Recently, I wrote an article for the Hennepin County Lawyer addressing some of the kinds of tax questions that non-tax attorneys receive from their clients. The text of this article is included below:
Tax touches almost everything. As a tax attorney, this keeps my job very interesting. This also means that even non-tax attorneys likely get at least a few tax-related questions from their clients.
In this article, we address three common tax questions that might come up from your clients and some tips for answering these questions, specifically: (1) how to qualify for relief from IRS tax debt for “pennies on the dollar,” (2) how to qualify for relief from joint tax debts after a divorce via a request for innocent spouse relief, and (3) whether the IRS and Minnesota Department of Revenue (MN DOR) can pursue a business owner’s personal assets and income to pay business tax debts.
- I owe the IRS money, and I hear people are getting settlements with the IRS for pennies on the dollar. Is this for real? If so, how do I get it?
Yes. It’s called an Offer in Compromise (OIC). Effectively, a taxpayer submits an offer to the IRS to settle their debts for less than the full amount owing. However, just because a taxpayer wants an OIC (who wouldn’t?),that does not mean they will get one.
The IRS generally will only grant an OIC if it appears that the OIC payment is more than the IRS could reasonably expect to collect from the taxpayer within the statutory period for collections (generally 10 years from the date the return was filed), and accepting the OIC is “in the best interest” of the government. In this article, we’ll address the factors considered by the IRS related to reasonable collection potential. More information related to the “best interest of the government” analysis can be found in the IRS’s Internal Revenue Manual, Section 22.214.171.124.1 (12-20-2018) (Not in the Best Interest of the Government Rejection).
To request an OIC, a taxpayer must submit a complete financial statement detailing their equity in assets, income, and expenses, as well as information and documentation to support the financial statement.
The IRS uses this information to determine the taxpayer’s “reasonable collection potential” (RCP). RCP is the amount the IRS anticipates it could collect from the taxpayer within the statutory period for collections.
The IRS generally calculates RCP by adding the value of the taxpayer’s: (1) equity in assets plus (2) the present value of the taxpayer’s excess monthly income. The present value of excess monthly income is generally calculated by deducting the taxpayer’s monthly ordinary and necessary living expenses (the IRS has standard allowances for such expenses) from the taxpayer’s average monthly income. This amount is then multiplied by some factor (often 12 for purposes of calculating the minimum amount the IRS will accept for an OIC, although the IRS may also utilize a multiplier equivalent to the number of months remaining on the collection statute of limitations).
If it appears that the taxpayer’s RCP is greater than the amount owed, then the IRS likely will not accept an OIC. Conversely, if the taxpayer’s RCP is less than the amount owed, the amount of the RCP is generally the least amount the IRS will accept as an OIC payment.
Although RCP seems simple on its face, there are a number of variables, discounts, exclusions, etc. that taxpayers may qualify for to reduce the value of their equity in assets or excess monthly income for purposes of an OIC. To that end, it can be very helpful to work with a professional when submitting an OIC.
Tip: Many taxpayers mistakenly believe that their home and retirement accounts are excluded from IRS collection efforts or OIC calculations. This is not correct. The IRS may take foreclosure action against a taxpayer’s home or levy action against their retirement accounts to collect debts owed, and the equity value of these kinds of assets is generally considered a part of the IRS’s OIC analysis.
- I’m getting divorced and just found out my ex-spouse and I owe taxes from when we were married. I don’t think I should be responsible for paying them. What should I do?
When married taxpayers file a joint tax return with their spouse, they sign the joint return under penalties of perjury, affirming that the information in the return is accurate and they are liable for any taxes associated with the joint return. The spouses are considered jointly and severally liable for the amount due associated with their joint-filed tax returns. The same is true of any additional amounts due if the IRS audits the return or otherwise assesses additional tax, penalties, etc., associated with the joint return.
There is a way out of joint and several liability: innocent spouse relief. A taxpayer may apply for relief from joint and several liability if they can demonstrate, based on approximately 14 non-exclusive factors enumerated in federal tax guidance, that, effectively, it would be unfair to hold them personally liable for the debt.
The analysis for innocent spouse relief is fact-intensive. IRS guidance instructs that no one factor or set of factors determines whether the requesting spouse qualifies for relief. Here we address a few examples of factors considered by the IRS in its innocent spouse relief analysis:
- History of compliance. A taxpayer’s “history of compliance” generally refers to their history of timely filing their tax returns and paying their taxes. A good history of compliance (or good faith efforts at compliance, such as timely requesting an installment agreement and making payments per the terms of the installment agreement) favors relief; a bad history of compliance weighs against relief. The IRS may consider the taxpayer’s history of compliance before and after filing the joint returns at issue. To that end, after the taxpayer discovers the non-compliance issue related to their joint filed returns (i.e. unpaid taxes, etc.), it is important that the taxpayer take steps to come back into compliance by timely filing their individual returns and paying their taxes.
- Knowledge or reason to know that the non-requesting spouse could not or would not timely pay the taxes. The IRS will consider the taxpayer’s financial and other factual circumstances around the time the tax returns at issue were filed to determine whether the requesting spouse knew or had reason to know the non-requesting spouse would not or could not pay the taxes. For example, if the taxpayers were behind on their other bills, this could be construed as evidence that the requesting spouse should have questioned the non-requesting spouse’s ability to timely pay their taxes. Knowledge or reason to know the taxes would not be timely paid generally weighs against relief, whereas no knowledge or reason to know generally favors relief.
- Allocation of the joint taxes in the divorce decree. The IRS will not be bound by the terms of a divorce decree. For example, a divorce decree allocating all joint tax liability to the husband will not stop the IRS from taking collection action against the wife related to the joint liabilities. However, how the taxes are allocated in the divorce decree is considered as part of the analysis for innocent spouse relief. If the taxes are allocated to the non-requesting spouse, this factor favors relief. If the taxes are allocated to the requesting spouse, this factor may weigh against relief.
- Significant benefit. The IRS will consider whether the requesting spouse received any “significant benefit” during the periods at issue. For example, whether they purchased or received from the non-requesting spouse any luxury items (jewelry, cars, etc.) or were otherwise afforded an arguably luxurious lifestyle (country club membership, expensive vacations, etc.) during the periods the taxes were not paid.
- I’m a business owner and my business is behind on its taxes. Can the IRS and MN DOR come after me personally for those debts?
Unfortunately, yes. For certain types of business tax debts, the IRS and MN DOR have statutory authority to effectively pierce the corporate veil and personally assess business owners and a variety of other individuals associated with a business (executives, employees, etc.) for certain types of “trust” taxes. Trust taxes include: withholding tax, unemployment insurance tax, and sales and use tax. Often, when a business owes these kinds of taxes and is not paying the taxes or appears it will not be able to fully pay the taxes within the collection statute of limitations, the IRS and MN DOR often cast a very wide net in making personal assessments to try to collect the outstanding debts.
When an individual is personally assessed business taxes, they generally have a right to appeal the assessment. We do not have time in this article to address all of the factors involved in the personal assessment analysis, but, in a nutshell: for the MN DOR to make a personal assessment, the individual generally must have authority to direct the payment of creditors. For the IRS, the individual must both: (1) have been responsible for the payment of taxes and (2) willfully failed to pay the taxes.
If an individual is personally assessed, the MN DOR or IRS may take the same kinds of collection actions against the individual as would be available if the taxes were associated with the individual personally, including filing liens against the taxpayer’s home and other property and levying the taxpayer’s bank, investment, retirement accounts and wages. The taxpayer also has similar collection alternatives available to them, such as an offer in compromise, addressed above, and installment agreements.
Read the full article here.