Frequently Asked Questions
Bankruptcy

How does declaring bankruptcy affect my tax obligations?

Your goal in declaring bankruptcy is to gain a “fresh start”. You may either file bankruptcy under Chapter 13 or Chapter 7 of the Bankruptcy Code. Whether you decide to file bankruptcy under Chapter 13 or Chapter7, depends on your decision to get relief from tax debts through liquidation or a repayment plan.

One of the immediate benefits of declaring bankruptcy is the “automatic stay” function that halts all collection activities by the creditors including the IRS. The automatic stay also operates to suspend U.S. Tax Court proceedings. In addition, during the automatic stay period, the running of the statute of limitations on assessment of tax is suspended. When the bankruptcy case is dismissed or discharged, the automatic stay is lifted.

In a bankruptcy proceeding, your debts can be classified as either a tax debt or a nontax debt; a prepetition or a postpetition debt and a secured or an unsecured debt. Whether a particular debt qualifies as a tax debt depends on a host of factors. Prepetition debt refers to debt incurred before the petition for bankruptcy was filed. A postpetition debt is a debt incurred after the bankruptcy petition was filed. A tax lien makes an unsecured tax debt into a secured one. Discharging secured tax debts is more difficult than discharging unsecured tax obligations.

Under Chapter 7, you receive discharge of personal liability for most prepetition debts in return for giving up all of your non-exempt assets. Most taxes are not dischargeable under Chapter 7 bankruptcy. Under Chapter 13, you enter into a plan of payment in return for discharge of your obligations.

In general, several conditions need to be met in order for a tax debt to be discharged in a bankruptcy procedure:

The taxes sought to be discharged must be for those taxable years, for which the tax
returns were due more than three years before the date of filing for bankruptcy;

The tax return for those taxes must have been filed at least two years before the date of
bankruptcy filing;

At least 240 days must have elapsed between the tax assessment date and the date
when the bankruptcy petition was filed;

The tax returns referred to above must not have been fraudulent.

Complex rules govern the priority of tax claims over other debts sought to be discharged in a bankruptcy proceeding.

To sum up, declaring bankruptcy may be a viable option for reducing or eliminating your tax debts. However, many taxes may not be dischargeable in bankruptcy. Other options such as entering into an installment payment agreement with the IRS or filing an offer in compromise may be less drastic ways of achieving the same goal.

Declaring bankruptcy is an important decision both for an individual and for a business. Deciding whether bankruptcy is a tax efficient resolution for your financial problems requires expert knowledge of tax laws. An experienced tax attorney is well-equipped to help you navigate the legal intricacies at the crossroads of tax and bankruptcy laws.

Business Taxes (Worker Classification)

I am a small business owner. Several people work for me as independent contractors. Recently, the IRS sent me a notice informing me that my workers should be classified as “employees” as opposed to “independent contractors”. What are the consequences of this reclassification and what should I do now?

Or,

I am confused about the proper way of reporting my income. I receive a 1099 Form from my employer. Can I report the income reflected on Form 1099 on my tax return as “wages and salaries”?

Whether a worker is classified as an employee or an independent contractor has important tax consequences both for the worker and for the employer.

From the employer’s viewpoint, classifying workers as independent contractors eliminates a large amount of paperwork that otherwise the employer needs to prepare and process. In addition, when it comes to employment litigation hazards, businesses prefer the independent contractor classification because independent contractors are less likely to sue the employer under the myriad employment laws and regulations. Such laws and regulations afford broader protection to employees than to independent contractors.

Workers usually refer to themselves as either a “W-2 employee” or a “1099 employee”. This is because the employer should report the wages paid to an employee on a W-2 form while compensation paid to an independent contractor should be reported on a Form 1099-MISC. As a general rule, income from self-employment is reported on Form 1099-MISC and wages and salary of an employee is reported on a Form W-2. However, the employer’s reporting preference is not determinative as to the proper classification of workers as either independent contractors or employees.

As far as the worker is concerned, one issue is how to report his compensation: as wages and salary on Form 1040 income tax return or on Schedule C as income from self-employment. If the employer reports the compensation on Form 1099-MISC but the worker chooses to report the same income as wages and salary on Form 1040, the IRS will identify the problem as a matching issue.

The IRS uses common law standards in order to classify workers as either “employees” or “independent contractors”. Courts have identified numerous factors that should be taken into account in the classification process.

How a worker is classified has important tax consequences. For example, an independent contractor should deduct his unreimbursed business expenses on Schedule C. If the same worker were to be classified as an employee, those expenses should be reported on Schedule A as miscellaneous itemized deductions.

Another consequence of worker classification as either an employee or an independent contractor is the cost burden of fringe benefits such as vacation pay or sick leave. If the worker is classified as an employee, the burden is carried by the employer. This is one reason why it is more advantageous to the employer to classify as many workers as independent contractors as opposed to employees. Yet another tax consequence of worker classification is the identity of the party who pays the required contribution for Social Security and Medicare. Employees pay only half of such contribution which is also known as FICA. The other half is paid by the employer. An independent contractor, however, is responsible for the entire contribution (SECA).

