Let’s back up and do an introduction and talk about some important points about what tax debt is and how to best deal with it. Much of the introduction may not lend itself to a step-wise exploration, many of the principles tend to range throughout the process. This particular post may be supplemented or amended from time-to time.
Tax Relief Companies – The Bad Rap —
First, lets talk about “Tax Relief Companies.” The complaints about these companies tended to be that they were (a) expensive, (b) didn’t provide useful planning, (c) had an open-ended cost structure, (d) resulted in action that didn’t attempt to discover all the records, (e) performed actions that had little chance of success, (f) used “urgency” to try and excite taxpayer action, and (g) were so disjointed even a taxpayer trying to move the process forward encountered “progress resistance.”
It may be that the more important within this group of factors is a combination of (b) & (f) planning & false urgency. Included in the “Tax Debt Approach” blog is the need to consider monitoring as a positive, tangible alternative. In fact, many of the cases in which the taxpayer took action and failed, there was something that caused such a sense of urgency that it prevented a more balanced consideration of all the factors in the case.
The other factors cited by critics of “Tax Debt Services” will be dealt with in a different order because the ability to most efficiently free one’s self from tax debt starts at the earliest stages of interaction with IRS. The entire set of limits on tax collection are based upon the need to “move on” both for the good of IRS and for the good of the productive humans that create tax trouble for themselves. There are many instances where a taxpayer’s troubles started with the IRS, not all taxpayers get into trouble on their own. But, its very much like having an annoying relative at your work place; they have to be dealt with in a unique fashion to prevent the relationship and the controversy from irretrievably going down the drain.
Choosing to be in America – What it means to join the American Tax System —
This is not as tautological nor trivial as it might seem. If someone comes to America to reside here, what are they promising to do, and what are they giving up? They promise to be honest and to participate in a voluntary tax system. They agree to disclose ALL of their bank holdings overseas that cumulatively total over $10,000 in U.S. currency every year(FBAR). They agree to disclose overseas interests having a threshold total based upon income and filing status (Fatca).
This seems strange for foreigners used to having the bank remove their interest income tax before letting them touch their interest earnings for the year. Most foreigners come from majority tax jurisdictions that only tax people when they earn money while located in the country of residence. The U.S. and Eritrea are probably the only two countries that tax their citizens and current residents on income from all sources no matter where located.
So, when you think of an EB-5 immigrant you may be impressed that the moment they become a tax resident, they essentially have to disclose the bulk of their worldwide cash and interests. There are more disclosures relating to foreign company and controlled corporations. In essence, an immigrant of substance gives up many privacy rights that are not imposed on all (except Eritrea) of the other countries on the planet. Much of the additional rules and disclosure requirements happened as a result of 9/11, but they may always be the law, and will probably become more onerous over time.
A typical immigrant may have spread a portfolio of cash and assets across many bank accounts located throughout many countries. Absent laws and rules, this is basic diversification action as any given country, currency and bank can fail. The first tax return filed after becoming a U.S. resident essentially will disclose nearly all of the assets under taxpayer control, creating perhaps the first moment that the nexus of ownership of these assets have ever appeared in one document. Most solvent immigrants would do well to simply transfer everything they own to the U.S. to avoid extra accounting and disclosure associated with having overseas assets.
Efforts required to remain in Good Standing in the American Tax system —
Americans have a duty to keep records in relation to the complexity level at which they live. A worker for wages only with no need for deductions only needs a pay stub from an employer and an annual W-2 wage and income statement to file with a short form 1040-EZ tax return. A worker with extended holdings, including real estate and a business has to keep a much more detailed set of records. Good record keeping kept in the ordinary course of business can be shown to the IRS as proof of the basis upon which the proper tax is owed.
Lack of good record keeping can be punished civilly with loss of deductions. Criminally, the lack of records can be construed as an indication lack of criminal intent, or it might be construed to indicate a cover-up. If a taxpayer is honest, keeping records is the best policy. If a taxpayer either will not or can not keep adequate records, making an attempt to get help can go a long way to eliminate criminal intent.
Tip #1: A tax account with IRS should be treated with the same concern and care as one would treat a credit card or billing account. There are rights for credit card accounts, billing accounts and tax accounts and they are each different.
Non-tax Accounts Compared —
Non-tax accounts usually have rules that reward close scrutiny and this is also true of tax debt accounts. For a checking account, the account holder is responsible to see that forged checks are discovered, and can avoid payment if the error is reported to the bank early enough. Credit card accounts with erroneous entries or unsatisfactory purchases can be reversed if discovered and reported within a reasonable time. Tax accounts which have error should be challenged in writing at the first available moment.
