CHAPTER 5: NASTY THINGS THE IRS LEGALLY CAN DO TO YOU
The IRS has a lot of power when it comes to enforced collection, especially with employment taxes (940 and 941 taxes). There is a lot of reason for that.
The Small Business and Self-Employed division in the IRS consider the enforcement of payroll tax liability to be one of their most important jobs. Every year, this division posts their enforcement priorities list and that list will always include the enforcement of payroll tax collections.
If you have ever looked at the Treasury Daily Statements (you can find on the Treasury’s website), you will discover that payroll tax deposits are funding the daily Government operations.
The single biggest chunk of incoming tax deposits is withheld income and employment taxes. These are federal tax deposits, money from employers. These are the withheld income taxes, social security, and Medicare taxes coming into the government.
Out of the trillions that the government spends on operations, a lot of it is debt funded, but the rest is funded primarily by employment tax deposits.
That is why this is such a huge collection priority. The deposits you were supposed to be making, funds the day-to-day operations of the federal government.
The single biggest emphasis of enforcement within the employment tax arena has to do with taxpayers that pyramid their employment tax liabilities, meaning that they owe money, and continue to accrue new liabilities each quarter. The IRS is also heavily targeting the owners of S-Corporations that do not pay corporate officers a fair wage (and thus payroll taxes), but rather take nothing but distributions (which are not subject to payroll taxes).
If a business accrues more than four quarters of 941 liability, and continues to do so, and is not making current Federal Tax Deposits, then they are quickly bumped to the head of the line regarding assignment to a Revenue Officer.
Now that you understand why it is such a big deal to the IRS, let us talk about the nasty things the IRS legally can do to you and a few strategies to help you protect your interests.
Federal Tax Lien
Once the IRS makes a valid assessment against you, they can take actions; one of which is a tax lien.
A federal tax lien is the government’s legal claim against your property when you neglect or fail to pay a tax debt. As your new favorite (or not so favorite) creditor, the government is trying to protect their interest in all your business property. If you are a sole proprietor, your business assets AND personal assets can be at jeopardy.
Before a lien can exist, the IRS must:
- Assess the liability, and
- Send you a bill that explains the amount you own (Notice and Demand for Payment).
When the IRS decides to file a lien, they will file a public document called, Notice of Federal Tax Lien. This notice will alert creditors that the government has a legal right to your property.
They can attach this lien to all your assets (business property, vehicles and equipment, accounts receivables, etc.) as well as to future assets acquired during the duration of the lien.
*Special Note: If you file for bankruptcy, your tax debt and Notice of Federal Tax Lien may continue after bankruptcy.
Tax Lien Withdrawal Process
First and foremost, a lien withdrawal is not a release of the lien. The withdrawal process can remove the paper lien, the public notice lien, but does not remove the statutory lien within the IRS. While the public notice can be removed, the IRS will still have claim on business assets or property while the liability has not been paid.
Just to clarify…
- The 10916(c) is the withdrawal of the lien. This is the removal of that public record document.
- The 668(Z) is the release of lien. This will not occur until the CSED expires or the liability is paid in full or taken care of.
There are specific conditions on which a tax lien can be withdrawn:
- Premature filing
- Resolved – payment agreement
- To facilitate collection
- “…best interest of the taxpayer and the United States” – Taxpayer Advocate
1. Premature Filing
Situations can occur where a tax lien should get filed, but due to extenuating circumstances within the IRS they can issue a withdrawal.
Some of those situations that might affect businesses include errors with administrative procedures, some bankruptcy situations, or those businesses that have suffered due to a natural disaster declared by the President of the United States.
2. Resolved – Payment Agreement
If a taxpayer and the IRS has reached an installment agreement, then the IRS can offer a withdrawal of the lien. This can be an automatic agreement if the balance due is $25,000 or less with a direct deposit agreement, if the business is no longer operating, or the agreement will full pay in 5 years of by the CSED whichever is earlier.
Again, they do not want to force a lien, it is just mainly being used to help push people into resolution.
*Special Note: in the event of a default of the installment agreement, the lien will be filed again within 30 days.
