Why you need to Act Now on your IRS Debt Problem

It’s a natural tendency to want to avoid dealing with an unpleasant task such as an IRS debt problem. After all, the IRS is not particularly speedy in most of the things they do, so ignoring them, in the beginning, is easy. But this is probably going to cost you. Waiting for that levy notice to come in the mail is going to reduce the time available for you to arrange your finances so that your payments to the government are minimized.

Why is this? Unless you qualify for a streamlined payment plan, the IRS is going to perform a financial analysis of your situation to determine how much money they should be able to collect. Basically, they are going to relate your income to what they consider to be the “reasonable” costs of living. If that cash flow projection is positive, they are going to want a deal that gives them that amount as a minimum.

Here is where the time problem comes in. Given enough time in advance of that levy notice, you can use the IRS financial analysis approach in advance to figure out what changes you can make to minimize the amount that the IRS might think of as collectible. For example, say you do not have life insurance. The IRS allowable expenses include term life insurance premiums. But, you need at least 3 months of payments to the insurance company before the IRS will include this money in their calculations. So, signing up for life insurance tomorrow is not going to work. Given enough time in advance of negotiating with the IRS could result in you having life insurance with zero difference to your cash flow.

Performing the financial analysis early allows you to develop a strategy to minimize the IRS’s impact on your life. Waiting for the levy notice is a mistake

How does the IRS define “Economic Hardship”?

Economic Hardship is a kind of get-out-of-jail-free card when it comes to dealing with IRS Collections Division. It can be used to get a levy released or an Offer-in-Compromise accepted if the financial analysis showed the result would place the taxpayer in an economic hardship


So, just what is an Economic Hardship? Economic hardship occurs when a taxpayer is unable to pay reasonable basic living expenses. The IRS considers the taxpayer’s equity in assets and expected cash flow to determine how much money should be available to pay their tax debts. This information is brought together with a formula that is called the Reasonable Collection Potential or RCP. Much of the “reasonableness” in the formula comes from various tables of allowed or allowable living costs.


Plug all the numbers into the RCP and if the result is positive, the IRS figures you can make payments. If the number comes out negative, then you are in an Economic Hardship situation.


This leads us to one of the major reasons for Offers-in-Compromise to fail. Nobody did the RCP analysis and instead made an offer that was unacceptable on the face of it. 

Are Retired People Screwed when it comes to IRS Debt?

A retired couple decides to liquidate some of their stock investments because they are no longer able to handle the ups and downs of the market. This action puts them into a strong and safe cash position but also produces a large tax bill. Paying that bill significantly reduces the savings they have built and depend upon for their retirement years.

They decide to make an Offer-in-Compromise with the IRS instead. The offer is rejected by the IRS because the analysis of their financial position shows that they could full-pay the debt. Is it a lost cause for this couple?

Not necessarily. The IRS can accept the Offer under Special Circumstances where the collection of the debt in full would create an “Economic Hardship”.  This would be the case for the retired couple depending upon their savings for the rest of their lives.

The big factor for taxpayers hoping to have an Offer with Special Circumstances accepted is a history of compliance. Investing in dubious tax shelter schemes, repeated non-filing penalties, or failure to pay on a regular basis are all factors that will work against the offer.  Most of these offers are in fact initially rejected by the IRS, so you can expect that a trip to Appeals is going to be part of the process.

I will discuss the meaning of “Economic Hardship” in more detail in my next post.

Can the IRS have your Passport Revoked?

The IRS does have the power to have the State Department revoke your passport for owing back taxes is YES. Recently the Fifth Circuit upheld the constitutionality of the government restricting international travel for James Franklin due to back tax debts of $55,000. Mr. Franklin had claimed that revoking his passport had violated his 5th Amendment rights to due process. Luckily, the US is a big country, so you can still have some places to go while all those IRS notices are building up in your mailbox.

Revoking your passport is not the only tool in the IRS toolkit that goes beyond liens and levies. In 2014 Congress passed the Consolidated and Further Continuing Appropriations Act that prohibited federal agencies from awarding contracts or grants to contractors with any amount of delinquency in federal taxes. This law does not get used consistently, but it is another good reason to avoid getting in the hole with the IRS.

What to do when you can’t pay your payroll taxes?

