IRS Individual Tax Payment Plans

I anticipate a question about an IRS payment plan this tax season. It almost always comes up, so I review payment options every year. It occurred to me that this topic would make a good post, and I could just send a link to CTG if and when the question arises.

Let’s review the options for individual taxes. We are not discussing business taxes in this post, with one exception. If the business income winds up on your personal return – say through a proprietorship or an S corporation – then the following discussion will apply. Why? Because the business taxes are combined with your individual taxes.

YOU DO NOT HAVE THE MONEY BUT WILL SOON

You do not have the money to pay with your return, but you do have cash coming and will be able to pay within 120 days. This is a “short-term” payment plan. There is no application fee, but you will be charged interest.

BTW you will always be charged interest, so I will not say so again.

YOU OWE $10,000 OR LESS

You cannot pay with the return nor within 120 days, but you can pay within 3 years. This is the “guaranteed” payment plan. As with all plans, you have to be caught up with all your tax filings and continue to do so in the future.

If you are self-employed you can bet the IRS will require that you make estimated tax payments. I have seen this requirement sink or almost sink many a payment plan, as there isn’t enough cash to go around.

The IRS says they will not allow more than one of these plans every 5 years. I have had better luck, but (1) I got a good-natured IRS employee and (2) the combined tax never exceeded $10 grand. Point is: believe them when they say 5 years.

YOU OWE MORE THAN $10,000 BUT LESS THAN $25,000

This is a “streamlined” payment plan. Your payment period can be up to six years.  

As long as your balance is under $25 grand, the IRS will allow you to send a monthly check rather than automatically draft your bank account.

YOU OWE MORE THAN $25,000 BUT LESS THAN $50,000

This is still a “streamlined” plan, and the rules are the same as the $10-25 grand plans, but the IRS will insist on drafting your bank account.

DOWNSIDE TO THE GUARANTEED AND STREAMLINED PLANS

Have variable income and these plans do not work very well. The IRS wants a monthly payment. These plans are problematic if your income is erratic – unless you sit on a stash of cash no matter whether you are working or not. Then again, if you have such stash, I question why you are messing with a payment plan.

UPSIDE TO THE GUARANTEED AND STREAMLINED PLANS

A key benefit to both the guaranteed and the streamlined is not having to file detailed financial information. I am referring to the Form 433 series, and they are a pain. You have to attach copies of bank statements and provide documentation if you want more than IRS-provided amounts for certain cost-of-living categories. Rest assured that – whatever you think your “essential” bills are – the IRS will disagree with you.

Another benefit to the guaranteed and streamlined is avoiding a federal tax lien. I have had clients for whom the threat of a lien was more significant than the endless collection letters they received previously. Once the lien is in place it is quite difficult to remove until the tax debt is substantially paid.

YOU OWE MORE THAN $50,000

If you go over $50 grand you will have to provide Form 433 financial information, work your way through the cost-of-living categories, fight (probably) futilely with the IRS to spot you more than the tables and then agree on an amount that will pay off the debt over your remaining statute-of-limitations (collections) period.

If you are at all close to the $50,000 tripwire, SERIOUSLY consider paying down the debt below $50,000. The process, while not good times with old friends, will be easier.

YOU CANNOT PAY IT ALL OVER THE REMAINING COLLECTIONS PERIOD

It is possible that – despite the best you can do – there is no way to pay-off the IRS over the remaining statute-of-limitations (collections) period. You have now gone into “partial pay” territory. This will require Form 433 paperwork and working with a Collections officer. If one is badly injured in a car wreck and has indefinitely decreased earning power, the process may be relatively smooth. Have a tough business stretch but retain substantial earning power and the process will likely not be as smooth. 

HOW TO APPLY

There are three general ways to obtain a payment plan:

(1)   Mail

(2)   Call

(3)   Website

There is a charge for anything other than the 120-day plan. The cheapest way to go is to use the IRS website, but the charge – while more if not using the website – is not outrageous.

You use Form 9465 for mail.

The website is https://www.irs.gov/payments/online-payment-agreement-application for online.