Tip #2: A taxpayers opportunity to demand and make use of taxpayer rights are maximum at the earliest possible moment of discovery, and diminish for every time increment and deadline which passes, whether because of not knowing the problem or ignoring the problem.
Non-tax Debt Compared —
Non-tax debt usually has a requirement that a creditor bring a lawsuit and prove the existence, reasonableness and lack of defenses for a given debt. Tax laws give government the many of the rights that a non-governmental creditor has, but without having to bring suit and “prove up” the debt. Some of these rights include the right to tale money from the debtor’s bank account, record a security interest in the debtor’s property, and garnish the debtor’s wages. Government’s need to sue every taxpayer for its tax debt would overload and burden and possibly paralyze government. It is believed that taxpayer rights and procedures form a more efficient substitute for lawsuits against the debtor, and enable a more differentiably controllable apportionment of burden of proof.
Tip #3: The procedural burden and risk on the taxpayer to suffer the punitive financial pain from misunderstandings regarding the tax debt account should encourage high involvement in investigation and tracking of the taxpayer’s tax accounts, but many taxpayers “put their heads in the sand” because facing something they believe they cannot control is simply too painful. Ignoring the problem is a gateway to disaster.
IRS Engagement and Analytical Effort —
“Engagement and Effort” are key to dealing with the IRS, and a part of being present in the American Tax System. Non-engagement is perceived by IRS as an indication that the taxpayer is trying to skirt tax obligations. Non-effort is an indication that perhaps the taxpayer is possibly deliberately intending not to pay tax obligations.
A good financial analysis performed or kept by the taxpayer, especially with an assist from a tax professional ( if the taxpayer has a better use for their time in organizing it) can help formulate a solution. If no early contact is made, IRS will use its lien rights for real property equity, high price personal property, bank levy, and wage garnishment. Put another way, if you have been operating honestly, you need to reveal your circumstances to IRS or risk being treated as if you were trying to get away with something. Understanding, preparing and filing one’s own taxes will likely connect a taxpayer with knowledge as to what is going on with their own finances and tax account.
Tip #4: Lien, levy, garnishment should be NO REASON for taking blind, quick action with a mind simply to stop such lien, levy, or garnishment. First, taking action will extend the IRS collection statutes (all years), and the bankruptcy tax discharge statutes(all years). Where there is a distant milestone with significant savings to the taxpayer, an immediate action is likely to push such a valuable milestone, such as a CSED expiration date farther into the future. It could be that if the taxpayer avoided doing such a tolling act, that the taxpayer may have a balanced chance to achieve enough passage of time to reduce the tax owed.
Go Adversary if it Goes Criminal —
If a taxpayer has made a fraudulent misrepresentation as to income, deductions, evidence or critical facts, the taxpayer is in danger of being criminally charged. Its difficult to realize as its developing, but always be on guard. In many cases what starts as an ordinary audit can turn into a criminal investigation. Most pure tax evasion issues are somewhat complex, in that even if a single element is mis-stated, there are other elements that may mitigate fault or intent. Due to this complexity, and partially motivated by political concerns, the government requires several high level sign-offs and a thorough investigation before initiating actions resulting in a criminal indictment.
A key to government prosecution for tax evasion is related to a magnitude threshold judgement on whether the result will result in felony incarceration. The sentencing current sentencing chart requires a “tax loss” of over $6,500 to correspond to more than a year in prison an offense level of 10. But this level is too chancy, especially for a first time offender. With subtracted points for “acceptance of responsibility” (2), “minor role” (2) and “cooperation” (?) depending upon how a defendant cooperates. An offense level of 10 could be reduced to 6 or 4 and become eligible for probation with no time spent in prison.
However, even an establishment of a “tax loss” of over $6,500 is subject to argument. So, adding 6 points to 10 to make 16 corresponds to a tax loss of over $100,000. Remember that the elemental transactions that contributed to that $100,000 tax loss might not all be of equal strength. In that case, maybe a prosecutor might tend to look for cases with double this tax loss.
Conversely, there may be additional elements which bootstrap the offense level, but a prosecution having a core tax evasion might not be filed if heavy dependence on ancillary crimes is required to obtain prison time. Conversely, if the non-tax-evasion elements are sufficiently strong and the tax evasion elements somewhat weak, the requirement to obtain IRS signatures at the highest levels simply disappears. A taxpayer suspected of identity theft (which carries a 2 year mandatory minimum sentence) and $5,000 in tax loss might be charged only as an identity theft violation with the addition of tax evasion only at sentencing (since it might not mathematically extend the 2 year mandatory minimum).