Cash flow is in the toilet, and you are past due on prior quarters’ payroll tax liabilities. You can barely cover the next payroll check run. What to do? My number one rule for having a better life is “Don’t go broke while owing the IRS for payroll taxes”. The reason is simple. They will make your life even more miserable by assessing the Trust Fund portion of the taxes on you personally. You will not be able to discharge this penalty in bankruptcy which means that the IRS will be after you for the next 10 years.

Must Do Steps

Step Number One is you need a new business plan, and you need it fast. Moreover, it must be a real plan that shows a clear path to cash flow and profitability. If you can’t produce this plan, it’s time to shut the business down. Either go back to being a sole proprietor without employees or move on to something better.  Digging the hole deeper is a bad bet.

Step Number Two is to reduce the liability for the Trust Funds portion of the payroll tax liabilities. Assuming the business is being taxed as a corporation, transfer whatever cash is available to the owner and let them make a voluntary payment to the IRS for the payroll taxes. The owner needs to pay the IRS by check along with a letter that designates that the payment is to be applied to the “Trust Funds Only” for each outstanding liability period under Rev. Proc. 2002-26. Eliminating the trust fund portion of the tax debt eliminates the possibility of the Trust Fund Recovery Penalty being assessed on the owner individually.

Staying in Business

Here are a couple of ideas if the business is going to continue:

    1. The business should immediately set up a payment plan to cover the balance of the payroll taxes owed. Do not wait for the IRS to contact you. Things will not get better with a Revenue Officer assigned to your case.
    2. Make future payroll tax deposits on the same day that you pay the employees. Your payment plan will automatically be in default if you do not make all tax deposits timely. It is critical that you don’t let this get away from you.

The great thing about the American Economic System is that you are allowed to fail and go on to other things. However, a payroll tax liability that is perhaps in the hundreds of thousands is going to make that recovery ever so much harder.

Who is a responsible person for payroll taxes?

Companies that fail to make their payroll tax deposits will eventually be faced with dealing with IRS Collections. One of the tools that the IRS has in its arsenal is the Trust Fund Recovery Penalty which is assessed on the people responsible for not making the payments. Defending against this assessment starts with understanding who the IRS will consider to be a responsible person.

The IRS considers a responsible person to be anybody who is accountable for collecting OR paying the payroll taxes and who then willfully fails to do so.  “Willful” sounds like a possible out if your cash flow is in the toilet, but it’s not. Paying other bills before the IRS is considered evidence of willfulness.

Typically, the IRS will assess people in the following positions:

    1. The owner/operator – There is no out for anybody in this position. Even if you did not know the taxes were not being paid, the courts have held that you should have.
    2. Other officers of the corporation if they had signature authority on bank accounts and knew that the payroll taxes were not being paid.
    3. Accountants that had signature authority on bank accounts and signed the payroll tax returns.
    4. Lenders who have funded payrolls in the amount that only covers the employees’ net paycheck. The theory here is that they knew the company owed the funds and could have required them to borrow enough to pay the taxes.

The best defense for anybody in these positions, other than the owner, is to not have signature authority on any business bank accounts. The ultimate responsible person is always the top guy or gal. Business owners and CEOs cannot delegate this responsibility away.

My next post will cover some strategies for dealing with a potential Trust Fund Recovery Penalty.

IRS Data Book

The IRS recently released their Data Book for 10/1/19 – 9/30/20. This publication is a compilation of various statistics for the fiscal year ended 9/30/20. You can find some interesting information that might be useful in dealing with the IRS.

For example, ever wonder which penalties are the easiest to abate? Table 26 shows penalties assessed vs. penalties abated. I did a little spreadsheet work and compiled the following table for individual penalties:


Type of tax and type of penalty Civil penalties assessed Civil penalties abated % of # % of $ abated
Number Amount Number Amount
Civil penalties, total 33,393,194       17,132,623       3,069,510       2,702,606       9% 16%
Accuracy 788,243 1,821,183 37,241 230,451 5% 13%
Bad check 1,041,858 96,592 55,027 18,976 5% 20%
Delinquency 3,404,985 4,568,266 430,604 1,081,078 13% 24%
Estimated tax 11,103,032 2,165,917 336,758 432,405 3% 20%
Failure to pay 17,048,457 8,028,212 2,209,541 903,366 13% 11%
Fraud 1,296 403,787 150 33,184 12% 8%
Other [5] 5,323 48,665 189 3,145 4% 6%

The failure-to-file penalty is the most likely penalty to be abated. The accuracy penalty is the one that causes taxpayers the most angst and is one of the hardest to get relief.

