Resolving federal tax liabilities.

• Author: Leibowicz, Barry

Federal income tax debts can arise from a tax self-assessed on a tax return, an IRS audit adjustment, or even a substitute for return, which the IRS normally prepares when a taxpayer fails to file a return. (1) The assessment can be for one's personal activities, activities stemming from a corporation or limited liability company for which one is a responsible party, or simply from personal liability as in the case of a partner in a partnership.

Depending on the nature of the assessment, a taxpayer may be aware the assessment is coming long before he or she receives a bill or may be shocked to first learn of a liability upon receipt of an unexpected bill and demand for payment. Often the first notice a taxpayer's representative has of a taxpayer's liability is having to respond to a letter threatening to institute an enforced collection measure requiring immediate action to forestall damage that may be irreparable. This article provides an understanding of the various tools and procedures that can be used to resolve a taxpayer's liabilities in the least costly or disruptive way possible.

Initial contact: Collection hold

A taxpayer's representative's first contact with the IRS in attempting to resolve a client's federal tax debt should be to request a collection hold while the representative determines the nature and scope of the liability. The IRS will typically grant one, especially if it is a first-time request and the representative has just been retained.

If a collection hold is denied and collection activity is likely to cause harm to the taxpayer, immediately file a Form 911, Request for Taxpayer Advocate Service Assistance. The IRS will typically not levy against the taxpayer until the Form 911 has been resolved.

A notice of a proposed levy, a notice of levy, or a Notice of Federal Tax Lien will be accompanied by a notice of a right to a Collection Due Process (CDP) (2) hearing. As discussed more fully below, a CDP hearing request must be made within 30 days of the date on the notice or the right to the hearing and possible judicial review will be lost. A CDP hearing should be requested to preserve the taxpayer's rights, regardless of any assumptions that negotiation will resolve the matter.

Once the lines of communication with the IRS are open and a collection hold is in place, the next step is to determine if the liability is correct and legally subject to collection. A Freedom of Information Act (FOIA) request (3) is used to obtain the taxpayer's file for the years and taxes at issue, along with a request for transcripts using Form 4506-T, Request for Transcript of Tax Return, to determine the chronology of assessment actions. Upon receiving the information, the representative should review the file and transcript to determine the nature of the liability, the manner in which it arose, the procedures by which it was assessed, and the accuracy of the calculation that underlies the bill. If any of the liability arises from trust fund taxes, such as withholding from payroll, the representative should carefully determine if payments were properly applied between trust fund and non-trust fund liabilities.

Although married taxpayers filing a joint return are usually jointly and severally liable for the taxes due on that return, "innocent spouse relief" (4) may be available to the client. Innocent spouse relief is requested by filing Form 8857, Request for Innocent Spouse Relief, or a similar statement. Innocent spouse relief under Sec. 6015(b) or separate liability relief under Sec. 6015(c) must be requested no later than two years after the IRS has begun collection activities. Sec. 6015(f) equitable relief must be requested within the 10-year limitation period on collection in Sec. 6502 or within the period of limitation on credits or refunds under Sec. 6511. (5)

Is the collection of the debt time-barred by the statute of limitation?

In general, the statute of limitation on the IRS's authority to collect a tax liability is 10 years from the tax assessment. (6) However, numerous circumstances can "toll" or suspend the collection statute of limitation, including taxpayers' making requests for installment agreements, offers in compromise (OICs), Taxpayer Advocate Service assistance, or CDP hearings, to name a few. Given that there are a variety of potential circumstances that can suspend the collection statute of limitation, it is critical to review a taxpayer's transcripts to determine the collection statute expiration date (CSED).The CSED is the IRS's internal system for tracking the statute of limitation on a tax liability; each tax assessment has a CSED associated with it. (7)

If the IRS has filed a federal tax lien to collect a liability, it is generally valid until the taxpayer's liability is satisfied or until the time for enforcing the lien expires. (8) The IRS's time to collect upon the lien may be extended in a variety of circumstances, including: (1) a taxpayer's waiver in the case of an OIC; (9) (2) until six months after a bankruptcy stay under Sec. 6503(h); or (3) if a taxpayer is continuously outside the United States for at least six months. (10)

In some circumstances, the IRS can mitigate the effect of the expiration of the collection statute by requesting that the Department of Justice bring an action to reduce the federal liability to a money judgment before the CSED. Once reduced to judgment, the tax liability reflected in the judgment can be collected until it is satisfied or becomes unenforceable, as in bankruptcy. (11) The judgment can also be incorporated into a judgment lien, which is good for an additional 20 years and is subject to renewal for an additional 20 years upon its initial expiration. (12)

Options available to resolve federal tax liabilities

If the tax liability is correct, and the statute of limitation on collection action is still open, numerous options are available to discharge the liability. These include entering into an installment agreement with the IRS, making an OIC for the liability, or having the account put into "uncollectible" status if the taxpayer cannot pay the liability.

The IRS uses an objective approach to determine a taxpayer's ability to pay. The starting point for that determination is the information the taxpayer submits on Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, for individual taxpayers, including the self-employed, or on a Form 433-B, Collection Information Statement for Businesses, for business entities. These documents are signed under penalty of perjury, and a false statement on the form can result in criminal prosecution. For example, in a recent case, a taxpayer was indicted under Sec. 7206(1) for submitting a false Form 433-A, stating that he had not transferred any assets for less than full value in the last 10 years; however, he had transferred stock to his sons and to one of his affiliated companies for less than fair market value (FMV). (13) Every participant who is knowingly involved in filing a false statement is liable for that falsehood.

Taxpayers often overstate the value of assets on the Forms 433, due to either lack of attention or lack of understanding; they can also simply be overly optimistic or fail to use forced sale value. Quick sale value is generally 20%-25% lower than the regular market value and can therefore wipe out a significant amount of home equity. (14)

The Forms 433-A also ask a taxpayer to identify living expenses, as well as the taxes due on income. As part of the living expense analysis, the IRS has standard amounts that are allowed for housing costs and food. Taxpayers can claim these amounts without providing further proof. Higher costs must be documented along with justification for them. For example, while private school tuition is typically not allowed as an expense, tuition for private schooling required by a child's medical or emotional problem may be.

The IRS will calculate reasonable collection...