Getting Divorced? What You Need to Know About Your Unpaid Tax Liabilities.

Getting Divorced? What You Need to Know About Your Unpaid Tax Liabilities.

Getting divorced is unpleasant, even in the best of situations, and nothing can make it more unpleasant than when issues from the marriage continue to haunt the former couple after the marriage is ended. Unpaid taxes is just one of those issues. I am talking specifically about unpaid Federal and state income and the reason the problem persists past the end of the marriage is something called called joint and several liability.

What is Joint and Several Liability?

Joint and several liability is just a fancy way of saying both spouses are on the hook for the whole amount of any income tax liability, regardless of whose income it is. The IRS and state tax authorities can collect such taxes from one or both spouses in pretty much any manner they choose. Let me illustrate this with a simple example:

Tom and Sue are married. Tom works from home (he is self-employed) while Sue is employed at a bank and is paid a wage. Tom is less than diligent about paying his estimated taxes while Sue has her income taxes withheld from her paycheck. At tax time, the couple files a joint return which results in a balance due because Tom did not pay anything towards his taxes (to keep things simple lets just assume the taxes are due on just the Federal return).

Once the return is filed and the IRS is made aware of the unpaid taxes, the IRS has almost absolute discretion to collect from the couple in any manner it chooses. It can collect just from Tom or Sue or from them both. The IRS is not required to attempt first to collect from Tom, the person whose tax liability caused the shortfall. The IRS doesn’t even have to try to collect from the spouse who earns the most or who has more assets! There is absolutely no requirement that the IRS ever try to collect from Tom. Practically speaking, that means that the IRS could levy a bank account held in Sue’s name or garnish her paycheck without attempting to collect from Tom first. 

I think this example explains how joint and several liability operates. For that reason you can see why a couple should understand the concept of joint and several liability, especially if you are in the process of getting divorced. In all likelihood, under my example, the IRS will try to collect from both Tom and Sue equally but if Tom stops working and goes on unemployment then the burden will fall on Sue to pay the taxes due. Even if Tom and Sue later get divorced this joint and several liability will continue to exist until it is paid, compromised or the statute for collections pass. So what can the divorcing couple do to deal with a joint tax liability?

First, understand that the IRS is not bound by any agreements or the divorce judgment.

The hardest thing to explain to a divorcing couple is that the IRS is not bound by a state court divorce judgment or settlement agreement. The reason is that Federal law trumps state law – it’s as simple as that. As unfair as that may seem, that is the law. If the court assigns the repayment of a joint tax debt to a party (or the parties agree to divide the debts among them) then that is binding only on the couple but not the IRS. What ends up happening is that if the IRS collects unpaid taxes from a spouse who is not obligated to pay such liability then the non-liable spouse will need to go back to family court to try and collect the difference from the liable spouse. This result can be particularly galling when the liable spouse has no assets or earnings or who actively fights attempts to pay the other spouse under the divorce judgment or settlement agreement.

Second, consider married filing separate for any current year returns.

While this is not helpful when a joint return has been filed, it is important to understand that there is no requirement to file a joint tax return. If the other spouse is habitually behind in paying his or her taxes then you may want to consider filing a separate return to only be liable on your portion of taxes. Be careful though! While the IRS may not be able to collect your spouse’s tax liability from you (whether by garnishing your wages or seizing your assets) that doesn’t mean it cannot seize your spouse’s share of any joint assets. It is not unheard of for the IRS to foreclose on the marital home.

Before moving on I want to add that even if the joint return shows a refund that doesn’t protect you 100%. If the joint return is later audited and additional taxes are assessed then you will be on the hook, jointly and severally, for the additional amount due. So the lesson here is to be careful about signing a joint return if you suspect your spouse may be playing fast and loose with the tax rules.

Third, you may be able to sever joint liability through innocent spouse relief.