Some tax deductions are only available to independent contractors. For example, the deduction related to one-half of SECA can only be claimed by independent contractors. The favorable tax treatment afforded by the Tax Code Section 280A(c) related to home-office deduction is more readily available to independent contractors as well. Another example of advantageous tax treatment of independent contractors is deductions for business loans interest.

Worker classification issues can entail significant tax consequences. An experienced tax attorney can help you understand and deal with the consequences of classifying workers as either employees or independent contractors. Regardless of whether you are an employee or an employer, consulting with a competent tax lawyer can result in significant tax savings and help you achieve your employment goals.

Criminal Penalties for Tax Fraud

Are there criminal penalties for tax offenses and can I go to jail for not paying my taxes?

      The short answer is yes. Tax Code Sections 7201 through 7207 define what a tax crime is and how the government may go about prosecuting such crimes. What distinguishes a civil tax offense from a criminal one is the element of “bad intent” or “willfulness”. You may have neglected to include an item of income on your tax return through oversight. This omission will subject you to a civil tax penalty. Or, you may have intentionally underdeclared your income. If the IRS can prove such willfulness, you will be held criminally responsible for such an offense. “Willfulness” is defined as “a voluntary, intentional violation of known legal duty.” Tax Code Section 7201 states that “any person who willfully attempts in any manner to evade or defeat any tax imposed by” the Tax Code is guilty of a felony or a tax crime.

      Examples of criminal tax evasion are filing a fraudulent tax return, keeping a double set of books with an intention to mislead the government about the personal or business income, making false invoices or receipts, intentionally destroying tax records in order to hinder tax collection efforts and concealing assets from the government.

      Under Tax Code Section 7206(1), a person who willfully signs a tax return which he or she does not believe to be true and correct may be subjected to criminal sanctions. The maximum punishment for such a false return is three years imprisonment and a fine of $100,000 for individuals or $500,000 for corporations.

      Failure to file a tax return is also a criminal offense if the element of willfulness is present. The maximum sentence for this tax crime is one year of imprisonment and a fine of $25,000 for individuals and $100,000 for organizations.

      Under Tax Code Section 7207, if a taxpayer fraudulently alters documents, such as invoices and checks and then submits them to the IRS as supporting documentation for a tax return, he or she has committed a tax crime punishable by one year of imprisonment and up to $10,000 fine for individuals and $50,000 for organizations.

      In addition to the Tax Code, criminal punishments are provided for tax crimes under the Criminal Code. Thus, filing a fraudulent tax return is punishable not only under the Tax Code, but is also a criminal offense under Section 1001 of the Criminal Code. The punishment for false statements to the government is five years in jail and up to $500,000 in penalty.

      A false tax refund claim will subject a taxpayer to the punishments contemplated by the Criminal Code Title 18, Section 287. The punishment is the same as that of filing a fraudulent tax return.

      Imposition of criminal tax penalties can entail severe consequences. An experienced tax attorney can help you by preventing the assessment of such penalties against you or by minimizing their effects.

Failure to File and Pay Tax Penalties

When I reviewed the tax bill that I received from the IRS, I discovered that a large part of my tax liability related to interest and penalties assessed by the IRS. Why interest and penalty were imposed and what can I do about them?

      The IRS regularly assesses interest and different types of civil penalties for various reasons. To begin with, interest on a given tax liability begins to accrue when the taxes are required to be paid. Generally, for individuals this is April 15 of each tax year. The interest rate imposed by the IRS is significantly higher than the market rate in order to encourage taxpayers to borrow from a bank or access lines of credit to remit taxes to the IRS. In addition to interest on the unpaid taxes, the IRS assesses interest on certain types of penalties.

      Another integral component of a tax liability is penalties assessed for a variety of reasons.

      An important type of tax penalties is accuracy-related penalty. The accuracy-related penalty is imposed for the following reasons:

  •  Negligence or disregard of rules or regulations;
  •  Substantial understatement of income tax;
  •  Substantial valuation misstatement;
  •  Substantial overstatement of pension liabilities; and
  •  Substantial estate or gift tax valuation understatement.

      A penalty of 20% is applied to any portion of underpayment of tax attributable to accuracy-related violations. If you can show that the underpayment of tax was due to reasonable cause and you did not act with bad faith, the accuracy related penalties would not be applied.

      If the underpayment of tax was due to fraud, a penalty equal to 75% of the underpayment will be imposed. In addition, interest will accrue on the amount of penalty. Intent to evade tax needs to be present in order for the IRS to be able to assess fraud penalty. Mere negligence is not sufficient and the burden of proof is on the IRS to prove the element of fraud.

      You should remember that both the fraud penalty and the accuracy-related penalty are imposed when a tax return is filed. If you don’t file a tax return, you will be subjected to a failure to file penalty. In addition to civil penalties, a nonfiler exposes himself or herself to criminal sanctions. For each month that the tax return is late, the IRS will assess a penalty of 5% of the tax due. The maximum amount of this penalty is 25% of the tax.

