Dealing With A Tax Lien

A client contacted me this past week. He received a Notice of Federal Tax Lien, and he wanted to find out if (1) he should worry about it and (2) if I could do anything about it.

Here is the pat answer in tax practice: it depends.

A lien is different from a levy. Odds are you and I would worry more about a levy than a lien.

A levy means that the IRS comes in and takes your money. The two classics are the wage garnishment, where they contact your employer and have him/her send them part of your paycheck, and the bank levy, where they swoop in a drain your bank account.

The IRS places a lien on a taxpayer’s property when he/she has unpaid tax debt. It does not mean that they are going to garnish your paycheck or seize your house, but it does mean that they have filed something at the courthouse alerting the world that you have unpaid debt. That lien can cost you over a hundred points on your credit score. In today’s world, that could affect you being offered a job or being approved for an apartment.

A lien can stay on your credit report for years, even after the tax is paid-off.

The IRS has realized the injurious effect of its previous lien policy. It has taken steps, albeit small, to alleviate some of the sting:

(1) The IRS has increased the minimum amount of tax debt that prompts the filing of a tax lien from $5,000 to $10,000.

(2) If you owe less than $25,000, the IRS will withdraw the lien if you set up a direct debit installment plan. This means they automatically draft money from your bank account every month. You have to pass a probationary period of three months (and three payments). The IRS will then withdraw the lien.

OBSERVATION: Words are important here. Record of a lien can remain on your credit report, even after it is removed. You prefer a withdrawal of the lien, as a withdrawal is as if nothing ever happened.

(3) Even if you owe less than $25,000 and have made at least three payments under a direct debit plan, you still have to request that the lien be withdrawn. You should submit Form 12277 Application for Withdrawal of Filed Notice of Federal Tax Lien, although any written request that provides the necessary information likely will suffice.

(4) Even after all this, you want to contact the credit bureaus to be certain that your records have been updated.

What if you owe more than $25,000? This is my client’s situation, and there are not many good options.

(1) Pay off the tax debt in full.

OBSERVATION: This one ranks a ‘duh.” Nonetheless, the point to consider is that you might be able to borrow and pay off the IRS. Granted, you still owe money, but at least you can stop the ongoing ding to your credit.

(2) Post a bond.

OBSERVATION: Again, if you have enough money to post a bond, you likely can pay-off the debt. I have never seen someone post a bond to release a lien.

(3) Request a partial release

You own several assets encumbered by the lien. If you need to sell an asset, you can request partial release from the lien. Expect the IRS to want the money from the sale, of course.

(4) Offer in Compromise

This is the “pennies on the dollar” commercial on radio or overnight television. The idea here is that you offer the IRS what you have, plus a portion of your future earnings, to pay-off a tax debt. If you still have years to go in the workforce and have reasonable earnings potential, you likely will not qualify for “pennies on the dollar.” The IRS can also see your earning power over the next few years, and they will be loathe to let you walk away. However, if you have modest assets and are disabled, retired or near retirement, the OIC may pack a punch.

What did I recommend to my client? He owes more than $25,000, and enough more where I cannot have him pay-down to $25,000. He is young enough, and has enough earning power, where any offer in compromise would yield little (if any) more benefit than a payment plan. In that case, I would prefer to remain in a payment plan, as an offer will toll the statute of limitations.  That takes away my last ditch option…

(5) Run the 10-year statutory collection period

The IRS has 3 years to audit your return and 10 years to collect. Sometimes they overlap, and the two periods run concurrently.  Think of running the bulls in Pamplona for 10 years, and you can visualize this tax strategy. Still, sometimes it works, which is why tax advisors continue to talk about it. 

The trap here is “tolling,” which means that the collection period is suspended. Toll enough and the 10 years can become 15 or 20 years. What causes a toll? A bankruptcy application causes it. So does an offer in compromise.

There is no releasing my client’s lien early. Why? The IRS will generally not release a lien if it knows it will not be fully paid-off.  My client has a partial pay plan, which means that his full liability will not be paid off unless the plan payment or period changes.  

He owes over $25 thousand and will not pay-off the IRS in full as the plan now stands. He is hosed.

IRS Has Another Way To Levy

You may know that – if you fall behind on your taxes – the IRS may draft your bank account or garnish your wages. These actions are called “levies.”

The IRS has a new revenue source to levy.

If you sell on eBay or Amazon, or accept PayPal, you may have received a Form 1099-K. The 1099-K reports monies paid to you, if you exceed a certain dollar or number-of-transactions threshold.

There are new instructions to IRS revenue officers.

1.      They now have another address at which to contact you, should you have moved and disappeared from their radar.

2.      They now can levy those eBay, Amazon or PayPal payments, if you owe the IRS money and have not entered into a payment plan. They will levy future payments until the taxes are fully paid.

The 1099-K is joining the long-established levy program on W-2s and bank accounts. The levy program on 1099-Miscellaneous (that is, independent contractor) income has also been around for a while.

Small Business Health Care Tax Credit Redux

We’ve been looking again at the small business health care tax credit. Truthfully, I have been less than impressed with this credit, at least for our clients. It seems quite heavily engineered to accomplish so little.

