Not Filing A Return and Owing Tax

 

The question comes up periodically, even among accountants: 

Is there a penalty for filing a late return if the taxpayer has a refund?

In general, the answer is no. Mind you, this is not an excuse to skip filing. If anything, you have money due to you. Do not file for three years and you are losing that refund.

Let’s switch a variable:

Is there a penalty for filing a late return if the taxpayer owes taxes?

Uhhhh, yes.

As a rule of thumb, assume an automatic 25% penalty, and it can be more.

So what happens if someone cannot file by the extended due date?

I have a one of these clients. I called him recently to send me his 2020 information.

His comment?

         I thought you took care of it.”

Now, I have been at this a long time, but I cannot create someone’s return out of thin air. Contrast that with estimating a selected number or two on a tax return. That happens with some regularity, although - depending on the size and tax sensitivity of the numbers – I might flag the estimates to the IRS’ attention. It depends.

Let look at the Morris case.

James and Lori Morris were business owners in Illinois. In 2013 James expanded the business, creating a new company to house the same. They had a long-standing relationship with their CPA.

The IRS came in and looked at the 2013 return. It appears that there were issues with the start-up and expansion costs of the new business, but the case does not give us much detail on the matter.

The Morris’ held up filing a return for 2014. They also held up filing 2015 and 2016, supposedly from concern of repeating the issue the IRS was addressing on the 2013 return.

Seems heavy-handed to me.

Well, as long as they were fully paid-in:

They did not make any estimated tax payments during the year at issue and did not have tax withheld from their paychecks during 2015. Petitioner-husband had a minimal amount of tax withheld from his wages during 2016. Petitioner-wife had withholding credits of $10 and $11 during 2015 and 2016, respectively.”

Got it: next to nothing paid-in.

Maybe the businesses were losing money:

For 2015 and 2016 petitioners, respectively, had ordinary income from their S corporations of over $2.2 million and $3 million.”

What was going on here? I am seeing income over $5 million for two years with little more than $21 of tax paid-in.

The Morris’ argued that their long-standing CPA advised that filing a return while an audit for earlier years was happening could subject them to perjury charges.

COMMENT: Huh? There are areas all over the Code where a taxpayer and the IRS might disagree. If it comes to pass, one appeals within the IRS or files with a court. The system does not lock-down because the IRS disagrees with you.

Frankly, I am curious what was on that return that the issue of “perjury” even saw the light of day.

Oh, well. Let’s have the CPA testify. Hopefully the Morris’ will have reasonable cause for penalty abatement because of their reliance on a tax professional.

Mr Knobloch (that is, the CPA) did not testify at trial, and there is no evidence in the record except for petitioner-husband’s testimony of Mr. Knobloch’s alleged advice.”

The Court was not believing this for a moment. 

We need not accept a taxpayer’s testimony that is self-serving and uncorroborated by other evidence, and we do not do so here.”

I find myself wondering why the CPA did not testify, although I have suspicions.

I also do not understand why – even if there were substantive issues of tax law – the Morris’ did not pay-in more for 2015 and 2016.  Did they think they had losses? OK, they would be out the money for a time but they would get it back as a refund when they file the returns.

They instead racked-up big penalties.

Our case this time was Morris v Commissioner, T.C. Memo 2021-120.

Talking Tax Levies

I don’t see it very often.

I am referring to an IRS bank levy.

However, when it happens it can be disrupting.

Let’s distinguish between a lien and a levy.

A lien is a claim against property you own to secure the payment of tax that you owe. The most common is a real estate lien, and I have one on my desk as I write this.

A lien means that you are fairly deep into the collection process. It does not necessarily mean that you have blown-off the IRS. Owe enough money and the IRS will file a lien as a matter of policy. It does not mean anything is imminent, other than the lien hurting your credit score. When I see one is when someone wants to either sell or refinance a property. In either case the lien has to be addressed, which – if you think about it – is the point of a lien.

A levy is a different matter. A levy takes your stuff.

The threat of a levy is a powerful inducement to come to a collection agreement with the IRS. Perhaps the agreement is to pay-off the liability over time (referred to as an installment agreement). There is a variation where one cannot – realistically – pay-off the full liability over time. The IRS settles for less than the full liability, and this variation is called a partial-pay agreement.  A cousin to the partial-pay is the offer in compromise, that of notorious (“pennies on the dollar”) middle-of-the-night TV fame. If one is in dire enough circumstances, there is also currently-not-collectible status. The IRS will not collect for a period of time (around a year). A code is posted on your account and further collection action will cease (again, for about a year).