      Frivolous tax returns will trigger a $500 penalty in addition to other types of penalty. Such a tax return takes a frivolous position or is filed with a clear intent to impede the administration of the law. Other types of penalties are imposed for tax offenses such as failure to disclose reportable transactions, failure to file information returns or provide correct information and failure to timely deposit tax.

      If the IRS or the taxing authorities in Maryland, Virginia or Washington, D.C. have assessed civil tax penalties against you, consultation with an experienced tax attorney will help you understand the nature of those penalties and also help you in minimizing such tax penalties. The law provides that if the taxpayer has reasonable cause for incurring the tax debt, tax penalties could be reduced or eliminated. An expert IRS tax lawyer is in the best position to evaluate your options in challenging the assessment of civil tax penalties.

Innocent Spouse Relief

My husband and I divorced two years ago. We used to file joint tax returns during the time we were married. I had very little to do with preparation of those tax returns and just signed them after they were prepared. Two weeks ago, I received a notice from the IRS informing me that one of those tax returns had been audited and that I owed taxes. What should I do?

      When a husband and wife file a joint return, they assume joint and several liability for the payment of the tax including interest and penalties. Tax Code §6013(d)(3). A spouse, however, may obtain release from joint liability under Tax Code §6015 for tax (including interest), penalties and other amounts as an “innocent spouse” provided the spouse can show that the prerequisites to the relief have been satisfied. Under Tax Code §6015(b), such release may be obtained if the spouse can establish the following:

  1.  A joint return has been made for the taxable year;
  2.  On  the joint  return,  there was an understatement of tax attributable to erroneous items of
    one spouse;
  3.  The innocent  spouse establishes  that in  signing the  return, he  did not  know and had no
    reason to know, that there was such understatement;
  4.  Taking into  account all  the facts  and circumstances,  it is inequitable  to hold the innocent
    spouse liable  for the  deficiency in tax  for such taxable  year attributable  to the deficiency;
    and
  5.  The  innocent  spouse  elects  the  benefits  of  Tax  Code  §6015(b)  no  later  than  two
    years after the date on which the Secretary has begun collection activities.

      Proving that the innocent spouse not only did not know but also had no reason to know of the tax deficiency is no easy matter. Case law provides guidance on how this can be legally established. Several factors such as the level of education and financial sophistication of the claiming spouse are considered.

      If you think you may qualify as an innocent spouse, you should consult an experienced IRS tax lawyer who is best equipped to help you marry the specific facts of your case to the relevant laws and regulations governing this area of the tax law.

Installment Agreement

Last time when I called the IRS, they offered to set up an installment payment arrangement, which would help me pay off my tax debts. Should I enter into an installment payment agreement with the IRS, or a similar agreement with the taxing authorities of Maryland, Virginia or Washington, D.C.?

      If you indicate to the IRS that you are not able to pay off your back taxes in one lump sum, the IRS will offer you an installment payment agreement under which you agree to pay a certain amount each month. Sometimes this is your best option to gradually eliminate your tax debt.

      However, you should remember that during the life of the installment agreement, interest continues to accrue on your tax debt. The theory is that by delaying to pay off your tax debt, you have in effect borrowed from the government and therefore need to pay interest. The IRS interest rate is higher than the commercial rate. Therefore, from the taxpayer’s point of view, it is more advantageous to borrow from a bank or from another financial institution and pay the IRS. The interest rates on tax debts in Maryland, Virginia and Washington, D.C. are similarly set higher than the commercial rate.

      You should also have in mind that entering into an installment agreement does not prevent the IRS from filing a tax lien against you. The IRS may or may not file a tax lien when an installment agreement is in place. This depends on the amount of the tax liability and also other factors. In addition, the IRS may ask you to complete a financial disclosure form before the IRS agrees to enter into an installment payment agreement with you. By examining your finances, the IRS wants to assess your ability to pay the installment amount. Having reviewed your financial disclosure form, the IRS may or may not agree with the amount you have offered as the monthly installment amount.

      Because the interest keeps accruing on the tax debt during the life of the installment agreement, the total tax debt may never decrease, even when regular monthly payments are made. The situation is similar to a high-interest credit card debt. Even though the credit card borrower keeps paying the minimum balance due for years on end, the principal amount of credit card debt may remain the same or even go up.

      To sum up, installment payment agreements with the IRS or with other taxing authorities such as those in Maryland, Virginia or Washington, D.C. may or may not be advantageous to the taxpayer. If the amount of the tax debt is small, an installment payment agreement may be to taxpayer’s benefit. But the combination of large tax liabilities and high interest rates often creates a snowball effect and the taxpayer will soon be burdened by an unmanageable tax debt.

      If you are considering an installment payment agreement with the IRS or with the taxing authorities of Maryland, Virginia or Washington, D.C., you should seek the advice of a competent tax lawyer who after having evaluated your overall tax situation would be able to recommend entering into an installment payment agreement with the government or using the installment payment option as one of the tools in order to arrive at a tax efficient solution for your problem.