Sentencing Danger for a Taxpayer with a Criminal History —
The interesting aspect of the federal system is that sentencing enhancements occur based upon the summation of a lifetime of prior convictions and prior criminal acts (both state and federal). Criminal history point additions for felony served (3), 60+ day sentence (2), and any other sentence (1), to name a few. Each two criminal history points (using offense level 10 as an example) can add an average additional incarceration for columns 1-4 of about 1.6 months per criminal history point. This means that someone with prior criminal convictions faces a more severe punishment than someone who had none.
Tip #5: Any criminal trouble a taxpayer has had in the past should make them doubly anxious to insure additional corroborating documentation and proof of legitimacy for all tax transactions, especially since the taxpayer with prior convictions will receive longer sentences than a taxpayer having had no such prior convictions. (Put another way, the Justice Department can prosecute a case with a lesser tax loss and still achieve a felony incarceration for a defendant.)
Willful Failure to Pay is also Tax Evasion —
Taxpayer sometimes forget that not all tax evasion prosecutions are based upon a transaction in the past that becomes discovered and prosecuted some time in the future. Some may occur based simply upon not paying, despite a line of cases that would seem to give the taxpayer a right to withhold payment until some absolute (non-ratio, or non-partial)form of relief became available. For example, In Re: W. David Fretz (11th Cir 2001), a tax debtor didn’t file a tax return for 10 years, and then filed all his past returns at once and was successful in discharging tax debts in issue ($1 million) in bankruptcy court more than 2 years later. The government appealed and the court of appeals for the 11th circuit, reversed, noting that the alcoholic debtor worked overtime for 10 years (was aware of his duty to pay) and that circumstances were a little to neat, holding “[that] Dr. Fretz’ attempt to evade or defeat his tax liability was not willful is clearly erroneous.
Many taxpayers each year are successful in discharging their tax liability. Most discharges are based upon multiple years of tax debt owed. However the old adage “pigs get fat, hogs get slaughtered” is one form of explanation as to why extreme cases that fit within a pro-taxpayer rule (“simply not paying owed taxes is not enough” to prove wrongdoing) will fail when the facts are extreme. If a taxpayer owes taxes, the actions, attitudes and showing made by the taxpayer could ameliorate the result that occurred in the Fretz case, above.
Tip #6: If the reader of this blog was sitting on a jury and judging another taxpayer’s good faith efforts, what types of actions would you want to see them attempt or do in order to show good faith? For example, a tax debtor should consider making a payment to IRS from time to time, and especially diverting a portion of an unusual windfall to show intent to repay. Should a prosecution occur, it might be difficult for a judge to block the evidence of payments from the jury.
Think How Events Now Will Appear in Future —
Every action a tax debtor takes may be examined under a microscope in future. The legitimacy of a taxpayer’s tax debt should be challenged immediately. Full engagement with IRS should be achieved every step of the way. It is much more difficult to later charge fraud or evasion when early engagement and early statement of position has been employed.
Psychologically, it is much easier for IRS to compromise and in a more favorable way, earlier than later. Once sides become entrenched, the chance for a more taxpayer favorable outcome is reduced. Even if the settlement is not what the taxpayer wanted, it is less expensive to settle early given penalties and interest than later. If other tax debts from other years are such that the taxpayer genuinely cannot pay, fighting over a small magnitude tax debt can (depending on the routes chosen) push the 10-year collection statute on the other tax debts even farther forward in time. Both the magnitude and legitimacy of the more recent tax debt should be considered.
Every taxpayer should keep in mind that every action or lack of action should be explained and made reasonable with good and sufficient evidence. Every negative deviation perceived by IRS will increase the lack of trust in the facts and data that will translate into a belief that a taxpayer is really withholding the much more fraudulent facts which need discovering. Always be truthful to IRS, but the scope of any inquiry needs to be controlled both for efficiency and to prevent an unbridled fishing expedition.
Tip #7: One of the most valuable tools a taxpayer has in dealing with the IRS is an independent tax practitioner that will deal with IRS in a non-emotional way, keep IRS on topic to both limit the scope of the audit where possible, as well as to document any attempts to “hunt” for other taxpayer problems in order to leverage the outcome of the audit to the IRS’ favor.
Privilege Level is Important —
Each taxpayer should think deeply about their level of culpability regarding their problems with IRS. Representation can be important, and there is a set of rules on privilege. Loss of privilege generally means that the government could call a person to testify against the taxpayer.
