The IRS Causing Economic Hardship

 

It is a famous case. It is also an example of different Collection rules not playing well together.

We find Kathleen Vinatieri and the IRS in Tax Court.

Life had been unkind to Kathleen:

I don’t know what you want to know cause I do not understand all the legal stuff you sent me. I can’t afford a lawyer. And the closest legal aid is in Knoxville 30 miles away. My poor car will not go that far.”

The IRS was chasing her 2002 federal taxes.

She requested a Collection hearing.

When the Settlement Officer (SO) asked Kathleen whether she wanted a payment plan, she replied that she could not pay. She had $14 in the bank; a 1996 Toyota with 243,000 miles and worth $300; she had pulmonary fibrosis; was dying; and was taking care of kids.

COMMENT:  This is a sad case to read and extremely unflattering to the IRS. It should have drawn an immediate currently not collectible (CNC) status.

The SO agreed on CNC status, but there was a problem: The Internal Revenue Manual (IRM) required one to have filed all tax returns before obtaining CNC status. Kathleen had not filed 2005. She had tried, but the payroll company that (was supposed to) issue her a W-2 had gone out of business. She had previously contacted the IRS for a transcript, but the IRS had no information on that W-2 either.

You can see the issue. Unless Kathleen had retained that last 2005 pay stub, there was no way for her to file that tax return. The IRS could not help, as they did not have a copy of the W-2 either. Kathleen was stranded.

BTW, the IRM is internal to the IRS.

Here is the Regulation – and external to the IRS.

§ 301.6343-1 Requirement to release levy and notice of release.

(a) In general. A district director, service center director, or compliance center director (director) must promptly release a levy upon all, or part of, property or rights to property levied upon and must promptly notify the person upon whom the levy was made of such a release, if the director determines that any of the conditions in paragraph (b) of this section (conditions requiring release) exist. The director must make a determination whether any of the conditions requiring release exist if a taxpayer submits a request for release of levy in accordance with paragraph (c) or (d) of this section; however, the director may make this determination based upon information received from a source other than the taxpayer. The director may require any supporting documentation as is reasonably necessary to determine whether a condition requiring release exists.

(b) Conditions requiring release. The director must release the levy upon all or a part of the property or rights to property levied upon if he or she determines that one of the following conditions exists—

(1) Liability satisfied or unenforceable

(2) Release will facilitate collection.

(3) Installment agreement.

(4) Economic hardship—(i) General rule. The levy is creating an economic hardship due to the financial condition of an individual taxpayer. This condition applies if satisfaction of the levy in whole or in part will cause an individual taxpayer to be unable to pay his or her reasonable basic living expenses. The determination of a reasonable amount for basic living expenses will be made by the director and will vary according to the unique circumstances of the individual taxpayer. Unique circumstances, however, do not include the maintenance of an affluent or luxurious standard of living.

The Regulation requires the IRS to release a levy in the event of economic hardship. There was no question that Kathleen was in economic hardship. It seems absurd to issue a levy under the IRM to only have it stayed by a Regulation – that is, if Kathleen had the staying power to continue her fight against IRS Collections.

Which one overrides: the IRM or the Regulation?

The Tax Court decided:

A determination in a hardship case to proceed with a levy that must immediately be released is unreasonable and undermines public confidence that tax laws are being administered fairly.”

Well, fairly and sanely, I would add.

In a section 6330 pre-levy hearing, if the taxpayer has provided information that establishes the proposed levy will create economic hardship, the settlement officer cannot go forward with the levy and must consider an alternative.”

The Regulations to the Code take precedence over an internal IRS publication. The IRS cannot itself cause economic hardship when pursuing a levy. It took time and treasure, but the Court eventually got to the correct result.

I note that the reason for nonfiling was likely important. In this case the payroll company had gone out of business, and even the IRS did not have a copy of the W-2. Consequently, neither the Settlement Officer nor the Tax Court questioned whether Kathleen was acting in good faith. Substitute a taxpayer who simply refused to file – an extreme example would be a protestor – and I doubt the result would be the same.

Our case this time was Vinatieri v Commissioner, 133 T.C. 392 (2009).