IRS Appeals

I have been calling the IRS about my tax debt numerous times. I have spoken to several IRS employees but it appears that I am not making any progress towards resolution of my tax problem. What should I do?

      To begin with, communicating with the IRS and furnishing information about your finances is not always a good idea. Such information could be, and routinely is, used against taxpayers later on.

      The IRS employees who handle taxpayers’ phone calls are usually only trained in collection matters and simply do not have the authority to negotiate with the taxpayers about reducing the tax bill. The only two options offered to the taxpayer are either making a lump sum payment to pay off the tax debt which includes interest and penalties, or entering into an installment payment plan. Taxpayers’ communications with the IRS, therefore, often resemble those with collection agencies. The only difference is that the IRS is capable of inflicting more pain on the taxpayer than a mere collection agency. The IRS is fully aware of this fact and takes full advantage of it.

      As a matter of principle, if you disagree with the preliminary IRS finding about the amount of tax you owe, you may appeal the matter administratively. An administrative appeal means that you are asking the IRS Appeals Office to review your case.

      Administratively appealing an adverse finding by the IRS requires presenting factual and legal arguments as to why the preliminary determination of tax was not justified. You may argue that the procedural requirements of notifying you about the tax debt or lien filing or some other IRS action were violated. Alternatively, you may present arguments as to why the underlying tax amount was erroneously assessed by the IRS. You may also argue that some other IRS action such as the rejection of your offer in compromise was unjustified. Both types of administrative appeals (procedural and substantive) need to be grounded on solid legal and factual grounds in order to be successful. Presenting identical arguments that have already been rejected, will usually lead to the same result. For example, if during an IRS tax audit, you fail to convince the auditor that a certain item of expense is deductible and subsequently the IRS issues an audit report rejecting your arguments, you should not simply limit yourself to presenting the identical arguments that were rejected by the auditor. Even though your arguments may be right, you may nevertheless lose your appeal if you fail to craft an argument which is grounded on the relevant statutes and court rulings. The IRS appeals officer reviewing your case is not a tax lawyer and does not necessarily know the applicable tax law. He or she is an overworked government employee who wants to wrap up the case as soon as possible. Therefore, if the Tax Code contains provisions supporting your position, or if the United States Tax Court or another court has already ruled favorably on a similar case, it is your job to find and cite these legal authorities as part of your appeal.

      Before proceeding to the U.S. Tax Court, IRS Appeals is your last opportunity to convince the IRS that your tax position complies with the applicable tax laws and regulations. Therefore, it is imperative that you put your best foot forward by presenting concise and effective arguments in support of your position. An experienced IRS appeals lawyer can help you achieve your goals by crafting strong arguments supported by the applicable legal authorities. A competent tax debt attorney can also effectively represent you during an appeals hearing and negotiate a favorable resolution to your tax problems.

Offers in Compromise

What do I need to show in order to settle my tax debt for a smaller amount than the amount claimed by the IRS?

      Tax Code §7122 authorizes the IRS to compromise the tax debt. This is usually called the Offer in Compromise. The Tax Code requires the IRS to evaluate whether the offer made by the taxpayer meets the requirements for acceptance. There are basically three grounds for compromising a tax debt: (1) doubt as to liability, (2) doubt as to collectability, and (3) effective tax administration. Doubt as to liability exists when there is a dispute about the existence or the amount of the tax. Doubt as to collectability exists when the taxpayer can demonstrate that his or her assets are not sufficient to pay the entire tax. The IRS may also settle the tax debt if, regardless of the taxpayer’s financial situation, it is shown that public policy considerations require such a settlement.

      Offers in compromise based on doubt as to collectability are the most popular ones. When the IRS evaluates such an offer, the revenue officer considers the taxpayer’s ability to pay all the tax after paying for his or her basic living expenses. The taxpayer needs to show that his living expenses are in line with the national and local living expenses established by the IRS. In addition, the taxpayer’s assets are taken into account by the IRS in estimating ability to pay the tax. Concealing such assets from the IRS is not a good strategy because if it comes to light later on, even an accepted offer may be revoked by the IRS.

Can the IRS engage in collection activities such as a wage levy or a bank levy during the period of consideration of the offer in compromise?

      No. All collection activities are prohibited during consideration of the offer in compromise. If the offer in compromise is rejected, the taxpayer has another 30 days to appeal the decision without being subject to tax collection activities.

What are the advantages and disadvantages of an offer in compromise?

      Before making a decision about approaching the IRS with an offer in compromise the pros and cons of such an offer should be considered.

      Advantages:

  •  If your offer is accepted, you will settle your tax debts for a smaller amount than the original
  •  tax.
  •  Unless  you offer  to settle  your tax  debt for a lump sum, you may pay your tax liability over
  •  an extended period of time.
  •  During the consideration period of the offer, the IRS ceases its collection activity.
  •  If your  offer is  accepted, and  you abide  by the  terms of  the agreement with the IRS, no
  •  collection activities will be initiated against you during the length of the contract.
  •  Assuming that  your offer  is accepted  and you enter into an agreement with the IRS, your
  •  tax liability becomes final and may not be revised upward by the IRS at a later date.
  •  If you enter into a collateral agreement with the IRS as part of the offer in compromise, the
  •  IRS may release all tax liens.