The bad check penalty is interesting. It’s one of the easiest penalties to have abated since it requires someone to knowingly issue an insufficient funds check. Most of the corporate bad check penalties are abated, but only 5% of the assessments on individuals get removed presumably because the amounts are too small to bother with.

How do you prove a negative to the IRS?

One of the hardest and most irritating problems to work with the IRS is when someone has issued a W-2 or 1099 with an incorrect social security number on it. Generally, what happens is that you receive an IRS notice of proposed changes to your tax return for unreported income. The notice includes a list of 3rd party 1099s and W-2s issued to your social security number. One of those 1099’s, for say $20,000, is from some company that is not even in your part of the country.

Calling up the IRS and complaining about this does nothing. The IRS’s position is that it is up to you to prove that the 1099 is in error.  Several people I have known over the years have given up at this point and just paid the additional taxes.

However, there are better options:

    1. Call the company on the form and try to get them to amend it.
    2. Fill out IRS Form 2624 giving the IRS permission to contact the payor. The IRS will race at a snail’s pace to contact them, but this is usually enough of a prompt to get it fixed.
    3. If this does not work, it’s possible that you are a victim of identity theft. You should call the IRS and request an IP PIN.
    4. The next step is to file a Form 911 with the Taxpayer Advocate Service. One of their primary purposes is to get the bureaucracy to correct errors when its processes fail.
    5. Finally, if it’s enough money, consider an Offer-in-Compromise due to Doubt as to Liability. Make an offer of $150 to cover the processing costs and hopefully, the IRS will let it go at that.

What is so irritating about this issue is its unfairness and the IRS response that this is your problem, not theirs. Luckily, most of the millions of 1099s and W-2s are issued with correct id numbers.

What can you do about a Federal Tax Lien?

The most effective IRS tool for getting paid is the Federal Tax Lien Notice. Should you sell your real estate, they are virtually guaranteed to get your share of the proceeds to cover your tax debt. Most payment plans on the other hand end up in default. As a result, they will not remove the lien notice simply because you start making monthly payments.

There are some options open to you when it comes to Federal Tax Lien Notices:

    1. They will usually issue a Subordination of Federal Tax Lien to allow a bank refinancing of a mortgage provided they get a significant chunk of any cash coming out of the deal.
    2. They will also remove a particular property from their lien provided they get some cash. This is called a Certificate of Discharge from a Federal Tax Lien.
    3. You can get a Lien Withdrawal if you are on a Direct Debit Installment Agreement and your debt balance is $25,000 or less. The catch on this one is that the agreement must lead to full payment in less than 60 months or before the Statute of Limitations runs.

Of course, the option the IRS likes the best is for the taxpayer to just pay off the debt balance. Should that happy day happen, the Lien Withdrawal will be automatically issued within 30 days.

Lien Notices are usually not very disruptive to your life like a levy of your wages or bank account. They do affect your credit score and will result in you getting umpteen letters from people offering to get you out of your problem for “pennies on the dollar.” However, most closing agents have experience in dealing with these when it comes to selling real estate making them a minor complexity in the deal.

IRS Liens are “Self-Releasing”

The IRS issues millions of liens on tax debtor property every year. Unlike other creditors, IRS liens are “self-releasing”. There is a highlighted box on each Notice of Federal Tax Lien that states that this notice will also operate as a lien release one day after the Last Date for Refiling. The problem is that most people, including financial professionals, do not read this and keep looking for a formal release that is not coming.


The easiest way I have found to handle the problem with bankers and closing agents expecting a formal withdrawal is to send them a copy of the lien notice and highlight in red the already highlighted box. You can also send them IRS Publication 1468 which explains the self-releasing nature on page 4.


The IRS will formally withdraw the lien notice if the debt is cleared prior to the Statute of Limitations. This is usually done automatically within 30 days after the debt has been paid off with money or an Offer-in-Compromise. There are also other reasons they will issue a withdrawal if the government can be convinced it is in their best interest.