IRS reasonable cause – Wilson Rogers & Company

10 Options For Solving Your IRS Debt

When it comes to settling your tax debt, there are 10 options “commonly” employed by resolution professionals (such as ourselves) or the individual taxpayer (see full explanations below):

»          Full pay the tax owed
»          File unfiled returns to replace Substitute for Returns (SFR’s)
»          Dispute the tax on technical grounds
»          Currently Not Collectable
»          Installment Agreements
»          Offers In Compromise
»          Penalty Abatement
»          Discharging taxes in bankruptcy
»          Innocent Spouse relief
»          Expiration of the Collection Statute

OPTION ONE – Full pay the tax owed
While seldom a popular option, sometimes the taxpayer does have the ability to pay the tax outright or borrow against an existing asset e.g. refinance a home mortgage or take out a home equity loan.

Surprisingly, in this situation, this option is usually the least costly of viable options available to the taxpayer. The reason for this is two-fold:
» The taxpayer’s equity in assets will usually disqualify the taxpayer from benefiting from options which grant debt forgiveness.
» Until the tax debt is paid in its entirety, it will continue to accrue additional penalties and interest.

OPTION TWO – Filing unfiled tax returns and replacing Substitute for Returns
When resolving a tax problem, it is relatively common to find that the taxpayer has back tax returns which have not been filed. There are three reasons why it is necessary to file the required back tax returns and get the taxpayer “Current” so to speak:
»         Failure to file tax returns may be construed as a criminal act by the IRS and can be punishable by one year in jail for each year not filed. Filing unfiled returns brings the taxpayer “Current”
»          Filing unfiled returns to replace “Substitute for Returns” may lower the tax liability owed and the associated interest and penalties
»          A settlement cannot be negotiated with the IRS until the taxpayer becomes “Current”

OPTION THREE – Dispute the tax on technical grounds
If there is a technical basis to dispute the amount of tax owed, there are a number of paths to consider, including:
» Filing an amended return if the statute of limitations to file has not expired
» Filing an Offer In Compromise – Doubt as to Liability

OPTION FOUR – Currently Not Collectable Status
If a taxpayer does not have positive cash flow above the level to pay their necessary living expenses or have equity in assets to liquidate, the taxpayer may qualify for Currently Not Collectable Status (CNC). This is most commonly seen when the tax payer is unemployed or underemployed. In this situation, the IRS places a temporary hold on the collection of the tax owed until the taxpayer’s financial situation improves. If over a longer period of time, the tax payer’s financial situation does not improve, the taxpayer may then become a viable Offer In Compromise candidate.

OPTION FIVE – Installment Agreements
In most cases, the IRS will accept some type of payment arrangement for past due taxes. In order to qualify for a payment plan the taxpayer must meet set criteria. They include:
»          The taxpayer must be current- all returns must be filed
»          Disclose all assets owned
»          The difference between the taxpayer’s monthly income and allowable monthly expenses will be the amount that the IRS will request that the taxpayer pay on a monthly basis
»          Monthly payments will continue until the taxes owed are paid in full

OPTION SIX – Offers In Compromise
The IRS Offer in Compromise program provides taxpayers that owe the IRS more than they could ever afford to pay, the opportunity to pay a small amount as a full and final settlement.

»          This program also allows taxpayers that do not agree that they owe the tax or feel that the tax has been incorrectly calculated, a chance to file an Offer in Compromise and have their tax liabilities reconsidered.
»          The Offer in Compromise program allows taxpayers to get a fresh start.
»          All back tax liabilities are settled with the amount of the Offer In Compromise.
»          All federal tax liens are released upon IRS acceptance of an Offer In Compromise and payment of the amount offered.

An Offer in Compromise filed based on the taxpayers inability to pay the IRS looks at the taxpayer’s current financial position and considers the taxpayers ability to pay as well as the taxpayers equity in assets. Based on these factors, an Offer amount is determined.

» Taxpayers can compromise all types of IRS taxes, penalties and interest.
» Even payroll taxes can be compromised.

If the taxpayer qualifies for the Offer In Compromise program, they may be able save thousands of dollars in taxes, penalties and interest.

OPTION SEVEN – Penalty Abatement
In most cases, penalties make up 10-30% of the total tax obligation. A penalty abatement request can eliminate some or all penalties if the taxpayer has reasonable cause for not paying the tax on time or paying the appropriate amount of tax.

Reasonable cause includes:
»         Prolonged unemployment
»         Business failure
»         Major illness
»         Incorrect accounting advice
»         Incorrect advice from the IRS

To prevail in a penalty abatement request, as in most tax matters, the burden rests with the taxpayer to be able to adequately document the reasonable cause.

OPTION EIGHT – Discharging Taxes in Bankruptcy
Bankruptcy can discharge federal income taxes if certain requirements are met. However this depends upon both the type of bankruptcy and the type of tax owed.