3. To Facilitate Collection
If the lien is directly correlated with a decrease of income production, and therefore a decrease in collection potential for the IRS, it might be grounds to offer a withdrawal. Liens can hamper businesses to get access to credit to full pay the liability or even operate the business.
4. “Best Interest…”
This is the “catch all” where the best interest of the taxpayer and the United States are taken into condition. These are special cases and are mainly cases that the Taxpayer Advocate are helping with. For this book, we will not be going into this one.
Use Form 12277, the Application for Withdrawal of Filed Form 668(Y), Notice of Federal Tax Lien. Send a copy of the tax lien along with your application (and that should include multiple tax liens if you are pyramiding your tax liabilities each quarter).
The form is straightforward, other than the area where they ask you to explain the basis for the withdrawal. You should use one of the four reasons above and give ample evidence and reasoning behind requesting the withdrawal and the consequences of the lien.
How to File
You can apply directly with the Revenue Officer if they have been assigned. If a RO has not been assigned, file with Advisory Group serving your local area (see pub. 4235). You can also file these in Appeals if you are already at that stage.
Provide supporting documentation to back up your reasoning behind the withdrawal request.
*Special Note: Be sure to request 3rd party notification of the withdrawal of tax lien. Meaning that once the withdrawal occurs, those that have been notified of the public lien will then be notified of the withdrawal. You may need to attach a letter of explaining and authorization of notification to 3rd party.
Tax Lien Subordination
A lien subordination does not release or withdraw the lien. There is no removal of the lien in a subordination process. What a subordination does is that is moves the federal tax lien to a junior position in the claim priority order and allows another creditor to take the senior position.
*Special Note: Under federal law, 180 days after the 668(Y) a federal tax lien will become superior to any other creditor automatically.
Use Form 14134. You need to describe both the collateral in question and the lender that needs to be in the superior position. You cannot submit this application that is general in scope and does not include specific assets and specific lenders.
You need to cite code section you are applying under. These codes are all about when and how much the government will get paid. Here are the relevant code sections:
- 6325(d)1 – IRS gets their share now
- 6325(d)(2) – IRS will get more later
*Special Note: There is a 45-day processing time on this, so be patient and allow the Advisory Group to do finance and accounting steps to review applications and assets.
Tax Lien Discharge
This is a handy tool to discharge a specific asset from being covered under the lien. It is not a removal of the lien, but the removal of a specific asset being covered under tax lien. A tax lien covers all rights to property and assets of the business, so this specifically removes one asset from under the lien umbrella, normally when a taxpayer is selling a business asset or piece of property.
Use Form 14135. Just like a subordination, you need to describe the asset, sale details and what the IRS is getting out of it. You will need to also cite the specific code you are requesting:
- 6325(b)(1) – The remaining assets = 2x the tax debt
- 6325(b)(A) – The IRS receives amount equal to their interest in the asset up front
- 6325(b)(2)(B) – The value of the U.S.’s interest is $0
- 6325(b)(3) – The sale proceeds are escrowed, and the IRS will get their share
- 6325(b)(4) – The 3rd party (buyer) puts up a bond for the value of the governments interest in the asset
Subordinations & Discharges
You will want to file directly with the Advisory Group. Please know that they will typically require an appraisal and you will need to pay for that. Whether or not the IRS allows a subordination or discharge is likely driven by the math of the situation.
Lastly, these situations are not general and are specifically within certain asset types.
Federal Tax Levy
A levy is different than a lien. A lien only secures interest in your property, a levy takes the property to satisfy the tax debt. The IRS can legally levy, seize and sell any type of real or business property that you own or have an interest in. Most often, these types of properties include bank accounts, vehicles and equipment, buildings, stock or interest in another company, etc.
Before an IRS levy process begins to take place, the IRS will send you a Notice and Demand for Payment. This will notify you regarding the tax amount owed, as well as interest and penalties that the IRS has assessed.
If you do not pay the amount assessed, the IRS will then give you a 30-day levy notice, called a “Final Notice of Intent to Levy and Notice of Your Right to a Hearing”. If you do not respond or take any action to resolve the issue, the IRS will move forward with the seizure.