Set aside time if you intend to call the IRS. You may want to download a movie.

Do You File An Accurate Return Or A Timely Return?

I have alerted the staff here at CTG command center that I prefer and expect to file all business returns, especially passthrough returns, on a timely basis, irrespective of whether we have all required information. Granted, there is some freeplay – we cannot file if we have no information, for example, or if so much information is missing that a filing would not be construed as substantially correct.

The reason?

Penalties for late filing.

Let’s say that you and a partner have an LLC. The return is due in March and can be extended to September. You file an extension but, for whatever reason, do not file the partnership return until December.

What just happened?

(1)  You might think that the return is only 2 months late, as it was extended until September. That is incorrect. You have until September 15 to file the return. Fail to do so, and it is as if you never filed an extension. That return is now late beginning March 16.

(2)  So what? Here is so what: the penalty is $195 per K-1 per month. There are two K-1s: you and a partner. The penalty is $390 per month. Multiply that by the number of months, and you can see how this gets expensive fast.

(3)  You might be able to get out of this penalty. Revenue Procedure 84-35 allows an avenue for small partnerships with 10 or fewer partners, for example. Depending on the facts, however, there may be no easy out. Like fire, you do not want to be playing with this.

There are a hundred variations on the theme. Let me give you one. This one involves an estate tax return. Let’s review the key points, and you decide whether there is cause for a late-filing penalty. 

• The decedent died February 24, 1986.
• On May 6, 1986 the estate was admitted to probate.
• The wife was appointed executrix.
• The estate hired an attorney.
• The estate tax return was due November 24, 1986 (nine months after death). No extension was filed.
• In January, 1987 the executrix filed an inventory with the probate court. Four assets were listed but given no value. One of those assets was an interest in a trust, which asset took on a life of its own. 
• The assets which were valued - that is, excluding the four which were unvalued - were enough the require the filing of a federal estate tax return.
• In 1991 (five years later) the estate filed suit concerning the trust.
• In 1994 the common pleas court entered judgement.
• In 1996 the executrix filed a revised and final accounting with the probate court.
•  In 1997 the estate finally filed a federal estate tax return. 

     The IRS immediately went after late filing penalties. Why wouldn’t it? The tax return was filed more than 10 years after the decedent died.

The gross estate was over $2 million. Those items that could not initially be valued came in around $200 grand.

The IRS charged in and chanted its standard wash-rinse-repeat hymn: the taxpayer cannot escape penalties for the non-extension or late filing of a return pursuant to the Supreme Court’s Boyle decision.

But the estate punched back with reasonable cause: the executrix did not have values for some of the assets that were eventually distributable from the estate. Heck, they had to sue to even get to some of those assets!

What do you think? Is there reasonable cause?

Let me give you a clue: the disputed assets were about 10% of the final estate.

And we come back to a phrase I used early on: “substantially correct.” Tax Regulations require only that the estate return be “as complete as possible.” There are numerous cases where pending litigation – even if the outcome is expected to materially affect the estate’s final tax liability – has not been considered reasonable cause for not filing a return.

The Court pointed out two things:

(1)  The executrix knew (or should have known) early on that the estate was large enough – even excluding the disputed items – to require filing a return.

(2)  She could have paid at least the tax on that amount, or estimated and also included tax on the disputed items.

a.     The Court pointed out that disputed assets were only 10% of the estate.

The executrix did not have reasonable cause. She should have filed and paid something, even if she later had to amend the estate tax return.

My thoughts?

I agree with the Court. I believe the estate was ill-advised. 

There is a sub-story in here concerning the attorney (who thought the accountant was taking care of the estate tax return) and the CPA (who was never told to prepare an estate tax return, at least not until years after the return would have been due). Why didn’t the attorney reach out earlier to the CPA, at least for peace of mind? Who knows? Why didn’t the long-standing CPA – who would have known the decedent - ask about an estate return? Again, who knows?

Our case this time was Estate of Thomas v Commissioner.

COMMENT: I am looking (translation: I printed but have not yet read) a case where a taxpayer did use estimates but still got nailed with penalties. We may come back to that one in the near future.

