What Can The IRS Do To You For Ignoring That Wage Or Levy Request?

What happens if the IRS sends you a levy (say on an employee, but it could also be your account payable to a vendor) and you ignore it?

You can guess that it is not going to be good.

I am looking at U.S. v 911 Management.

Daniel Dent was the sole manager of 911 Management, a limited liability company. The company must have been successful, as it was distributing $5,700 monthly to Kathy Weathers, one of its members. In 2007, the company further entered into an agreement with Kathy to operate two hotels owned by her, from which it would pay her 3% of the monthly gross proceeds.

In 2007, the IRS served levy against the bank accounts of 911 Management. That action wound up in litigation.

In February 2008, the IRS served Notice of Levy on 911 Management. It wanted both the $5,700 and 3%, as the Weathers had fallen behind on taxes for 1996 and from 1998 through 2006. Turns out that Tom and Kathy Weathers were convicted of tax fraud. Tom was serving 60 months at Club Fed, and Kathy received two years of probation.

OBSERVATION: Tom Weathers went to prison in October 2005. Coincidentally, 911 Management was formed the same month. The Company was paying Kathy $5,700 monthly, and that amount increased when she added the management of two hotels into the mix. The IRS was fairly confident that the transaction was a sham and a way to provide monies to her while her husband was in jail.

There were technical issues with the levy notice, and the previous levy effort by the IRS was in litigation. Dent contacted his business advisor as well as an attorney, and he in turn received two separate but not conflicting responses. The business advisor informed him that a bond had been posted, satisfying all the back taxes for the Weathers. It was therefore not necessary to honor the Notice of Levy, as the matter had been resolved.

COMMENT: The Revenue Officer informed Dent otherwise and that monies were still due. This must have alerted Dent that not all the facts were in.

Dent also contacted an attorney, who had reservations about the levy procedure itself. The attorney believed that the levy did not apply, because the levy was for salaries and wages and the payments to Mrs. Weathers were neither.

OBSERVATION: Thus began a high-stakes gambit. There are tax practitioners who play a heavy-procedural game, waiting if not stoking the IRS to make a procedural mistake. For the most part, I have found this to be the arena of the tax attorneys rather than tax CPAs, and I have been on the listening end of some scathing anecdotes by IRS revenue agents over the years. The IRS catches on, of course, and will commonly assign more experienced agents when such a practitioner surfaces. Still sometimes the tactic works, and the tete a tete continues another day.

Dent informed the revenue officer that the levy did not apply. He of course did not remit the $5,700 or the 3%. The revenue officer vociferously disagreed. Dent did not remit anything, relying upon his attorney’s advice that the levy was erroneous.

Remember that I mentioned the IRS had levied in 2007, a year before? That case was decided, and both 911 Management and Dent were held personally liable for the levy request. That is what happens when one ignores a levy: one steps into the shoes of the delinquent taxpayer. It is the levy equivalent of the “responsible person” taxes, which apply when one does not remit withheld payroll taxes.

So Dent was held personally responsible. Can it get worse?

You bet.

There is another penalty: the Section 6632(d)(2) penalty, which is 50% for failure to honor the levy. The IRS wanted this penalty against Dent. Remember, the IRS believed 911 Management to be a sham, so they were going to go the extra mile against Dent for participating in the sham and resisting the levy.

There is a “reasonable cause” exception to the penalty, and the Court decided that Dent had reasonable cause. How? Apparently, there was enough smoke on the water over IRS procedure in pursuing the levy that the Court accepted Dent’s reliance on his attorney as reasonable cause.

Mind you, they accepted his reliance on an attorney as reasonable cause to not levy another 50%. Dent was already personally responsible.

Another “win” like that and Dent might bankrupt himself.

COMMENT: 911 Management came into existence when Mr. Weathers went to jail in 2005 for five years. When did 911 Management cease doing business? Five years later – 2010 – when Mr. Weathers was released from jail. Coincidence? Just saying.