An IRS Examination And A New IRS Hire

 

I have gotten dragged into a rabbit hole.

I often get involved with clients on a one-off basis: they are buying a company, selling their business, expanding into other states, looking into oddball tax credits and so forth. Several of our clients have been selling their businesses. In some cases, they have been offered crazy money by a roll-up; in others it is the call of retirement. I was looking at the sale of a liquor store last fall. As business sales go, it was not remarkable. The owner is 75 years old and has been working there since he was a teenager. It was time. The sale happened this year.

Fast forward to a few weeks ago. The CPA who works with the liquor store was taking time off, but I was in the office. The owner remembered me.

“Can I see you this afternoon,” he asked.

“Of course. Let me know what works for you.”

He brought an IRS notice of appointment with a field revenue officer. I reviewed the notice: there was a payroll issue as well as an issue with the annual deposit to retain a fiscal year.

I had an educated guess about the annual deposit. This filing is required when a passthrough (think partnership or S corporation) has a year-end other than December. We do not see many of these, as passthroughs have mostly moved to calendar year-ends since the mid-eighties. The deposit is a paper-file, and clients have become so used to electronic filing they sometimes forget that some returns must still be filed via snail mail.

The payroll tax issue was more subtle. For some reason, the IRS had not posted a deposit for quarter 4, 2022. This set a penalty cascade into motion, as the IRS will unilaterally reorder subsequent tax deposits. Let this reordering go on for a couple of quarters or more and getting the matter corrected can border on a herculean task.

I spoke with the revenue officer. She sounded very much like a new hire. Her manager was on the call with her. Yep, new hire.

Let’s start the routine:

“Your client owes a [fill in the blank] dollars. Can they pay that today?”

“I disagree they owe that money. I suspect it is much less, if they owe at all.”

“I see. Why do you say that?”

I gave my spiel.

“I see. Once again, do you want to make payment arrangements?”

I have been through this many times, but it still tests my patience.

“No, I will recap the liabilities and deposits for the two quarters under discussion to assist your review. Once you credit the suspended payroll deposit to Q4, you will see the numbers fall into place.”

“What about the 8752 (the deposit for the non-calendar year-end)?

“I have record that it was prepared and provided to the taxpayer. Was it not filed?”

“I am not seeing one filed.”

“These forms are daft, as they are filed in May following the fiscal year in question. Let’s be precise which fiscal year is at issue, and I will send you a copy. Do you want it signed?”

The manager chimes in: that is incorrect. Those forms are due in December.”

Sigh.

New hire, poorly trained manager. Got it.

I ask for time to reply. I assemble documents, draft a walkthrough narration, and fax it to the field revenue officer. I figure we have one more call. Maybe the client owes a couple of bucks because … of course, but we should be close.

Then I received the following:

 

I am not amused.

The IRS has misstepped. They escalated what did not need to escalate, costing me additional time and the client additional professional fees. Here is something not included when discussing additional IRS funding for new hires: who is going to train the new hires? The brain drain at the IRS over the last decade and a half has been brutal. It is debatable whether there remains a deep enough lineup to properly train new hires in the numbers and time frame being presented. What is realistic – half as many? Twice as long? Bring people out of retirement to help with the training?

Mind you, I am pulling for the IRS. The better they do their job the easier my job becomes. That said, there are realities. CPA firms cannot find qualified hires in adequate numbers, and the situation does not change by substituting one set of letters (fill-in whatever word-salad firm name you want) for another (IRS). Money is an issue, of course, but money is not the only issue. There are enormous societal changes at work.

What is our next procedural move?

I requested a CDP hearing.

The Collections Due Process hearing is a breather as the IRS revs its Collections engines. It allows one to present alternatives to default Collections, such as:

·      An offer in compromise

·      An installment agreement

I have no intention of presenting Collections alternatives. If we owe a few dollars, I will ask the client to write a check to the IRS. No, what I want is the right to dispute the amount of tax liability.

A liability still under examination by a field revenue officer. I have agreed to nothing. I have not even had a follow-up phone call. A word to the new hires: it is considered best practice – and courteous - to not surprise the tax practitioner. A little social skill goes a long way.