Estimated Taxes Matter

Sometimes I read a case and I wonder if the most interesting part was not included.

There is a couple – a doctor and a financial consultant - who are not keen on paying their taxes. Here is a quick recap:

          Year            Tax           Withheld         Due

          2014         $70,018      $24,148         $45,870

          2015         $58,293      $11,677         $45,995

          2016         $52,474      $20,230         $32,244

          2017         $37,001      $11,720         $25,281

This is not rocket science. Chances are that one person has withholdings and the other person is supposed to pay estimated taxes. No estimated taxes were paid. The solution? Simple: (1) pay estimated taxes, or (2) increase the other spouse’s withholdings to compensate for the lack of estimated taxes.

On November, 2016 the IRS sent a Notice of Intent to Levy.

COMMENT: This tells you the taxpayers had been in the system for a while.

The taxpayers requested for a Collection Due Process Hearing.

COMMENT: Good step. The CDP is a chance to halt the IRS automated machinery and allow the taxpayers an opportunity to speak with an Appeals Officer about their specific situation.

The taxpayers were interested in collection alternatives, including:

(a)  an installment agreement

(b)  an offer in compromise

(c)  a “cannot pay balance” status

Seems to me they covered the bases.

They did not submit financial data with the CDP request, but they did later when the Appeals Officer requested. Their information showed monthly income of $25,317 and monthly living expenses of $17,217, leaving a monthly net of $8,100.

The IRS wanted the $8,100.

Surprise factor: zero.

The taxpayers balked, arguing that it was beyond their means.

COMMENT: How can the $8,100 be beyond their means, if that is the amount they calculated? The likely reason is that the IRS has tables for certain expense categories, such as transportation. Say that you have an expensive monthly car payment. You will bump up against that limit, and good luck getting the IRS to spot you more. Mind you, the IRS says that it will consider specific circumstances, but they do not consider them for long. You may find yourself having to trade-down on your car or pulling your kid from private school.

The taxpayers indicated they were going to file an offer in compromise.

They did – eight months later.

COMMENT: Folks, seriously, do not do this. If you are hip deep in a CDP hearing with the IRS, it is a very poor decision to stall.

The Appeals Officer – not willing to wait the better part of a year – sustained the proposed levy.

Next stop: Tax Court.

From the Court we learn that the taxpayers withdrew the offer in compromise because they were “unable” to make estimated tax payments.

Huh?

Folks, this act is fatal. Here is a requirement for an offer:

“Proof of sufficient withholding or estimated tax payments”

The Tax Court’s purview can be broad or narrow, depending on the issue. If there is an issue of tax law, the Court generally has broad powers. This case was not an issue of tax law; rather it was an issue of IRS procedure. Did the IRS follow its own rules? To phrase it another way, did the IRS abuse its authority?

This narrows the Court’s reach – a lot.

It means the Court is not reviewing whether the taxpayers should have received an installment plan, an offer in compromise or whatnot. Rather, the Court is reviewing whether the IRS abused its authority by not allowing said installment plan, offer in compromise or whatnot.

The Court decided the IRS had not.

Why?

“Proof of sufficient withholding or estimated tax payments”

To me, the take-away question is: what are these people doing with their money?

Our case this time was Reid v Commissioner.

You Receive A Wage Garnishment

I was minding my own business. My partner sweeps into my office and says we have to take care of something right away – hopefully that very afternoon.

Hey, I am a career CPA. Some level of ADD is almost requisite to longevity in this profession.

He drops an IRS Form 668-W on my desk.

There is something I had not seen in a while.

What is a 668-W?

A wage garnishment. The IRS refers to it as a “levy.” If you get to this point, you have almost gone through the belly of the whale. The IRS has sent notice after notice, giving you a chance to contest, request abatement, defer collection or set up a payment plan. You have ignored them all. They got angry. They are now garnishing your paycheck.

This notice goes to your employer, and your employer is charged with notifying you. Your employer is going to garnish your next paycheck. Your employer does not want to go resistance here, as an employer becomes liable should they just blow it off. And then there is a 50% “hi there” penalty on top of that.

