Category Archives: Managing and Solving Tax Problems

When is Paying Something Better than Paying Nothing?

I have previously outlined the range of options when someone is dealing with vigorous collection activity by either the IRS or NYS (see the August, 2013 entry).  At one end of the spectrum are those who have the financial ability to pay but they need more time to do so.  For those taxpayers, a payment plan is really the right solution to work through.  But what if full payment will never be feasible?  For these taxpayers, two very real possibilities are the submission of an Offer in Compromise or having the case marked as “currently not collectible,”  or “CNC.”  This brings us to the question: When is it better to resolve a tax debt through an Offer and when is it better to have a case marked “CNC?”

Simply stated, having your case marked CNC is always the least expensive and most expeditious way to fend off the collection process.  If the IRS (or NYS) is persuaded to reach this determination, no money must be paid for this result nor will any payments be expected to be made on the account.  That will continue to be the case unless something happens to change that determination.  This last clause is really the rub; CNC is not a complete resolution of the situation.  As a practical matter, a CNC determination may turn out to be the final resolution but that finality only comes if the CNC determination remains in place until the collection statute of limitations (generally 10 years for the IRS and 20 years for NYS) expires.

In comparison, if an Offer is accepted now there is closure to the collection process, but with one important proviso: once an offer has been accepted the taxpayer must remain fully compliant with the filing and payment requirements for at least 5 years after the Offer is accepted or else the compromised debt will be reinstated.

So which is better, settlement through an Offer or having the matter marked as non-collectible?  Five primary considerations factor into the question:

  1. The cost of getting CNC versus an accepted Offer. (Without question, the Offer process will be more expensive.)
  2. The time remaining on the collection statute of limitations. (If that time is short, then the CNC result is more attractive.)
  3. The likelihood of financial circumstances changing before the collection statute of limitation expires. (If positive changes are anticipated, the Offer will be more attractive.)
  4. The impact of having a Notice of Federal Tax Lien on record. (The tax lien filing will go away when an offer is accepted and remain if CNC is the result.)
  5. The need for closure/peace of mind. (While both bring peace of mind, usually the Offer is the more lasting solution.)

Both the Offer and the CNC determination are good outcomes.  Which is better can be debated.  Our knowledgeable tax professionals at Bousquet Holstein can help you evaluate the foregoing factors, and perhaps others, when making this important decision.

Disclosing Foreign Assets to the IRS – A Significant New Option

As of July 1, 2014, the IRS has substantially revised its streamline procedure for reporting foreign assets and now this option is available to U.S. taxpayers residing in the United States regardless of the amount of tax due once in the process. This new streamline procedure is intended to encourage more U.S. taxpayers to voluntarily come into compliance with the foreign asset disclosure obligations. Notably, this enhanced streamline procedure is specifically designed for “non-willful” violations of the foreign asset reporting rules. (Non-willful means conduct due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.) These new streamline procedure rules are much less onerous and costly than the foreign account disclosure options which have been in effect for the past several years; however, there is considerable risk if the failure to disclose is found to be willful. The significance of this change, and the considerations which should now factor into the disclosure of previously unreported foreign assets, are outlined below.

U.S. taxpayers, including U.S. citizens living abroad and resident aliens, are required to report and pay taxes on their worldwide income from all sources, including assets located outside of the United States. But reporting and paying tax on any such income is only part of the obligation associated with foreign assets. Even if assets held abroad do not generate taxable income, U.S. taxpayers have an obligation to disclose the existence of such accounts to the IRS. If an account has over $10,000, then anyone having either a financial interest in or signature authority over the account must also disclose the account to the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) on Form 114, Report of Foreign Bank and Financial Assets (known as the “FBAR”). When such disclosures to the IRS and FinCEN do not happen, the consequences can be severe; the failure to disclose could lead to both criminal charges and civil penalties for as much as $100,000 or more per year.