      Disadvantages:

  •  In the  event  your  offer is  rejected, the  IRS  will  have a  detailed  picture of your  financial
  •  status since financial  disclosure is a condition of  consideration of any offer in compromise
  •  by the IRS.
  •  By  offering to  compromise your tax debts,  you waive certain rights  such as the statute of
  •  limitations on collections beyond the normal six-year period.
  •  If you  do not  perform your  end of the  bargain, the  IRS may initiate  immediate collection
  •  activity.

      To sum up, preparing an offer in compromise is no easy matter and requires detailed knowledge of the law and regulations governing this area of the tax law. Approximately, nine out of ten offers in compromise are rejected by the IRS. If you are considering making an offer in compromise to the IRS or to the taxing authorities in Maryland, Virginia or Washington, D.C., you should seek the advice of a competent IRS tax attorney who can help you resolve your tax problem by evaluating your overall tax situation and if making an offer in compromise is in your best interest, by helping you prepare a strong offer in compromise application.

Sales and Use Tax

What do I need to show in order to settle my tax debt for a smaller amount than the amount claimed by the IRS?

      Tax Code §7122 authorizes the IRS to compromise the tax debt. This is usually called the Offer in Compromise. The Tax Code requires the IRS to evaluate whether the offer made by the taxpayer meets the requirements for acceptance. There are basically three grounds for compromising a tax debt: (1) doubt as to liability, (2) doubt as to collectability, and (3) effective tax administration. Doubt as to liability exists when there is a dispute about the existence or the amount of the tax. Doubt as to collectability exists when the taxpayer can demonstrate that his or her assets are not sufficient to pay the entire tax. The IRS may also settle the tax debt if, regardless of the taxpayer’s financial situation, it is shown that public policy considerations require such a settlement.

      Offers in compromise based on doubt as to collectability are the most popular ones. When the IRS evaluates such an offer, the revenue officer considers the taxpayer’s ability to pay all the tax after paying for his or her basic living expenses. The taxpayer needs to show that his living expenses are in line with the national and local living expenses established by the IRS. In addition, the taxpayer’s assets are taken into account by the IRS in estimating ability to pay the tax. Concealing such assets from the IRS is not a good strategy because if it comes to light later on, even an accepted offer may be revoked by the IRS.

Can the IRS engage in collection activities such as a wage levy or a bank levy during the period of consideration of the offer in compromise?

      No. All collection activities are prohibited during consideration of the offer in compromise. If the offer in compromise is rejected, the taxpayer has another 30 days to appeal the decision without being subject to tax collection activities.

What are the advantages and disadvantages of an offer in compromise?

      Before making a decision about approaching the IRS with an offer in compromise the pros and cons of such an offer should be considered.

      Advantages:

  •  If your offer is accepted, you will settle your tax debts for a smaller amount than the original
  •  tax.
  •  Unless  you offer  to settle  your tax  debt for a lump sum, you may pay your tax liability over
  •  an extended period of time.
  •  During the consideration period of the offer, the IRS ceases its collection activity.
  •  If your  offer is  accepted, and  you abide  by the  terms of  the agreement with the IRS, no
  •  collection activities will be initiated against you during the length of the contract.
  •  Assuming that  your offer  is accepted  and you enter into an agreement with the IRS, your
  •  tax liability becomes final and may not be revised upward by the IRS at a later date.
  •  If you enter into a collateral agreement with the IRS as part of the offer in compromise, the
  •  IRS may release all tax liens.

      Disadvantages:

  •  In the  event  your  offer is  rejected, the  IRS  will  have a  detailed  picture of your  financial
  •  status since financial  disclosure is a condition of  consideration of any offer in compromise
  •  by the IRS.
  •  By  offering to  compromise your tax debts,  you waive certain rights  such as the statute of
  •  limitations on collections beyond the normal six-year period.
  •  If you  do not  perform your  end of the  bargain, the  IRS may initiate  immediate collection
  •  activity.

      To sum up, preparing an offer in compromise is no easy matter and requires detailed knowledge of the law and regulations governing this area of the tax law. Approximately, nine out of ten offers in compromise are rejected by the IRS. If you are considering making an offer in compromise to the IRS or to the taxing authorities in Maryland, Virginia or Washington, D.C., you should seek the advice of a competent IRS tax attorney who can help you resolve your tax problem by evaluating your overall tax situation and if making an offer in compromise is in your best interest, by helping you prepare a strong offer in compromise application.

Tax and IRS Audits

I recently received a letter from the IRS informing me that my tax return has been selected for a tax audit. What should I do?