The IRS publishes tables telling you how much you get to keep. Say that the you are married, have one kid and receive a weekly net check of $1,017.65. The table indicates that you can keep $541.35. The employer withholds and remits the $476.30 balance ($1,017.65 – 541.35) to the IRS.

On the upside, the IRS is not touching your health insurance or 401(k) withholding. On the down side, it is jonesing the rest of your paycheck.

Can you live on $541.35?

That is not the point.

The point is that the IRS wants you to reenter the grid and establish a payment plan. Once you do so, the IRS will release the levy. As far as they are concerned, you should have done so already. The levy is to slap you into reality.

And you have forfeited some (at this point) important procedural rights.

Say that there is a question whether you actually owe some or all of the tax. Had you paid attention to the increasingly strident string of IRS notices, you would have noticed one titled “Notice of Intent to Levy.”

That one is serious. Not as serious as the 668-W, of course, but serious.

At that time, you had the right to request an IRS appeals hearing, called a Collection Due Process hearing. That puts you in front of an Appeals officer to plead your case, including whether you actually owe some or all of what the IRS wants.

Say you ignored the Notice of Intent.

It is a year or two later and you receive the 668-W.

You bring it to me. You may note that I am not humored.

Guess what important right you forfeited by ignoring the earlier notice?

That’s right: being able to argue whether you actually owe some or all of the tax.

That is dandy if there is no question whether you owe the money.

Not my situation. The friend has a very good case that he does not owe (at least some) of the tax.

But we are past the point where I can force a collection hearing to talk about the matter.

Is it hopeless?

Nope. A proficient tax practitioner still has tricks.

Like?

Like an offer in compromise. You know, those middle of the night commercials to settle millions of dollars of tax debt for the change in your pocket.

Is the friend broke?

Not the point.

What is the point then?

There is more than one type of offer. The one I am considering has nothing to do with your ability to pay. It instead has to do with whether you actually owe the money. The first addresses doubt as to collectability. The second addresses doubt as to liability.

It is one way to get the IRS to review the file with an eye as to liability.

Is this what we are going to do?

Doubt it.

Why not?

Because an offer will stay that levy only so long. The IRS can still demand a weekly wage levy WHILE they are considering the offer. Will it happen? Maybe yes, maybe no, but why run the risk?

What is an alternative?

File an appeal.

An appeal shuts down all collections action, meaning that I do not have to bank on the IRS’ better nature to stay that levy. Appeals allows me to introduce evidence that the friend does not owe all the assessment. I am also hoping to get penalties abated, at least some, but that would be a bonus.

Should the friend’s situation have gotten to this point?

I am sympathetic. Those who have followed me know that I am generally pro-taxpayer, but that is not what we have here. There were notices, which were ignored. There was a statutory notice of deficiency, which was ignored. After the statutory notice, taxes and penalties were officially assessed, which was also ignored. There was a chance for reconsideration, which was ignored. 

During all this there was ALWAYS a chance for a payment plan.

As I said, you may note that I am not humored.

A Divorce Decree And Past Taxes

Let’s say that a couple divorces. The divorce decree stipulates that liability for previous federal taxes will be split 50:50. They had always filed jointly The IRS audits one or more of those earlier years and assesses additional taxes.

Question: what is each spouse’s liability?

Your first thought might be 50:50, as that is what the divorce decree says.

Our protagonists this time would find out.

Mae Asad and Sam Akel filed joint returns for 2008 and 2009. The IRS audited those years, looking at rental losses. They disallowed the losses and assessed over $30,000 in taxes and penalties.

Mae filed for innocent spouse.

Later Sam filed for innocent spouse.

NOTE: Filing for innocent spouse status means that a spouse (probably an ex-spouse, but I had a client who was still married) has been assessed taxes for which he/she does not believe he/she is responsible. The classic case is the stay-at-home spouse, the other self-employed spouse, and the stay-at-home has no participation in or knowledge of the other’s business. Think Carmela Soprano.

The IRS bounced both requests for innocent spouse.

Both ex-spouses filed with the Tax Court.