(1) Anyone that accepted money to prepare a tax return for submission is a “preparer” and has no privilege as to that return. This is true regardless of whether the preparer is non-enrolled, an enrolled agent, a CPA or an attorney. This is one reason that I generally don’t prepare individual’s returns, including late returns. If a taxpayer files late returns and uses a preparer, that preparer may be forced to testify if the identity of the preparer were discovered.
(2) Federally authorized tax practitioners include EAs, CPA’s, and Attorneys. However, the privilege of EAs and CPA’s are governed by 26 U.S.C. sec. 7525 and it only extends to civil representation matters. What this means is that if an investigation goes criminal, the practitioners that rely only upon 26 U.S.C. sec. 7525 lose their privilege. Loss of privilege (as would be the case for practitioners that were “return preparers”) means that the practitioner can be called as a witness against the taxpayer from whom they learned potentially damaging information.
(3) Attorneys are the only class of federally authorized tax practitioners that can hold privilege in a criminal tax matter. If a taxpayer needs to oppose IRS in a matter that might become criminal, it makes sense to start with an attorney. Any EA, or CPA that is exposed to your case, and who can be found, can potentially be called as a witness against a taxpayer. Life is not always fair, as we learn from US v. Willena Stargell (CA 9th. Cir. 2013) No. 11-50292, where a district court allowed a fired criminal defense attorney to become an expert testifying against the client at sentencing. This is rare and really not fair, but why should a taxpayer make it easy for the government to put them in jail by starting with an EA, or CPA when there is any possibility that a tax controversy could turn criminal?
Tip #8: Consider choosing an attorney for IRS representation and be completely forthright about which aspects of the IRS interaction may likely turn criminal. An attorney that can represent a taxpayer criminally, and who is forearmed with knowledge of the problem has a much greater chance of either minimizing the probability of trouble, or at least minimizing the degree of damage.
Payment Plan Trap —
There are two main things to watch out for if you sign up with IRS for a level payment plan. First, you lose the ability to designate what years and what taxes your payments are being applied. To make it simple, lets say a taxpayer owes $5000 on their taxes from a year ago and $5,000 on their taxes from 5 years ago. Because the tax debt from 5 years ago could potentially disappear via bankruptcy, the government would like to payoff that 5 year old debt first. The more recent $5,000 debt is not dischargeable in bankruptcy and thus the government would rather apply it to an older debt that could be discharged. An installment agreement allows the government to choose which taxes and tax periods in which it will apply the payments.
A taxpayer has the ability, by communicating the year and tax to which a voluntary payment applies along with the payment and IRS has to apply it as per the taxpayer’s wishes. I’ve had older taxpayers say “I fully intend to pay the government back, so who cares how it is applied?” When it is pointed out that they could have an accident in the coming years, or a heart attack and may not be able to work, they might have bankruptcy as a “no choice” option. In the example above, paying off the more recent $5,000 debt first would leave them in a position to discharge the older $5,000 debt later. Further, there may be non-tax debts that drive the bankruptcy decision, and a pressing need for early filing would cause more recent tax debts to survive the bankruptcy.
The second payment plan trap involves defaulting on an installment agreement’s payments. The government will be more reluctant to trust a taxpayer or a taxpayer’s other pleas for help when an installment agreement is defaulted. With no installment agreement, there is no installment agreement to default. If a taxpayer had a record of sending various amounts per month to pay a tax debt, those amounts would create their own record of intent to repay the IRS. And, the taxpayer could designate the years and taxes to which they apply while doing it. Further, a month when the taxpayer cannot make a payment (or makes a small payment) will still not disrupt the establishment of a record of intent to repay.
Tip #9: Depending upon all conditions, it can be a real advantage for a taxpayer to operate their own repayment plan in accord with month-to-month and week-to-week ability to pay. Such a “taxpayer directed” payment plan will provide flexibility, the ability to allocate tax and years, and proof of intent to pay.
Discover as Many Aspects of Assets and Tax Before Taking Action —
A taxpayer has a greater chance consider and craft an optimum tax debt solution strategy if the taxpayer starts planning at the earliest possible moment. So many taxpayers adopt a strategy to “putting off” dealing with the tax problem until they believe they are forced to take action — usually in response to a threat of garnishment, levy, or lien filing. In most cases, garnishment, levy, or lien can be avoided by early action.
However no imminent threat of garnishment, levy, or lien should trigger an unthinking reaction to avoid the inconvenience of any or all of these possibilities. If a taxpayer requires 2 – 4 months to get a complete picture of their position and options, the possibility of 2 – 4 months of garnishment or levy will be unpleasant, but the taxpayer needs to know and understand a full analysis before taking action. Taking action that fails to achieve the goals costs the tolling of tax debt statute of limitation, possibly prolonging the debt condition for additional years.