What collection agreements do is put a stop to IRS levies – with one exception.

Let’s talk about the three most common levies that the IRS uses.

The first is the tax refund offset.

This happens when you file a tax return showing a refund. The IRS will not send you a refund check; rather they will apply it to tax due for other periods or years. It is a relatively innocuous way of collecting on the debt, and I have seen clients intentionally use the offset as a way of paying down (or off) their back taxes.

The offset, by the way, is the one exception to continued IRS levy action mentioned above.

The second is the garnishment. The most common is the wage garnishment. The IRS sends a letter to your employer, advising them to start withholding. Your employer will, because – if they don’t – they become responsible for any amounts that should have been garnished. I have heard of people who will then keep changing jobs, with the intent of staying one step ahead of the IRS.  

There are other types of garnishments, depending on the income source. An independent contractor can be garnished, for example. Even social security can be garnished.

In general, if you get to this type of levy, you REALLY want to work something out with the IRS. The tax Code addresses what the IRS has to leave for you to live on; it does not address how much it can take.

The third is the bank levy.

The IRS sends a notice to the bank, which then has to freeze your account. The notice can be mailed (probably the most common way) or it can be hand-delivered by a revenue officer. The freeze is for 21 days, after which the bank is (unless you do something) sending your balance (up to the amount due) to the IRS.

That is how it works, folks. It is not pretty, and it is not intended to be.

You may wonder what the 21 days is about. The IRS wants you to contact them and work-out a collection plan. Hit the ground running and you might be able to stop the levy. Delay and all hope is likely gone.

The risk of a bank levy is one reason why some taxpayers are hesitant to provide bank information with their tax returns. Granted, as private information becomes anything but and as tax agencies are mandating electronic bank payments this issue is receding into the distance.

Did you, for example, know that the IRS can ping your bank account, just to find out your balance?

Take a look at this:

         § 6333 Production of books.

If a levy has been made or is about to be made on any property, or right to property, any person having custody or control of any books or records, containing evidence or statements relating to the property or right to property subject to levy, shall, upon demand of the Secretary, exhibit such books or records to the Secretary.

There is something about a bank levy that you may want to know: it is a one-time shot.

An offset or wage levy is self-sustaining. It will continue month after month, payment after payment, until the debt is paid off or the levy expires.

The bank levy is different. It applies to the balance in your bank account when the levy is delivered.  This means that it cannot reach a deposit made to the account the following day, week or month. If the IRS wants to reach those deposits, it has to reissue the levy (the term is “renew”).

What got me thinking about bank levies is a Chief Counsel Advice I was reading recently. A bank received a levy, and, wouldn’t you know, the taxpayer made a deposit to the account the same day – but after the bank’s receipt of the levy. The bank had zero desire to mess with surrogate liability and asked the IRS what it should do with that later deposit.

Remember that a bank levy is a photograph – a frozen moment in time. The IRS said that the later deposit occurred after that moment and was not in the photograph. The bank was not required to withhold and remit that later deposit to the IRS.

Makes sense. What doesn’t make sense is that the IRS would have/should have issued a blizzard of paperwork to the taxpayer, including an ominous “Notice of Intent to Levy” and “Final Notice of Intent to Levy and Notice of Your Rights to a Hearing.” Both those notices give one collection rights. I prefer the rights given under the “Final Notice,” but sometimes it takes a saint’s patience to explain to a client why we are not responding to the “Notice of Intent” and instead waiting on its sibling “Final Notice of Intent.”

Anyway, the taxpayer apparently blew-off these notices and kept depositing to the same bank account as if nothing was amiss in their world. Everything in the CCA made sense to me, with the exception of the taxpayer’s behavior.

This time we talked about Chief Counsel Advice 202118010.

Having Assets And Filing An Offer In Compromise

I glanced at the case because it involved an offer in compromise, a collections hearing, a lien and currently noncollectible (CNC) status.

That is a lot going on for approximately $23 grand in tax debt.

