Tax Liability Options

Some things in life are overwhelming.  A large income tax liability can be one of those things.  How can you deal with the IRS lurking over your shoulder?  Seid & Company uses a 10-step approach to analyze the best option for resolving a tax liability.  It’s methodical – and even alphabetical!

A.  AMEND/ABATE.  Income tax liabilities that are created from a mistake made on a tax return can be resolved by amending the incorrect tax return.  An amended income tax return can be filed within the first three years after filing the original income tax return.  So if there was a mistake made we can fix it!  If the liability is the result of penalties the option may be to request an abatement.  Penalties can be abated at any time prior to collection or within two years after they have been paid.

B.  BANKRUPTCY.  Yes, income taxes can be discharged in bankruptcy.  There are three requirements for income taxes to be discharged.  First, the income taxes must be from a tax return that was originally due at least three years before the bankruptcy petition is filed.  Second, the tax return must have been filed at least two years before the bankruptcy petition is filed.  Third, any income tax assessment must have been made at least 240 days before the bankruptcy petition is filed.

C.  COMPROMISE.  The IRS offer in compromise program is alive and well!  There are two primary reasons that the IRS will compromise a tax liability.  First, a compromise can be made if the taxpayer can show that there is a doubt that the IRS will ever be able to collect the balance owed.  Second, a compromise can be made if the taxpayer can show that there is a doubt that the tax liability actually exists.  The offer in compromise  program went through some dramatic changes last year making it more attractive and available to a wider range of individuals.  This may be the time to try an offer, even if one was denied in the past.

D.  DO NOT PAY.  The IRS will suspend all collection activity if a taxpayer does not have the current ability to pay any amount toward their outstanding liability.  The IRS calls this status “currently not collectible” and will allow a taxpayer to not make any payments as long as they are unable to do so under current guidelines.  If the taxpayer’s financial condition improves then the IRS will expect some money and collection activity may resume.

E.  EXPIRED STATUTE OF LIMITATIONS.  The IRS has only 10 years to collect a tax liability after it has been assessed.  If they have not been able to collect in the 10-year time frame the tax is written off the books.  There are several actions that extend the 10-year statute of limitations such as bankruptcy, filing an offer in compromise or a collection due process request.

F.  FULL PAY.  If a taxpayer can fully pay a tax liability the IRS will demand payment.  Let’s face it, the last creditor you really want hounding you is the federal government.  If you can pay the tax in full, pay it.

G.  GUARANTEEED INSTALLMENT AGREEMENTS.  Taxpayers have a statutory right to an installment agreement.  To qualify for the guaranteed installment agreement the tax must be $10,000 or less (excluding penalties & interest); the taxpayer must have timely filed and paid their income tax liabilities for each of the last five years and they can not have entered into an installment agreement under this provision in the last five years; the installment agreement will pay the liability in full within three years; the taxpayer must agree to timely file and pay any taxes while the agreement is in effect; and finally, the taxpayer must submit financial statements at the IRS request.  While the statutory provisions above are the requirements, the IRS has policies in place that are much more liberal in both the amount of taxes they will consider and the length of time they will allow a taxpayer to extend their payments.

H.  HARDSHIP.  One additional basis on which the IRS will consider an offer in compromise is a hardship, referred to as “effective tax administration.”  This type of offer in compromise is available for taxpayers who can pay their liability in full, but doing so would cause an economic hardship or be unfair and inequitable.  Very few of these type of offers are viable – but it is certainly an option.

I.  INNOCENT SPOUSE vs INJURED SPOUSE.  An innocent spouse can escape liability if they can show that an understatement of tax liability from a joint income tax return is attributable to their spouse.  The innocent spouse could not have known about the understatement when they signed the joint tax return and taking all facts and circumstances into consideration, it would be inequitable to hold the innocent spouse liable for the deficiency.  An injured spouse is one whose tax refund has been taken for a liability owed by their spouse from a separate liability.

J.  JUST IGNORE IT AND HOPE IT GOES AWAY.  This is not an option that we recommend.  Frequently when individual choose this option, we have a new client!  However, in some cases it may actually be the best option.  If the statute of limitations on a tax liability is about to expire, using an option like an offer in compromise could keep that statute open and the ability of the IRS to collect will continue.