All hope is not lost if you have a joint tax debt. The IRS has a process called innocent spouse relief which provides a means of severing a couple’s joint and several liability for taxes. This relief is available often where there is some inequity in holding you liable for the whole tax liability – usually where there is some bad behavior on the part of the other spouse. If you qualify, innocent spouse relief will de-couple your tax liability (in whole or in part) from your spouse or ex-spouse. Innocent spouse relief comes in three “flavors” as it were:

General Relief – relief is available where there is a tax understatement that results from an “erroneous item” solely attributable to your spouse (erroneous items are things such as unreported income or claiming non-deductible/fictitious expenses). Beyond the requirement of the erroneous item solely attributable to your spouse or ex-spouse, you must also show that: one, had no actual or constructive (meaning that someone in your shoes should have known) knowledge of the erroneous items; and two, it would be inequitable to hold you responsible for the understatement, considering all of the facts and circumstances.

Separate Liability – relief can be granted up to your share of the tax liability (based on what your liability would have been if you had filed separately). Separate liability relief will not be granted if: one, the IRS can show that assets were transferred between you and your ex-spouse as part of a fraudulent scheme; or two, you signed the joint tax return with actual knowledge of the item giving rise to the tax understatement, unless the return was signed under duress.

Equitable Relief – this is a catch-all if you do not qualify for relief under innocent spouse or separate liability relief. To qualify for equitable relief, you must show that under the facts and circumstances of your situation that it would be inequitable to hold you liable. In this case, the IRS will consider a series of factors that point to whether or not relief should be granted. Factors that indicate relief should be granted are: taxpayer would suffer an economic hardship if relief is not granted, taxpayer was abused by the spouse, the other spouse has a legal obligation, such as in a divorce decree, to pay the tax liability, and the liability is solely attributable to the other spouse. Factors that indicate that relief should not be granted are: the taxpayer had reason to know or knew of the tax liability, the taxpayer benefited significantly (beyond normal support) from the understatement, and the taxpayer has not made a good faith effort to comply with the tax laws during the year the tax liability arose and thereafter.

Finally, you do have options even if you are jointly and severally liable and there is no way to obtain innocent spouse relief.

Even if you cannot obtain relief or avoid joint liability you can still work with the IRS to reduce or remove the unpaid tax liability. Installment agreements, offers-in-compromise, currently not collectible status and penalty abatement are all tools to obtain relief from your tax liabilities and you may be able to use these tools to handle your tax debts.

In summary, be aware of the rules regarding joint and several liability as it may have an impact on your divorce. I hope you found this information useful and if you have any questions about what I have written feel free to call or email me.

image courtesy of stubblepatrol.com

Are Student Loans Dischargeable?

Can Student Loans be Discharged in Bankruptcy?

The answer, surprisingly is yes, but the road to discharge is long and hard. I decided to write this post because potential clients who have student loan debt instinctively tell me when the subject comes up that they “know” student loans are “never dischargeable” in bankruptcy, which just isn’t true. Now I freely admit that the process of getting a discharge is hard enough that for most people it is de facto non-dischargeable. My goal in this post is to shed a bit of light on what it takes to discharge a student loan debt. While the topic can get complicated, I hope that by the end you will have at least a general understanding of the topic.

The best place to start when talking about discharging student loans is the beginning. Sometime during the early 70s, Congress changed the law regarding the dischargeability of student loans as a reaction to stories of ne’er-do-well students who, after obtaining a prestigious degree – usually medical or legal – filed for bankruptcy promptly upon graduation to wipe out their student loan debts (oftentimes at the government’s expense). In response to these lurid tales, Congress made it harder to get out from under student loan debt by making such loans non-dischargeable by default. If the student could show that repayment of those loans would impose an “undue hardship” then he or she could get a discharge. Whether this fear of rampant abuse of the student loan system were real or imagined, this is now the system we operate under.

How do you get a student loan discharged?

When you file for bankruptcy all debts that are dischargeable are extinguished when the court grants the debtor a discharge, which is not true for student loans. You have to file what is called an adversary proceeding in bankruptcy court (essentially a civil trial) to have the court declare the debts are dischargeable. This can be expensive and time-consuming but it provides an opportunity for the debtor to submit evidence about their current inability to pay, something that you cannot really do when you are talking over the phone with a lender or loan servicer. I have seen cases where once the process gets started that the loan company makes a settlement with the debtor that works for everyone, so the opportunity is there to avoid a trial.