Has The IRS Noticed You?

My partner asked me today whether I thought we are seeing more tax notices. We are pretty keen on this issue, as tax notices – any tax notice – reflect badly on the quality of our work.  I would begin to question my dentist if I routinely received notices from the Internal Dental Service, the Ohio and Kentucky Departments of Dentistry, the Cincinnati Dentistry Division, …. You get the idea.

Have you heard about the IRS’ recent fishing expedition? It is called “Notification of Possible Income Underreporting.” There’s a name. Why don’t they just bash down your door and arrest you? 

What is causing this is the use of debit and credit cards. The payment settlement entities (think Visa) and third-party payers (think PayPal) are now required to relay financial data to the IRS via Forms 1099-K. The IRS has their nose into how much you are depositing into your business checking account. You can pretty much guess that the IRS is matching A to B and is sending out letters when they do not match.

There are four possible letters the IRS may send, each requiring its own response:

1. Letter 5035 – the softest of the letters. You do not need to respond.
2. Letter 5036 – you want to respond within 30 days as the IRS reserves the right to assess you.
3. Letter 5039 - you now need to complete yet another form – Form 14220 Verification of Reported Income. Lucky you.
4. Letter 5043 – if you believe that the return you filed is accurate, then you must provide the IRS with a written explanation of why you believe that. (Think about that sentence for a minute).  Again, failure to respond may trigger an assessment.

Now, a normal person would anticipate that the IRS would compare what a business reports as gross revenue to the 1099-K.  As long as the first number equals or exceeds the second, all should be OK.

Oh, to be young and naive.

That is NOT what the IRS is doing.

How can the numbers go awry? Well, a couple of very common transactions come immediately to mind: 

• The 1099-K “sales” will include sales taxes. Generally speaking, accountants do not include sales taxes in “sales,” primarily because sales taxes are not sales. A business collects sales taxes as an “agent” and is required to remit them to the state tax department. Does this sound like “sales” to you?
• The 1099-K includes cash draws by the customer. Say you buy something and take an extra $20 in cash. Again, most accountants would not report that transaction as a “sale.” Same reason as (1).

The IRS has created an alternate universe. How? Well, they did a study, apparently super-secret and better concealed than donor lists to Section 501(c)(4) nonprofit applicants or the tax records of the American Issues Project. This study has determined sales levels for different lines of business – dry cleaners, florists and so forth – as well as “average” proportions of debit and credit card sales to total sales. The IRS has one piece of this information – the debit and credit cards – so now it backs into expected sales (based on averages). If you report lower sales than that… BAM!... here’s your letter.

Why does this upset me?

(1)  This exercise is based on averages. The IRS is wasting a taxpayer’s time because somebody-who-knows-somebody-overheard-somebody-talking-about…. You get the idea. It would waste less time and possibly be cheaper for the government to just mug the taxpayer.

(2)  How much of a tax professional’s time – my time –are they wasting? Can I even bill for this nonsense? Last time I checked, the IRS is still not sending me a paycheck. Maybe I should start invoicing them.

(3)    Understand what the IRS is doing here: they are shifting an examination function onto the shoulders of the taxpayer and his/her tax advisor. The IRS can potentially ask for anything: maybe the name of the church you attend. It can then conduct a “study” to determine average donations to that church. Guess what? If you exceed that amount, get ready for a notice. Where does this end? If the IRS wants to examine you, then let them examine you! At least they would have skin in the game, as they would have to pay the examiner’s salary. Perhaps that would cool their heels a bit.  

(4)    The backbone of our tax system has been voluntary compliance. As the nation becomes increasingly bankrupt, the “voluntary” part is becoming laughable. The government – enforcing through the IRS – is forever wringing us for more information: for FBARS, for cost basis on the mutual fund you sold, for the tax ID number of your child’s day care, for foreign bank reporting (FATCA) on your account overseas.

