February 1999 Issue

Answers to 20 Questions on

Dealing with

IRS Collections

By Peter A. Karl, III

In Brief

Armed with the Answers

The author has prepared 20 questions and answers on dealing with IRS collections covering the following topics:

  • The statute of limitations

  • Documentation available from the IRS

  • Abatement of penalties and interest

  • Repayment options

  • Benefits of designating where amounts being repaid are to be applied

  • The difference between innocent and injured spouse

  • Schedule of issuance of various notices by the IRS

  • The differences between IRS seizure and sale of levied realty versus personal property

  • When a court order is required for the IRS to enter
    the premises

  • Creditor protection subsequent to filing of an IRS lien

  • Provisions for the release of a lien on a specific piece of property

  • The difference between necessary and conditional expenses

  • Determining the amount of an offer in compromise

  • The disadvantages in filing an offer in compromise

  • The procedures available when a taxpayer's representative is dissatisfied with the actions of a collections
    revenue officer

  • Other major changes in collections procedures under the IRS Restructuring and Reform Act of 1998

  • The discharge of income taxes under Chapter 7 bankruptcy filing

  • The treatment of taxes in Chapter 13 bankruptcy filing

  • Alternative bankruptcy options for taxes in arrears

  • Other planning considerations.

    What to do when Uncle Sam asks for his money

    1. What is the statute of limitations applicable to tax collections?

    The normal period is ten years from the date the return was filed or the liability was assessed. This period is extended by filing--

  • an offer in compromise [currently for the period that the offer is under consideration plus one year; for offers submitted after December 31, 1999, the provision for the extra year has been deleted pursuant to the IRS Restructuring and Reform Act of 1998 (IRSRRA)],

  • Form 9465, Installment Agreement Request (which permits an extension for the duration of the installment agreement plus 90 days), or

  • a petition in bankruptcy (for the period of time in bankruptcy plus six months).

    2. What type of documentation is available from the IRS to provide verification of amounts owed by a taxpayer?

    In addition to filing Form 4506, Request of Tax Return Information, to obtain a copy of a tax return, the most commonly requested items to obtain specific information concerning an individual or business taxpayer are--

  • a Penalty and Interest Notice Explanation (PINEX),

  • an Individual Master File (IMF) or Business Master File (BMF) that reflects dates of return filing, assessments of taxes, penalties and interest, along with credits,

  • an Information Returns Program (IRP) that shows the sources and amounts of income and credits reported to the IRS through information forms such as Forms W-2 and 1099, or

  • a Return View Printout (RTVUE) that summarizes a particular tax return from IRS records.

    3. How can IRS penalties and interest be abated?

    Under a "reasonable cause" standard, a penalty can be abated for the following reasons:

  • Death, unavoidable absence, or serious illness of the taxpayer or the taxpayer's family

  • Fire, casualty, natural disaster, or other disturbance that destroyed records or prevented compliance

  • Inability on the part of the taxpayer to obtain records needed for the completion of the return

  • Lack of funds (but only where the taxpayer could demonstrate the exercise of ordinary business care and prudence), or

  • Other reasons establishing that the taxpayer exercised ordinary business care but could not comply with the time limits.

    In connection with the failure to deposit penalty, IRSRRA permits a waiver for a penalty assessment with respect to the taxpayer's first deposit after there has been a change in deposit frequency.

    Interest, on the other hand, is only forgiven if a delay resulted from the IRS "performing their ministerial acts."

    4. What repayment options exist when a taxpayer owes taxes?

    The taxpayer may--

  • contact the Voice Balance Due System (VBD) at (800) 829-8815 if the liability is less than $10,000 in individual income taxes. A maximum 28-month payment plan is permitted.

  • file an Installment Agreement Request (Form 9465) with a fee of $43 to pay over a maximum 36-month period. If the amount owed is over $10,000, financial forms 433-A (for individuals) and 433-B (relating to businesses) will be required.

  • submit an Offer in Compromise (Form 656) to discharge the liability in return for paying a portion of the outstanding taxes, interest, and penalties.

    Pursuant to IRSRRA, an individual taxpayer whose tax liability (without regard to interest and penalties) is less than $10,000 can require the IRS to enter into an installment agreement for a period not to exceed three years provided that within the preceding five taxable years the taxpayer and spouse have--

  • not failed to file any income tax return or pay any amount due, nor

  • otherwise had an installment agreement with the IRS with respect to any income tax.

    5. Is it beneficial for a taxpayer to designate (in the case of a voluntary repayment to the IRS) where an amount being repaid is to be applied?