If a settlement cannot be reached then the debtor has the burden to prove an undue burden exists. In Maine, a debtors situation is analyzed under the totality of circumstances test. Under this test, the debtor must show that his or her financial resources (past, present and future) and necessary living expenses, when considered in conjunction with any other factors that might impact the debtor’s ability to repay the student loans, does not allow the debtor to repay the loans while maintaining a minimum standard of living. I don’t think you need to be a lawyer to understand that the debtor has his or her work cut out for them to prove undue hardship under this standard.

If, after trial, you show that paying your student loans will place an undue hardship upon your life then the student loan debts and associated interest and costs will be discharged unless the servicer or loan company appeals the ruling. Alternatively, if you lose at trial you now have the right to appeal. During the appeals process the reviewing court only considers legal arguments and you cannot introduce new evidence but if the case was a close one you might have another opportunity to get a ruling in your favor or to settle the matter on good terms.

So what are some of the things courts consider when determining if an undue hardship exists?

Listed below are some factors I have compiled from reading student loan discharge cases. I tried to write down factors that are cited by multiple courts but there is always the chance that a court hearing your case might come up with additional factors to consider or only consider some of the factors listed below. Still I think the list I have complied below is a good guidepost for what courts look at when considering undue hardship:

  • Has the debtor made reasonable efforts to find gainful employment? If the debtor is employed, has the debtor taken extra shifts or a second job?
  • Will the debtor’s income steadily increase over time or remain relatively stable?
  • Can the debtor only make loan payments by deferring other necessary expenses, such as home maintenance, medical care and auto repairs?
  • Does the debtor suffer from a long-term medical condition which impairs his or her future job prospects? Or is the condition only temporary or otherwise not an impediment to working?
  • Is the debtor nearing retirement age or just starting his or her working career?
  • How much time has passed since the debtor obtained his or her student loans and subsequently filed for bankruptcy?
  • Does the debtor have other assets that he or she can liquidate to pay something on the loan?
  • What is the availability of any Federal or state programs that might help the debtor that might reduce or eliminate payments? If these programs exist, has the debtor tried to take advantage of them?

In conclusion

Getting a discharge of your student loans is not easy but not impossible. Thankfully, whether or not you qualify for a student loan discharge, there are other avenues for dealing with your debts. Most student loan servicers offer programs like the income based repayment plan, which can reduce or eliminate your loan payments, or a hardship discharge, if your situation is bad enough. It all depends on your particular situation but you do have options to get relief if you cannot afford to make payments. If you have questions about whether bankruptcy may be an option to help you deal with your student loan debts feel free to call or email me.

Photo courtesy of http://www.cafecredit.com

 

Foreign Account Reporting in a Nutshell

When I first started preparing tax returns in the late 90’s, foreign account reporting was not really a concern. Rarely was there a need to check yes to the question on Schedule B (Interest and Dividend Income) of Form 1040, to indicate the taxpayer had an interest in or signature authority over a foreign account. No more. The times, as they say, are a’changing.

In the last decade the IRS has started a real push to identify U.S. taxpayers who are hiding assets offshore. Just read some of the IRS’ press releases  regarding foreign accounts (see here, here and here) and it is easy to see that the IRS believes its efforts are bearing fruit. The IRS is not alone in this. The Financial Crimes Enforcement Network is also part of the enforcement effort. Combined both agencies are putting a lot of pressure on taxpayers to come clean. The two major programs dealing with foreign asset reporting are FBAR and FATCA, which stand for “Report of Foreign Bank and Financial Accounts”, and “Foreign Account Tax Compliance Act”, respectively. Taxpayers who run afoul of either reporting requirement can face severe penalties (at a minimum) or criminal prosecution (at worst), so I thought it worth a quick explanation. Not that many of my clients are of the wealthy jet-set who fly their private jets to the Caymens for sun, sin and financial shenanigans…yet.

FBAR

If you possess an interest in or have signature authority over a financial account located in a foreign country then you may need to file a FinCen114 report through the Financial Crimes Enforcement Network (link is here). FinCen114 is due April 15th of each year and which is filed electronically. If you cannot meet this deadline then you can get an extension up to October 15th. The FBAR applies to both individuals and businesses (unlike FATCA, which applies only to individuals).