Think about that last one. How would you feel if Japan required all U.S. banks to report to Japan on accounts owned here by Japanese citizens? And – to put the cherry on the sundae – slap a 30% tax on any U.S. bank obstinate enough to not comply with Japan’s decree? I tell you what I would do if I were a bank president: I would not accept accounts from Japanese citizens. Guess what foreign banks are doing to American expats. Congratulations, you are smarter than an average U.S. Representative or Senator.

Going back to my partner’s question: yes, we are seeing more notices these days, because almost every year the IRS finds new ones to send out.

Goodness knows what they will trot out next year.

Dealing With A Tax Levy

We recently spoke about IRS liens. Let’s continue the conversation and talk about levies.

A levy taps into our primal fear of the IRS. This is where they come and take your checking account, repossess your car and sell your house. You get behind on your taxes and you get to relive the Grapes of Wrath.

Rest assured that your fear of losing your car and your house are greatly overblown. Your fear of losing your checking account may not be, however.

How did you get to this point? 

Somewhere in the recent past, the IRS sent you a notice – actually, a series of escalating notices. An early one may have read something like:

According to our records, you have an amount due on your income tax.”

There will be several notices, increasing in intensity. It is likely that you ignored them. Perhaps you just knew that their numbers were wrong. Perhaps you were broke and had nothing to send. Whatever the case, the one thing you failed to do was talk to them. 

Eventually you will receive the CP 504 letter (“Intent to Seize Your Property or Rights to Property”), where the IRS says that they intend to intercept your state tax refund. The notice also allows IRS to increase your penalties, but it is the state refund that catches people’s attention. Not that much attention, though. I do not get too many calls on a 504. Chances are if you are behind on federal taxes, you are behind on state taxes too.

The 504 is the demarcation line when your account leaves Automated Collections. You are now moving to regular Collections. The 504 is also the last notice before the IRS sends Form CP 90 “Final Notice of Intent to Levy and Notice of Your Right to a Hearing.” 

If you have a CP 90, you have serious business. The IRS will send it certified mail to your last known address, so if you have moved – especially if you did not file returns – you may not even know that this notice went out. The IRS has to go through certain hoops before it can levy, and this notice is key. You have 30 days to claim a Collection Due Process Hearing. If the IRS moves against you without issuing a Final Notice, or before the 30 days are up, you can stop them. If you claim a CDP Hearing, you can present your side of the story.

What if the 30 days pass?

One thing the IRS can then do is levy your bank account. How do they know your bank account information? One way is pretty simple: you had your refunds electronically deposited to your bank account. They can still get to that information otherwise, but electronic transfer made things easier for them. A bank levy is a one-time shot. The IRS instructs the bank to turn over whatever you have in your account as of a given date. The bank has 21 days before they have to turn over the money. There are important points we should review:

·        It is 21 days from when the bank received the notice, not the date of the notice.

·        The levy amount is your balance when the bank received the notice. If you deposit money later, that later deposit will not go to the IRS.

·        If the IRS wants that later deposit, it will have to issue another levy.

My experience has been that banks may not be overly concerned with informing you about the levy. Odds are that you will have less than 21 days before you find out, unless you attempted to withdraw funds or some similar action shortly after the bank received the levy. I have had clients who learned about the levy after the 21 days ran off. Let me tell you, there is almost no chance of getting that money returned when that happens.

Another thing the IRS can do is a wage levy. The IRS contacts your employer and tells him/her to send money. IRS Publication 1494 has tables telling you and your employer how much of your money you get to keep. For example, if you are divorced with two kids and are paid monthly, you keep $1,720. The balance goes to the IRS. The upside is that the $1,720 is after taxes, health insurance and whatnot. The downside is that you and your two kids might not be able to live on $1,720 per month.

It gets worse. The wage levy is continuous. It need not be reissued like a bank levy. People have quit their jobs over a wage levy. There isn’t much an employer can do. If your employer refuses to remit the money from your paycheck, then he/she is personally liable to remit the money from his or her own funds. Good luck finding an employer who will do that for you.