  • With respect to the trust fund 100% penalty (assessed against an individual "responsible party" in the case
    of FICA and withholding taxes not remitted by the corporate employer), the designation of the payment as solely to taxes will avoid the IRS applying the payment towards interest and penalties assessed against the corporation for failure to deposit. (This latter portion of the corporate liability is not included in the assessment against the individual responsible party, i.e., merely the taxes).

  • By designating payments to the most recent assessments, older ones closer to the ten-year statute of limitations will eventually expire; absent any designation, the IRS obviously applies payments to the oldest assessment first. IRSRRA permits taxpayers to designate tax deposits (such as those for employment taxes) to a specified tax period (e.g., the current period); this avoids incurring another failure to deposit penalty for the presently required deposit. Beginning in 2002, the IRS must apply a deposit to the most recent period (unless the taxpayer designates otherwise).

  • In the case of a business, the designation of the payment as interest will create a tax deduction.

    6. What is the difference between an innocent spouse and an injured spouse?

    The concept of an innocent spouse was liberalized by IRSRRA. An Innocent Spouse Election may be made within two years of the IRS commencing collection activities by an individual who filed a joint return in which--

  • the return was erroneous with respect to items attributable to the other spouse resulting in an understatement, and

  • there was no knowledge (or reason to know) by the individual making the election and it would be inequitable not to grant this relief (or in part to the extent the understatement was not or should not have been known).

    Besides providing for innocent spouse relief, newly revised Form 8857 includes an allocation of the original joint and several tax liability by an electing spouse who is divorced, separated, or not living with the other spouse. If a taxpayer does not qualify for the innocent spouse benefits or for an allocation of liability, this form also has a provision for the application of equitable relief (under a facts and circumstances standard) when a taxpayer feels that it would be unfair to be held liable for any understatement or underpayment of tax that is attributable to a spouse (or former spouse).

    An Injured Spouse designation is used to obtain a refund of monies retained by the IRS as a result of the other spouse's debt. When a refund is owed to one taxpayer but there is a past-due tax, child/spousal support, or Federal nontax debts (such as student loans), all or part of the joint filers' overpayment of tax may be used to pay the debt. An injured spouse can obtain a refund for the share of the overpayment that was used to pay the other spouse's past-due debt by filing Form 8379, Injured Spouse Claim
    and Allocation, with the original return. Alternatively, the form can be submitted upon the notification of a withheld refund.

    To be considered an injured spouse, the taxpayer must have--

  • filed a joint tax return,
  • received income such as wages, interest, etc.,

  • made payments such as Federal income tax withheld from wages or estimated payments,

  • reported the income and payments on the joint tax return, and

  • had an overpayment, all or part of which may have been applied against the past-due amount of the other spouse.

    7. What is the approximate schedule of the issuance of various notices by the IRS from the time of initial assessment to an IRS levy?


    As shown in the Exhibit, the CP notification number (as reflected on the upper right hand corner of the notice near the date) has specific timelines generated by the IRS's computer system. That time allotment is shorter for business taxes. It may be noted that different CP notices are used for nonfilers of Form 1040; CP 515 and 518 provide eight weeks and then six weeks, respectively, before the IRS can initiate the Substitute for Return (SFR) process.

    As a result of IRSRRA, a tax lien may be filed as long as the taxpayer is provided written notice by certified or registered mail of the IRS's intention to file a notice of lien. A levy, which follows the lien, requires a final 30-day Notice of Intent to Levy via certified mail. A levy can either be continuous, in the case of one filed against wages, or "one time," such as a confiscation of a bank account. The minimum bid price
    for the sale of a levied asset based on IRS Form 4585 is approximately 60% of net equity.

    Pursuant to IRSRRA, a taxpayer must be provided an opportunity for a hearing before the IRS Appeals Office in the 30 days following the mailing of a Notice of Lien (or a subsequent issuance of a Notice of Intent to Levy). With the exception of jeopardy assessments (i.e., where assessment or collection would be hindered by delays such as the taxpayer leaving or removing property from the United States), collection activities are suspended during the hearing and appeals process. It should be noted that while an offer in compromise or installment agreement is pending, the IRS is also prohibited from issuing a levy, and, if either is rejected, there is an additional 30-day prohibition.

    8. What differences are there between an IRS seizure/sale of levied realty versus personal property?

    In the case of certain realty, IRSRRA prohibits levies on a--

  • residence used by the taxpayer (or nonrental real property owned by a taxpayer used by another as a residence) in which the tax liability is $5,000 or less, or

  • principal residence, unless approved by a U.S. District Court judge or magistrate.

    Following an IRS auction for realty, there is a 180-day post-sale redemption period in which the levied taxpayer (or any other party having an interest in the real property) can redeem the property upon the payment of the bid price plus 20% interest; no similar right exists for personal property.