Over the past several years the IRS has offered a series of Offshore Voluntary Disclosure Programs (OVDP) which have been the primary means by which more than 45,000 U.S. taxpayers have come into full compliance with these foreign asset disclosure rules without incurring severe criminal and civil penalties. As a result of these programs, the IRS has collected $6.5 billion. But the OVDP process has always been time-consuming, onerous, and costly. Under the current OVDP initiative, taxpayers accepted into the program must file amended returns for as many as 8 years and pay all the tax, interest and penalties, including a 20 percent accuracy-related penalty, on any unreported income from foreign assets. In addition, the taxpayer has to file all unfiled FBARs and pay a separate penalty equal to 27.5 percent of the highest aggregated value of such assets. (After August 4, 2014, this penalty goes to 50 percent if the IRS has disclosed it is investigating the foreign financial institution in question at the time of the OVDP submission.)

Before July 1, 2014, the IRS had offered a “streamline procedure” as an alternative to OVDP, but previously this option had been limited to U.S. citizens living abroad, and then only when the tax for the failure to disclose was below $1,500 per year. Because of these prior limitations, the only real alternatives to OVDP for U.S. taxpayers living in the United States was continued noncompliance or what became known as “quiet disclosure” – in other words, file amended returns and previously unfiled FBARs and hope such filings did not lead to an audit or any further inquiry. The new streamline procedures now changes the playing field.

Taxpayers electing to use this new streamline procedure may now file amended returns (up to 3 years only) and unfiled FBARs (up to 6 years) and pay only tax and interest (no penalties) on unreported income and only a 5 percent penalty on the highest aggregate value of the foreign assets. Clearly, these new rules for the streamline procedure are much less costly than the OVDP. However, because the revised streamlined procedures are only for non-willful violations, unlike the OVDP, there is no closing agreement with the IRS and no assurance that further investigation will not take place should the IRS determine the failure to comply was willful.

If a taxpayer has been truly caught off guard by these foreign asset disclosure requirements, this new procedure is a welcomed development and may very well supplant the quiet disclosure option. However, although these new streamline procedure rules offer real economic savings, there is considerable risk if the failure to disclose is found to be willful; and once a streamline submission is made, the OVDP option is foreclosed. Accordingly, careful consideration of the circumstances surrounding the foreign assets in question will be important before any choice is made.

IRS Issues Guidance on Tax Issues for Same-Sex Married Couples

On August 29, 2013, the Internal Revenue Service (IRS) released guidance regarding the treatment of same sex spouses for tax purposes. The IRS guidance came in response to the U.S. Supreme Court Decision of United States v. Windsor, in which the Court struck down a portion of the Defense of Marriage Act (DOMA).
The IRS guidance indicates that same sex couples who are legally married will be treated as married for all federal tax purposes, including income and gift and estate taxes. The guidance also makes clear that the IRS will apply a “place of celebration” approach, rather than a “place of domicile” approach. That means same sex couples who are married in a state or country where such marriage is legal will be treated as married, even if they live in a state that does not recognize same sex marriage. This will likely create issues for states that do not recognize same sex marriage but use a person’s Federal tax return as the basis for calculating state taxes.
The guidance also directs that same sex couples who are in civil unions or domestic partnerships are not eligible to file as married.
Same sex married couples must file their 2013 federal income tax return using either the married filing jointly or married filing separately filing status. They may also file amended returns for any tax years that are still open under the statute of limitations (generally the past three tax years). Couples will likely want to amend returns if it will result in a refund, but are not required to amend returns if they would have paid more.
For more information on this issue, please see the article at the link below written by our colleague, M. Paul Mahalick, CPA of Grossman St. Amour Certified Public Accountants PLLC:

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.

Tax Problem Fundamentals-Phase II Considerations

In my recent blogs, we looked at an overview of how to approach a tax problem and identified the two distinct phases of such problems that should be evaluated. This discussion picks up at the end of Phase I and the beginning of Phase II where now the focus is on how/whether the tax obligation will be paid.

When we get to Phase II of a tax problem, we are dealing with the collection efforts of what is generally regarded as the most powerful creditor in the country. As a general rule, the IRS has 10 years to collect unpaid taxes and the laws are written to enable the IRS to have considerable advantages when doing so. Having said that, the IRS can be expected to follow the rules quite carefully, thus making the IRS one of the most predictable creditors to be dealt with.

