Tax Problem Fundamentals: Making the Best Plan

In my last few blogs I provided some insight into how I would approach a tax problem. While I have attempted to break down the analysis into what I have called Phase I and Phase II issues, in the real world there are not always bright lines that allow for such segregation. What is more important is that you are working with a tax professional that sees the whole picture, understands how the process unfolds, anticipates options that may arise, and plans for an outcome that suits your situation.

Let’s consider this hypothetical to make the point. Mr. Smith has been running a struggling business for several years. There are mounting unpaid payroll tax obligations for the business (estimated to be $30,000) and Mr. Smith has fallen behind on filing his income tax returns largely because he did not have the money to pay the tax that he knows he will owe (estimated to be at least $50,000). Mr. Smith wants to get out of the struggling business and minimize his losses. He has $15,000 in cash value in a life insurance policy and his brother has offered to loan him up to $25,000 if he needs it. What should he do?

These are the big picture tax issues as I see it. First, that unpaid payroll tax obligation concerns me because the IRS is most aggressive and the law is most restrictive when dealing with trust fund obligations such as employee funds collected for payroll taxes. I would want to know exactly what that payroll tax obligation is and how much of it is employee money or “trust funds” ( Phase I issue). Second, I want to see a financial statement for Mr. Smith to understand whether is in a position to ever pay both the payroll tax and the income tax obligations (Phase II issue). Third, as soon as we engage in conversations with the IRS they are going to insist that Mr. Smith be compliant with this tax return filing. Those returns need to get prepared and filed before any collection options can be considered (Phase I and Phase II issues). Fourth, I do not want Mr. Smith borrowing any money from his brother before have come up with plan. Once that money is in Mr. Smith’s bank account, the ability to negotiate a settlement of the amounts owed may be lost (Phase II issue).

As you can see from this simple example, it is possible to work through any tax problem the matter how overwhelming it may seem. Consideration needs to be given to both distinct phases of the tax process to ensure that the best outcome possible can be achieved. Calling upon the experience and guidance of a seasoned tax professional is often the best place to begin.

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