Resolving tax debt, no matter the size, should be a top priority. Aside from gangland loan sharks, there’s no one worse to owe money to than the government. Penalties and interest on tax debt are incredibly high. And, if you don’t make an effort to resolve the liability, the governement can eventually levy your bank accounts, garnish your wages or seize property.
I’m an Enrolled Agent and specialize in tax relief for businesses, individuals and families. Here I present 5 steps to identifying and resolving tax debt, advice on when to enlist professional help and who to approach when you do.
Disclaimer: The opinions and statements herein are solely my own and do not represent the opinions of any firm that employs me, or of the Internal Revenue Service. Resolving a tax debt can be complicated and involves a significant investment of time, meticulous record keeping and knowledge of the tax code. Please do not undertake complex debt resolutions without these resources.
The 5 Steps to Resolving Tax Debt
Identify your Liability and the Collection Stage
Do you have personal debt, business debt or both? Identifying the type of debt you have and how it will be treated is a crucial step. Personal tax debt is either repaid voluntarily, or taken forcefully through bank account levies or wage garnishments. You’ll receive plenty of written warnings and opportunities to resolve tax debt before they levy/garnish in most cases.
If you’re a sole proprietor and file Schedule C for your business taxes, your debt is personal. As a sole proprietor there is no distinction between you and your business. You can freely combine personal and business funds and use business profits to pay for personal expenses. But, if your sole proprietorship owes money, so do you and the IRS can levy your personal accounts to get it.
If your business is an LLC, Partnership or Corporation, it’s considered a separate entity from the owners. This doesn’t mean that an owner’s personal accounts are entirely sheltered however. The IRS can still go after these accounts if certain taxes are owed (i.e. Employee Withholding Taxes). The best way to get a clear picture of your tax situation is by contacting the IRS or state taxing authority and requesting a review. Notate your liabilities, missing returns and and whether you are open to levy action. Generally, all tax returns must be filed prior to resolving tax debt through a payment plan.
It’s important to know where you are in the collection process. You can determine the stage of collection by reviewing the most recent notice you received. Call the IRS (or state) and ask them if you have received a “final notice of intent to levy.” If you didn’t receive a final notice, your accounts are usually still safe from levy action. But if you did receive a final notice, find out if 30 days have passed (or if you’re dealing with the state, when they can levy your accounts). If so, ask for some time to review your finances and determine a payment amount. Otherwise, find out how many days have passed since the issuance of the final notice and move on the step 2.
Evaluate your Ability to Repay a Debt
The taxing authorities sometimes talk a big game but you should only have to repay an amount that is affordable to you. In order to have the upper hand in negotiations you need to have an excellent understanding of your finances. The easiest way to do this is by completing Form 433A if you’re an individual, and Form 433B for a business. States sometimes require their own forms but these will give you a great starting point.
Pay special attention to Section 5, Income and Expenses. Take an average of your gross monthly income and reduce it by all of your ordinary expenses, including taxes and benefits removed from your paycheck. Whatever money is left over will considered available for your monthly payment plan, so be sure to include every necessary living expense you can think of. Be smart about your expenses, the government doesn’t want to see excessive spending on luxuries or entertainment when you owe them money.
If you have very few assets and are struggling to pay your monthly living expenses you may be a good candidate for an Offer in Compromise. This program allows one to resolve tax debt for less than the total owed and is based on a calculation of total net worth.
Preparing a Proposal
Now you know what you owe, the status of your case and what you can afford to repay. If your debt is relatively low you may be able to simply call and propose your payment amount over the phone. If you have a significant debt, you’ll want to prepare a written proposal. State your name, address and I.D. number (SSN or EIN) at the top left hand side of the page. In a few paragraphs, state that you have filed all tax returns and corrected the issue that caused your original liability. Propose your payment amount and how you derived it. Lastly, attach the financial form you previously completed along with 3 months of your financial records (bank statements, income statements etc.) which support the figures on your financial form. Once your proposal is received by the IRS, your account will be under review and generally safe from collection actions until a determination is made.
If the taxing authorities accept your proposal, congratulations! You can skip this step but make sure that the amount you’re paying covers the interest and penalties that continue to accrue. You may need to adjust your budgets further and make additional voluntary payments.
If the IRS or state does not accept your plan, you must review their reasoning carefully. When there are issues that are hindering the agreement, for instance your business is not paying employee withholding taxes on a timely basis, fix them immediately. Notify the IRS that you resolved the issue and provide proof. If you disagree with their findings you will likely have appeal rights so read your mail closely.
Monitoring and Avoidance of Future Debt.
Once you are in an agreement, automate it if possible. Missed payments can default your resolution and cause a major headache. Monitor your account by calling in for monthly reports of your tax liabilities. You can order Account Transcripts for each tax year to be mailed to your house. These transcripts will show all penalties and interest applied to your account, as well as any payments you’ve made and other important information. If the debt isn’t decreasing over time you must increase your payments whenever possible.
You may also be able to reduce or remove penalties, once you’re in a payment plan. If the mistake was unavoidable or the result of a hardship, you may be able to reduce or remove penalties with a written proposal. Make sure you review the accepted rationale and forms for penalty abatement on the IRS or state website. You can also request a First Time Abatement with the IRS. If you have been timely with your taxes for at least three years, a first time abatement will remove all penalties from the preceding year. So for instance, if you had tax debt from 2013 but had filed and paid 2014-2016, you can request an abatement for 2013 to reduce your debt.
When Resolving Tax Debt is Beyond Your Ability
The above is a rough outline of the tax debt resolution process. It can be incredibly complicated and time consuming. If you have a significant debt and don’t have hours to spend on the phone or complete accurate financial statements, you will want representation.
Even simple tax cases can snowball and become significant problems. Many people are happier having a professional take on that stress. Resolving tax debt adequately can be achieved by most people, with enough time and effort. However, you’re far less likely to get the best results possible when you’re handling it alone. The tax code is just too complex and even most accountants have no experience with IRS collections. If you need help, make sure you get good help. Only Enrolled Agents, attorneys and CPAs can represent clients before all levels of the IRS. Licensed professionals specializing in tax resolutions are going to be your best option.
If you need some professional advice, help resolving tax debt, or just want to be pointed in the right direction, please don’t hesitate to contact me.