In the Phase II arena there are generally three different outcomes that can be pursued: no payment, partial payment, or full payment. Aside from the obvious distinction between these options, other considerations come into play as well. While of course the “no payment” outcome may seem very appealing, a determination that the taxpayer is presently unable to make payments– in IRS parlance the account is marked “currently not collectible” — is not necessarily a lasting solution. A currently not collectible determination is based upon detailed financial disclosure which demonstrates the taxpayer has neither available assets nor income in excess of necessary living expenses available. Because the tax debt is not canceled under these circumstances, should the taxpayer’s financial situation change before the 10 year collection period expires, the IRS may resume collection activity. For this reason, the no payment option does not necessarily bring closure.

The full payment option typically involves negotiating the timing for payment, and significantly, ensuring that more aggressive collection activity such as the filing of tax liens and issuance of tax levies does not occur while payment is made. As a general rule, the sooner the payment is made the easier it is to keep the IRS collection activity on hold. A promise of full payment within 60 or 90 days is usually enough to prevent any such activity. The promise to pay over four or five years may result in the filing of a tax lien. Factors such as the total amount owed, a history of noncompliance, and the type of assets owned may also come into play.

The partial payment option — the offer in compromise program — is the option that is getting the most publicity these days. There is nothing new about this option as the IRS has been entertaining offers in compromise for some time. Most offers are submitted on the basis that full payment can never be made due to current and anticipated future financial circumstances. Detailed financial disclosure is required in connection with this process. There are many rules pertaining to the valuation of assets, the calculation of income, and the allowance of expenses that go into the determination of a taxpayer’s ability to pay. There is no formula for an offer in compromise. That is to say, there is no minimum percentage of the balance owed that must be offered. If you owe the IRS $50,000 and your ability to pay is determined to be $1000, then the IRS will accept $1000 in full satisfaction. On the other hand, if your ability to pay is determined to be $50,100, then no amount less than full payment will be considered.

Often times when evaluating these Phase II options the possibility of filing bankruptcy should be considered. Income tax obligations that are more than three years old may be discharged in a bankruptcy action. The age of an income tax obligation is determined by the assessment date for the debt. Usually this is the date on which the tax return is filed for the year in question but there are many exceptions and modifications to these rules. Certain types of tax obligations such as payroll tax related penalties and state sales tax obligations are generally not dischargeable in bankruptcy. If an individual has debts other than tax liabilities, the bankruptcy option may be the solution for a number of problems. A professional focused only on taxes may overlook the value of this option.

Hopefully this discussion has illustrated that Phase I and Phase II issues present very different considerations. Many times a tax problem will require working through issues in each of these phases. When that is the case, some interesting strategies may evolve. My next blog will look at some of those strategies.

If You Owe NYS Taxes You Can Now Lose Your NYS Driver’s License

Earlier this year the New York State legislature enacted a new provision of the Tax Law which provides for the suspension of a New York State driver’s license when an individual owes at least $10,000 in state taxes. This new law called for the Commissioners of the NYS Tax Department and DMV to reach an agreement on how to implement this new suspension program. That agreement has now been struck and the Tax Department has started to notify delinquent taxpayers. Once notified, taxpayers will have 60 days to pay the outstanding tax obligation or enter into a “satisfactory” payment arrangement to avoid the suspension. If a payment arrangement is set up, more than one missed payment in any twelve-month period will trigger a suspension of the license.

An individual’s ability to contest this proposed suspension is extremely limited. Drivers holding commercial licenses and individuals that are already subject to wage garnishments for child and spousal support obligations are exempt from this suspension process. Otherwise, anyone owing more than $10,000 (an amount that includes tax, interest and penalties) is subject to the new program.

Clearly this new provision is designed to motivate individuals to address their outstanding tax obligations. The impact of this new law could be quite disruptive for many people other than taxpayers, such as employers who depend upon their employee’s ability to drive. The State is just now beginning to issue notices under this new law and the effectiveness of this approach remains untested.

Tax Problem Fundamentals: Phase I Considerations

In the last blog I provided an overview on how to approach a tax problem. That overview broke the approach down into two phases. This installment considers Phase I: What do I owe?

Most income tax obligations arise through the filing of a tax return that reports a balance owed. This situation is typically referred to as a “self-assessment” since the taxpayer is volunteering, under penalties of perjury, what he or she believes to be his obligation. Once a self-assessment is made, the amount owed can still be changed by the taxpayer or by the IRS. The taxpayer can seek a change by filing an amended return. The IRS does so through an audit. As a general rule, any such change must occur within three years of when the return was filed.