Before the hearing, the IRS conceded that Mae was responsible for 28% of the 2008 tax and 41% of the 2009 tax. Sam of course was responsible for the balance.

Seems to me that Sam might not like this deal.

I do not know how, but Mae agreed to a 50:50 split. She did not have to, mind you.

The courts have been consistent that a divorce decree is not binding on the IRS, as the IRS is not party to the divorce.  A joint return means that both spouses are liable, and the IRS can go after one … or both, to the extent the IRS desires. The decree may provide for a former spouse to seek restitution against the other, but it has no impact on the IRS.

The Court accepted the IRS previous concession to Mae of 28% and 41%. It did not have to observe the divorce decree and it did not.

Then the Court reviewed the penalties of over $5,000.

But there had been a fatal flaw,

You see, Mae and Sam had filed pro se with the Tax Court. Pro se means one is going in without professional representation (not exactly correct, but close enough). It happens with small tax cases. The paperwork to get to Court and the procedural rules once there are more lenient for small cases.

Sam and Mae had not included the penalty in their petition to the Court.

The Court did not have authority to review the penalties.

But it did provide us a clear example of the downside to representing oneself pro se.

When The IRS Does Not Believe You Filed An Extension

I have a certain amount of concern whenever we approach a major due date. Let’s use your personal tax return as an example. It is due on April 15; an extension stretches that out to October 15. 

What is the big deal?

Penalties. Fail to extend the return, for example.

How does this happen?

A client moves to another city. A client was unhappy with your fees last year, and you are uncertain if the client is staying with you. A client’s kid starts working, prompting a tax return for the first time. A client gets involved with some business, and the first time you hear about it is when his/her information comes in. A client does business in a new state.

Or – let’s be frank here – you just miss it.

There are two common penalties; think of them as the salt and pepper of penalties:

·      Failure to file

·      Failure to pay

We associate the IRS with taking our money, so one would easily assume that the more onerous penalty is failure to pay. It is not. Owe money past April 15 and the IRS will charge a penalty of ½% per month.

Fail to file, however, and the penalty is 5% per month.

Yep, 10 times as much.

And when does the penalty start?

Miss that extension and it starts April 16.

Huh? Don’t you have until October 15 to file that thing?

Yes, IF you file an extension.

You do not want to miss that extension.

I was reading a case about the Laidlaw brothers. They sold Harley Davidson motorcycles, and they got pulled into Court for a welfare benefit plan that went awry.

There was one issue left: did their accountant file extensions for the two brothers by April 15? If not, those penalties included 5 zeroes. We are talking enough-to-buy-a-house money.

To add to the stress, the trial occurred about a decade after the tax year in question.

The accountant’s name was Morgan, and he presented extensions showing zero tax due for each brother. The IRS said it never received any extensions. Morgan did not send the extensions certified mail, but he recalled sending both extensions in the same envelope. He remembered taking the envelope to the post office and checking for proper postage. He took pride that the Post Office had never returned an extension request for insufficient postage.

He pointed out that there was no question about an extension for the year before, and the year before that, and so forth. The brothers were significant clients to his firm, and he went the extra mile.

The IRS was having none of it. They pointed out that Morgan had many clients, and the likelihood that he could remember something that specific from a decade ago was dubious. Additionally, any memory was suspect as self-serving.

Sounds like Morgan needed to present well in front of the Court.

And there is the rub. The Laidlaw case went Rule 122, meaning that depositions were submitted to the Court, but there was no opportunity for face-to-face questioning.

Here is the Court:

… we had no opportunity to observe Mr. Morgan’s credibility as a witness. The reliability of a witness’ testimony hinges on his credibility. We were not provided a full opportunity – so critical to our being able to find the witness reliable – to evaluate Mr. Morgan’s credibility on the issue of timely filing because petitioners never offered his live testimony in a trial setting. While we can learn much from reading the testimony, it is not the same as a firsthand observation of the witness’ demeanor and sincerity, both essential aspects of credibility and reliability.

The brothers lost, and the IRS collected a sizeable penalty amount.