The Notice of Intent to Levy was premature.

Someone was not properly trained.

Or supervised.

I question whether this would have happened 15 or more years ago.

But then again, 15 years from now the new hires will be the institutional memory at the IRS.

It is the years in between that are problematic.

Notice(s) Of Intent To Seize And Levy

 

I received the following notice under power of attorney for a client.  

Another accountant at Galactic Command works with the client. I am the tax nerd should problems arise.

Yeah, we have a problem.

For more than one year, too.

Combine the two and I can get cranky. Just because I know the route doesn’t mean I want to revisit the site.

But back to our topic.

The notice seems terrifying, doesn’t it? The IRS is talking about seizing and levying and all matters of unkindliness.

Let’s go through the sequence of these notices.

First, you owe the IRS. There is a sequence of four notices, sometimes referred to as the “500” sequence.

• CP501         You have unpaid taxes somewhere.
• CP502         We have not heard from you about unpaid taxes.
• CP503         Hey, dummy! Are you there?
• CP504         We intend to levy if you do not do something.

This is the fourth notice in the sequence for our client for tax year 2022. As you can see, he/she/they are moving through the IRS machinery rather quickly. Then again, almost $225,000 in taxes and penalties buys you a better spot in line.

The CP504 is however not the final:final notice.

Let’s talk IRS procedure.

Before the IRS can go after your stuff (bank account, car, John Cena collectibles), it must (almost always) allow you a hearing. This is called a Collection Due Process (CDP) hearing, and it entered the tax Code with the 1998 IRS Restructuring and Reform Act. The Act was Congress’ response to IRS horror stories, including aggressive collection actions.

The IRS is not allowed to go after you until you have been offered that CDP hearing. You can turn it down, blow it off or whatever, but the IRS must provide the opportunity before it can unleash the tender attention of Collections.

 Except …

There is a short list of stuff the IRS can levy before a CDP. The list is uncommon air, except for:

Your state tax refund

That’s it. For most of us, the IRS can only go after our state tax refund – at this stage.

Then you have the FINAL BIG BAD notice: either the 1058 or LT11.The difference depends on whether you have been assigned to a Revenue Officer (RO).

LIFE TIP: Avoid having your own Revenue Officer.

 

If you get to a 1058 or LT11, you are at the end of the line. You will be dealing with Collections, and it is unlikely you will like the experience.

You may want an attorney or CPA, depending upon.

Not that having a CPA seems to matter – because clearly not - to our client.

IRS Collection Alternatives: Pay Attention To Details

 

I was glancing over recent Tax Court cases when I noticed one that involved a rapper.

I’ll be honest: I do not know who this is. I am told that he used to date Kylie Jenner. There was something in the opinion, however, that caught my eye because it is so common.

Michael Stevenson filed his 2019 tax return showing federal tax liability over $2.1 million.

COMMENT: His stage name is Tyga, and the Court referred to him as “very successful.” Yep, with tax at $2.1-plus million for one year, I would say that he is very successful.

Stevenson had requested a Collection Due Process (CDP) hearing. It must have gone south, as he was now in Tax Court.

Why a CDP hearing, though?

Stevenson had a prior payment plan of $65 grand per month.

COMMENT: You and I could both live well on that.

His income had gone down, and he now needed to decrease his monthly payment.

COMMENT: I have had several of these over the years. Not impossible but not easy.

The Settlement Officer (SO) requested several things:

·      Form 433-A (think the IRS equivalent of personal financial statements)

·      Copies of bank statements

·      Copies of other relevant financial documents

·      Proof of current year estimated tax payments

Standard stuff.

The SO wanted the information on or by November 4, 2021.

Which came and went, but Stevenson had not submitted anything.

Strike One.

The SO was helpful, it appeared, and extended the due date to November 19.

Still nothing.

Strike Two.

Stevenson did send a letter to the SO on December 1.

He proposed payments of $13,000 per month. He also included Form 433-A and copies of bank statements and other documents.

COMMENT: Doing well. There is one more thing ….

