By Anthony Diosdi
If the Internal Revenue Service (“IRS”) has assessed a tax liability against you and it is not paid, the IRS can proceed with enforced collection actions you. Enforced collection actions includes seizure of your wages, your bank accounts, and your property to satisfy the outstanding tax liability. This can be financially devastating. Fortunately, with proper planning, IRS collection actions may be prevented. And, in some cases, an unsatisfied tax liability can be reduced or even eliminated.
Before the IRS will begin to proceed with enforced collection actions, you will be issued a series of notices from the IRS. These notices should be taken seriously and never ignored. In some cases, the notices you receive from the IRS may actually offer you an opportunity to resolve your outstanding tax liability. Below, I will discuss the notices someone with a back tax liability will receive from the IRS prior to the commencement of enforced collection actions and what should be done when such a letter is received.
IRS CP501 Notice
If you owe taxes to the IRS, the first notice that the IRS will forward to you is a CP501. This notice tells you that you have a balance due (money you owe to the IRS). If you receive a CP501 notice, you should understand that the IRS is not only putting you on notice that you owe back taxes, the IRS is putting you on notice that they intend to collect the tax from you in the near future. A CP501 notice should be a call to action for anyone that owes back taxes to the IRS to come up with a plan to resolve an outstanding tax liability. At this point, you essentially have two options. First, if possible, you can attempt to contest the tax liability. Second, you can attempt to resolve the tax liability through either a monthly installment payment agreement or an offer in compromise. I will discuss these options in more detail below.
How Can I Contest an Assessed Tax Liability?
If you are unsure why you owe the IRS or you do not understand why your bill is so high, now is the time to investigate why you you owe the tax and if the tax is correct. This can be done through a procedure known as the Freedom of Information Act Request (“FOIA”). The Freedom of Information Act 5, U.S.C. 552, provides any person the right to request access of federal agency records or information. The FOIA applies to records either created or obtained by an agency and under agency control at the time of the FOIA request. All IRS records are subject to FOIA requests. Through a FOIA, you obtain a copy of your administrative file from the IRS. The IRS’ administrative file should tell identify the origin of any tax assessment. However, it can take months for the IRS respond to a FOIA request. This is important because the IRS proceeds quickly with when collecting a tax liability. Thus, a FOIA request should be made almost immediately after you receive a CFC501 notice.
Once you obtain the IRS administrative file, the next step is to determine whether or not the assessment is correct and if it can be contested. Typically, a tax liability that is “final” cannot be contested in Tax Court, meaning that the liability at issue may need to be paid in full before it can be contested in court. A tax liability is not final if the IRS has not issued to you a notice of deficiency and you have not had a prior administrative or judicial opportunity to challenge the amounts assessed.
If you did not have a prior opportunity to contest the tax at issue and do not believe your tax bill is correct, you may take the IRS to Tax Court. Not only can you take the IRS to court, but you can prevent the IRS from collecting the tax assessment until your dispute with the IRS is resolved. However, an administrative proceeding known as a “collection due process hearing” must first be filed with the IRS. As will be discussed below, a “collection due process hearing” can only be requested once you receive a correspondence from the IRS known as “Final Notice of Intent to Levy or Notice of Intent to File a Tax Lien.”
Can I Attack a Tax Assessment Utilizing the Statute of Limitations?
In some cases a tax liability may be contested utilizing the statute of limitations. The law provides that the IRS has a limited time to make a tax assessment. As a general rule, an IRS tax assessment is invalid if not asserted within three years of the tax return filing (six years if more than 25 percent of income was omitted from the gross amount stated on the tax return). If the IRS failed to timely assess a tax liability and you did not have an opportunity to previously contest the tax, you may request a collection due process hearing and raise the statute of limitations as a defense to the tax liability.
Not only does the law provide a limitation for assessments, the IRS time to collect a tax liability is also limited. In most cases, the IRS has ten years from the date of a timely assessment to collect the tax through a levy or begin a proceeding in court. If the more than ten years have transpired from the date of the assessment, it may be possible to contest the tax the IRS is attempting to collect from you.
Requesting a Reduction of Penalties
Another potential way to reduce a tax liability is to request relief from penalties assessed by the IRS. When a tax liability is not timely satisfied and/or tax return is not timely filed, the IRS typically assess delinquency penalties. Delinquency penalties are imposed by Section 6651 of the Internal Revenue Code. The failure to timely pay penalty and failure to timely file tax returns are imposed at one half of one percent per month and five percent per month up to a maximum of twenty five percent for each penalty. These penalties are imposed upon the “net amount of tax due.” These penalties can significantly increase the amount of liability owed to the IRS. The good news is that sometimes IRS can be convinced to waive or reduce delinquency penalties. A transcript can be obtained from the IRS to determine if the IRS assessed delinquency penalties against you. A written request must be submitted to the IRS stating the reason as to why delinquency penalties should be abated or reduced.
Coming up with a Plan to Satisfy a Tax Liability
Whether or not your tax liability can be reduced by contesting or through a penalty reduction, if you owe a tax liability to the IRS, it will need to be resolved. Unfortunately, many taxpayers just do not have the funds available to satisfy an IRS tax liability in full. If you cannot satisfy an IRS tax liability, arrangements will need to be made to resolve the tax liability. Depending on your financial situation, sometimes the IRS can be convinced to accept a payment of less than the amount assessed through either a monthly payment plan. Other times, the IRS can be convinced to plan a tax liability in “uncollectible” status. This means that the IRS will agree not to collect the tax liability. Whether or not the IRS will agree to satisfy your tax liability through a payment plan or plan an account in hardship status depends on the facts and circumstances of your individual case.