First thing I noticed was that the taxpayer represented himself before the Tax Court. This is referred to as “pro se.” It happens quite a bit, and it usually does not work out well for the taxpayer.

I double-shudder when I think about “pro se” and going hard procedural with the IRS, such as with liens and offers in compromise.

Let’s walk through it:

(1) On November 16, 2016 the taxpayer filed an Offer in Compromise. The tax was approximately $23 grand. He offered approximately $12 grand.

COMMENT: There are several “flavors” of Offers in Compromise. This one was the traditional vanilla: inability to pay or to pay in full. Those late-night commercials are hawking this type.

(2) On May 30, 2017 the IRS sent a Notice of Federal Tax Lien Filing.

The taxpayer filed for a hearing, called a Collection Due Process (CDP) hearing. I probably would have done the same.

(3) On July 11, 2017 the IRS indicated it would not accept the Offer in Compromise, at least as submitted. 

Taxpayer appealed. Again, I probably would have done the same.

(4) On September 27, 2017 the IRS settlement officer sent taxpayer a letter that the CDP hearing was being delayed until the Offer in Compromise was resolved.

COMMENT: Left hand: right hand. Happens all the time.

(5) Wouldn’t you know that the appeal of the Offer in Compromise was assigned to the same IRS settlement officer handling the Collections hearing?

(6) The IRS scheduled a telephone hearing for December 14, 2017. The settlement officer also offered to place the taxpayer’s case in currently noncollectible (CNC) status.

COMMENT: I have used CNC status over the years, especially during and after the Great Recession of 2008. The IRS realizes that there is no money to collect, so it places the case on hold, generally for a year or so. Their normal collections machinery is paused.

Mind you, the IRS is not writing-off the debt. They are allowing a break in collection activity, hoping your situation improves.

(7) Not waiting until the hearing, taxpayer on December 1 sent the settlement officer a letter addressing the rejection of his offer in compromise.

COMMENT. He should include additional or expanded financial information, as his offer was based on inability to pay. The common-sense response to rejection of an offer based on inability to pay is to expand on why one is unable to pay.

Having taken the stage, taxpayer also alleged that the IRS engaged in criminal activity.

COMMENT: Stop that. You are not winning with that behavior.

The settlement officer rescheduled the hearing for January 9th.

(8)  On December 12 taxpayer sent the settlement officer another letter lamenting the rejection of his offer in compromise.

COMMENT: Once again: no additional or expanded financial information. This action was fruitless and ill-advised.

(9) We finally get to the hearing. The settlement officer reviewed the offer in compromise. She sees debt of approximately $23 grand and assets of approximately $110 grand. Receiving no additional or expanded financial information from the taxpayer, the officer decided that rejection of the offer was appropriate.

(10) After the hearing taxpayer sent a letter to the settlement officer, complaining about the IRS Fresh Start Program and including correspondence the taxpayer previously exchanged with the Taxpayer Advocate Service.

Taxpayer was focused on the lien and highlighted a TAS letter including the statement “the IRS has determined that the lien should be withdrawn.”

He wanted the lien withdrawn.

The settlement officer, to her credit, looked into this. It did not change the outcome, but she did try.

The immediate takeaway is the someone with $100-plus grand in assets is probably not going to be able to offer-down $23 grand in tax debt, irrespective of having low income. While true as a generalization, there are several specific considerations.

(1)  Given his focus on removing an IRS lien, I presume that taxpayer’s house comprised most if not all of taxpayer’s assets. I can see not wanting to refinance when one has limited income. In truth, one probably could not refinance, as no traditional mortgage provider would originate the loan.

a.     And there is how I would respond to the request for additional financial information: by providing rejection letters from a couple of mortgage companies.

(2)  Let’s say that the house is not the lion’s share of the assets. Perhaps it is something else, like a retirement account.

a.     If a retirement account, I would argue economic hardship.

                                                                         i.      That is, taxpayer needs that asset and the income therefrom in order to meet reasonable basic living expenses. The loss of said asset would be an economic hardship.

                                                                      ii.      It is already stipulated that the taxpayer is low income. How hard of an argument is this?

(3)  In general, I am unmoved by the IRS filing a lien.

a.     I may be moved if disclosure of said lien would adversely affect one’s career or public status (a mayor or judge, for example), but those instances are few and far between.

b.     Distinguish a lien from a levy.