The SO called Stevenson’s tax representative. She had researched and learned that Stevenson had not made estimated tax payments for the preceding nine years. She wanted an estimated tax payment for 2021, and she wanted it now.

COMMENT: Well, yes. After nine years people stop believing you.

Stevenson made an estimated tax payment on December 21. It was sizeable enough to cover his first three quarters.

COMMENT: He was learning.

The SO sent the paperwork off to a compliance unit. She requested Stevenson to continue his estimated payments into 2022 while the file was being worked. She also requested that he send her proof of payments.

The compliance unit did not work the file, and in July 2022 the SO restarted the case. She calculated a monthly payment MUCH higher than Stevenson had earlier proposed.

COMMENT: The SO estimated Stevenson’s future gross income by averaging his 2020 and (known) 2021 income. Granted, she needed a number, but this methodology may not work well with inconsistent (or declining) income. She also estimated his expenses, using his numbers when documented and tables or other sources when not.

The SO spoke with the tax representative, explaining her numbers and requesting any additional information or documentation for consideration.

COMMENT: This is code for “give me something to justify getting closer to your number than mine.”

Oh, she also wanted proof of 2022 estimated tax payments by August 22, 2022.

Yeah, you know what happened.

Strike Three.

So, Stevenson was in Tax Court charging the SO with abusing her discretion by rejecting his proposed collection alternatives.

Remember the something that caught my eye?

It is someone not understanding the weight the IRS gives to estimated tax payments while working collection alternatives.   

Hey, I get it: one is seeking collection alternatives because cash is tight. Still, within those limits, you must prioritize sending the IRS … something. I would rather argue that my client sent all he/she could than argue that he/she could not send anything at all.

And the amount of tax debt can be a factor.

How much did Stevenson owe?

$8 million.

The Court decided against Stevenson.

Here is the door closing:

The Commissioner has moved for summary judgement, contending that the undisputed facts establish that Mr. Stevenson was not in compliance with his estimated tax payment obligations and the settlement officer thus was justified in sustaining the notice of intent to levy.”

Our case this time was Stevenson v Commissioner, TC Memo 2023-115.

The Problem-Child Client: Recidivist

 

It happens: the problem-child client.

Let’s talk about one type of problem child: the recidivist.

Thomas Kelly was a securities broker in New York City. We have three tax years at play - 2013 to 2015. Thomas had not been filing his returns or paying his taxes.

On December 22, 2017, he filed 2013, reporting adjusted gross income of $1.9 million. The tax was approximately $690 grand.

A few days later (December 26, 2017) he filed 2014, reporting AGI of almost $1.5 million and tax of approximately $515 grand.

Keeping the streak going, on January 17, 2018, he filed 2015, reporting AGI of $1.2 million and tax over $400 grand.

Got it. Thomas fell out of the system and was now trying to get back in. Maybe there had been familial or medical setbacks. He was trying to correct his mistakes. Everybody likes a comeback story.

Let’s jump forward over a year and a half to September 2019. Thomas owed the IRS over $2.5 million for years 2013 through 2015.

Late file penalties. Late pay penalties. Interest on everything. Yep, it gets expensive.

The IRS issued three notices:

* Two for liens

* Another for a levy

Thomas requested a CDP (Collection Due Process) hearing. He was after three things:

* He wanted a payment plan

* He wanted withdrawal of the liens

* He wanted abatement of the penalties

Got it. So far this is standard stuff.

The hearing was scheduled for March 2020.

Then COVID happened.

The hearing was held-up until February 2021.

At the hearing …

FIRST, Thomas wanted to pay $30,000 per month.

Problem: Thomas owed enough that $30 grand would not pay his taxes in full before the statute of limitations played out.

CTG: This is a called a partial pay plan. There are requirements in the Internal Revenue Manual (IRM), and one is that the taxpayer be current on his/her other taxes. Thomas owed approximately $250 grand on his 2019 taxes.

The IRS did not want to include 2019 in his payment plan. In addition, the IRS did not see payments on his 2020 estimated taxes.

CTG: Borrow $250 grand and a bit more for those estimated taxes, Thomas. Battle, war, and all that.

