IRS Collection Action
Generally, taxpayers end up owing money to the IRS when they lose an audit, or when they self-report owing taxes on a return. In either case, once that tax is assessed, a balance due notice is mailed to the taxpayers. This notice will give the taxpayers 21 days to pay the balance, without the additional accrual of interest or penalties. This notice usually is identified as a CP 14 notice.
The Federal Tax Lien
The IRS has exactly three legal requirements to satisfy prior to the creation of a federal tax lien (FTL) on all the delinquent taxpayers’ property.
- Formally assess the tax
- Issue first notice and demand for payment of the tax (the CP 14 suffices)
- The tax goes unpaid
At the instant the taxpayers refuse or neglect to fully pay the tax assessment (including interest and penalties associated with that assessment), a lien in favor of the IRS arises on all the property and rights to property (including property acquired in the future) of the taxpayers. All property, of course, includes assets and income of all types, including houses, salaries, and pension assets such as IRAs and 401(k) accounts.
The Notice of Federal Tax Lien
Generally, taxpayers are unaware that the tax lien has come into being, and there is no public record of it. Also, the IRS will not divulge the fact that any particular taxpayer owes back taxes to anyone outside of the taxpayers themselves or their attorney.
However, that all changes when the IRS files a Notice of Federal Tax Lien (NFTL). As with secured transaction law (UCC-9) or even mortgages, the IRS records a document, usually in the county where the taxpayers reside, at the county clerk’s office. The purpose of this notice is to establish the IRS’ rights against other creditors of the taxpayers in the taxpayers’ property. For example, if the taxpayers own a house, most likely they have a mortgage on that house. The IRS files its notice of lien, thereby securing a second position on that house. This warns a potential lender that if they chose to grant the taxpayers a second mortgage, that lender will be in third position in relation to that house.
The Final Notice of Intent to Levy
Strange as this may sound, the IRS generally will issue two final notices of intent to levy. One is generally a bluff and limited in its ability to cause the seizure, of property. The other is the real deal and allows the IRS to seize virtually all of the taxpayers assets, outside a very limited amount of exempt property. Both notices will come via certified mail to the taxpayers’ last known address. The bluff notice is identified as a notice CP 504, while the real deal notice is identified in several ways. Sometimes it is identified as a notice CP 297A, sometimes as an IRC 6330 notice or sometimes as a Collection Due Process Appeal (CDP) notice.
The CP 504
This notice is intimidating and will state in bold letters, in much larger type face than the rest of the wording on the notice:
Intent to seize your property or rights to property
Amount due immediately $$$$$$
However, careful reading of the small print of the notice states that the IRS “may seize (levy) any state tax refund to which you are entitled.” Also, the notice states that if after the IRS seizes your state tax refund, if they have not already done so, they may send the taxpayers a notice to allow for a right to a hearing before the IRS Office of Appeals. Finally, this notice warns that the IRS may file a NFTL if they have not already done so.
The CDP Notice
The CDP Notice has much of the same language as the CP 504. However, it will state that the taxpayers have a right to a hearing before the IRS Office of Appeals. It is extremely crucial that this notice be responded to timely. This is a thirty day notice and once thirty days have passed, the IRS will be free to seize any assets or income, again outside a very limited amount of exemptions.
However, it is crucial that an attorney be consulted at this point. There are negative ramifications related to filing a timely CDP appeal. Certain statutes of limitations are impacted. Although it is counterintuitive, under some conditions, filing a CDP appeal may be the wrong choice.
The Notice of Levy
The IRS usually issues three types of Levy.
Form 668-A – is a “one time” levy. These are usually issued to banks. The moment the bank is served with this levy, any money in the taxpayers’ account is frozen for 21 days. The taxpayers have that long to convince the IRS to release the levy. If they fail, the bank will send the contents of the account to the IRS and the money is applied to the taxpayer’s delinquent tax.
Form 668-W – is a continuous levy. These are usually issued to employers. Once received, the employer has the taxpayer fill out an exemption statement, indicating how many tax exemptions they are entitled to and their filing status. For example, married three. Then a portion, which is usually quite significant in amount, of the taxpayers’ wages is sent to the IRS every payday, until the IRS releases the levy.
