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$25,000 and have made at least three payments under a direct debit plan, you still have to request that the lien be withdrawn.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.

New Tax On Self-Funded Health Plans Due By July 31

I knew that there was a new tax on self-insured medical plans. I was surprised that it reached health reimbursement arrangements (HRA), though.

I was surprised because it makes little sense, other than as a raw money grab. Next time perhaps the government will just select names at random from a phone book and require them to send money. I suggest they start with the District of Columbia phone book.

Have you heard of a health reimbursement arrangements? We are wading into alphabet soup-land, so let’s take a moment to compare and contrast an HRA with a health savings account (HSA).

 

If your employer is large enough, you may receive an annual letter laying out your health insurance options. Perhaps you can select from standard reimbursement, HMO, preferred provider or high-deductible health plans. That high-deductible plan likely is an HSA.

The concept of an HSA is simple: combine a high-deductible health policy with a medical IRA. If one incurs routine medical costs, one is reimbursed from the IRA. If one does not, then the IRA continues to compound and accumulate. The policy is there for big expenses. For a healthy family the medical IRA can add-up to tens of thousands of dollars.

A health reimbursement arrangement (HRA) is a different animal.   A key difference is that an HRA is all employer money. The HRA can reimburse employees for medical expenses, including vision, dental and chiropractic. It can reimburse on a first-dollar basis, a deductible-first basis, a sandwich basis and any other basis the plan advisor can dream up. It can have an annual cap … or not. Chances it will have an annual cap, as otherwise the employer borders on being financially reckless.

The employee doesn’t own this money, by the way. Should an employee quit, the money reverts to the employer. In truth, many if not most HRAs do not have any money at all. The medical bills are paid directly from company funds when presented for reimbursement. There may be an accounting somewhere that shows every employee and how many dollars are in his/her “account,” but this is for bookkeeping purposes only. The term for this is “notional,” and it means make-believe. Think unicorns, fairies and the New York Jets having a NFL-caliber quarterback.

ObamaCare (technically, The Affordable Care Act) is imposing a new fee on self-funded plans, which includes HRAs. It is coming up fast. If you have an HRA whose most current plan year ended after September 30, 2012 and before July 31, 2013 (that is, virtually every HRA), the HRA will have to pay a $1 fee per participant. Next year the fee goes to $2, and thereafter it goes to who-knows-what because some government bureaucrat will decide the amount.

The tax is due by the end of this month – July 31.

This tax will be reportable on Form 720, which may be a new filing for many employers.

It also has to be paid electronically. There is no attaching a check for this one.

I am a big fan of HRAs, as it allows companies to add to their employee benefits package without bankrupting themselves in the process. The HRA can cover deductibles, pay for braces or help with medical expenses that otherwise fall through the cracks left by the main insurance policy. HRAs have gotten more expensive, however, both by the per-participant fee as well as by the tax practitioner’s fee to prepare the return.

Can A Land Fill Make A Charitable Donation?

I have a client on extension for their individual tax return. They donated real estate last year. I am waiting on an appraisal and a signed Form 8283 before sending in the return.  

Charitable contributions have become a “gotcha” area for the IRS. The rules border on the insane. Does it make sense to you that I need a letter from the charity for donations over $250 even if I have a cancelled check? The IRS will accept a cancelled check as proof of a travel expense or of a child-care payment, but not for proof of a donation. Fail to follow their rules and you may lose the deduction altogether.

Sure enough, someone thought they followed the rules. Let’s go through the story of Boone Operations.

Boone Operations owned a landfill (Speedway). Right next to them, the city of Tucson (Arizona) also owned a landfill (Tucson). Both were surrounded by commercial and residential development. 

Tucson must have been a mess. The flare in its collection system kept going out and water kept collecting because of poor drainage. Tucson stopped accepted waste materials, but there were issues closing the place down. The neighbors howled; hearings were held. Douglas Kennedy (Kennedy), Boone’s owner, was concerned that Tucson was going to drag him down. He offered to help. In 1996 the two parties were happy and holding hands. Boone agreed to:

·        Share the cost of an interim gas system

·        Negotiate a permanent gas system

·        Cooperate to extend Boone’s aquifer permit to Tucson

You also had the following text in an agreement the attorneys drew up:

6.  Acceptable Waste Fill and Soil Fill

[Boone] agrees to provide [Tucson] with, and [Tucson] agrees to accept, acceptable waste fill and soil.

6.1 Placement of Acceptable Waste Fill

Boone shall, at no cost to [Tucson], fill the *** with acceptable waste to the approved final grades.

Seems clear: Boone will provide waste fill.

The promising relationship between Boone and Tucson soon soured:

·        6/99 - Boone places waste on Tucson to comply with agreement

·        10/99 – the Department of Solid Waste Management wants to know why Boone placed waste on Tucson

·        11/99 – Tucson wants Boone to remove the waste  

·         03/00 – Boone sues Tucson for $20 million

·        04/01 – Tucson provides Boone a settlement offer

·        09/01  -  Tucson files civil and criminal charges

·        04/02 – Boone files with the Superior Court

Shame. They seemed like such a nice couple.

Anyway, in December 2002, they settle. Tucson agreed to a number of things, including (a) paying $450,000 for Boone to construct drainage, (b) helping with easements and (c) releasing Boone and Mr. Kennedy from lawsuits.

And then the magic words:

8.1 Prior Contribution.  [Tucson] acknowledges that as of the date of the Settlement Memorandum, it had accepted Boone’s charitable contribution of 95,000 cubic yards of Acceptable Fill.

8.2 Future Contribution.  Boone agrees to make another charitable contribution of an additional 105,000 cubic yards of Acceptable Fill.

To the uninitiated, it appears that Boone has made a contribution of 200,000 cubic yards of Acceptable Fill to Tucson, don’t you think?

Boone files tax returns showing a donation of $449,000 for one year and $706,000 for another.

The IRS disallows the deductions. It has two arguments:

           

(1)  Boone failed to obtain contemporaneous written acknowledgement.

(2)  Boone received significant cash and noncash consideration and failed to prove that the value of the fill provided exceeded the consideration received.

The IRS argued that a written acknowledgement must include the following magic words:

·        The amount of cash and a description (but not value) of any property other than cash contributed.

·        Whether the donee organization provided any goods or services in consideration, in whole or part, for any property described.

·        A description and good faith estimate of the value of any goods and services received, or, if such goods and services consist solely of intangible religious benefits, a statement to that effect.

What does Boone have? The Settlement Agreement from December 2002. Without the magic words, however, Boone does not have “written acknowledgement.”  Since the donation was over $250, no deduction is allowed without written acknowledgement.

The Court then went on the argument (2). It went through the appraisal process in painstaking detail. There appear to have been significant errors in the appraiser’s calculations, for example, leading to an overvaluation of the donated fill. The Court also pointed out that Boone and Mr. Kennedy were released from a potential lawsuit. That release could have a value. If so, should that value be taken into account?

I question why the Court did this. The Court had already disallowed the deduction for lack of written acknowledgement. Why keep going?

My thinking? The Court expects a challenge on issue [1], and it thinks it could be reversed by a superior court. The Court therefore kept going, reasoning that if was reversed on issue [1] it would be sustained on [2].

You know how this turned out: the Tax Court disallowed the charitable deductions under both arguments.

COMMENT: Please do not mess with IRS in this area. If you are thinking about a significant donation of anything other than cash, please call your tax advisor first.  Get your papers lined up and do not play “gotcha” with the IRS.