Has Maryland Been Caught Reaching Into The Tax Cookie Jar?

There are several states that impose a county tax in addition to a state income tax. Maryland is one of those states, and it has attracted attention to itself with the Maryland v Wynne. This case will soon go before the Supreme Court, which will decide whether Maryland has run afoul of the Commerce Clause of the Constitution.

That sounds esoteric.

It is not that bad, though, as long as we stay out of the weeds.

Let’s start this tax tale with an S corporation shareholder. His name shall be Clark. You may remember that “S” corporations do not pay tax (except in rare circumstances). Instead the corporation “passes through” its income to its shareholders, who in turn report their proportionate share of the corporate income on their individual tax returns.

Let’s say that Clark and his wife live in Maryland.

Let’s say that the S corporation does business both inside and outside Maryland. This means that Clark gets to pay income tax to all the states where the S corporation does business. This happens all the time, much to the chagrin of the tax professional who gets to prepare the paperwork.

Clark's corporation does business in North Carolina,. Clark pays tax to North Carolina (remember: the shareholder pays the income tax for an S corporation). Clark then takes a tax credit on his Maryland income tax for the taxes paid North Carolina. As long as North Carolina is not more expensive than Maryland, there is no-harm-no-foul, except for the professional fees to sort all this out.

And there we encounter the rub.

You see, Maryland divides its tax between a “state” tax and a “county” tax. And it makes a difference.

Enter Brian and Karen Wynne (the Wynnes). They are shareholders in Maxim Healthcare Services, Inc., an S corporation that files returns in 39 states. They themselves live in Howard County, Maryland. When they filed their 2006 Maryland tax return, they claimed taxes that they paid the other 38 states as a credit against their Maryland tax.

And the Maryland State Comptroller changed their numbers and sent them a bill. This lead to Appeals, then Maryland Tax Court, followed by the Circuit Court and – now - the Supreme Court.

The Comptroller’s argument? The Wynnes could not claim a credit for taxes paid other states against the county portion of the Maryland tax. Maryland changed its law in 1975, which was like … a really, really long time ago. Why are we even going there? How can one reasonably offset a state tax against a county tax?

I have to disagree.

Take two people living in Maryland. Have one invest in an S corporation that does all its business inside Maryland. Have the other invest in an S that does all its business in Maine. Unless the other state’s income tax rate is less that the Maryland state income tax rate, the first investor will pay less tax than the second investor. Tell me, how is that fair? Is the state not burdening interstate commerce by taxing the second investor (who invested outside Maryland) more than the first (who invested exclusively within Maryland)? And there you have the core of the challenge under the Commerce Clause.

Let’s use some numbers to make this concrete.

Say that the S corporation income allocable to Maine is $1,000,000. 

(1) The top Maine income tax is 7.95%, so let’s say the Maine income tax will be $79,500.

(2) The top Maryland state income tax rate is 5.75%, so the state income tax will be $57,500.

(3) The Maryland county tax rate is 3.2%, so the county income tax will be $32,000.

(4) This makes the total tax to Maryland $89,500. This exceeds the Maine tax by $10,000.

One offsets the $79,500 paid Maine against the $89,500 otherwise paid Maryland, and it all works out, right?

This is where you get hosed. According to Maryland, you cannot take the excess $22,000 (that is, $79,500 – 57,500) and claim it against the county tax. After all, it is a …. county tax. It does not make sense to offset Maine’s state tax against Maryland’s county tax.

Uhhh, yes it does.

Let us play games with this, shall we? I live in Kentucky, for example. Kentucky has 120 counties. Only Texas and Georgia have more counties, and I wonder why anybody would want more. I understand this goes back to rural times, when travel was more arduous. Nowadays it doesn't make much sense. How much money is wasted on duplication of facilities, county commissions, staff and services that accompanies all these counties?

Let’s say that Frankfort finds itself in a financial bind. Some hotshot realizes that disallowing a resident credit to Kentuckians with income outside the state would help to bridge that financial bind. Said hotshot proposes to carve the Kentucky state income tax into two parts: the state part and the county part. When the county part arrives, Frankfort will just pass it along to the appropriate county. Considering that Frankfort is shuttling monies to the counties already, all one has done is rearrange the furniture.

Except that Frankfort now keeps more money by disallowing a resident credit against all those county taxes. After all, it does not make sense to allow a state tax credit against county tax, right? Pay no attention that Frankfort itself would have created the distinction between state and county income tax. Why that was ... a really, really long time ago. Why are we even going there?

Could Maryland possibly, just possibly, be cynical enough to be playing out my scenario?

I’ll bet you a box of donuts that they are.

So Maryland v Wynne is before the Supreme Court, which will review whether Maryland has violated the “dormant” Commerce Clause. The Maryland Association of Counties has joined in (I will let you guess on which side), and the case has attracted considerable attention from tax practitioners and government policy wonks. There is, for example, some interesting tension in there between the Due Process and Commerce Clauses, for those who follow such things.

The case is scheduled for hearing the second week of November.

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.