Back in the day, we used to log all extensions going to the IRS. We would certify each envelope and then attach the receipt to a log detailing each envelope’s contents. Granted, that log could not prove that a given envelope contained a given extension, but it did show our attention to policies and procedures. I recall getting out of at least one sizeable penalty by arguing that point to the IRS.

Those were different times, and many (including me) would say that today’s IRS is less forgiving of basic human error

And, to some extent, we are talking ancient history with extension procedure. Today’s practices, our included, has moved to electronic filing. Our software tracks and records our extensions and returns and their receipt by the IRS. I do not need to keep a mail log as my software does it for me.

Morgan needed something like a log. It would have given the Court confidence in and support for his recollection of acts occurring a decade earlier, even without him being present to testify in person.

Bill And The Gig Economy

I am inclined to title this post “Bill.”

I have known Bill for years. He lost his W-2 job and has made up for it by taking one or two (or three) “independent contractor” gigs.

However, Bills get into tax trouble fast. Chances are they burned through savings upon losing the W-2 job. They turned to that 1099 gig when things got tight. At that point, they needed all the cash they could muster, meaning that replenishing savings had to wait.

The calendar turns. They come to see me for their taxes.

And we talk about self-employment tax for the first time.

You and I have FICA taken from our paycheck. We pay half and our employer pays half. It becomes almost invisible, like being robbed while on vacation.

Go self-employed and you have to pay both sides of FICA – now called self-employment tax – and it is anything but invisible. You are paying approximately 15% of what you make – off the top - and we haven’t even talked about income taxes.

You find yourself in a situation where you probably cannot pay – in full, at least – the tax from your first contractor/self-employment year.

We need a payment plan.

But there is a hitch.

What about taxes on your second contractor/self-employment year?

We need quarterly estimated taxes.

You start to question if I have lost my mind. You cannot even pay the first year, so how are you going to pay quarterly taxes for the second year?

And there you have Bill. Bills are legion.

We arrange a payment plan with the IRS.

You know what will likely blow-up a payment plan?

Filing another tax return with a large balance payable.

All right, maybe we can get the first and second year combined and work something out.

You know what will probably blow-up that payment plan?

Filing yet another tax return with a large balance payable.

Depending upon, the IRS will insist that you make estimated tax payments, as they have seen this movie too.

A taxpayer named Allen ran into that situation.

Allen owed big bucks – approximately $93,000.

The IRS issued an Intent to Levy.

He requested a CDP (Collections Due Process) hearing.

COMMENT: The CDP process was created by Congress in 1998 as a means to slow down a wild west IRS. The idea was that the IRS should not be permitted to move from compliance and assessment (receive your tax return; change your tax return) to collection (lien, levy and clear out your bank account) without an opportunity for you to have your day.  

Allen submitted financial information to the IRS. He proposed paying $500 per month.

The IRS reviewed the same information. They thought he could pay $809 per month.

COMMENT: You would be surprised what the IRS disallows when they calculate how much you can repay. You can have a pet, for example, but they will not allow veterinarian bills.

There was a hitch. Monthly payments of $809 over the remaining statute of limitations period would not sum to $93,000. The IRS can authorize this, however, and it is referred to as a partial-pay installment agreement (PPIA).

EXPLANATION: Any payment plan that does not pay the government in full over the remaining statutory collection period is referred to as a “partial pay.” The IRS looks at it more closely, as they know – going in – that they are writing-off some of the balance due.

The IRS settlement officer (SO) read the Internal Revenue Manual to say that a taxpayer could not receive a partial pay if he/she was behind on their current year estimated taxes. Allen of course was behind.

Allen said that he could not pay the estimate.

The SO closed the file.

Allen filed with the Tax Court.

Mind you, Allen was challenging IRS procedure and not the tax law itself. 

He had to show that the IRS “abused” its discretion.

It would be easier to get a rhinoceros on a park swing.

I get it, I really do. Take two SO’s. One denies you a partial pay because you are behind on estimated taxes; the other SO does not. That however is the meaning of “discretion.”

Did Allen’s SO “abuse” discretion?

The Tax Court did not think so.