      Audit means an examination. During a tax audit, an IRS revenue officer will scrutinize your tax return(s) for any inaccuracies. One of the most frequent subjects of a tax audit is whether certain tax deductions were properly taken. Another issue that often comes up is the sources of income. For example, a retired taxpayer may have claimed that his sole source of income is his pension distributions. During an audit, the revenue officer will review the bank statements of the taxpayer to see if there were deposits made that did not relate to such pension distributions.

      The most important factor in surviving a tax audit is preparation. Before inviting you to attend a tax audit, the revenue officer in charge of conducting the audit has thoroughly reviewed your tax returns and is prepared to question you on the items that he or she considers suspicious. Lack of preparation in dealing with such questions will cost you dearly. If your answers do not convince the IRS revenue officer, other tax years besides the one under audit may be opened and become subject to the examination.

      Occasionally, taxpayers ask a tax attorney to begin representing them when they have already attended a tax audit alone or with their accountant. Such taxpayers have typically provided the IRS with various types of information about their sources of income, expenses and other tax-related documents. Unfortunately, almost always what has been provided to the government ends up being used against such taxpayers at a later date. Therefore, it is extremely important to retain a competent tax lawyer before communicating with the IRS once you learn that your tax return has been selected for a tax audit.

      Tax audits, sometimes but not very often, end in the issuance of a “no change letter” by the IRS. A “no change letter” means that the IRS accepts the tax return as originally submitted to the IRS. In all other occasions, the IRS proposes to revise the tax return and to assess higher taxes than those shown on the tax return. You may either agree with such changes, or present your arguments as to why such changes are inappropriate. These arguments should be grounded in statutory and case law governing the disputed items. If the IRS disagrees with your arguments, you may appeal your case within the IRS. If your appeal is unsuccessful, you may have the option to petition the U.S. Tax Court.

      If you have been contacted by the IRS regarding a tax audit, you should consult a competent audit defense attorney who will help you identify the likely issues that usually come up during an audit. An experienced IRS tax audit defense lawyer is in the best position to help you navigate the unpredictable twists and turns of a tax audit and arrive at the most favorable resolution of your tax problems.

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Tax and IRS Liens and Levies

What are my options when I receive a tax bill, a Notice of Intent to Lien or Levy or a Notice of Lien filing from the IRS or one of the states such as Maryland or Virginia?

      When you are confronted by an impending IRS collection action or when you learn that the IRS has already initiated the collection process, you may do one of the following:

  •  You may contact the IRS and propose an installment  agreement. You should  remember,
  •  however, that  entering into an  installment  agreement may  not be  your best  option. Tax
  •  debts like credit card balances accrue interest.  Over the life of the  installment agreement,
  •  the accrued  interest  may exceed  the tax  principal.  However,  an installment  agreement
  •  sometimes proves to be a viable option if used in conjunction with other options discussed
  •  below.
  •  You may propose an offer in compromise to settle your tax debts. Your objective in making
  •  such an offer is to propose to pay less than the delinquent amount, on the theory that  the
  •  account  is  either  not  collectible  in  full or  because  the  alleged  liability  for  taxes  is  not
  •  correctly  assessed.  Proving to the IRS that  your tax  debt should be  settled for less is no
  •  easy  matter.  Anecdotal  evidence  suggests  that 9  out of  10  offers  in  compromise  are
  •  rejected  by the  IRS. The reason for rejection could be that you either did not qualify under
  •  the tax  law and the relevant IRS regulations or because the offer amount was not realistic.
  •  Preparing  an acceptable  offer in compromise requires detailed  knowledge of the relevant
  •  Tax Code provisions and the IRS regulations (i.e. Tax Code §7122 and Regs. §301-7122).
  •  If you learn  that the  IRS has  already filed  a lien or has  levied  on your  property, you may
  •  bring a civil action against the government for wrongful collection action.
  •  If a lien has  been filed, you  may seek to show that  the process of lien filing was defective.
  •  Here, you are not arguing that you do not owe the tax or you owe less than the IRS claims.
  •  You are instead attempting to show that the IRS action was procedurally defective. This is
  •  basically  a due  diligence step  revealing  any potential  deficiencies in the procedures that
  •  the IRS needed to follow if the lien were to be effective.
  •  You may file an administrative appeal with the IRS Appeals Office and argue  that the lien
  •  should be released or that the IRS lien should be subordinated to another lien.
  •  If you can show that the IRS has committed abuses in the tax collection process, you may
  •  be able to recover damages from the IRS.

      Similar but not identical rules apply in Maryland and Virginia. For example, Maryland has a similar procedure for offer in compromise. However, the taxpayer cannot make an offer in compromise until the tax debt is two years old. During this period, Maryland Comptroller’s Office will attempt to collect the debt by contacting the taxpayer and initiating the lien and levy processes. If these attempts do not bear fruit, the Maryland Comptroller’s Office will then assign the taxpayer’s account to a collection agency. When the two-year waiting period expires, the taxpayer may file an offer in compromise application similar to the federal one. Tax authorities in Maryland and Virginia periodically announce tax amnesty programs. Taxpayers who enter into these programs may pay smaller amounts of penalty and interest but the principal sum of tax is not forgiven.

