Unfiled Tax Returns? Unpaid Taxes? What Are Your Options?
November 2011
Most people feel a bit stunned and overwhelmed when the Internal Revenue Service (IRS) contacts them. Do not ignore the IRS and hope they will go away, because they will not. Your problems will only increase.
Whether your tax problems involve income tax, employment taxes, excise taxes, or some other tax, unpaid taxes accrue interest (compounded daily) and will likely accrue penalties and interest on those penalties. The longer you ignore the IRS, the higher your total tax bill will become and the harder it will be to fix it.
So, what do you do when the IRS comes knocking? This article explores the IRS's procedures, your rights and potential solutions.
Assessment to Determine Amount Due
The first step in determining the amount of tax due is preparation of a tax return. If you do not file a return, the IRS may contact you for information so they can create a return for you. The IRS probably received information from outside sources (e.g., W-2s, 1099s, 1098s) and believes you owe tax. If you do not cooperate, the IRS will compute your tax, most likely without the benefit of various credits or deductions. Thus, it is best to gather your tax documents and meet with the IRS to determine the correct amount of tax.
The IRS could also decide the return you filed is incorrect. At this point, the IRS will send a notice of proposed adjustment to your tax due or commence an audit. Again, cooperate with the IRS to compute your tax liability so you get the tax benefits.
If the IRS believes you owe tax or more tax than you reported on your return, the IRS will notify you of a proposed assessment or a "notice of deficiency." The notices include opportunities to appeal the proposed assessment by way of a written protest, an administrative appeal, or an appeal to the United States Tax Court. Do not miss a deadline for disagreeing with the IRS's determination because it could constitute a waiver of your appeal rights.
After assessment, the collection process begins.
Collection
Collection usually starts with letters requesting payment of unpaid tax. The IRS prefers to collect the tax with the cooperation of the taxpayer, rather than forced collection. Often, the IRS files a federal tax lien on all real and personal property you own or later acquire (and gives you notice of it) before beginning forced collection.
Forced collection may include levy, seizure of assets, or a lawsuit to foreclose on real property. A levy -- the IRS's form of a garnishment -- could sweep your bank accounts or take some of your wages.
If you own or operate a business and have unpaid employment taxes, be particularly wary of the IRS's efforts to collect. The IRS may close your business through seizure. This includes notice to seize all business assets, padlocking the doors and putting property up for sale. The business's bank accounts and accounts receivable may be levied.
How do you deal with forced collection? Consider resolving your tax liability through collection alternatives.
Collection Alternatives
If you receive notice of a tax lien or levy, you may have the right to file a Collection Due Process (CDP) appeal. The appeal may contest the tax liability or propose alternate payment arrangements, and stops forced collection. If you fail to file your CDP on time, you can still request what is called an equivalency hearing, but that does not require the IRS to stop forced collection activity.
If you do not have the right to a CDP appeal, there are three primary collection alternatives: Installment Agreement, Offer in Compromise and bankruptcy. If you have the means to pay your total tax, penalties and interest in installments over a reasonable period of time, an Installment Agreement may be your only option. Forced collection will cease, provided you remain in compliance with the terms of the plan. An installment plan does not stop accrual of interest and penalties.
If you cannot pay your liability over time, consider an Offer in Compromise (OIC). An OIC settles a tax liability for less than full payment of tax, penalties and interest. Other than bankruptcy, this is the only means by which the IRS can waive penalties and interest. The amount of your OIC will be determined by the information presented in a financial statement, which includes the liquidated value of all assets plus future net disposable income. Taxpayers usually must borrow to fund an OIC, because all of the taxpayer's money and property have already been taken into consideration. An OIC stops forced collection. Be careful to comply with the terms of the OIC and remain in tax compliance going forward, or penalties and interest will spring back.
The IRS will likely request a financial statement when considering an installment plan, and will require a statement for an OIC. In both instances, the IRS applies "national standards" (available at www.irs.gov) to determine what expenses are reasonable. If your living expenses exceed the national standards, the IRS will expect you to change your lifestyle to pay off your tax liability.
Bankruptcy may offer you the ability to re-determine your correct tax liability, even if you have missed all appeal periods and opportunities to resolve the liability with the IRS, or provide a discharge of certain taxes. Be careful, however, not to rush into bankruptcy thinking your tax bill will disappear. Not all tax liabilities are dischargeable. Also, some tax liabilities can become dischargeable with the passage of time, so bankruptcy may be unwarranted.
Other Considerations
There are considerations for a failing business with unpaid business taxes. First, keep in mind owners of sole proprietorships and general partners of a partnership are personally liable for all taxes of their businesses, including income taxes, excise taxes and employment taxes. Additionally, owners and officers responsible for the payment of employment taxes can become personally liable for the unpaid withholding portion of those taxes (the amount of income tax, social security and Medicare/Medicaid withheld from an employee's paycheck). This is known as the Trust Fund Recovery Penalty or responsible officer assessment. Certain unpaid withholdings on excise taxes or sales taxes can also be charged against responsible officers.
Second, the IRS generally has priority over other creditors when a business closes. Payment of other creditors before the IRS could subject you to personal liability for the business's unpaid taxes. Third, you cannot simply shut down the business and restart a nearly identical business to avoid payment of taxes. To avoid having the new company be liable for the old company's tax debts, the new business must pay fair market value for the old business's assets.
If you have not filed tax returns for many years, it may make sense to get caught up on your returns and then propose a collection alternative. The order in which you file your past due returns can make a difference in how the IRS reacts to the filing of your returns.
Conclusion
It is in your best interests to face tax problems before they become too complex or expensive to deal with. There are tools available to resolve your tax liabilities. You can handle many of your options yourself, but in some cases, hiring a tax professional to guide you through various options may be necessary.
Heather Harriman is a partner at Greene & Markley. She concentrates her practice in federal, state and local tax controversies, including tax audits, offers in compromise and tax collection. She can be reached at 503-295-2668 or heather.harriman@greenemarkley.com.
This article appeared in the November 2011 issue of the Coast River Business Journal.