Tip #10: Review all financial aspects and debt relief possibilities for tax debt, including bankruptcy enabling statutes and tolling, Bankruptcy outcomes, the collection statute and tolling, the effect of taking an action, and the effect of monitoring and planning to take action after specific milestones are significantly passed in the future.
Preparing and Filing One’s Own Taxes —
Much like a river that begins with a small stream, most tax debt problems usually start with some small deviation early in time. A deviation from what “should have been done” can occur on the taxpayer side or the IRS side. Any two entities that transact information and accounts can have errors.
A taxpayer that keeps complete records can have an advantage on government when errors occur. Moreover, a taxpayer that keeps complete, provable records can begin to achieve a probability shift in which the government is probably the entity that made the error. A government error can be costly, but it is likely to be less costly when detected and addressed early.
(a) Self-filers have better knowledge of their own transactions: Taxpayers that file their own taxes are in a better position to know the match between what they are filing and their own earnings and deductions. Self-filing taxpayers are in a better position and have a better incentive to keep records than taxpayers that continually try to divorce themselves from involvement in their own financial affairs. Taxpayers that self-file know the effect of deductions, their marginal tax rate, and can make decisions in their business and financial life knowing how each decision will impact their taxes.
(b) Self-filers assume self-responsibility: Taxpayers often use a paid preparer along with an attitude that if something goes wrong, its the preparer’s fault. The preparer industry is under pressure to increase profitability, without charging a prohibitively high rate for the time they spend on a particular taxpayer. So, increased profitability for a tax preparer will generally translate into less time spent on each taxpayer, against the hope that responsibility for developing problems can disavowed or garner additional charges to fix. Intake checklists are used to help establish isolation of responsibility away from a tax preparer.
(c) Self-filers have records organizational control: Self-filing Taxpayers are more likely to keep and treasure their records both because they don’t visualize dumping the records and responsibility on someone else, and they know that those records may be needed to settle later disputes, tax or non-tax. Self-filers are probably more likely to store records for later retrieval to facilitate quickly providing IRS with record proof and detailed explanations the moment that IRS raises a question. Self-filers are more likely to have returns that match prior returns and have kept records that match with prior year’s records.
(d) Self-filers have tax compliance control: Self-filing Taxpayers are more likely to keep and treasure their records both because they don’t visualize dumping the records and responsibility on someone else, and they know that those records may be needed to settle later disputes. At present, taxpayers can file their own taxes and take greater steps to preserve the record of filing by using cover letters reciting contents, keeping detailed computer scans of what was sent, and using delivery service tracking numbers to show that a return was actually filed. Tax preparers are generally “forced/encouraged” to file electronically. Electronic failures include IRS failure to generate a proper receipt or rejecting an electronic filing or otherwise electronically “losing” a filing due to IRS computer problems. Self-filers can research their positions and assure themselves of the propriety of taking a position that a tax preparer might not risk such a position due to the “preparer penalty.”
(e) Self-filers have confidentiality control: Self-filing Taxpayers need not share their information with anyone. Self-filing taxpayer can submit returns and payments by mail and need not go on-line. A filing single taxpayer with no partnership business or employees need not share information with anyone and automatically avoids the 18 U.S.C. sec. 371 conspiracy to defraud government. As stated above in greater detail, anyone that helps a taxpayer prepare, decide on a position, or file a tax return for pay has no confidentiality (and can thus be made to testify against the taxpayer). Self-filers are better able to keep their identity, finances and confidentiality by staying off-line. Therefore also, avoid “the cloud.”
Tip #11: A taxpayer should self-prepare and file their own tax returns in accordance with their own involvement in their financial lives, and also remember to keep all financial information, discussions, and bookkeeping off the Internet and isolated from any possible breach in confidentiality by anyone.
Other Sections within this blog:
Instructive Warning Cases
Bankruptcy & Offer-In-Compromise – The Hot Dog Stand Paradigm
A Tax Debt Only Comparison of Offer-In-Compromise and Chapter 7 Bankruptcy in California Graduating From a Homelessness Base Case
How Far Can You Delay Paying Federal Tax Authorities Before Criminal Tax Evasion Charges are Filed?
Taxpayer First Act Credit Card Trap
There are Usually 6 Tax Choices At Any Given Point In Time
Other Articles Outside this blog:
Debt Control Extensive Outline (8/14/2019)
Pre-Startup Efficiency – Introduction (Parts 1&2) (2016)
9th Circuit Rejects “One Day Late Rule” for Late Filed Return Tax Dischargeability (2016)
Give My Start-Ups a Break! (2015)