In the case of an audit, if the taxpayer does not agree with the proposed audit adjustments there are both administrative and judicial appeal rights. The vast majority of administrative appeals are resolved without the need to go to court. The audit and appeal process can take months, sometimes years. But as long as this process is ongoing, the taxpayer is still dealing with Phase I issues. It is only after the taxpayer has foregone or exhausted all of these options to determine whether and how much is owed, does the tax problem move to Phase II of the process (the subject of my next installment.)

As a general rule, as long as Phase I is open no collection activity can be taken by the IRS under Phase II. But that is not always the case. For example, if no tax return is ever filed the IRS has the ability to file a return based upon information that has been reported by third parties (for example, W-2s and Forms 1099). When a tax liability arises as a result of this process, it is said to arise out of a “substitute for return.” If the IRS prepares a substitute for return, an amount owed has now been determined so collection activity (Phase II) will commence. And yet, when the IRS prepares a return for a taxpayer, usually the amount determined to be owed is significantly higher than what would have been owed had the taxpayer filed the return himself. Under these circumstances it is usually very beneficial to prepare the actual return for the year in question so the correct tax debt can be determined (Phase I).

Another instance when Phase II collection activity may occur before Phase I ends is when the IRS imposes penalties for the late filing of a return or the late payment of the tax owed. There may be no question that the underlying tax obligation is due but the circumstances that caused the late filing or late payment may serve as a basis to have penalties abated. Penalty abatement requests need to be submitted in writing and the written request must demonstrate reasonable cause and not willful collect. There is considerable guidance on what will constitute reasonable cause and things like serious medical issues or catastrophic events usually qualify.

Each of these Phase I examples — the substitute for return and penalty abatement request – muddy the Phase I and Phase II distinction I have made. In these situations, we clearly have Phase I issues to be addressed but IRS collection activity may also be well underway. Therefore, Phase II issues are also going to be in play.

In summary, any time the IRS asserts a liability, the possibility of there being what I call a “Phase I issue” should be considered. After it has been determined that Phase I is over, it is time to consider Phase II — the topic of my next installment.

Some Fundamental Considerations When Facing a Tax Problem

When a tax problem arises it is not uncommon to become overwhelmed and sometimes even paralyzed by the situation. No doubt much of the anxiety is due to the uncertainty of whether the problem can be solved and how to go about doing so. More and more self-professed tax experts advertise promising results with such individuals in mind. Many of these so-called experts, however, take a very narrow “one size fits all approach” when dealing with a tax problem. That is unfortunate; oftentimes there are many options that should be evaluated before a decision is made as to how best to proceed. My next few blogs will consider how, in my opinion, a tax professional should evaluate a tax problem. The discussion begins with an overview of how to approach a tax problem and then delves into some of the details regarding the different phases of a tax problem.

When I assist with a tax problem I always look at the situation as having two distinct phases. Phase I deals with how much is owed. Phase II deals with how to pay the amount owed. Most of the time you know whether you are in Phase I or Phase II of the process. For example, if you receive an IRS audit notice, you are clearly in the early stages of a Phase I situation. If you receive a collection notice after filing a tax return without full payment of what you agree is due, this is a Phase II issue. But what if you never filed a tax return reporting a balance due and now the IRS serves a wage garnishment on your employer? Where are you in the process? What are your options?

Faced with this scenario, a seasoned tax professional would rightfully want more information from both the taxpayer and the IRS before evaluating how best to proceed. The questions that come to my mind on hearing these basic facts include: Did you recently move and possibly not receive an audit notice? Is it possible the IRS prepared one or more returns for you (referred to as a substitute for return) based upon limited information reported to the IRS? Has there been an identity theft? Each of these inquiries relate to the Phase I question of whether a tax is owed in the first place, and if so, how much is really owed.

While sorting out these questions, additional consideration would need to be given to the impact of the wage garnishment that has now occurred. On that subject the questions that come to mind include: Was the wage garnishment issued from an IRS service center or out of a local office? Has there been any prior collection notice or action taken before the garnishment? Is a voluntary payment arrangement preferable? Is a bankruptcy filing something to be considered? All of these inquiries deal with Phase II aspects of the problem.