    At the IRS auction the successful bidder is given, in the case of personalty, a certificate that is tantamount to a bill of sale; in the case of realty, the certificate is not equivalent to a deed. That document is executed by the IRS only after the 180-day redemption period.

    In the case of a bank account, a 21-day rule exists to allow the taxpayer an opportunity to contest the seizure.

    9. When is a court order required for the IRS to enter the premises with respect to a realty seizure?

    A court order is needed by the revenue officer who wishes to enter a house, garage, or carport (or even a gated or fenced driveway). However, a motor vehicle parked outside the residence on an unobstructed driveway may be seized.

    In the case of a business, the cash register and the portion of the premises not available to the general public require a court order for entry by an IRS representative. Further, IRSRRA dictates that tangible personal property and real property used in a trade or business (i.e., not for investment purposes) may only be seized after all other collection options by the IRS (such as levy of other nonexempt assets) and proposals of the taxpayer (e.g., offer in compromise or installment agreements) have been exhausted; such a levy requires the signature of the IRS District Director or her assistant, unless a jeopardy assessment applies.

    10. Are any creditors protected subsequent to the filing of an IRS lien?

    Under the concepts of super priority and super super priority, certain creditors who advance money after the IRS lien recording are given special status. Examples include the following:

    * For a 45-day period following the filing of the IRS lien, a financial institution that has a floating lien on the accounts receivable or inventory of a taxpayer is protected for advances made during this time.

  • Advances for real property construction or improvement financing made after the IRS lien filing are protected if pursuant to an agreement and filed lien.

  • In certain cases, nondealer bonafide purchasers of tangible personal property (if less than $1,000) or contractors who improve owner-occupied residential property (if less than $5,000) can obtain priority over an IRS lien.

    11. What other provisions exist for the release of a lien on a specific piece of property other than by full payment?

    IRC section 6325 contains the following four provisions providing for lien release:

  • After an asset is sold, the net equity may be remitted through an escrow arrangement to the IRS.

  • A specific property may be discharged if the taxpayer's property remaining subject to the lien has a fair market value that is double the sum of the balance due on all Federal tax liens and all other nontax liens.

  • An amount may be paid in partial satisfaction of the liability secured by the lien, if it is determined the payment is not less than the value of the interest of the United States in the property to be discharged.

  • If the interest in the property to be discharged has no value.

    12. What is the difference between necessary and conditional living expenses when preparing a financial statement Form 433-A?

    In IRS publication 1854, the IRS issues national standards for necessary expenses that are revised periodically and are based on family size. These include clothing, food, and personal or miscellaneous items. Local standards may be established for other expenditures such as housing, taxes, utilities and transportation.

    Conditional expenses include the following:

  • Expenses exceeding national and local standards,

  • College and other educational expenses,

  • Charitable contributions, and

  • Credit card payments and other unsecured debts.

    Classification as a conditional expense has the following ramifications:

  • If the taxpayer is unable to pay the outstanding tax liability within 36 months, the expenses are not allowed.

  • Alternatively, the expenses are not considered in the calculations to the extent that they will be paid beyond one year.

  • Generally, the expenses are not considered by the offer in compromise program or when trying to have the tax debt declared uncollectible.

    It should be noted that, based on the mandates of the IRSRRA, the IRS is expected to be more flexible and liberal in its acceptance of offers in compromise.

    13. How is the amount of the offer determined for an offer in compromise?

    It is a combination of both--

  • the realizable equity of assets based on the quick-sale standard, defined as the value halfway between fair market and a forced sale (such as from a mortgage foreclosure); and

  • the disposable income (discounted using the applicable Federal rate) that could be collected over the lesser of 60 months or the remaining months under the statute of limitations.

    14. What are the disadvantages of filing an offer in compromise?

  • The statute of limitations is extended, as discussed in Question No. 1, supra.

  • The taxpayer must be in full compliance with respect to future filings, deposits, and payments for the five-year period subsequent to the acceptance of the offer. If not, the original tax bill will be reinstated.

  • Refunds that would normally be payable in the year in which the offer is accepted by the IRS are also forfeited.

  • To qualify, a detailed review of the taxpayer's finances is required, including at least three months of disbursements from the taxpayer's checking accounts.

    15. What procedures are available in the event a taxpayer's representative is dissatisfied with the actions of a collections revenue officer?

    By filing either a Collection Appeal Request (Form 9423) or an Application for Taxpayer Assistance Order (Form 911), an internal administrative review can be accomplished.

    In addition, IRSRRA allows for an early referral to the IRS office or appeals office on disputed collection (and audit) issues, permitting opportunities for binding arbitration and nonbinding mediation.

    As a last resort, the IRS has established a new toll-free number, (877) 777-4778, for assistance from
    the National Taxpayer Advocate Office when taxpayers are unable
    to resolve a matter through previous IRS contacts.