You are required to file under FBAR if you have an ownership interest in or signature authority over a foreign account, with an aggregate value of all such foreign accounts exceeding $10,000 US dollars, at any point, on a given day during the calendar year.

A foreign financial account is defined rather broadly and includes bank accounts, brokerage accounts, mutual funds, and trusts which are located in a foreign country. It doesn’t have to be a foreign bank to be considered located in a foreign country. So long as the branch, where the account is opened and held, is located in a foreign country it has to be reported, regardless if the branch is of a US or foreign company.

Aggregate value means the total value of all accounts over which a taxpayer has an interest in or signature account over during the year. If, on any given day, the aggregate balance of the accounts exceeds $10,000 (in terms of U.S. dollars) then a FinCen114 report needs to be filed. The taxpayer computes the aggregate amount based on 100% of the value of the account, whether or not the taxpayer’s actual ownership equal 100% of the account or not. If the account has a value denominated in a foreign currency, the taxpayer will use the conversion rates promulgated by the US Treasury to determine the value in U.S. dollars. You can find the link here for the Treasury Reporting Rates for FBAR.

Penalties for failure to file a FinCen114 or to prepare the return correctly are as follows. The IRS may assess a penalty, indexed for inflation, not to exceed $12,459 per violation for non-willful violations (meaning unintentional); if the violation is willful then this penalty increases to the greater of $124,588 or 50 percent of the balance in the account at the time of the violation, for each violation. Beyond the financial penalties, there is the potential for criminal prosecution for tax evasion, depending on the egregious nature of the violation.

FATCA

FATCA or the Foreign Account Tax Compliance Act is designed to prevent tax evasion by identifying individuals who possess an interest in certain foreign financial assets. To comply with FATCA, the taxpayer submits Form 8938, Statement of Specified Foreign Financial Assets, along with his or her tax return, which is due on April 15th of each calendar year (which can be extended to October 15th). FATCA has some very complicated filing requirement, making explanation in a short blog post difficult but I will try to distill it down as best I can.

FATCA applies to certain specified U.S. taxpayers holding specified foreign financial assets outside the United States (I know that sounds redundant but that’s the IRS’ formulation and not mine). If the aggregate value of these foreign financial assets exceeds a certain dollar threshold then the taxpayer must report such assets on IRS Form 8938, as stated above.

First, FATCA applies only to specified individual, such as US citizens; resident aliens who live in the United States for any part of the tax year; nonresident aliens who elect to be treated as resident alien for purposes of filing a joint income tax return; and nonresident aliens who are bona fide residents of American Samoa or Puerto Rico. So FATCA applies to US citizens, at home and abroad, and to certain foreign citizens residing in the US, American Samoa or Puerto Rico.

Second, the specified individual must possess an interest in specified foreign financial assets. These assets are divided into two categories: either a financial account maintained by a foreign financial institution (unless it is a US Bank or the institution has a US presence) or other foreign financial assets held for investment (that are not held in an account maintained by a US or foreign financial institution). Good examples of the second category of assets are: stock or securities issued by a foreign company; an interest a foreign entity (akin to a partnership or other non-corporate interest); and a financial instrument or contract which has a foreign individual or entity as the other party or issuer.

The final requirement is that the aggregate value of the specified foreign financial assets exceeds certain thresholds established under the law. For unmarried taxpayers living in the US, the aggregate value has to exceed $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. Married taxpayers living in the US (who file a joint return) must file a report if the aggregate value exceeds $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year (married taxpayers filing separately have to use the lower unmarried taxpayer threshold of $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year). If the taxpayer lives abroad (so US citizens only) then the thresholds increases considerably (the rules regarding taxpayers abroad can complicated so I won’t go into any detail).

Valuing foreign financial assets can be complicated and so taxpayers are allowed some leeway. For brevity purposes, I will not go into detail of how to value specified foreign financial assets; generally taxpayers are allowed to make reasonable estimates regarding an assets worth when determining whether he or she needs to make a report under FATCA.

Failure to file Form 8938 carries with it certain penalties. You can be penalized up to $10,000 for failure to file the report plus an addition $50,000 if you continue to properly file a report after the IRS notifies you. If that wasn’t enough, the IRS can assess an additional 40 percent penalty on an understatement of tax attributable to non-disclosed assets. Like the FBAR, the same threat of criminal prosecution applies depending on the circumstances.

