Overview of Federal Income Tax Debt: What Can Be Done to Solve Your Tax Debt.

You Can Eliminate Income Tax Debt In Bankruptcy!

Does this sound familiar?

The challenge with IRS debt is 2 fold; first, the average person FEARS the IRS. That fear often leads to inaction. A common story I hear: 5 years ago I was going to owe the IRS money but didn’t have it to pay. I didn’t file my tax return that year and I haven’t filed a return since. When asked why they didn’t file, the most common response: “I was scared!” The second challenge is the IRS is actually very slow in acting on delinquent taxpayers. You may receive a few innocuous notices in the mail; but nothing seems to happen. A few months go by, nothing happens. Next tax year rolls around, and now you think, “I don’t want to rock the boat, so I won’t file my tax return.” I have seen people go years before the IRS gets serious.  Eventually, the IRS catches up (unless you drop off the grid), or the person gets tired of waiting for the other shoe to drop (and when the IRS drops the shoe, it is usually a steel toed boot filled with sand) and decides to face the situation and take care of it.

There are options!

If you owe the IRS back income taxes, there are four permanent solutions, one temporary solution, and two options that are specific to particular circumstances for resolving tax debt. If you take no action to solve your IRS debt, you will be subject to wage garnishment, seizure of funds in a bank account, and possible seizure of your stuff (assets).

So, What Can Be Done To Solve Income Tax Debt?

The 4 permanent solutions are these:

1. Installment Agreement (payment plan)

2. Offer in Compromise (settlement)

3. Chapter 7 bankruptcy

4. Chapter 13 bankruptcy.

The 1 temporary solution:

1. Currently Non-Collectable Status

The 2 circumstance specific solutions are these:

1. Innocent Spouse

2. Penalty Abatement (forgiveness)

PERMANENT SOLUTIONS:

IRS Payment Plan, Installment Agreement

If you have the means to pay your tax, the IRS will allow some form of monthly payment plan to pay your back income taxes. The challenge with installment plans is IRS collection standards. In general, the IRS does not care what you actually spend on living expenses; they will base the monthly payment using IRS collection standards. What that means is if your mortgage payment is $2,000 but the IRS only allows $1,600 as its housing standard for your area, the IRS will require you to pay an additional $400 per month toward your payment plan, regardless if you actually can! Also, certain expenses are not allowed such as credit card payments, student loan payments, etc. Thus, the payment the IRS will accept and what you can actually afford are often far apart. However, the news is not all bad.

The good news is, if you owe less than $10,000 in income tax, you may request a payment plan of up to 36 months with no questions asked. This plan is known as a “Guaranteed Installment Agreement.” If you owe the IRS less than $25,000 in income tax, you can request a payment plan of up to 60 months with no questions asked. This plan is known as a “Streamlined Installment Agreement.”

The bad news is if you owe more than $25,000 in income tax. The IRS is becoming much greater stickler with its collection standards and it can be a very difficult negotiation to get a payment that you can actually afford. If you owe more than $25,000, then I strongly urge you to contact me to explore your options for resolving your tax debt. The key to getting your installment plan approved is in convincing the IRS that the payment is in the IRS interests and making it easy for the Revenue Office or Appeals Officer to agree with your position.

Offer in Compromise (Settlement)

An Offer in Compromise is probably the most misunderstood option for dealing with income tax debt due in large part to the constant T.V. commercials promising to “settle your tax debt for pennies on the dollar.” The facts about an Offer in Compromise are these:

• It is not just a number your “throw out” to see if the IRS will accept. An Offer in Compromise is a technical calculation based on your equity in assets and disposable income.

• The IRS accepts less than 25% of settlement offers.

• There is a legal standard that must be satisfied, Reasonable Collection Potential. Not only must you convince the IRS that you cannot pay your tax now, but the IRS must be convinced that the Offer amount is equal to what it could expect to collect during the statute of limitations, which is 10 years.

• The IRS doesn’t really need a reason to reject your Offer. A tax settlement is a privilege, not a right. You may very well meet the legal standard, have an accurate offer amount, and the IRS may still reject your offer for “policy” reasons.

The reality is an Offer in Compromise is a delicate negotiation and many tax practitioners simply do not comprehend the legal requirements; they simply approach an offer as filling out a few forms related to your financial circumstances. That is NOT what an Offer in Compromise requires. An Offer in Compromise often takes 6-18 months to negotiate. The IRS can take up to 24 months to accept or reject an Offer in Compromise. During that time, all financial information must usually be updated and a seasoned practitioner will present a compelling narrative (story) as to why you should be granted a tax settlement.

Also, an Offer in Compromise should not be done on a whim. Submitting the Offer can affect your ability to later discharge your tax liability in bankruptcy. I provide my clients with the insight and guidance needed to make an informed decision about which tax solution to pursue. Ultimately, it is the client’s choice; my role is to asses the chances of success, point out the pitfalls, and then pursue with all my ability the option the client chooses.

Chapter 7 Bankruptcy

Despite common myth, older income tax debt CAN BE eliminated in chapter 7 bankruptcy. I feel the rules for discharging tax debt are fairly straightforward, so I am often amazed by how many bankruptcy attorneys struggle with tax issues. I suppose this insight comes with experience, but many bankruptcy attorneys do not encounter the issue often enough to have much experience.

So, when can income tax be eliminated in chapter 7 bankruptcy? There are 5 basic rules.

• The tax return due date is more than 3 years before filing bankruptcy,

• Tax returns are due on April 15. For example, if you want to discharge your 2007 income tax debt, the eligible discharge date would be April 16, 2011.

• Also, if you file an extension, the 3 years starts from the extension date. For example, if you filed an extension for your 2006 income taxes (due April 15, 2007), your eligible discharge date is October 16, 2010.

