The IRS claims to have built a list of millions of non-filers with substantial income. They were ready to pull the trigger on a program to begin investigations of the people on that list when COVID hit. Everything went on hold. The IRS is now officially back in the office and picking up where it left off.
What should you do if you think you might be on this list? Your number one priority should be to keep your case from going criminal. If you think the past due taxes are substantial, talk to a tax attorney with experience in criminal tax matters. Attorneys have confidentiality privileges that CPAs and other tax preparers do not, so do not go blabbing to them about your problem.
The next step is to prepare the missing returns. If you have not filed for decades, there is some good news. IRS Policy Statement 5-133 only requires that you catch up the last 6 years of returns. Don’t have the records? Not a problem for the IRS. They will happily compute the highest tax possible with the information they have. Reconstructing the records using a forensic accountant is costly, but more likely than not, worth it.
Once you have the missing returns prepared and the scope of the problem identified, it’s time to work on the strategy. If criminal action is likely, listen to your attorney. Jail time is a real bummer. If it’s not a criminal case, then you need to work with someone who knows how the IRS Reasonable Collection Potential formula works to determine which path to follow to clear the debt. Most people in this situation do not have the assets and income that will allow them to pay the debt in full. An Offer-in-Compromise is the best bet in these cases.
Timing is everything in getting out of this mess. The best outcomes happen when you come forward voluntarily, with returns in hand, and a strategy to clear the debt. Waiting for the IRS investigation to start means you will be facing hard deadlines throughout the process along with an unsympathetic Revenue Officer.
There are several strategies to consider when it comes to dealing with IRS debt. The Offer-in-Compromise is an option for taxpayers who are simply not in a financial position to pay their IRS debt in full. The IRS will accept less than full pay, but the process of getting that agreement is not easy. But, contrary to the ads on TV, most of the offers are rejected by the government. In fact, only 14,000 out of 45,000 offers were accepted in 2020 as per the IRS’s latest data book.
- You must be able to prove that your financial situation is such that you are not likely to be able to full-pay the debt.
- All your tax returns due in the last 6 years must have been filed.
- Your estimated tax payments and withholding for the current year must be adequate to cover your current year’s tax liability. The IRS will not make an agreement if you are still digging the hole deeper.
- The offer amount must be adequate. The IRS uses a formula called the “Reasonable Collection Potential” to determine what they will accept.
- Your offer must include a payment equal to 20% of the offer amount if you are offering a lump sum payment agreement.
- Should the IRS reject your offer, the tax payments will not be returned.
- Should the IRS accept your offer, you must stay in compliance for a period of five years. Failure to do this, by say not filing on time or making estimated tax payments, results in the Offer being void. And, no, the IRS will not be returning any tax payments made.
- The 10-year Statute of Limitations is put on hold while the IRS is considering your offer.
The fact that most offers are rejected is undoubtedly the result of people making offers without understanding the process or the Reasonable Collection Potential formula. This is not helped by the TV ads promising ‘pennies on the dollar’ results without mentioning that you must prove your financial position.
I represent taxpayers in Gainesville and the state of Florida who have tax issues with the IRS.
The IRS accepts less than a third of the Offer-in-Compromises that it receives. This is according to its own Data Book. Since it is a costly process to make an offer, it would behoove people to understand why these offers fail.
- You must be in “Compliance” – meaning all the tax returns due for the last 6 years must have been filed and your current year estimated taxes and withholding are up to date. Failure here makes your offer Dead on Arrival. The IRS does not want to make deals with people who are digging the hole deeper.
- The financial information that you provide must show that you have an inability to pay the debt in full. The IRS uses a formula approach to its evaluation. They apply it to the financial information you supply regarding the stuff that you own and your expected future cash flow. Making an offer that is less than what the formula shows that you can pay is almost certainly going to be rejected.
Why is it that the IRS will not accept an offer when the financial information shows a taxpayer could full pay? After all, the commercials all talk about them accepting “pennies on the dollar” when you use their services. The answer is simple – Why should they?
The IRS has collection powers that far exceed those of private debt collectors.
- They have the police powers behind them and the force of law that will make a debtor’s life considerably more miserable than dealing with harassing phone calls from some debt collector agency.
- They can levy wages, bank accounts, and money due to you from third parties. They can get into IRAs and pensions which are off-limits to everybody else.
- Finally, they have an organization behind them that is not motivated by a profit percentage of the amount collected. They can be patient and persistent over the 10-year period that is the normal statute of limitations for collections.
Avoiding these two major pitfalls is why you probably need professional help from someone who understands the process and most importantly how the financial analysis works.
If you or someone you know has received a Notice of Intent to Levy or some other federal or state tax issue, please feel free to contact me at either (352) 317-5692 or email firstname.lastname@example.org.
Here are three reasons why the IRS may accept your Offer-in-Compromise — your offer to pay less tax debt than you owe:
- Doubt as to Liability – this applies to taxpayers with good arguments that they do not owe the tax, either partly or completely.
- Doubt as to Collectability – taxpayers have neither income or assets to pay their tax debt.
- Hardship to Taxpayer – the taxpayer has the funds to pay the full debt but doing so will create an economic hardship. Think of an 80-year-old with a lumpsum payout from their retirement plan. The funds are needed to pay their living costs for the rest of their life.
Wow – sounds very reasonable. Why then is it that most (60%) Compromise Offers are rejected by the IRS? The answer to this boils down to two major categories:
- The taxpayer is not current on their tax return filings or has not made their current year estimated tax payments. The IRS will not even consider an Offer if this is the case. First is because the taxes must first be assessed before they can be compromised. Secondly, taxpayers who are not making their current year tax payments will be in default before the ink is dried.
- The second big reason for rejection is that the Offer is too small. The IRS looks at both the equity in the assets you own and your future cash flow. The result of this analysis is the Reasonable Collection Potential or RCP Offer less than this amount and the IRS is going to reason that it is not in the best interest of the government to compromise.
What should you do if you think you might be eligible? Figuring out the RCP amount is complex, so it is probably a good time to get professional help. Understanding how the RCP formula works will allow you to arrange your financial affairs in advance of the offer to minimize the offer amount without having it rejected.