Michael Goldman & Associates, L.L.C. - Consulting
& CPA Services
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Goldman's Critical Support
-- Winter 2003
Resolving Old Tax
Debts
Failed
business ventures and failed marriages often leave somebody owing taxes. When
the taxes cannot be paid in full when they're due, there are a number of ways to
settle or discharge the debt. Statute
of Limitations The
statute of limitations on a tax debt is 10 years. The IRS will often increase
collection activity as the end of the ten-year period approaches, and may renew
the period with a court proceeding. On
the other hand, I have seen cases where the IRS seems to have let non-payers
fall through the cracks. Even in some cases where they have filed demands for
payment, they've been known to completely drop the ball in follow-up. While
running out the statute is a more successful tactic than is commonly believed,
the emotional toll it takes on the debtor -- in terms of lost sleep, anxiety,
and constantly looking over their shoulder – can become overwhelming. To top
it off, if you get married, finally see your business become successful, or
inherit money, you now have a lot more to lose if the government suddenly wakes
up and remembers you. I have seen more people voluntarily re-enter the tax
system (due to fear or conscience) than I have seen being dragged back into the
system kicking and screaming by vigilant IRS agents. Offers in Compromise As
a result of political efforts in the 1990s to make the IRS seem more
citizen-friendly, the agency has touted its Offer in Compromise process as a way
for poor taxpayers to escape the oppressive burden of old tax debts. Offers in
Compromise allow the discharge of tax debts that cannot be discharged in
bankruptcy. In
theory, the Offer allows settlement of the debt based on the taxpayer’s
ability to pay, and can wipe out debts for pennies on the dollar. In practice,
having an Offer accepted is almost impossible – the amount of the offer must
be greater than the liquidation value of the taxpayer’s assets, meaning that a
non-involved third party must be available to help fund the payment. Assets that
the IRS cannot get to, such as retirement plans in certain states, are
considered in the Offer process and usually must be liquidated and handed over
if the Offer is to be accepted. An accepted Offer may leave the taxpayer with
nothing to live on. Because of this, Offers in Compromise work only for certain
people, such as someone who is planning on getting married and wants to settle
his tax debts beforehand, or who has a rich relative who can fund the
settlement. Assuming
the offer is fundable, the bureaucracy involved in getting an Offer approved
makes the rest of the IRS look like a paragon of customer service – paperwork
will be rejected for the slightest flaw, and perfectly submitted paperwork can
take up to a year to be decided upon. Basically, the debtor has to convince the
IRS that the amount offered is the most that it can ever expect to collect from
a destitute taxpayer. Installment Agreements Taxpayers
who do not qualify for an Offer in Compromise can often work out an installment
agreement. While this may help with cash flow, it does not reduce the amount
owed or prevent the filing of liens on the taxpayer’s property. Interest and
penalties continue to accrue during the payment period, the taxpayer is left
with minimal amounts to live on during the payment process, and the payment
period cannot exceed sixty months. Businesses
that owe unpaid payroll taxes are generally considered to be insolvent by the
IRS, and they will shut the business down if those taxes cannot be paid within
six months. Innocent Spouse Relief Innocent
spouse rules cover both underpayments and inability to pay. Relief is available
only for income taxes. The
spouse requesting relief for a tax understatement must not have known or have
had reason to know that the amount of tax due was understated. The spouse’s
knowledge can be inferred from the spouse’s education level, degree of
participation in the family business or financial affairs, and the couple's
lifestyle . The
standards for relief for an assessed deficiency (one that the government has
formally declared due and placed in the collections department) are different
– the joint filers must not have been living together for at least twelve
months, and the standard of knowledge is liberalized from “should have
known” to actual knowledge. The requesting spouse must have clean hands in the
matter – innocent spouse relief cannot be used as an asset shield. Another
type of remedy is hardship relief for innocent spouses. The IRS allows this
remedy based on such factors as age, employment history, number of dependents,
medical condition, and reasonableness (according to government standards) of the
living expenses of the spouse requesting relief. There must also have been a
bona-fide separation, no fraudulent transfer of assets, and the requesting
spouse’s probable lack of knowledge. Intelligent people who prolong staying
with a fiscally irresponsible partner to try to work things out will probably be
penalized for their fidelity by being disqualified from hardship relief. Bankruptcy: Chapters 7, 11 and 13 Filing
a Chapter 13 bankruptcy case often allows a taxpayer who has not filed old tax
returns to settle the debt on returns that are more than three years old for
pennies on the dollar, Chapter 13 can be the best option when there are moderate
amounts of debt to discharge. This remedy is likely to be removed or tightly
restricted with the passage of new bankruptcy reform proposals. Like
an Offer in Compromise, Chapter 7 bankruptcy forces the debtor to liquidate
assets. Chapter 7 generally allows the debtor to keep more of the liquidation
proceeds than an Offer in Compromise does, but this depends on the types of
taxes that are due. Tax debts for which no lien has been filed, which are past
the statute of limitations on assessment, have not been assessed within the past
240 days, and are not subject to an Offer in Compromise can be discharged.
Chapter 7 will not discharge either debt that has had a lien filed or the most
common type of tax problem I have seen, the responsible-person penalty for
unpaid payroll tax withholdings. The latter, also referred to as trust-fund
taxes, are probably more aggressively pursued than any other type of tax
deficiency. The
IRS can assess trust-fund tax liability on any person with the power to
designate which creditors get paid – anyone from the chairman of the board to
the accounts payable clerk. Anybody who makes a deliberate, conscious,
voluntary, and intentional choice to pay creditors ahead of the government can
be considered a target for collection activity. Since the government usually
takes around nine months to discover that you have not remitted your payroll tax
withholdings, it is very tempting to use those funds to smooth out short-term
cash flow irregularities. Don’t do it – the laws requiring payment of
this money transcend bankruptcy, corporate limited liability, and virtually
every other protection available to business people. As
a source of business financing, trust fund taxes compare favorably with the
neighborhood loan shark: ·
The IRS
penalties and interest in the worst cases almost equate to loan shark rates ·
Collection
activity (while starting out slowly for trust fund tax debts) is quite vigorous ·
Neither
will cut you a deal, and ·
They
will eventually take your business from you if you don’t pay. There
is a greater chance of slipping through the cracks with the IRS, but it is
harder to hide from them once they do make an assessment. Chapter
11 is primarily used by businesses, but can also be available to individuals.
Its most common usage in tax situations is when the debtor is unable to meet IRS
installment payment guidelines. Bankruptcy judges are generally more realistic
(i.e., compassionate and liberal) about ongoing cash-flow needs than the
standards used by IRS collectors. The
combo plate Depending
on the debtor’s situation, a combination of the above remedies may yield the
optimal solution. For example, a successful Offer in Compromise could generate a
settlement on non-dischargeable trust fund taxes and remove any IRS liens on
retirement accounts. A subsequent chapter 7 bankruptcy could discharge the
debtor’s other debts and still, depending on the jurisdiction, leave the
retirement accounts unscathed. Of course, the most obvious remedy is not to incur excessive liabilities in the first place. Filing returns when due and remitting all trust-fund taxes (sales tax, payroll withholdings, etc.) as they are collected would eliminate almost all of the tax problems I see. Companies that are growing quickly or that are struggling to make ends meet need to avoid the temptation to finance their activities with taxes withheld from employees or customers.
© Michael Goldman 2003 For
more information, please go to www.michaelgoldman.com
Editorial material in these newsletters is intended to be informative, and
should not be construed as advice. For advice on any specific matter, please
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