In Conclusion

As you can probably guess, there are areas where both FBAR and FATCA reporting requirements can apply to a single foreign financial asset. Based on what I discussed above, you can well imagine that the cost of complying with both reporting requirements can be expensive but there is no exception for a taxpayer who meets the filing requirements of both.

I suspect that most of you who are reading (this probably all of you) will never own a secret Swiss bank account or hide assets in a Cayman trust but the rules are worth reviewing. I hope you found it interesting (even if probably a bit overwhelming). You never know when that nice Nigerian prince will finally get his money out of the country. He keeps emailing me to let me know that one more check should do it… Bahamas, here I come!

What to Know about Identity Theft and Your Tax Return

Identity theft and tax refunds are big business for fraudsters. To give you an idea of the scope of this problem, in 2015, from January through November, the  IRS rejected or suspended the processing of 4.8 million suspicious returns – the refunds claimed on those returns totaled around $2.9 billion! And that is just for 11 months of 2015. Add to that the fish that get through the net – the IRS cannot catch every fraudulent return and so the numbers are likely much higher. If you are one of victim of a fraudulent return scam, do you know what to do? How do you avoid becoming a target of such a scheme? This post attempts to answer those questions.

First, be proactive and educate yourself. You can read some of the helpful resources produced by the IRS and the Federal Trade Commission (FTC). Some of what the agencies put out is common sense, such as keeping current on anti-virus software, but there are still useful information to be found. You can find these resources here (for the IRS) and here (for the FDIC). Here is a list of some of the tips put out by both agencies:

  • Only share personal information through encrypted websites, those which have a https address.
  • Shred information which bears personal identification information, such as those with social security numbers and dates of birth.
  • Keep tax returns is a secure place.
  • Use a strong password and do not use it for all of your logins.
  • Be careful of attachments in emails.

Even if you do everything right that doesn’t mean you won’t find yourself a victim of identity theft – data breaches and unscrupulous employees may provide thieves with your information in spite of your best efforts. So be aware of the warning signs:

  • Your electronically filed return is rejected as being a duplicate return filed under your social security number.
  • The IRS sends you a letter asking you to verify your tax return information.
  • You receive wage or income information from an unknown employer or third-party.
  • You receive an unexpected refund from the IRS; the IRS notifies you that you owe money for a tax year which you have not filed or which you show no tax due; or you receive a debit card from a third-party which you did not request (fraudsters often convert their ill-gotten gains into debit cards).
  • Your credit report shows unexplained or unexpected debts.

If you do find yourself a victim of identity theft or suspect you are a victim, you should take these steps to mitigate or stop further damage:

  1. File a complaint with the FTC at identitytheft.gov.
  2. Place a fraud alert with one (or more) of the three major credit reporting agencies: www.Equifax.com (1-888-766-0008); www.Experian.com (1-888-397-3742; and www.TransUnion.com (1-800-680-7289).
  3. If the IRS sent you a notice regarding potential identity theft, respond to the number provided immediately.
  4. If a duplicate return has been filed then you should prepare and file the IRS Identity Theft Affidavit Form 14039.
  5. Contact the Social Security Administration (SSA) if you find discrepancies on your SSA account.
  6. File a report with your local police department and state Attorney General’s office.

Be aware that even if you are a victim of identity theft through the filing of a fraudulent return, you are required to still file your returns and pay your taxes even if that means you need to file a paper return. If you cannot get help and you’ve previously contacted the IRS, call 1-800-908-4490, the IRS has set up a hotline for taxpayers who are victims of identity theft.

I hope this post provides some helpful guidance on identity theft and the IRS, good luck and here’s to a happy identity theft free end to tax season!

Image courtesy of: http://www.gotcredit.com/

 

 

You Have Rights When Dealing with the IRS!

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When dealing the the U.S. Government, you have rights such as the right against unreasonable search and seizure and the right to free speech as guaranteed by the Bill of Rights. Dealing with the IRS is no different but in addition to the rights guaranteed to you by the Constitution you have certain additional rights, aptly named the Taxpayer Bill of Rights. Nina Olsen, the National Taxpayer Advocate, advocated for years to have the IRS explain in plain simple terms the rights that each taxpayer has when dealing with the IRS and so in 2014, the IRS published the aforementioned rights, grouped into ten broad categories, such as the Right to be Informed.

