The Tax Court held that the wording, “In general”, meant there could be instances when the government should not be filing a lien. In fact, the taxpayer argued just that point. Under IRC 6330(c)(3)(C), the government must legitimately balance and weigh the interests of efficient government collections against the taxpayer’s legitimate concern that the collection action be no more intrusive than necessary. Mr. Budish argued that the notice of lien would do irreparable harm to his vendor and customer relationships, rendering him unable to do his work and deny him with his only source of income.

The Court held for the taxpayer, stating that:

  1. The IRS incorrectly concluded that a lien filing was required.
  2. There was no consideration in balancing the government’s needs for collection against the taxpayer’s concern that the collection action be overly intrusive.

The case was then remanded back to the Appeals Office of the IRS with instructions to hold a supplemental Collection Due Process hearing with the taxpayer. However, for this hearing they would be required to balance the factors noted in IRC 6330(c)(3)(C).   

Back in the System

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January 19, 2015

By Dan Gibson, CPA

Gibson_New(1)So you haven’t filed a tax return for a while. In fact, it’s been several years. So many years that, frankly, the thought of filing them is overwhelming.

You ask yourself: How many years do I have to go back and where do I start-- 5 years, 10 years, 20 years?

The fact of the matter is that the Internal Revenue Service requires you to file, in most cases, the last 6 years of tax returns. This also includes making arrangements to pay all taxes, penalties and interest. The 6-year enforcement period for delinquent returns is found in IRS Policy Statement 5-133 and Internal Revenue Manual

Why would the IRS be so merciful? To a large extent, the IRS does not have the manpower or infrastructure to easily process unfiled returns that go back 10 or 20 years. Believe it or not, the IRS is looking to be practical, so it draws a line in the sand that can be supported by its internal resources—and they have determined that this line be 6 years.

Filing the returns is actually the easy part; for most of us, the payments are what really hurt. However, the Service does provide several programs to help with this. These include installment payment programs, offer-in-compromise settlements and a program known as ‘currently no collectible.’ In some cases bankruptcy is an option, but make sure you see my blog dated 10/17/2014 and, of course, speak to an experienced bankruptcy attorney first.

If you are currently a non-filer, don’t continue to ignore the problem. Consider a fresh start by filing the last 6 years of returns and setting up a payment plan with the IRS. There is no need to continue to live in a state of fear and inaction. Taking the few steps to help you move on can actually be easier than you think.

Be sure to check out our upcoming webinar, “Dealing with the IRS, Part II”, which will be hosted by myself and Tim Schuster on January 21, 2015 at Noon EST. Register here

IRS Warns of Refund Delays Due to Budget Cuts

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Daniel GibsonAfter absorbing a $346 million budget cut, IRS officials are warning taxpayers not to expect their phone calls to get answered or their refunds to be delivered as quickly as in the past. Employees shouldn't count on overtime pay, or for empty staff slots to be filled. And lawmakers seeking to reduce the deficit should assume the agency will collect far less revenue than it could have. The warning includes something that will affect many taxpayers – tax refunds from the 2015 tax filing season may be delayed.

IRS Commissioner John Koskinen is saying everything from taxpayer services to enforcement efforts could be affected.

He assured the public that "Everybody's return will get processed. But people have gotten very used to being able to file their return and quickly getting a refund. This year we may not have the resources, the people to provide refunds as quickly as we have in the past."

In recent years, the IRS says it was able to issue most tax refunds within 21 days, if the returns were filed electronically. Koskinen wouldn't estimate how long they might be delayed in the upcoming filing season, which begins in just a few weeks.

The cuts come at the same time that the IRS is starting its significant role in implementing President Obama's health care law. For the first time, taxpayers will have to report on their tax returns whether they have health insurance. Koskinen said the IRS is required to enforce the law, so other areas will have to be cut, including taxpayer services and enforcement.

Budget cuts will mean less people to do more work. "In some ways, these budget cuts are really a tax cut for tax cheats," Koskinen said. "Because to the extent we have fewer people to audit and enforce the tax code, that means some people cutting corners on their taxes or not complying are going to get away with it, and that is a decision that Congress has made."

In all, the IRS is operating with roughly $1.2 billion less than it did in 2010, when the agency's budget reached its high-water mark of roughly $12.1 billion.

The $10.9 billion the agency is slated to receive for 2015 is a 3% cut from last year and the IRS smallest budget since 2007. Adjusted for inflation, the IRS budget is roughly equivalent to what Congress gave it in 1998 — an era when the agency processed about 30 million fewer returns in a given year.

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