Do you have clients, even friends and family, who may be facing serious financial difficulties and may be unable to pay previous or upcoming tax obligations? Do you have any unpaid tax liabilities?
Given that it’s tax season, filing is on the mind of many, and, if tax liabilities can’t be paid, an extra level of emotional and financial burden is added.
First, and most importantly, do not ignore the obligation to timely file annual tax returns and do not let inability to pay the tax liability in full keep you from timely filing or timely extending your tax return. Failure to timely file, with or without full payment of tax, could add significant penalties. For those who are unable to timely pay their tax obligations, options exist.
The Internal Revenue Service’s Fresh Start program expanded payment options last year and these options now make either (1) the installment agreement or (2) an offer in compromise (OIC) a more attractive and feasible strategy, even if those who owe money to the IRS previously failed to qualify. The refreshing feature is that the program has been tested and is really working. We have successfully represented numerous taxpayers, including lawyers, before the IRS under the old and newly expanded program, and can attest that the IRS has finally gotten it right.
A few highlights of the Fresh Start program include:
• Eases installment agreement requirements for taxpayers owing $50,000 or less.
• Eases installment agreement requirements for taxpayers owing payroll taxes of $25,000 or less.
• Extends the period of time over which a taxpayer may pay any balance due under an installment agreement thereby making payments more affordable.
• Creates a more flexible OIC program by expanding the collection financial standards and types of allowable living expenses.
• Revises the required calculation of a taxpayer’s future income.
The Fresh Start provisions provide more taxpayers with the opportunity to utilize installment agreements. An installment agreement permits qualified taxpayers with outstanding and unpaid tax liabilities to repay the amount owed via monthly payments over a period of time. In order to qualify for an installment agreement, a taxpayer must have (1) filed all required tax returns and (2) be up-to-date on current year tax obligations.
One of the program provisions is the expansion of the streamlined installment agreement. The limit of outstanding tax liability that would qualify a taxpayer for a streamlined installment agreement has been raised from $25,000 to $50,000. A streamlined installment agreement is termed "streamlined" due to the fact that a financial statement disclosure to the IRS is not required. Taxpayers who qualify for the streamlined agreements are individuals and defunct businesses with any type of outstanding tax liability, as well as operating businesses with income tax liabilities only. The financial statement disclosure requirement has posed an obstacle to installment agreement relief for these taxpayers because of the cost and/or time restraints involved. Additionally, a financial statement could potentially provide the IRS with a financial road map for seizure and enforced collection action in the event the installment agreement is not granted and/or the taxpayer defaults.
Further, the Fresh Start provisions have extended the time in which taxpayers must pay the balance due under an installment agreement from 60 months to 72 months. This one-year extension of time will allow for lower monthly payments and may render the installment agreement a more feasible option for more taxpayers with outstanding tax liabilities.
For operating businesses that owe payroll taxes, another area significantly impacted by the program is the In-Business Trust Fund Express Installment Agreement. This is a streamlined installment agreement for businesses that have delinquent payroll tax liabilities. Payroll taxes are considered trust fund taxes and collection of delinquencies are aggressively pursued by the IRS. In order to qualify, a business owing payroll taxes must satisfy the following requirements:
• Business must owe $25,000 or less at the time the agreement is established. If more than $25,000 is owed, the taxpayer may pay down the liability before entering into the agreement in order to qualify.
• The debt must be paid in full within 24 months or prior to the collection statute expiration date, whichever is earlier.
• The taxpayer must enroll in a direct debit installment agreement if the amount owed is between $10,000 and $25,000.
• The taxpayer must be compliant with all filing and payment requirements.
A distinct advantage of applying for an In-Business Trust Fund Express Installment Agreement is that a business is generally not required to provide a financial statement as part of the application process. In addition, the Internal Revenue Manual, which is the official compendium of IRS guidelines and policies, notes that a trust fund recovery penalty determination (payroll taxes are considered trust funds, and penalties for nonremittance are typically significant) is not required against an individual in a business that is attempting to establish such an installment payment plan. If any of your business clients are behind in payroll taxes, this customized installment agreement should be considered.
Offers in Compromise
The OIC program permits qualified taxpayers with outstanding and unpaid tax liabilities to negotiate a full settlement for an amount that is less than the tax owed. An OIC agreement generally will not be accepted by the IRS if it believes that the outstanding liability can be paid through a lump sum or other type of payment arrangement, so carefully evaluate your client’s ability to pay based on the service’s criteria before attempting to enter the program as the IRS will evaluate the taxpayers’ income, expenses, assets and liabilities in great detail to make a determination regarding the taxpayers’ ability to pay.
In an effort to expand this program to a greater number of struggling taxpayers, the IRS has become more flexible in what it deems "ordinary and necessary" expenses in arriving at a taxpayer’s net monthly income. Specifically, under the Fresh Start program, the IRS has expanded the "allowable living expense" category to include additional expenses, such as credit card payments and bank fees, while increasing the total amount allowable. The program also allows expenses for the repayment of student loans and delinquent state and local taxes.
The most significant change to the OIC program under the Fresh Start initiative is the change in the calculation of the taxpayer’s "reasonable collection potential" under the future income component. The reasonable collection potential is determined by analyzing the taxpayer’s net realizable equity in assets and future income. The IRS now considers only one year of future income for offers that will be paid in full within five months when previously they considered four years of income. The IRS will now consider two years of future income for offers paid in full within six to 24 months, down from five years of income. For taxpayers whose reasonable collection potential is driven by future income and less by net realizable equity in assets, this change is likely to have a meaningful impact in the determination of whether they qualify for an OIC.
The overall result of these changes and improvements is that increasingly more financially troubled taxpayers will qualify for OIC relief.
Apart from these favorable changes, there may still be negative implications of filing an OIC, and entry into the program should be approached cautiously. One potentially negative repercussion, and perhaps the most noteworthy, is that information provided through the OIC provides the IRS with a financial road map for seizure and enforced collection action in the event the offer is rejected or withdrawn or the taxpayer defaults on the offer. Additionally, submission of an OIC will automatically extend the statute of limitations for collection during the pendency of the offer, plus 30 days, which will give the IRS more time to try to collect the full balance owed.
Taxpayers who are experiencing financial hardship and who are unable to pay their current tax obligations may wish to consult with a qualified tax professional to achieve a "fresh start" to potentially avoid or minimize interest and penalty assessments, as well as IRS collection, enforcement and seizure activity. •
Mary Beth Lee is a senior manager in the tax accounting group of Duane Morris, where she devotes her practice to federal, state and local income taxation and civil and criminal tax representation as well as litigation consulting services, including damage measurement, fraud and embezzlement detection, forensic and investigative accounting, and marital dissolution. She can be reached at 215-979-1644 or email@example.com.
Steven M. Packer is a manager in the tax accounting group of the firm, where he devotes his practice to federal, state and local income taxation, financial reporting, including generally accepted accounting principles analysis and consultation as well as fraud and embezzlement detection and forensic and investigative accounting. He can be reached at 215-979-1697 or firstname.lastname@example.org.