Helping Delinquent Taxpayers
It’s April 14, 2017. I find myself sitting across the conference room table from a long-time client. John has owned a landscaping business for 15 years. I have just told him that he owes over $10,000 in income taxes. John looks up at me, his face white, eyes brimming with tears. He slowly says, “Kris, I don’t have that kind of money. I don’t even have enough money for next week’s payroll. What am I going to do? Do I need to layoff all my guys? Am I going to lose my house? I have never owed money before. What am I going to do?”
It’s no surprise that in these tough economic times, we are dealing with more taxpayers who have fallen behind on their tax payments. These first-time delinquent taxpayers not only have a balance due with last year’s returns, but they are also falling behind on their current estimated tax payments. With little or no cash available, the tax liabilities are piling up, and taxpayers just don’t know what to do. That’s where we come in. As tax professionals it’s our responsibility to give our clients all the information they need in order to best deal with their situation.
This article touches on the basics of various options that are available to taxpayers. Because each situation is different, the pros and cons of each option must be carefully discussed so a decision can be reached that best meets the taxpayer’s needs. What taxpayers need to understand is that they should not panic, they should not wait, and they should not ignore communications from the taxing agency involved.
The first and most obvious option is to pay the balance in full. However, it’s the lack of available cash that has put the taxpayer in this predicament in the first place. In this economy, business owners are spending any available cash on operating expenses just to keep their doors open. Individual taxpayers are spending their income on housing, gas, food, and utilities. Many taxpayers may be facing unemployment. Many more are forced to withdraw cash from their retirement funds just to get by. Most of these taxpayers didn’t get to this point by choice. The situation was forced upon them by factors beyond their control. Therefore, to suggest that they gather up their dollars and pay the balance in full becomes a ridiculous option.
A more appropriate option available is requesting an installment agreement. The IRS, as well as most states, will consider an installment agreement. If the amount due is less than $10,000 and other conditions are met, the IRS will automatically accept the agreement. However, it’s important to note that penalties and interest will still accrue. Therefore, installment agreements should be created with the shortest term possible. During the installment period, the tax agency will most likely confiscate any other tax overpayments from other periods and apply them to the outstanding balance. Taxpayers must make sure that the monthly amount they agree to pay is appropriate and they can pay it every month, on time. If the taxpayer becomes delinquent on his monthly payments, the taxing agency can easily void the agreement and the taxpayer is back at square one.
Perhaps a short-term private loan would work for some taxpayers. This option includes a possible home equity loan, a short-term unsecured loan, or even a short-term cash advance from a credit card. In these cases, the taxpayer needs to be aware of any hidden fees, such as the closing costs associated with a home equity loan, or the “cash advance” fee associated with accessing cash via a credit card. Either way, interest will be charged. The taxpayer should weigh the interest charged by the taxing agency versus the interest charged by a bank. This option does eliminate any additional penalties the IRS and/or state may impose and it frees up any other tax overpayments.
Amnesty programs are also another option for taxpayers, although these tend to be more beneficial to taxpayers who have failed to file tax returns in the past. Often times, to qualify for these programs, the taxpayer must not be on the tax agency’s “radar screen.” This means, of course, that they haven’t received any failure to file notices. Amnesty programs will often forgive some or all of the penalties and/or interest, but may require that the original tax liability be paid in full at the time the taxpayer requests amnesty. These programs are offered sporadically and their requirements vary from state to state.
Another, more drastic option is an offer in compromise. I liken this to filing for bankruptcy. It’s a last-ditch effort with the IRS and many state tax agencies. The process is very time-consuming and invasive. I would not recommend that a taxpayer represent themselves during the offer process. The client needs to be aware that there are often filing fees associated with submitting an offer in compromise, and there are no guarantees. With an offer in compromise, the tax agency analyzes the taxpayer’s assets and liabilities, current and future income, and current monthly expenses. There are heavy documentation requirements. A taxpayer will need to prove monthly items of income and expense with copies of bank statements, bills, and invoices. The fair market value of assets such as real estate, personal property, and investments needs to be determined. The tax agency takes all this information into account and calculates an amount for which they are willing to settle the debt and what payment arrangements they are willing to accept.
During this process, there is a great deal of dialogue between the tax agency and the tax professional or taxpayer. Negotiating appropriate fair market values, cost of living expenses, and payment plan options are among some of the conversations that will take place. If the tax professional is not satisfied with the outcome, an appeal can be filed. From my professional experience, I have never been satisfied with the first figure that a tax agency has presented, and have always appealed the decision. Once an offer is accepted, the taxpayer needs to keep his tax account in good standing (filing tax returns and paying taxes on time) for a certain period of time or the offer can be rescinded, and again, he’ll be back to square one. Often times a lien may be placed against the taxpayer and become part of his credit report and public record. However, under the right circumstances, the tax agencies have accepted pennies on the dollar. For a taxpayer who is truly in a tough spot, an offer in compromise can be not only a blessing, but the only viable option available.
I do need to warn tax professionals and taxpayers concerning some television and/or internet advertisements for these services. Taxpayers should perform their own due diligence and make sure that the professional they are hiring to represent themselves during the offer process is truly qualified to perform such services (such as a CPA, or EA). Even if someone is a licensed CPA or EA, that doesn’t mean they have the proper experience. Check to make sure that they have direct experience with the offer process. I’ve seen wonderfully qualified EAs who can prepare any 1040 placed in front of them, but that does not mean they have the technical background to prepare returns for a multi-state S corporation that reports in all 50 states. If you don’t deal with offers in compromise, be wary of referring your clients to anyone who promises they are able to settle for a specific amount before they even see the facts. Be especially cautious of anyone who offers to provide this service with their fee based on a percentage of the tax they save the client. These folks are often under-qualified to represent the taxpayer and their business practices may be suspect.
Unfortunately, tax professionals all over the country expect to see more and more of these delinquent taxpayers in the near future. The writing is already on the wall. Unemployment rates are high, business closings are on the rise, loans are getting harder to obtain, and taxpayers are going to continue to fall behind on their tax liabilities. Tax professionals can help by being proactive, not reactive. Tax pros should get their clients on the phone and into their offices. Go through their records and take an honest look at where they stand. The more we know about their financial situation at this very moment, the more we can help them. The more time we have to implement a plan of action, the less often we will have to sit at the conference table telling clients that they owe more taxes than they thought possible. I, for one, don’t want to go through another client meeting like that on I had on April 14, 2017.