                                                                         i.      A lien just secures the government’s interest. A lien on my house cannot be collected until I sell the house.

                                                                      ii.      A levy is a different matter. The IRS going into your bank account is an example of a levy.

(4)  Let’s circle back to the presumption that taxpayer’s residence represented the majority of his assets, hence his focus on removing the lien. The IRS just bounced his offer. What happens next?

a.     Folks, the IRS cannot (barring exceptional circumstances) take one’s primary residence.

b.     Yep, he will get periodic and annoying IRS correspondence, but …

c.     … so what? There is little bite left in that dog.

d.     And after 10 years (without the IRS taking the matter to Court to obtain judgement), the statute of limitations will kick-in.

You can see the downside to a pro se, especially when dealing with IRS procedure. There is a lot going on here, and I suspect that – with professional advice – taxpayer could have gotten the offer. I doubt he would have gotten the lien released, though. He saved a few grand in professional fees in order to completely strike out with the IRS.

The case for the home gamers is Banks, TC Memo 2019-166.

Use Certified Mail With The IRS

I am looking at Baldwin v U.S., at least as much as I can between the September and October 15^th due dates.

In the blog equivalence of cinematic foreboding, the case comes out of the Ninth Circuit.

The Baldwins filed a 2007 joint tax return showing an approximate $2.5 million loss from a movie production business.

They filed to carry the loss back to 2005 for a refund.

They had three years to file the refund claim. The three years started with the filing of their 2007 return – that is, the year that showed the loss. They filed their 2007 return on extension, so three years later would be October 15, 2011.

They filed the refund claim on June 21, 2011.

Seems plenty of time.

They filed using regular mail.

The IRS said they never received the refund claim.

Problem.

The three years expired. Sorry about your luck, Baldwins, purred the IRS.

You know this went to court.

It went to a California district court.

And we get to talk about the mailbox rule.

There is a provision in the tax Code that timely-mailing-equals-timely filing with the IRS. That is the reason you hear (not as much now in the era of electronic filing) of people heading to the post office on April 15^th. Folks want to get that “April 15” stamped on the envelope, as that stamp means the return is considered timely filed with the IRS.

By the way, that provision did not enter the Code until 1954.

What did folks do before 1954?

They relied on common law.

Common law allows one to presume that a properly-mailed envelope will arrive in the ordinary time required to get from here to there. One would have to prove that one mailed the envelope, of course, but once that was done the presumption that the mail arrived in normal time would kick-in.

In 1954 Congress added the following:

§ 7502 Timely mailing treated as timely filing and paying.

(a)  General rule.

(1)  Date of delivery.

If any return, claim, statement, or other document required to be filed, or any payment required to be made, within a prescribed period or on or before a prescribed date under authority of any provision of the internal revenue laws is, after such period or such date, delivered by United States mail to the agency, officer, or office with which such return, claim, statement, or other document is required to be filed, or to which such payment is required to be made, the date of the United States postmark stamped on the cover in which such return, claim, statement, or other document, or payment, is mailed shall be deemed to be the date of delivery or the date of payment, as the case may be.

Section (c) is important here:

(c)  Registered and certified mailing; electronic filing.

(1)  Registered mail.

For purposes of this section , if any return, claim, statement, or other document, or payment, is sent by United States registered mail-

(A)  such registration shall be prima facie evidence that the return, claim, statement, or other document was delivered to the agency, officer, or office to which addressed; and

(B)  the date of registration shall be deemed the postmark date.

Section (c) is why accountants encourage the use of certified mail with tax returns.

But the Baldwins did not certify their mailing.

They instead argued that they met the common-law standard for timely filing.

Seems a solid argument.

The IRS went low.

There are Court cases out there (Anderson, for example) that decided that the common law standard continued to exist even after the codification of Section 7502. It makes sense – at least to me - as that is what common law means.

The IRS argued that Section 7502 did away with the common-law standard, and the cases deciding otherwise were decided erroneously.

Sounds like a truckload of fine-cut bull manure to me.

Let’s load the truck.

There was a case in 1984 called Chevron. From it came the Chevron doctrine, an administrative law principle that a government agency’s interpretation of an ambiguous or unclear statute should be respected by a court.

I get the concept.

The first thing the agency has to do is show that the statute is ambiguous or unclear.