Can I Reach a Settlement with the IRS through an Offer in Compromise?
One of the most frequently asked questions I receive is “can I just offer a settlement to the IRS” or “can I submit an offer in compromise to the IRS and pay pennies on the dollar.” Although the IRS is authorized to settle or compromise tax debts if it determines that there is “doubt as to liability” for the debt or “doubt as to collectibility” of the debt, as a practical matter, convincing the IRS to accept a formal offer in compromise is not an easy task. Most offers are submitted to the IRS on a theory of “doubt as to collectibility.”
The policy behind the offer in compromise program is that there are some taxpayers who owe more in taxes, penalties, and interest than they could ever repay before expiration of the statute of limitations on collections. The offer in compromise program is a mechanism whereby an individual can present financial information to demonstrate his or her “reasonable collection potential.” Once the IRS verifies the financial information submitted, the IRS may agree to accept less than what is owed if the amount offered is more than the IRS believes it would otherwise ever collect. On the other hand, if the IRS determines that a tax liability can be paid in full, (as in most cases), an offer in compromise will not be accepted.
A taxpayer’s “reasonable collection potential” is the sum of 1) the present value of the taxpayer’s ability to make continuous monthly payments to the government; and 2) the net realizable equity in the taxpayer’s assets. To determine the “reasonable collection potential” of a taxpayer, the taxpayer must complete and file Form 656 with supporting documentation to substantiate the taxpayer’s assets, liabilities, income, and “necessary” living expenses.
The taxpayer’s ability to make continuous monthly payments is determined by subtracting from his or her average monthly income the taxpayer’s average monthly “necessary” living expenses. In determining a taxpayer’s “necessary” living expenses, the IRS uses published “national standards” of what it will allow for food, clothing, and other items as well as for out-of-pocket health care costs. It uses “local standards” for housing and utilities and for transportation expenses. The IRS uses these calculations regardless of the taxpayer’s actual living expenses.
The resulting net figure is also reduced by the amount of any court ordered child support and alimony payments. The final figure constitutes the amount the IRS determines the taxpayer can afford to pay on a monthly basis toward the unpaid liability. The present value of that stream of income is calculated by multiplying the monthly figure by 48. The product comprises the first part of the taxpayer’s “reasonable collection potential.”
Reasonable equity is determined by taking the asset’s fair market value and reducing it by 20 percent percent. This figure is then reduced by the amount of secured debt. Once the positive equity is calculated for all the taxpayer’s assets, they are added together to determine the second part of the taxpayer’s “reasonable collection potential.”
The two components determined above are added together to arrive at the minimum amount a taxpayer must offer for the offer in compromise to be eligible to process. Anyone considering submitting an offer in compromise should carefully review the “national” and “local” standards published on the IRS’ website before moving forward with an offer. The “national” and “local” standards can be found at https://www.irs.gov/payments/offer-in-compromise.
IRS CP503 Notice
If you have not responded to the IRS Notice CP501, the IRS will forward to you a CP503 Notice. The IRS CP503 Notice is a reminder. However, the IRS CP503 Notice should not be taken lightly. If you have not come up with a plan to resolve your back tax liability by the time you receive a CP503 Notice, the IRS should be contacted and a hold negotiated on collection activity.
IRS CP504 Notice
You have an unpaid amount due on your account. If you do not pay the amount due immediately, the IRS will seize (levy) your state income tax refund and apply it to pay the amount you owe. The CP504 is serious because not only does the notice put you on notice that the IRS is ready to proceed with enforced collection actions against you. If you receive a CP504 notice, the IRS should be contacted immediately and a hold on enforced collection actions should be negotiated.
IRS Notices CP90/CP297/CP297A “Final Notice of Intent to Levy or File Tax Lien”
If you receive an IRS Notice CP90, CP297, or CP297A, you must understand that the IRS may proceed with enforced collection actions within 30 days of the notice date. Once you receive a notice entitled “Final Notice of Intent to Levy or File Tax Lien,” a request for a collection due process may be filed with the IRS. If you do not demand a collection due process hearing request within 30 days of receiving a “Final Notice of Intent to Levy or File Tax Lien,” you may be forever forfeit your right to a collection due process hearing. A collection due process hearing is filed with the IRS be filing a Form 12153. If you owe a tax liability and do not believe the tax bill is correct (and did not have a chance to contest the tax in the past), you should consider filing a request for a collection due process hearing. Not only will this afford you the opportunity to contest the tax, filing a collection due process hearing will prevent the IRS from proceeding with enforced collection actions against you until your hearing is conducted and in certain cases, when the Tax Court adjudicates your matter. A collection due process hearing may not only be utilized to contest a tax liability, a collection due process hearing in certain occasions to dispute the IRS’ denial of a collection alternative such as a request for an installment payment plan, request to place an outstanding tax liability in “uncollectible status,” or the rejection of an offer in compromise.
Determining how to best resolve a tax liability is complicated process. The sooner you come up with a plan to resolve a tax liability the better. Retaining a good tax attorney how understands how to resolve a tax liability can be invaluable when dealing with the IRS.
Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in tax matters domestically and internationally throughout the United States, Asia, Europe, Australia, Canada, and South America. Anthony Diosdi may be reached at (415) 318-3990 or by email: firstname.lastname@example.org.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.