• The tax return was FILED more than 2 years before filing bankruptcy,

• To discharge tax debt in bankruptcy, you must have filed the tax return.

• The tax was assessed 240 days, or more, before filing bankruptcy,

• This rule is frequently known as the “tax audit rule.” If you were subsequently audited by the IRS and the IRS assessed more tax, you must wait 8 months to discharge that tax debt assuming the other requirements are met,

• The debtor did not file a fraudulent tax return, and

• The debtor did not willfully attempt to evade the tax due.

There are other technical rules regarding discharging tax debt, but in general, if the above rules are satisfied, the income tax debt can be discharged in bankruptcy.

If you have other debt issues, credit cards, medical bills, etc. in addition to your tax debt, chapter 7 bankruptcy is probably the most comprehensive solution for solving your financial challenges.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy is emerging as the preferred option for resolving income tax debt over $25,000. Chapter 13 bankruptcy is a payment plan YOU force onto the IRS. The real benefit of chapter 13 is that you have more flexibility in allowable expenses. If you get a hard nosed IRS revenue officer or IRS appeals office that is going to stick to IRS collection standards no matter how unrealistic the situation, chapter 13 is a good alternative. Chapter 13 bankruptcy allows you to pay your IRS debt over 60 months. In addition, if you have other debt issues (credit cards, personal guaranteed business loans, medical bills, etc.), a chapter 13 bankruptcy becomes a more comprehensive solution to your debt.

Chapter 13 bankruptcy is a monthly payment plan, and in most cases, your monthly payment will pay your IRS debt first; if anything is left over, only then will your other creditors be paid.

I must admit, in recent years, chapter 13 is becoming my preferred alternative relative to an IRS installment agreement. Most clients have other debt issues, so chapter 13 bankruptcy solves those challenges as well, and even if there are no other debt issues, the control I have over the IRS with chapter 13 bankruptcy is preferable to the luck of the draw with IRS appeals.  Also, if some of the debt is dischargeable in bankruptcy, then you need only pay that portion of tax debt that cannot be discharged.

TEMPORARY SOLUTIONS

Currently Non-Collectable Status

If you can demonstrate to the IRS that you have no ability to pay your back income taxes based on IRS collection standards or if paying the taxes would create an undue hardship, the IRS may designate your account as currently non-collectable. Non-collectable means that the IRS will not take action to collect your back income taxes (e.g. seize assets, levy bank accounts, garnish wages, etc.).

Non collectable status may be reviewed by the IRS at anytime and revoked if your financial condition changes. As such, non-collectable is not a permanent solution. Non-collectable will typically be revoked if you file a tax return showing an increase in income or if you fail to file a tax return for a given year.

You might be asking; if I am non-collectable, why not submit an Offer in Compromise? One of the main reasons for seeking non-collectable over an Offer in Compromise is if the client really has equity in assets. For example, I recently negotiated non-collectable status for a client that had over $100,000 in home equity. If we had tried a standard Offer in Compromise, the IRS would require payment of $100,000. However, because of this client’s circumstances, non-collectable status was a more realistic option.

In general, a permanent solution should be sought whenever possible, but a non-collectable status is a good way to stabilize an account and allows the client and I to implement a long term strategy of financial recovery.

CASE SPECIFIC SOLUTIONS

Innocent Spouse Relief

In many marriages usually one spouse takes responsibility for handling taxes and finances and most married couples will file as married, filing jointly because of the tax advantages of doing so. However, if the responsible spouse does something wrong or underhanded, both spouses are responsible for any tax liability. In legal jargon, we call this joint and several liability, which means that each spouse is individually responsible for 100% of the tax due and therefore the IRS can choose whom to pursue.

Within the context of Innocent Spouse Relieve, there are actually 3 remedies. (1) Innocent spouse relief (IRS forgives the innocent spouses tax liability), (2) Separation of Liability (the IRS allocates the tax debt to each spouse based on their share of the tax due), and (3) Equitable Relief (which is the catch-all remedy that is used when it is simply unfair to hold the innocent spouse responsible for the tax).

Unlike many IRS remedies which have objective standards, Innocent Spouse relief is very subjective. As such, it is extremely important to present a compelling case as to why one spouse is innocent. It is not enough that the innocent spouse simply didn’t know what the other spouse was doing; the innocent spouse must convince the IRS officer that it would be totally unfair to hold you responsible for the tax debt under the circumstances.

In all tax resolution cases, I try to present a compelling story or narrative to make it difficult for the IRS officers to say no to my proposal, but with Innocent Spouse Relief, the decision will usually turn on the presentation of that story. Innocent Spouse relief often requires skilled negotiation and story telling ability to succeed.

Penalty Abatement (Forgiveness)

If you didn’t file a tax return or if you didn’t pay your tax due, then you are subject to penalties. For example, if you fail to pay your tax when due, you are charged a 0.5% penalty for each month you are late up to a maximum of 25%. The total penalty for failure to file and failure to pay can reach 47.5% of the tax due.

To request forgiveness of tax penalties, 2 conditions must be satisfied.

1. You have either paid the balance due, or you are on an Installment Payment plan, and

2. You have reasonable cause as to why the penalties should be forgiven.

Having penalties forgiven is a privilege not a right. As such, the taxpayer must present a compelling reason why he should not be responsible to pay the penalties. The basic inability to pay your taxes is not enough, you need a convincing reason why you weren’t able to pay your tax when due.  However, if you were in the hospital, in a coma, when your tax return came due, that is a good reason. Thus, having an expert that can present your story within the context of the legal requirements for Abatement of Penalties is vital to a successful case.

Contact Denver bankruptcy attorney Matt Berkus today by calling 720-545-0339 to discuss possible solutions to your Federal Income Tax Debt.