While there are often recurring themes and typical situations when tax problems arise, solutions are best when tailor-made for the specific taxpayer in question. Evaluating where the taxpayer is in the process helps determine what options are available. The “one size fits all” approach may result in a resolution, but it may not be the best solution under the circumstances.

I Haven’t Filed My Tax Returns…Is There Hope?

              I am often asked:  “If I can’t pay the tax due with my return, am I better off not filing until I have the money to pay?”  While the situation presents some complexities, the advice is simple:  it is always best to file your tax returns on time even if you can’t pay.  Such filing eliminates the failure to file penalty (which, along with the failure to pay penalty, can grow to as much as 25% of the tax due) and the possibility of the much more serious criminal consequences for not filing.  (These are the IRS consequences; each state has similar rules for their returns as well.)

            But what happens if I didn’t file a tax return, or worse yet, several returns?  Here’s the good news, it’s not hopeless.  Many people don’t file their tax returns.  The reasons for non-filing can run the gamut from serious medical or personal issues, natural disaster, economic reversal, business failure, and so on.  (I intentionally exclude illegitimate reasons for non-filing as the consequences for those are much different.)  In my experience, if someone hasn’t filed for one year, typically they haven’t filed for several years.  This prolonged period of non-filing typically starts with one of the reasons listed above, but the repeated failure to file results from the uncertainty – – really the fear — that “coming back into the system” will be too costly and potentially devastating.  Those that do not file one or more returns very often find themselves in what seems an inescapable and unsolvable predicament. 

            Fixing a non-filing situation is not always pain-free but there are options for non-filers and certain choices are much better than others.   Most importantly, for at least 25 years it has been the IRS’ policy not to press criminal charges for non-filers who voluntarily file their past due returns.  Returns are considered filed “voluntarily” as long as the IRS hasn’t commenced any investigation or contacted the non-filer before the returns are filed.  So the best option for the non-filer is to get the returns filed – before the IRS asks you to file them.  (Even when the IRS asks for unfiled returns, it is not automatic that criminal charges will be asserted.)

            What if you haven’t kept your records (W-2s, 1099s, etc.) to prepare your returns?  Don’t let that be an excuse.  All of that information is available from the IRS.  In fact, if you plan to file returns for the past several years it is a good idea to request that information before filing just to be sure you report everything that the IRS already knows about.   Once the return(s) have been filed, there are three basic options to then consider in dealing with the amount due:  full payment (all at once or over time), settlement through an offer in compromise, or having the debt found to be “currently not collectible.”     If penalties are been imposed after the return is filed, which is very likely to be the case, those additional charges may be removed if the taxpayer can demonstrate that the late filing was due to reasonable cause and not willful neglect.

            Nonfilers that I have worked with are almost universally relieved to learn that the heavy burden of not being in noncompliance can be resolved, often with consequences much less severe than ever envisioned.

If you find yourself in a hole, stop digging…

Ever hear the expression, “If you find yourself in a hole, stop digging.” That is as good a place to start when someone has fallen behind in their obligation to pay their taxes. So often when someone has a tax problem I see that they are always playing catch up.

A typical scenario may be: Bob files his 2009 return late with a big balance due. Determined to fix the problem, he stops his withholding for 2010 and he starts paying all of his 2010 tax money over to the IRS to pay off the 2009 bill. Or if Bob is self-employed, he commits to pay over a lump sum payment (when his next deal closes) and neglects to make his estimated tax payments for the 2010 income. So now, when the 2009 debt is satisfied, the 2010 return comes now due and Bob realizes he is going to owe about as much again for 2010. My advice: stop digging Bob. What Bob is doing is running up more penalties and interest than is necessary.

A better approach would be to contact the IRS and come up with a payment plan to pay off 2009 which allows Bob to stay current on his obligation for 2010, and beyond. Yes, penalties and interest will continue to accrue on the 2009 balance until it is paid off, but failure to file and failure to pay penalties max out at 25% of the tax for each year. Consider that the cost of needing more time to pay the 2009 debt. Using the “catch-up” approach, Bob is now likely to face that 25% penalty for each year he owes. In the long run, he will pay a lot more than he should have to.

If you fall behind for one year, work out a plan for that year that allows you to stay current for subsequent years. Now you have minimized the cost of having fallen behind.