Does Section 7502 appear ambiguous or unclear to you?

We are going to need a jump to get this truck going.

Let’s introduce National Cable & Telecommunications Association v Brand X. That case has to do with the internet and whether it is an information service or a telecommunication service.

Sounds boring.

Let’s look at the Ninth Circuit’s take-away from Brand X:

But [a] court’s prior judicial construction of a statute trumps an agency construction otherwise entitled to Chevron deference only if the prior court decision holds that its construction follows from the unambiguous terms of the statute and thus leaves no room for agency discretion.”

Let me translate that word salad:

Since the prior Court decisions (let’s use Anderson as an example) did not specifically say that the statute was unambiguous, the statute is therefore ambiguous.

Huh?

So, if I do not make clear that I am not a Robert Howard sword-and-sorcery, skilled, powerful and fearless giant weapon-wielding barbarian, then it can be deduced that I am that very said barbarian?

Cool!

Brand X lets me say that Section 7502 is ambiguous, at which point Chevron kicks-in and allows me to argue that the underlying statute means anything I want it to say.

There is an aisle for this at Borders. It is called “Fiction.”

The Baldwins did not get to rely on common-law. Since they could not meet requirements of Section 7502(c), they lost out altogether. No carryback refund for them.

Memphian Appeals An Offer In Compromise

I am looking at a case dealing with an offer in compromise.

You know these from the late-night television and radio advertisements to “settle your IRS debts for pennies on the dollar.”

Yeah, right.

If it were so easy, I would use it myself.

Don’t get me wrong, there are fact patterns where you probably could settle for pennies on the dollar. Unfortunately, these fact patterns tend to involve permanent injury, loss of earning power, a debilitating illness or something similar.

I will just pay my dollar on the dollar, thank you.

What caught my attention is that the case involves a Memphian and was tried in Memphis, Tennessee. I have an interest in Memphis these days.

Let’s set it up.

Taxpayer filed tax returns for 2012 through 2014 but did not pay the full amount of tax due, which was about $40 grand. A big chunk of tax was for 2014, when he withdrew almost $90,000 from his retirement account.

Why did he do this?

He was sending his kids to a private high school.

I get it. I cannot tell you how many times I have heard from Memphians that one simply cannot send their kids to a public school, unless one lives in the suburbs.

In December, 2016 he received a letter from the IRS that they were going to lien.

He put the brakes on that by requesting a Collection Due Process (CDP) hearing.

Well done.

In January he sent an installment agreement to the IRS requesting payments of $300 per month until both sides could arrive at a settlement.

The following month (February) he submitted an Offer in Compromise (OIC) for $1,500.

That went to a hearing in April. The IRS transferred the OIC request to the appropriate unit.

In late August the IRS denied the OIC.

Let’s talk about an OIC for a moment. I am thinking about a full post (or two) about OICs in the future, but let’s hit a couple of high spots right now.

The IRS takes a look at a couple of things when reviewing an OIC:

(1)  Your net worth, defined as the value of assets less any liabilities thereon.

There are certain arcane rules. For example, the IRS will probably allow you to use 80% of an asset’s otherwise fair market value. The reason is that it is considered a forced sale, meaning that you might accept a lower price than otherwise.

(2) Your earning power

This is where those late-night IRS settlement mills dwell. Have no earning power and near-zero net worth and you get pennies on the dollar.

There are twists here. For example, the IRS is probably not going to spot you a monthly Lexus payment. That is not how it works. The IRS provides tables for certain categories of living expenses, and that is the number you use when calculating how much you have “left over” to pay the IRS.

Let’s elaborate what the above means. If the IRS spots you a lower amount than you are actually spending, then the IRS sees an ability to pay that you do not have in real life.

You can ask for more than the table amount, but you have to document and advocate your cause. It is far from automatic, and, in fact, I would say that the IRS is more inclined to turn you down than to approve any increase from the table amount. I had a client several years ago who was denied veterinary bills and prescriptions for his dog, for example.

The IRS workup showed that the taxpayer had monthly income of approximately $12,700 and allowable monthly expenses of approximately $11,000. That left approximately $1,700 monthly, and the IRS wanted to get paid.

But there was one expense that made up the largest share of the IRS difference. Can you guess what it was?

It was the private school.