When it comes to getting a levy released, IRC 6343 provides reasons why a business could be granted a levy release, namely if the tax debt is paid in full, if the CSED clock runs out, if levy release will help the IRS facilitate collection, or if the levy is creating an economic hardship for the business or its employees.
Let us go through a few common levy release situations:
The IRS decides to seize a plumber’s work truck due to a major 941 liability. By taking that work truck, however, the IRS has greatly reduced the plumber’s income generating potential (and therefore collection potential). This is a situation where the IRS really should not have even seized the truck in the first place, but they may do so just to get his attention. From there, the plumber has a perfectly good argument for requesting a seizure release because it will reduce the IRS’ collection potential.
Another common situation is if the levy action will make it so that the business cannot pay its’ employees. Will paychecks bounce if the IRS levies a payroll bank account? If so, then each of those employees will not be able to pay their bills and will create 3rd party harm.
The IRS has a mandate from Congress to not put people in a position that they cannot pay their bills. This is a clear-cut area that the business owner will be able to secure a levy release if he/she can prove that it will create 3rd party harm to their employees.
A HVAC business is viable as a going concern, but the IRS chooses to levy against the accounts receivable list. Specifically, the IRS levies against the company’s single largest customer which inherently destroys the relationship. Once that relationship has been destroyed, that customer will look elsewhere and losing that large customer will put the HVAC business out of business immediately resulting in a loss of collection potential for the IRS.
Steps to Get Levy Release
You will need to approach Appeals (see next sections in this chapter) with Form 9423. You also need to complete Form 433-B and be prepared to explain why the levy needs to be released and have supporting documentation.
Trust Fund Recovery Penalty
If you withhold (or don’t withhold when you should have withheld) federal income, social security, or Medicare taxes that you do not deposit or pay to the U.S. Treasury, you may be assessed the Trust Fund Recovery Penalty.
The penalty is 100% of the unpaid trust fund tax. This is in addition to the amount of the taxes that should have been paid from the beginning.
If these unpaid taxes can’t be immediately collected from the employer or business, the penalty may be imposed on all persons who are determined by the IRS to be responsible for collecting, accounting for, or paying over these taxes and who acted willfully in not doing so.
The key here is responsible and willful.
Responsible – This could be an officer of a corporation, a partner or employee of a partnership, an accountant or payroll professional, a specific check signer, or any other person or entity that is responsible for collecting, accounting for, and paying trust fund taxes to the Treasury.
Willful – This means voluntarily, consciously, and intentionally. A person that is willful is someone that knows the required actions of collecting, accounting for, and paying trust fund taxes to the Treasury.
For those responsible and willful persons, the Trust Fund Recovery Penalty will be imposed. If this is imposed upon you, the full weight of the IRS can pierce the corporate veil and touch you personally.
When you owe the Trust Fund Recovery Penalty, the IRS will attempt to collect from you personally and the business at the same time. The IRS can take collection action against your personal assets. For instance, the IRS can file a federal tax lien, tax levy, or take seizure actions.
This does not mean you owe double the taxes. The Trust Fund Recovery Penalty is equal to the Trust Fund Portion owed by the business. If the business pays the Trust Fund Portion, you will get credit towards the Trust Fund Recovery Penalty owed by you. If you pay the Trust Fund Recovery Penalty, the business will get credit towards the Trust Fund Portion owed by the business.
*Special Note: To be clear here, it is exceedingly rare to avoid personal assessment in small companies except in IBTF-E situations discussed in Chapter 9, but even then, its simply deferred. Also, if you are a single member LLC or single shareholder S-Corporation, there is no question about it; you are going to be assessed.
Fair Debt Collection Practices Act
The IRS is subject to the conditions of the Fair Debt Collection Practices Act just like any other debt collector. This act is a federal law that gives consumers crucial protections against predatory practices, such as calling you late at night, harassing you, and pursuing you for a debt you do not owe.
Here are five specific ways the Fair Debt Collection Practices Act protects you, including regarding the IRS.