Can the IRS levy monies you receive as an independent contractor? You bet. Can it levy your social security? Yes, up to 15 percent. Can it go after your PayPal? Surely, you jest. Of course they can.

What about your house and car? Not so much. Let’s go over some statistics to put your mind at ease. In 2011, the IRS issued almost 3.8 million third-party levies. The IRS seized less than 800 houses, cars and other personal property. The IRS does not want the hassle of taking and selling your property. It wants cash.  It does not want your car, unless your car is a late-model Ferrari or something of the sort. In fact, if you have minimal equity in the asset, the IRS is prohibited from taking the asset from you.

Alright, you have received a Final Notice. What do you do next?

First, be aware of time. Remember that you have 30 days. Use it.

File a collection appeal. This will temporarily pull you away from the part of the IRS that is trying to collect and puts you in another part that will hear your case. How long is temporary? Figure on about 4 to 6 months before your hearing. 

Be ready to talk about a payment at the hearing, though, because that is where Appeals will take the conversation. They will ask for full payment immediately, the same way my dog is always hopeful I have brought her home a hamburger or something similarly tasty. 

What if you are truly broke? Then the IRS may place your account on “cannot collect” status. This means that you are so broke that you cannot make a payment, any payment. How can that happen? Let’s say that you could not pay rent if the IRS wiped-out your checking account. Perhaps you could not pay for necessary prescriptions. The term is “hardship,” and they will consider this. 

What if the taxes belong to your ex-spouse from a year when you filed a joint tax return? An innocent spouse claim will get the IRS to stay collection.

What if you file an offer in compromise? An offer will get the IRS to stay collection.

What if the IRS assessed you without your knowledge? Let me give you an example. I represented a client whose wife passed away. He received IRS notices when she became gravely ill, and upon her death he retreated from the world for a year or more. The IRS – not hearing from him – made adjustments and assessed all kinds of taxes and penalties. What did we do? We requested a reconsideration, which is also a way to stay collection.

Then we get to a payment plan. The particular type of plan depends on how much you owe. If you owe less than $50 thousand, you can request a “streamlined” plan. You promise to pay the IRS over 6 years, which translates into a maximum of $694 per month ($50,000 divided by 72). It is called streamlined because you get to submit minimal information to the IRS. This is a big deal, as the normal paperwork can be a pain. 

Let’s say that you owe over $50 thousand. You will now be submitting financial information, including bank statements and copies of bills, to the IRS. The IRS will apply “standards” to your expenses, and if your expenses exceed those standards they may (and likely will) disallow the excess. I have been through this exercise many times, and I can assure you in advance that the IRS’ calculation of what you can pay is more than what you think you can pay. You likely will be saying goodbye to your I Phone data package, your satellite TV, the leased car you really cannot afford and so on. The IRS does not want to subsidize your lifestyle. 

There may be variations in your particular payment plan. A standard payment plan requires you to pay-off the IRS over time. What if you cannot? The IRS may agree to a “partial pay” plan, which means that the plan will not completely pay-off the IRS unless the plan payment or plan term is changed. In my experience, I have had to go to Appeals to get this plan, but I have gotten it. 

Another possibility is to file bankruptcy. Although a last resort, a bankruptcy results in a “stay” of all credit actions, including the IRS.

What if you miss the 30-day window on the Final Notice? Not all is lost. You can still request a hearing, now called an “equivalency” hearing. You still get Appeals involved, but the IRS does not have to delay collection action – including bank levy or wage garnishment - until the hearing.

Depending on your situation, consider a tax professional. You want an attorney or CPA who specializes in taxes. As a heads up, most CPAs and attorneys do not specialize in taxes. Another alternative is an Enrolled Agent, who – by definition – specializes in taxes. Be sure to clarify whether they have done tax representation before.  One can “do taxes” and have never represented. It really is two different things, and you do not need to pay someone while they learn the ropes.