The IRS will not spot you private school tuition, unless there is something about your child’s needs that requires that private school. A special school for the deaf, for example, would likely qualify.

That is not what we have here.

The IRS saw an ability to pay that the taxpayer did not have in real life.

Taxpayer proposed a one-time OIC of $5,000.

The IRS said No.

They went back and forth and agreed to $200 per month, eventually increasing to $700 per month.

COMMENT: This is not uncommon for OICs. The IRS will often give you a year to rework your finances, with the expectation that you will then be able to pay more.

The taxpayer then requested abatement of interest and penalties, which was denied. Generally, those requests require the taxpayer to have a clean filing history, and that was not the case here.

The mess ended up in Tax Court.

Being a court, there are rules. The rule at play here is that the Court was limited to reviewing whether the IRS exercised abuse of discretion.

Folks, that is a nearly impossible standard to meet.

Let me give you one fact: he had net assets worth approximately $43 thousand.

His tax was approximately $40 thousand.

Let’s set aside the 80% thing. It would not take a lot of earning power for the IRS to expect him to be able to repay the full $40 grand.

He lost. There really was no surprise, as least to me.

I do have a question, though.

His monthly income was closer to $13 grand than to $12 grand.

It fair to say that is well above the average American monthly household income.

Private school is expensive, granted.

But where was the money going?

Our case this time was Love v Commissioner, T.C. Memo 2019-92.

The Freak Tackles The IRS

Let’s go hard procedural on this post.

He played defensive end in the NFL with the Tennessee Titans and Philadelphia Eagles from 1999 to 2010. At 6’4”, 260 pounds, 86-inch wingspan and 4.43 forty, NFL fans remember him as “The Freak.”

Jevon Kearse is in the tax literature.

It looks like a business deal went bad, because in 2010 he claimed a $1,359,000 bad debt deduction.

The IRS bounced it. The IRS now wanted over $430 thousand in tax. They issued a Notice of Deficiency (NOD) on May 11, 2012.

COMMENT: Procedurally, the IRS issues a NOD (also known as a SNOD) before it can officially assess the additional tax. Once assessed, the IRS can bring all its collection powers to bear.

Problem: Kearse says he never received the NOD.

Let us start our walk through IRS procedure.

Once assessed, the IRS sent Kearse a Notice of Federal Tax Lien.

COMMENT: One has the right to request a hearing (called a Collection Due Process hearing) in response.

Kearse requested a CDP hearing, at which he asserted that he never received the NOD and presented an offer in compromise (liability – for the home gamers) for $1.

COMMENT: There are three flavors of offer in compromise. The one we are talking about is when there is substantial doubt that the assessed tax is correct. At $1, that is exactly the point Kearse was making.

IRS Appeals tuned him down, and off to Tax Court they went.

A taxpayer has the right to challenge the underlying tax liability in a CDP hearing IF he/she never received the NOD or otherwise never had a chance to dispute the proposed assessment. This is a procedural requirement, and the Court can bring it up even if the taxpayer fails to.

Responsibility now shifted to the IRS. The Appeals officer had to prove that the IRS properly mailed the NOD. There are two general ways to do this:

(1) Reviewing an internal IRS document management system

(2) Reviewing a postal Form 3877 or an equivalent mailing list with date stamps and/or initials.

The IRS said they did the first option: they reviewed the internal system.

Kearse’s tax attorneys also got the Appeals officer to stipulate that she could not produce a Form 3877 or otherwise prove the mailing of the NOD.

NOTE: We will come back to the importance of a “stipulation” in a moment.

There is a second procedural issue here: the IRS can rely on its internal system unless the taxpayer alleges that the NOD was not properly mailed.

Which is what Jevon Kearse had done. The IRS could not rely on option (1).

Incredibly, the IRS finally found the Form 3877, explaining that the eventual success had resulted from an update to their systems.

The Court bounced the Form 3877.

What ….?

It has to do with the stipulation. You see, a stipulated fact is treated as conclusive evidence. It cannot be changed, barring extraordinary circumstances.

The IRS had to argue extraordinary circumstances.

And we have the third procedural issue: the IRS failed to do so.

Meaning the IRS was bound by its stipulation that it could not prove the mailing of the NOD.  

The IRS attorney flubbed.

Jevon Kearse won.

What a freak case.