1. You control communication with debt collectors
You limit when and how debt collectors contact you. They cannot tell third parties about your debt and cannot call at any inconvenient time. This typically means they can’t call before 9 a.m. or after 9 p.m., they can’t contact you at work once you ask them not to, they must communicate through your attorney if you are presented by one, and must cease contact entirely if you request it. You must make the request in writing for it to be enforceable. Keep in mind the debt is not gone just because you asked the collector to stop talking to you. They can still seek payment through a lawsuit.
2. You are protected from harassing or abusive practices
Debt collectors cannot use any harassing or abusive practices to collect the debt. Along with other restrictions, debt collectors cannot use profane language, threaten or use violence, call repeatedly to annoy or harass, call you to collect payment without identifying themselves as debt collectors, or list your debt for sale to the public.
3. Debt collectors must be truthful
Debt collectors cannot use any false, deceptive or misleading representation to collect the debt. They cannot misrepresent the amount of the debt, legal repercussions for not paying the debt, or pretending to be someone else or with another company.
4. Unfair practices are prohibited
Debt collectors are not allowed to solicit postdated checks for payment, deposit or threaten to deposit a postdated check before your intended payment date, take or threaten to take property if it’s not allowed, or collect more than you owe on a debt, which may include fees and interest.
5. Collectors must validate your debt
Lastly, debt collectors must prove that you owe the debt they are attempting to collect. Collectors must send a validation letter within five days of first contact. That letter should contain how much you owe, the name of the creditor seeking payment, and other items.
Working with Appeals
The Appeals division of the IRS are your friend. They are an independent division within the IRS that makes decisions independent from any other group at the IRS. They review tax disputes and will consider both sides, the taxpayer and the IRS to strive for a healthy outcome for both parties.
They strive for impartial judgement and fair application of the tax law.
The best part about filing and Appeal is that most often it stops the clock. In other words, it buys you time to fix the root cause that has been going on and give you a chance to build your case to defend yourself against the IRS.
There are several different types of Appeals, but let us focus on two of the most common throughout the resolution process:
- Collection Due Process Appeals
- Collection Appeals Program
Collection Due Process Appeals
Collection Due Process (CDP) Appeals typically gets offered after you have received a Notice of Intent to Levy or a Notice of Federal Tax Lien Filing. As part of the lien and levy process, they IRS offers an Appeals hearing. At the end of the day, the IRS does not want to put liens or levy assets and business property. Instead, they are taking these aggressive steps to incentivize (a nice way to put it) you to start taking steps to resolve your tax debt.
You need to file a request for a CDP hearing within 30 days of the date you received either of these notices (lien or levy). You can do this by preparing and submitting Form 12153 (Request for a Collection Due Process or Equivalent Hearing). You will need to provide background information and the reasons why you think the IRS should not be pursuing the lien or notice of intent to levy against you.
Send the letter to the address that was used to send your notice of lien or levy.
Once you have successfully requested your hearing, you will have a chance to make your case with an Appeals officer. During the hearing, you can go through your case in-depth, dispute the tax liability, review your transcripts, and even agree to a resolution pathway right then.
Appeals is your friend and you may be able to walk out of this phone call with all periods resolved at once.
*Special Note: Every tax period has the right to only one Collection Due Process Appeal. With 941 cases, that means that each quarter only has one CDP allowance, so make it count!
Collection Appeals Program
The Collection Appeals Program (CAP) is the streamlined, fast track Appeals process. The IRS offers a conference with a General Manager within two business days. Further, the Settlement Officer must review and get to a resolution within five business days.
Normally, this program is used when a levy has been put in place and you need help removing it quickly. The most common situation is a bank account levy which will result in third-party harm when payroll needs to be ran.
The biggest benefit for taking a levy situation to CAP is that doing so comes with a 15-day stay of enforced collection.
The biggest downside for taking a levy situation to CAP is that you cannot challenge the liability amount, nor can you appeal the Trust Fund Recovery Penalty or an OIC rejection.
Other common situations for going through the Collection Appeals Program is when the collection of tax liability will jeopardize or disrupt business operations. If having the levy in place ruins cash flow and devastates the business, then you should fast track the case through this program. Like I have mentioned before, the IRS will not be able to collect as much if the business is forced into bankruptcy by their collection actions.