It makes sense if you think about it. Thomas was asking the IRS to accept less than a dollar-on-a-dollar for past taxes. He was then asking the same deal for his current taxes. The IRS was not going to agree to this.

Thomas dug in his heels and wanted the IRS to include 2019 and 2020 in the payment plan.

The IRS of course didn’t.

Thomas complained that the IRS settlement officer abused his discretion in denying him a payment plan.

CTG: Thomas, shut up.

SECOND, Thomas wanted the liens removed.

CTG: This one is going to be tricky. The IRS is reluctant to remove a lien, especially once you get to those dollar levels.

Thomas argued that the IRS Settlement Officer abused his discretion in refusing to withdraw the liens.

CTG: Thomas … SHUT UP!

Thomas next argued that releasing the lien would facilitate his being able to pay the tax. The lien would affect his licensing, and that effect could negatively impact his earning power.

CTG: Nice segue. We now need to go from “could” to “would,” as we need to persuade skeptical parties. Is there a cite from governing body rules and regulations we can copy and paste? Can you get a letter from your employer? We need something more than our word, as that is considered self-serving.

Nope, says Thomas. My word is good enough.

CTG: You are not taking advice well, Thomas.

THIRD, Thomas wanted the penalties abated. He had two arguments.

CTG: Bring it.

The first was that he qualified for first time abatement (FTA).

CTG: OK, but that will address 2013 only. You won’t be able to use it again for the other years.

FTA is bread-and-butter. If you have been clean for the preceding 3 years, the IRS can waive the penalty. The FTA applies to a limited number of penalties, but the good news is that limited number included Thomas’s specific penalty.

Good job, Thomas.

However, the IRS pointed out that Thomas had penalties for 2012. The … tax … year … immediately … preceding 2013.

CTG: Thomas, did you even google what FTA is?

Thomas had a second argument: he had reasonable cause.

CTG: OK, Thomas, sway me.

His wife started spending money like madwoman in 2007. This caused all matters of marital and financial problems. She filed for divorce in 2015.

CTG: Thomas …

The attorney fees were crushing. He was having financial hardship …

CTG: Thomas …

… emotional problems …

CTG: Thomas …

… battling depression.

CTG: Thomas, the Court is going to want to know how your divorce proceedings – in 2015 – affected your tax responsibilities for 2013 and 2014.

Tax Court: Yes, Thomas, please tell us.

Here are a few trenchant comments by the Court:

He successfully conducted his securities business during 2013 – 2015, earning more than $1 million annually …”

… he has a history of tax noncompliance, dating as far back as 2009.”

His allegations of financial hardship at the relevant times thus seem questionable.”

CTG: We are losing them here, Thomas.

Tax Court:

In any event, financial hardship ‘generally does not affect a person’s ability to file.’”

CTG: Going…

Tax Court:

At the time of the CDP hearing petitioner’s outstanding liabilities for 2013 - 2015 exceeded $2.5 million. Those liabilities arose from his repeated failure to file returns and pay tax, despite earning between $1 million and $2 million annually. During the hearing he refused to pay even his (comparatively modest) estimated tax liability for 2020.

CTG: Gone.

Yes, the IRS sours with a recidivist. I have seen the IRS dig in when they see someone failing to file, never paying estimates, extending with no payment, repetitively filing returns with significant balances due. This is not a matter of knowing how to navigate the IRS. One can navigate like Magellan and not get there.

Thomas could have - I believe - gotten a partial pay. Perhaps he needed to borrow to pay 2019 and 2020, but: so what? He had the earning power, and borrowing would have facilitated the (much more significant) $2.5 million at play for 2013 through 2015.

He had a shot at releasing the liens if he could show (likely) injury to his earning power. He had to show some cause, though, otherwise everyone would make this argument and the IRS would never be able to lien.   

He was hosed on penalty abatement, however. Recidivist.

He certainly did not need to fling charges of abusing discretion. The Settlement Officer was just following IRM guidelines, which Thomas (or his tax advisor) could have double-checked at any time.   

Our case this time was Thomas E Kelly v Commissioner, T.C. Memo 2022-73.

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.