I recently received a Notice of Federal Tax Lien in the mail. What is it and what should I do?

      Tax Code Section 6321 contemplates a “statutory lien” which would attach to a taxpayer’s property equal to the amount of the tax liability. Section 6322 of the Tax Code states that the statutory lien attaches to the taxpayer’s property when the tax assessment is made. Depending on a host of factors such as the amount of the tax debt and the actions that the taxpayer has taken in order to address his tax liabilities, the IRS may then move to file the lien. Filing of the tax lien has severe consequence for the taxpayer such as a sharp drop in credit rating and credit score. A tax lien also harms a taxpayer’s business prospects because it makes the transfer of property subject to lien virtually impossible.

      If you believe that the IRS had mistakenly filed the tax lien, you may appeal such filing within the IRS. However, you need to prove one of the following:

  •  You had already paid your tax debt before the IRS filed the tax lien.
  •  Deficiency procedures set out in the Tax Code were violated by the IRS.
  •  Bankruptcy Code prevented assessment of the tax liability underlying the tax lien.
  •  The statute  of limitations on the  collection of the  tax debt had  expired prior to filing of the
  •  tax lien.

What would the IRS do if I ignore the Notice of Federal Tax Lien?

      If the IRS does not hear back from you after a reasonable length of time, it would take more drastic actions in order to collect the tax. The next step is usually imposition of tax levy. Section 6331 of the Tax Code defines a tax levy as the power to collect taxes by seizure of the taxpayer’s assets. Note the difference between a tax lien and a tax levy: while a filed tax lien announces to the world that your properties are subject to a tax lien, a tax levy actually removes the property from your possession. One of the IRS’s favorite methods of tax levy is bank levy. It is a favorite method because it does not involve the sale of property and instead directly removes the funds from your bank account and deposits it with the U.S. Treasury. If you do not happen to have very strong arguments to show the inappropriateness of such action, recovering such funds is virtually impossible.

      The IRS may also garnish your wages or salary. Wage garnishment involves informing your employer of your tax delinquency. The IRS then serves notice on the employer that under the law it is obligated to direct a certain portion of your paycheck to the government. A wage levy permits a continuous attachment of the wages or salary due to a taxpayer. If no payment arrangements are made with the IRS, the wage levy continues until all tax debts are satisfied. This can last for years, especially since during the wage levy period, interest and penalties continue to accrue on the principal amount of the tax.

      Only certain types of property are exempt from tax levy. These include taxpayer’s wearing apparel, schoolbooks, unemployment benefits, undelivered mail, certain pension benefits, payments needed for child support and service-connected disability payments. Most pension distributions are subject to tax levy. For example, if you have a 401(k) account but you are not entitled to distributions from the account because you have not reached the retirement age, the IRS can levy on your present right to such 401(k) distributions in the future. Thus, when you finally reach the retirement age, your pension money will be distributed to the government instead of being paid to you. Social Security retirement checks are regularly subjected to tax levy by the IRS. Your income from state retirement funds is also subject to federal tax levy.

      Tax Code Section 6343 sets forth the conditions under which the IRS should lift a tax levy. These conditions include the following:

  •  The tax  liability underlying  the levy has been  paid or the statue of limitations  on collection
  •  has expired;
  •  Collection of tax would be facilitated by lifting of the tax levy;
  •  The taxpayer has entered into an installment agreement with the IRS in order to satisfy the
  •  tax debt;
  •  The IRS has concluded that the tax levy has created economic hardship for the taxpayer.

      If you have received a Notice of Lien or Levy, you may request a Collection Due Process Hearing within 30 days. The hearing is conducted by an IRS Appeals Officer. During the hearing you may present evidence as to why you do not owe the tax, or how the IRS violated your due process rights by giving you defective notices.

      If you suspect that the IRS or state taxing authorities are about to file a tax lien against you, or institute a tax levy, you should seek the advice of a tax counsel. The timely intervention of a competent tax attorney can help prevent a tax lien filing and assist you in releasing or lifting the tax lien if a tax lien has already been filed. In addition, an experienced IRS tax lawyer can help you release a tax levy against your bank account or your wages and salary and can represent you during a Collection Due Process Hearing and help you achieve the best results.

Tax Consequences of Marriage & Divorce

My ex-husband and I used to file joint tax returns and ended up owing federal taxes. After my divorce, I filed my tax returns as single and owe taxes on these returns as well. How can I resolve my tax liability?

      You have two types of tax liabilities. First, you are jointly liable with your ex-spouse for the tax returns you filed together. This means that the IRS may proceed against either of you for the entire tax debt. You also have a separate liability for the returns you filed as a single taxpayer. You may file an innocent spouse relief application with the IRS if you believe you qualify. If you succeed, then your remaining liability will be for your post-divorce taxes only. You may now proceed to file an offer in compromise to resolve your post-divorce taxes.

      Filing an offer in compromise before you have resolved the innocent spouse issue, will require the cooperation of your husband for the joint liability years.