Form 668-B – is used when the IRS seizes property. The IRS uses this form when they are going to take property from a taxpayer and sell it at auction. Generally, cars are a favorite target.
The Law Suit
The IRS is an administrative agency of the United States government. Generally, that means that the IRS “administers” the federal tax laws as passed by Congress and the President. The IRS has broad administrative powers to propose tax regulations and enforce the provisions of the federal tax code (the Internal Revenue Code), without seeking permission from the courts. Actions such as filing the NFTL and seizing property via levy are done completely at the discretion of IRS personal, without judicial oversight or recourse.
However, sometimes the IRS sues taxpayers in federal courts. Also, under some very narrow circumstances, taxpayers may sue the IRS in federal courts.
Some of the IRS’ more popular suits against taxpayers are:
- The suit to foreclose the federal tax lien.
- The suit to reduce the federal tax lien to judgment.
- The suit to set aside a fraudulent conveyance.
- The suit to impose an injunction against the taxpayer.
All of these are very serious and an attorney should be consulted if a taxpayer is faced with any of these actions.
Solutions to collection cases
Generally, there are four solutions available to an IRS collection case.
Installment agreement (IA) – In some very limited cases, the IRS is required to enter into a monthly installment agreement with the taxpayers. In cases where they are not required to do so, the IRS requires detailed financial disclosure (see IRS Form 433-F, 433-A). The taxpayers’ verified income is reduced by a standard list of acceptable “necessary” expenses, determined by the IRS. This results in an amount the IRS will accept as a regular monthly payment. For example, gross income of $4,000 a month, reduced by necessary expenses of $3,500 a month, yields a $500 a month payment to the IRS. This solution is the easiest to accomplish, but most costly to the taxpayers. The IRS standard expense list is not generous, and interest and penalties will continue to accrue through the term of the agreement. Many times a taxpayer will pay double the original amount owed if this solution is utilized.
Currently not Collectable (CNC) – the same financial disclosure is required and the same income and expense analysis is conducted. However, if the taxpayers can verify that they have no ability to make a monthly payment what-so-ever, then the IRS may place the taxpayers’ collection case in a CNC status. This simply means that the IRS will not pursue the taxpayers for payment until they are removed from CNC status. Generally, taxpayers in CNC status will be monitored to see if their income rises. For example, the collection case is closed CNC $24,000. If the taxpayers file a subsequent tax return (or they fail to file a return at all), showing income in excess of $24,000, the case is placed back in collection status.
Offer-in-Compromise (the settlement) – the IRS will settle for less than the full amount due through their OIC program. The process follows the same detailed financial disclosure requirements as the IA and CNC process. Using a formula of X+Y = OIC the offer amount is determined. If the IRS accepts the offer, the taxpayers are relieved of any remaining balance due, with a few strings attached. In the formula X equals approximately 80% of the taxpayers’ net equity in assets and Y equals the taxpayers’ monthly surplus income times a multiplier (usually 48).
For example, if the taxpayer’s only asset is a truck with a fair market value of $10,000, X = $8,000. If the taxpayers’ surplus monthly income is $100 a month, Y = $4,800. Thus, the OIC amount should be $12,800 regardless of the amount owed in excess of $12,800.
CAUTION: There are many “tax resolution firms” that promise to settle your case for pennies on the dollar. It is extremely unlikely that the IRS will accept an OIC that deviates from the above-cited formula. If the value of your assets exceeds your tax liability, an OIC most likely will not be accepted. The IRS requires a filing fee in most cases and a significant up front payment, usually twenty percent of the offer amount to consider the offer. Both payments are non-refundable.
Bankruptcy (BK) – many times a taxpayer can discharge income tax debts in bankruptcy or pay the tax (and penalties and interest) at a reduced rate. In some cases, it is a significantly reduced rate. There are different types of bankruptcy, such as a chapter 7 or chapter 13, and each type has different rules and processes to deal with tax debts. Dealing with tax debts in a bankruptcy case is extraordinarily complex. Therefore, only a qualified attorney with both tax and bankruptcy experience should be consulted.