Allen lost.

But there is something here I do not understand.

Why didn’t Allen make the estimated tax payment, revise his financial information (to show the depletion of cash) and forward the revised financials to the SO?

I presume that he couldn’t: he must not have had enough cash on hand.

If so, then abuse of discretion makes more sense to me: someone in Allen’s situation could NEVER meet that SO’s requirement for a payment plan.

Why?

Because he/she could never make that estimated tax payment.

Tax Preparers And Making Things Up

The following question came up this year. It was from an experienced CPA, so I was surprised that he even asked:

Are there rules on overstating income on a tax return?

You can anticipate the thought process. It is intuitive why one is not allowed to overstate deductions, as that has the effect of reducing taxes otherwise going to the government. But to overstate income? Why would the government care if you wanted to pay more tax?

Because folks, 999 times out of 1000 that is not the reason someone overstates income.

People do this to tap into the tax-credit-money-goodies in the tax Code. Most credits will reduce your tax, but when you get down to zero tax the credit ends. There are some exceptions. The main one, of course, is the earned income credit, although in recent years the government has added the American Opportunity (usually called the college) and the child tax credits.

The government will send you a check.

The earned income credit has the peculiar feature that the credit increases (as does your refund) as your income increases – up to a point, of course, and then the credit goes away.

I have reached a point in practice where I simply do not accept a client with an earned income credit. Chances are they could not afford my fee, granted, but I have a bigger issue: as a professional preparer, I take on additional penalty exposure by signing a return with this credit. I am “supposed” to perform extra due diligence, such a verifying that there is a child in your house. I have options other than parking across the street from your place overnight to verify your comings and goings, though: I can look at your kid’s report card (if it shows an address) or a doctor’s bill (again, if it shows an address).

Sure, pal. You know what I am not going to do? Prepare your return, that is what I am not going to do.

Unless I have known you for years, and I know that you have had a financial reversal. That is different. My due diligence has already been done and over several years.

There are unscrupulous preparers who do not observe such niceties. One could set up a temporary storefront, crank out a thousand make-believe, earned income/American Opportunity/child credit tax returns, charge a usurious fee (refund anticipation loans are sweet profit), skip town and enjoy the summer at a nice beach.

I knew one of these guys, although his schtick was made-up deductions more than false tax credits. You automatically had business mileage if you were his client. It did not matter if you owned a car.

Oh, did you know that is one way for you to get audited? If the IRS looks at your preparer, your odds of also being audited go up astronomically.

I am looking at a case from my hometown – Tampa, also known as the tax-fraud capital of the nation.

Our protagonist (the “Tax Doctor”) prepared a 2007 return for Shakeena Bryant. She brought a W-2 for less than $200 from Busch Gardens and information regarding her kids.

You are not going to get much of a credit with $200 worth of income.

But the Tax Doctor had a solution: report additional income from a business.

So she went out, got a business license for auto detailing and returned with it to his office the same day.

He then put a bit over $18,000 auto-detailing income on her return.

I suppose business licenses in Tampa also allow one to travel back in time.

Wouldn’t you know she got audited?

The IRS asked her about the auto detailing business.

She told the IRS she did not have an auto detailing business.

The IRS then wanted to talk to the Tax Doctor.

He explained that he “reasonably” relied upon her statements and exercised “due diligence.” He had that license, for example, and two pages of notes. He may also have had a soiled napkin from Dunkin Donuts, but I am not sure.

Out comes the preparer penalty - $2,500 of it.

Then the Tax Doctor – not knowing when to walk away – filed suit to get his $2,500 back.

This was a really bad idea, as it allowed the IRS to depose Ms. Bryant and the friend who accompanied her to the Tax Doctor’s office that day. 

Both testified that the business income idea was his.

The Tax Doctor fired back: he observed the due diligence rules, meaning that he should not be penalized. Why, he had a business license and two pages of notes in his files!

He had a point.

The Court also made a point: Ms. Bryant never talked about an auto-detailing business until he brought up the need for more income to drive the tax credit. Perhaps a reasonable preparer would have asked for documentation …. bank statements, receipts, FaceBook postings, State Department leaks. Folks, it is acceptable for a preparer to use his/her skepticism-radar.