Before I married, I incurred a large federal tax debt. I am now married and recently received a collection notice from the IRS about my back taxes. My spouse has no tax problems and I don’t want to involve my spouse in my tax problems. How can I take care of my back tax debts?

      Because your tax debt was incurred by you alone, the IRS will not take enforced collection actions against your spouse’s property. The IRS may insist that you should liquidate your share of joint property which you hold with your spouse in order to pay the tax. Whether the IRS would succeed depends on a host of factors. Two of these factors are: the type of joint property (for example, principal residence, bank account or retirement account) and the state where you reside (the property laws in some states are more protective of taxpayers).

      If you file an offer in compromise, the IRS will consider your spouse’s property as well as yours in making a decision as to whether your offer is acceptable.

Tax Settlements

I see lots of commercials on T.V. about tax companies promising to settle back tax debts with the IRS or with state tax authorities. Is it possible to settle my tax liability for a smaller amount than I owe?

      You may settle both individual income tax debts and business taxes with the IRS or with state tax agencies if certain conditions are met. You should remember that the IRS is not in the business of forgiving or settling taxes. It is in the business of collecting taxes. However, sometimes the taxpayer is able to show the government that he either does not owe the tax or even if he owes the tax, he is not able to pay all of it.

      Unfortunately, commercials by tax companies which frequently run on television present an overly optimistic picture of chances of successful settlement of tax debts. Negotiating and settling tax debts is a long process and requires intimate knowledge of the IRS rules and regulations and also of relevant tax law. The IRS receives a large number of settlement offers each year and only a small percentage of them are successful.

      If you are thinking about settling your tax debts, contact our Ivy-League trained tax attorney who has extensive experience in representing individuals and businesses before the IRS and state taxing agencies.

Trust Fund Recovery Penalty

I own a small business and have several employees. I used to regularly collect the required payroll tax from my employees and pay it over to the government. Two years ago, my business experienced a cash flow problem. In order to meet the general business expenses, I was forced to use the sums that I had collected from my employees as payroll taxes. I hoped that as the economy improved, I would be able to generate more income and pay back the delinquent taxes. However, in the past two years I have fallen further behind and now owe tens of thousands of dollars in back taxes. Recently, I received a notice from the IRS informing that I was found to be the responsible person for these taxes. The notice said that I was now personally responsible for these delinquent business taxes. What does this mean and what should I do now?

      This question describes the usual circumstances confronted by thousands of small businesses nationwide during the recent economic downturn. When a business faces a financial crisis, the payroll and employment taxes collected from the employees are sometimes used for general business purposes or paid to business creditors instead of being turned over to the government. Section 6672 of the Tax Code states that when a business fails to remit employment taxes to the IRS, those taxes can become the personal responsibility of the “responsible person” within the business. In other words, responsible persons within a business become personally responsible for the business taxes. These taxes are usually called trust fund taxes because the business was to collect and hold them in trust for the government.

      A responsible person could be an officer or employee of a corporation, a shareholder, a corporate director or a partner in a partnership. In determining who a “responsible person” is for the purposes of delinquent trust fund taxes, the IRS looks into the nature of job responsibilities of the individuals. Usually, when a person has the authority to decide which of the creditors to pay, or is in charge of collecting and paying over the tax to the government, he or she is designated as a responsible person for the purposes of the trust fund taxes. The IRS then assesses a penalty on such individual called the trust fund recovery penalty. Under Tax Code Section 6672(a), the penalty for failing to collect and pay over tax, or attempting to evade or defeat tax, is equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.

      In order to impose the trust fund recovery penalty, two separate elements of the statutory language of Tax Code Section 6672 need to be met. First, the IRS has to show that the individual in question was indeed a “responsible person” within the meaning of the statute. The IRS must carry the burden of proof on this issue. If the IRS successfully meets this burden, the “responsible person” must show that his or her failure to pay over the trust fund taxes was not “willful”. Willfulness is not defined in the statute but courts have held that it denotes a conscious and voluntary decision to pay other creditors instead of the government.

      Who a “responsible person” is and what constitutes “willfulness” have been the subject of many court cases. A successful defense against the imposition of the trust fund penalty by the IRS requires the close reading and thorough understanding of the relevant statutes and the court cases. If you suspect that the IRS may seek to assess the trust fund recovery penalty against you, you should consult an experienced tax attorney and seek expert advice on how to best defend against the IRS claims.

USEFUL TAX LINKS

We recommend the following Internet resources for researching your tax law issues. If you need assistance with your specific tax question, please contact Kamyar Mehdiyoun, Esq.

TAX QUOTES

“The hardest thing in the world to understand is the income tax.”

Albert Einstein

It’s about ten times the size of the Bible – and unlike the Bible, contains no good news.”

Don Nickles

“The only difference between a tax man and a taxidermist is that the taxidermist leaves the skin.”

Mark Twain

“The power to tax involves the power to destroy.”

Chief Justice John Marshall

“The difference between death and taxes is death doesn’t get worse every time Congress meets.” Will Rogers

“The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least amount of hissing.”

Jean-Baptiste Colbert