There are three key steps to this credit:

(1)    How many employees do you have?

(2)    How much do you pay them?

(3)    Do you have a “qualifying” insurance arrangement?

Let’s go through them.

HOW MANY EMPLOYEES DO YOU HAVE?

To be fair, the credit does not address the number of employees. It instead addresses “full time equivalents.” This makes sense, as it may require two (or three) part-time employees to have one “full-time equivalent” employee.

The first thing to do is count the number of employees. This requires a definition of “employee” (remember, this is the tax code). The term “employee” does NOT include the following:

·         a sole proprietor

·         a partner in a partnership

·         a more-than-2% shareholder in an S corporation

·         a more-than-5% owner in any other business

Wait, there is more:

·         a family member of the above, including spouses, lineal family (ancestor/descendent) and in-laws.

So, you start with your year-end payroll summary. You eliminate the owners and their family. That leaves you with “employees’ for purposes of this credit.

Next you add-up the hours worked for those who remain. You stop counting at 2,080 hours per employee. After you adding-up all the hours, you divide by 2,080 to arrive at the number of FTEs. If this number is less than 25, you are still in the hunt.

The magic number is 10 or less FTEs. Above that number you will start to phase-out. By 25 you have phased-out completely.

HOW MUCH DO YOU PAY THEM?

We are talking Medicare wages, not income-taxable wages. The key difference will be contributions to 401(k)s, as those are Medicare-taxable but not income-taxable.

Fortunately you get to exclude the wages for the people left out above: the owners, their spouses and other family.

This can get you into an odd factual situation. You can have a workforce over 25 people – all full-time – and still qualify for this credit. The reason is that you have to eliminate the owners, their spouses and family. For some of our clients, that eliminates a sizeable part, if not the majority, of the workforce.

The key number here is $25,000 per FTE.  Above that amount you will start to phase-out.  By $50,000 you have completely phased-out. 

DO YOU HAVE A “QUALIFYING”INSURANCE ARRANGEMENT?

The insurance we are discussing is what you would anticipate: traditional insurance, HMO, PPO and hospital indemnity. It also includes specified illness (think cancer insurance) as well as some dental and vision insurance.

What it doesn’t include is an HSA.

The key requirement is that you – the employer - have to pay at least 50% of the cost of the insurance. There are some tweaks around the edges (such as if the insurance company does not charge the same premium for all employees in single coverage).

If you do not pay at least 50% of the health insurance, there is no point in even starting the calculation.

There is also a “ceiling” test: your insurance can only be so expensive for purposes of this calculation. The government will publish state-specific amounts for “small group market average premiums.” Your insurance cannot exceed that amount for your state.

AN INTERIM STEP

Add-up your cost of premiums for “qualifying” insurance for your “FTEs.”

WHAT IS THE AMOUNT OF THE CREDIT

If you are for-profit, the credit is 35% of the interim step.

ARE WE DONE?

Of course not. If you have too many employees – or the right number of employees but pay them too much – your credit gets phased-out, eventually to zero. No credit for you.

There are two phase-outs, which means that you cannot do this in your head.

(1)    If you have more than 10 FTE’s you start to phase-out. The phase-out is

(FTE – 10)

15

                                So, at 25 FTE’s you are completely phased-out.

(2)    If your average wage is more than $25,000, you start to phase-out.

(average annual wage - 25,000)

25,000

                                So, at $50,000 you are completely phased-out.

HOW ABOUT AN EXAMPLE?

Let’s say that you have 9 FTEs with an average wage of $23,000.

4 are single coverage and 5 are family coverage. You pay 50% of the single rate.

The premiums are $4,000 for singles and $10,000 for family. The state limits are $5,000 for singles and $12,000 for family.

Here is the calculation.

                                $2,000 times 9 equals                     18,000

The credit is 35% times 18,000 or $6,300.                      

LET’S CHANGE AN ASSUMPTION

What if the employer pays 50% whether of single or family coverage?

Here is the calculation:

                                $2,000 times 4 equals                     8,000

                                $5,000 times 5 equals                   25,000

                                                                                           33,000

The credit is 35% times 33,000 or $11,550.                    

HOW ABOUT ANOTHER EXAMPLE?

Let’s say you have 40 part-time employees. They total 20 FTEs. The average wage is $25,000. To keep this easy, let’s say that your cost of the health insurance is $240,000

(1)    First phase-out

20 FTE - 10                           equals 66.6% phase-out

15

(2)    Second phase-out

$25,000 - $25,000              equals 0% phase-out (that’s good!)

$25,000

The credit is (35% times $240,000) times (100% minus 66.6%) times (100% minus 0%) - or $28,000.

MISCELLANEOUS

The credit is part of the general business credit, which means that you get to carry it over if you cannot use it in a given tax year. In addition, the credit is allowed for AMT, which is good. You do have to reduce your deductible insurance by the amount of the credit.

As I said, we have been less than impressed. It is, however, a great way for Congress to increase someone’s tax preparation fees.