Chapter 7 is the chapter of bankruptcy law that provides for the liquidation of non-exempt assets and the discharge of dischargeable debts. Chapter 11 and Chapter 13 provide for repayment of debt in whole or in part.

To discharge taxes in bankruptcy, a number of criteria must be met including:
»         36 months have expired from the tax return due date
»         24 months have expired from the date the tax was assessed
»         240 days have passed since the tax was assessed and filing bankruptcy
»         All tax returns must have been filed

OPTION NINE – Innocent Spouse relief
Sometimes a taxpayer will find themselves in trouble with the IRS because of their spouse’s or Ex-spouse’s actions. The IRS realizes that these situations do in fact occur.

In order to help taxpayers that have tax problems which are due to the actions of their spouse, the IRS has developed guidelines for taxpayers to qualify as an innocent spouse. If a taxpayer can prove they meet these guidelines, then the innocent taxpayer may not have to pay some or all the taxes caused by their spouse or ex-spouse.

OPTION TEN – Expiration of the Collection Statute
The IRS has 10 years from the date of assessment (usually close to the filing date) to collect all taxes, penalties and interest from the taxpayer. The taxpayer does not owe the tax after the 10-year date has passed.

Listed below are some of the most common exceptions to this rule:
»          If the taxpayer agrees in writing to allow the IRS more time to collect the tax
»          If the taxpayer files bankruptcy during the 10 year period
»          If the taxpayer files an Offer In Compromise.

Reducing IRS Penalties

Often times when someone owes taxes that they haven’t paid for a few years, they are surprised when they find out how much the IRS says they owe. This is because the IRS inevitably tacks on several of the dozens of penalties they are allowed to charge. However it’s the late filing, the late payment and the penalty for not making Federal Tax Deposits (when combined) that can add a whopping 65% to your total IRS bill. The good news is that if your tax debt is more than two years old, you’ve maxed out all these penalties.

The IRS does actually have a compassionate side, and it’s typically found in the penalty abatement process. It’s also noteworthy that penalty abatement applications can also be appealed if initially denied. Thus, you can always get a second set of eyeballs on the issue if it initially doesn’t go your way. The thing to keep in mind is that the IRS has very strict guidelines for granting penalty abatements, and these guidelines are referred to as “reasonable cause criteria.” It should be noted up front that “we didn’t have the money” is NOT a reasonable cause criteria. Why is this? Here is the IRS’ logic: when you made the money you should have either paid the taxes at that time (e.g. payroll taxes for a business) or saved the money until it was due (e.g. individual taxpayer who gets a 1099 the next year).

For example, if you are self-employed and receive a check, then you HAD the money, you simply didn’t give the IRS their chunk of it. Same goes with payroll taxes, particularly trust fund taxes (money you withhold from employee paychecks for income tax and Medicare/Social Security). If you had the expectation to pay some amount of wage, then you theoretically HAD the money sitting somewhere to pay that person, and should have withheld it and turned it over to the IRS. If you couldn’t cover the taxes, you shouldn’t have had the employee and should have laid people off or cut back their hours.

There are ways to argue around this, and we have done so very successfully, but there has to be some other circumstance involved. For example, you had the money to pay the tax, but paying the tax instead of something else would have created an “undue hardship.” Examples could include a large medical expense that unpaid would have left a condition untreated, or a court ordered payment that would have resulted in other legal consequences, or a bill such as a large automobile repair which would have left you unable to work and resulted in job loss. These arguments are difficult to make and require significantly more work than standard reasonable cause criteria applications, but they CAN be won.

The primary IRS penalty abatement reasonable cause criteria center on natural disasters, loss or destruction of vital business records, bad advice from the IRS or an accounting professional, criminal activity, medical issues, substance abuse problems, and other serious circumstances. Thus, you are more likely to have your penalties abated if the circumstances fall into one of these areas:

Were any business records lost or destroyed?
Were there any circumstances that led to a substantial drop in collecting on accounts receivable?
Was there any transition in the business that lead to the failure to pay taxes?
Was there a death or serious illness that directly affected the business or personal wages?
Was there any embezzlement of funds, theft of valuable property, or identity theft?
Were there any alcohol or drug abuse issues that affected the business or wage earning capability?
Was there a natural disaster that impacted you or your business?
Did you rely on the advice of a CPA or IRS employee in making tax decisions?
Were there any circumstances that created substantial financial hardship, to the point where your business was close to going bankrupt?

The above questions cover all of the IRS reasonable cause criteria to one extent or another, so finding an answer to your personal or business situation that covers one or more of these questions is the key to a successful penalty abatement application. If you are facing penalties related to back taxes and believe your situation falls into the above, give us a call at 773.239.8850 and we’d be happy to help you.

Until next time…

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