He was reckless.

The Court found intentional disregard of his preparer responsibilities and sustained the penalty.

My thoughts? 

Very little patience. The Tax Doctor got off easy.

The IRS Could Not Collect When Limitations Period Expired

Let’s talk a bit about the tax statute of limitations.

There are two limitations periods, and it is the second one that can lead to odd results.

(1) The first one is referred to as the limitations on assessments. This is the three-year period that we are familiar with. The IRS has three years to audit your return, for example. If they do not, then – in general – the opportunity is lost to them.

There are a number of ways to extend the three-year period. When I was young in the profession, for example, tax practitioners would “hold back” certain tax deductions until the client was closing-in on the three years. With a scant few and breathless days remaining before the period expired, they would file amended tax returns, thereby obtaining a refund for the client and simultaneously kneecapping the IRS’ ability to look at the return.

The rules have been revised allowing the IRS additional time when this happens. I have no problem with this change, as I consider the previous practice to be unacceptable. 

(2) The second one is the collections period, and this one runs ten years.

Say you filed your return on April 15, 2014. You got audited and the IRS assessed $15,000 on December 15, 2015. The IRS has ten years – until December 15, 2025 – to collect.

There are things that can extend (the technical term is “toll”) the collections period. Make an offer in compromise, for example, and the period gets tolled. 

Sometimes tax practice boils down to letting the ten-year period click-off, hoping that the IRS does not initiate action. It happens. A few years ago I had a client who had moved to Florida, remarried and had her new husband involve her in an unnecessary tax situation. It was extremely unfortunate and she was extraordinarily ill-advised. He passed away, leaving her as the remaining target for the IRS to pursue. She had a fairness argument, but that meant as much as a snowball in July to IRS Collections. They have a different mind frame over there.

So I am looking at a case where a taxpayer (Grauer) had an issue with his 1998 tax return. He filed it late (in 2000).  That was his first problem. He owed around $40 grand, which quickly became almost $58 grand when the IRS was done tacking-on interest and penalties. That was his second problem. He could pay that much money about as easily as I can fly.

In 2001 he signed a waiver, extending the ten-year collections period.

What makes this point interesting to a tax nerd is that someone would not (knowingly) sign a waiver without something else going on.  In fact, Congress disallowed this in the late nineties, responding to perceived IRS abuses - especially in Collections.

Sure enough, the IRS said that he signed an installment agreement in 2001 (around the time of that waiver), but that he broke it in 2006

Grauer said that he never signed an installment agreement.

It was now 2013, and off to Tax Court they went.

The Court looked at the account transcript, which showed that the IRS had issued an earlier Notice of Intent to Levy.  This was an immediate technical issue, as the Court would not have jurisdiction past the first Notice. The IRS persuaded the Court that the transcript was wrong. 

COMMENT: Your transactions with the IRS go to your “account.” That account is updated whenever a transaction occurs. The posting will include a date, a code, and sometimes a dollar amount and perhaps a meaningful description.  Some codes are straightforward, some are cryptic. 

The Court next observed that Grauer asserted that he had not signed a payment plan. In legal jargon, this was an “affirmative defense,” and the IRS had to prove otherwise. The IRS argued that its transcript was correct and that Grauer was incorrect.

The Court was a bit flummoxed by this response. The IRS was having it both ways.

The Court told the IRS to “show us the installment agreement.” 

The IRS could not.

The Court went on to describe the IRS account transcript as “indecipherable and unconvincingly explained.”

The Court decided for the taxpayer.

Remember: ten years had passed. The waiver needed to attach to something. In the absence of something, the waiver fizzled and had no effect.

The statute had expired.

Did the taxpayer get away with something?

I don’t know, but think about the alternative. Let’s say that the IRS could post whatever it wanted – to speak bluntly, to make things up – to your account. You then get into tax controversy. You are required to prove that the IRS did not do whatever it claimed it did. Good luck to you in that scenario. I find that result considerably more unacceptable than what happened here.