    16. What other major changes in IRS collections procedures were enacted under IRSRRA?

    For the next five years, the IRS will have 18 months to assess interest and penalties (such as those for a math error) on a timely filed individual income tax return from the later of the due date of the return (without considering any available extensions) or the date the return was filed. Beginning in 2004, the period for assessment will be reduced to 12 months.

    The Federal Fair Debt Collection Practices Act applicable to the actions of private creditors against debtors has been extended to cover the operations of the IRS.

    17. How are income taxes
    discharged under a Chapter 7 bankruptcy?

    Whether or not income taxes will
    be forgiven under the liquidation
    provisions of Chapter 7 will depend upon whether the IRS has secured
    its position.

    If no lien has been filed or the lien is insufficient to cover the tax liability, the position is unsecured. Income taxes and accompanying interest and penalties will be discharged if no tax fraud or evasion was involved, and--

  • the original time the tax return was due is at least three years ago (i.e., April 15th or, if an extension was requested, the extension deadline), or

  • the filing for that return (which was due at least three years ago) by the taxpayer (i.e., not an IRS substitute return) occurred at least two years before the bankruptcy filing, or

  • any assessment by the IRS (such as for an audit change) occurred at least 240 days prior to the filing.

    The three-year, two-year, and 240-day rules are extended under Chapter 7 during the applicable period for a prior Chapter 13 bankruptcy (the extension equals the time from filing of the original wage earner's reorganization to its dismissal, plus an additional six months) or a prior offer in compromise (the extension of time is from the submission of the offer until it is rejected or withdrawn, plus 30 days).

    The IRS will be able to collect secured income taxes to the extent of the value of (and based on their position on) the security. In other words, any lien recorded before the bankruptcy filing still exists on that liened property that can be foreclosed upon after bankruptcy.

    18. How are taxes treated in a Chapter 13 bankruptcy filing?

    This bankruptcy provision allows for the repayment of creditors, including the IRS, over a period of 36 to 60 months from disposable income (a more
    liberal definition than the IRS's). With respect to taxes, it is a form of a forced installment agreement with the IRS.

    Taxes fall into the following two categories under Chapter 13:

  • Taxes that need not be paid in full under the plan. Taxes that would have been dischargeable had a Chapter 7 been filed will be discounted in the repayment calculation provided they are unsecured (i.e., no lien has been filed or there are insufficient assets to cover the lien).

  • Taxes that usually must be paid in full under the plan. They include taxes secured by a recorded lien to the extent of the value of the collateral attached and taxes that are nondischargeable under Chapter 7, such as payroll trust taxes.

    Interest and penalties on unsecured taxes accrue up to the date of filing, at which time they cease.

    19. What alternative bankruptcy options exist in dealing with taxes in arrears?

    The following two unconventional strategies are available:

  • "Chapter 20" is the filing of Chapter 7 for the dischargeable taxes and Chapter 13 for the nondischargeable ones.

  • "Chapter 26" involves the filing of two Chapter 13s, the second one before the first one is dismissed (e.g., because of a failure to pay a balloon payment scheduled under the initial Chapter 13 plan). These two successive five-year plans create a total of 10 repayment years, reducing the monthly obligation.

    20. What initial recommendations to taxpayers (initially and at the time of IRS problems) can be made in addition to those outlined in Question 5?

    For individual taxpayers:

  • At the first meeting with the client, suggest adjustment of income tax withholdings to create a break-even or nominal pay status for the next tax filing deadline to avoid automatic IRS seizure of future refunds. This withholding issue should again be reviewed with any change in financial circumstances (such as a job change by a spouse).

  • To avoid arbitrary sweeps of bank accounts and other liquid assets (such as the cash value of any nonterm life insurance policy), consider transferring these funds to an attorney's escrow for remittance to the IRS (a portion to be separately deposited towards the current year's estimated taxes, particularly for any premature IRA withdrawals, and the balance to be submitted to the IRS towards the offer in compromise).

  • Existing credit lines (e.g., remaining credit available on credit cards) with high interest rate charges should be scrutinized for possible cancellation before submitting documentation to the IRS, since these could otherwise be deemed a source of payment.

    In the case of business taxpayers:

  • For unincorporated enterprises, title to the business assets should, from the beginning, be in the name of the business spouse and personal assets in the name of the other spouse (after taking into consideration applicable local marital law). Once IRS problems have arisen, consider the use of a new corporate entity with ownership being held by others. *

    Peter A. Karl, III, JD, CPA, is with the law firm of Paravati, Karl, Green & DeBella in Utica, N.Y., and an associate professor with the State University of New York­Institute of Technology (Utica­Rome).

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