While most of these rights tend to be aspirational, such as language used by the IRS to explain the Right to Quality Service which states that the IRS will provide taxpayers with “prompt, courteous, and professional assistance in their dealings with the IRS….” Still the idea is sound, which is to provide taxpayers with an understanding of what they can expect when dealing with the IRS and in that regard it works. Listed below are the Rights and a brief description of each:

The Right to Be Informed. You have the right to know what is required to comply with the Tax Code. To that end, you are entitled to clear explanations of the tax laws by the IRS, to include IRS procedures, forms, instructions, publications, notices and correspondence. Finally, the IRS must inform you about any decisions it makes regarding your account and to receive a clear explanation of the outcome of their decisions.

The Right to Quality Service. You have the right to prompt, courteous and professional assistance from IRS staff. Similar to the Right to Be Informed, you have the right to receive communications from the IRS that is clear and easily understood; if you receive inadequate service, you have the right to speak to a supervisor.

The Right to Pay No More than the Correct Amount of Tax. You have the right to pay the right amount of tax (to include penalties and interest) and no more. You also have the right to expect the IRS will apply all of your tax payments properly.

The Right to Challenge the IRS’s Position and Be Heard. You have the right to challenge any IRS determination in your case. You are to be provided an opportunity to provide additional documents in response to any formal or proposed action by the IRS. If you do object, the IRS needs to consider your timely objections and additional documentation in a prompt and fair manner; if the IRS disagrees with your objection, you have the right to receive a response from the IRS.

The Right to Appeal an IRS Decision in an Independent Forum. You have the right to appeal an adverse IRS decision, whether it be to the IRS Office of Appeals or to court.

The Right to Finality. You have the right to know how long you have to challenge an IRS decision. Conversely, you have the right to know how long the IRS has to audit your tax return or collect any taxes, interest and penalties due; if the IRS is auditing your return, you have the right to know the audit is finished.

The Right to Privacy. You have the right to expect the IRS will respect your privacy. The IRS’ inquiry, examination or enforcement action must comply with the law and be no more intrusive than necessary.

The Right to Confidentiality. You have the right to be protected from unauthorized disclosure of your tax information unless authorized by you or by law. If the IRS or third parties disclose your tax information you should expect the IRS will take appropriate action to punish wrongful disclose or misuse  your information.

The Right to Retain Representation. You have the right to be represented when dealing with the IRS, whether it be by an enrolled agent, CPA or attorney.

The Right to a Fair and Just Tax System. You have the right to a tax system which considers all of the facts and circumstances in your situation fairly and which provides for a just result. If you are having difficulty dealing the IRS, you have the right to seek assistance from the Taxpayer Advocate Service.

While this explanation does not put much meat on the bone, you can see in a nutshell what rights you can assert if the IRS takes an aggressive position in your case or unnecessarily delays action on your matter. I will leave a more in-depth exploration of these rights to a future post but if you want to know more about each of these rights you can follow this link to the Taxpayer Advocate’s website and read about each in more detail.

If you feel you are not being treated fairly by the IRS, you should contact my office to learn about your rights. You can call my office at 207-299-0515 or by email using my contact form.

Photo courtesy of Eugene Chan at flickr.

What to Know if the IRS Levies Your Assets.

If you owe money to the IRS, you face possible seizure of your assets such as wage garnishment or a bank levy. In some rare cases, the IRS can even foreclose on your home. This post is intended to give you some basic knowledge of what an IRS levy is and what you can do if your are the target of an IRS levy. To keep things simple, I will confine my discussion to wage garnishments and bank levies. Just be aware that the IRS can levy on almost every asset imaginable.

What is a levy?

A levy is simply a seizure of a taxpayer’s assets to pay a tax debt. It should not be confused with a tax lien, which is a claim placed on real estate or personal property. Liens are passive collection measures; the IRS will place the lien on your property and then wait for you to sell it, at which point the IRS will be paid. Levies, on the other hand, are an active collection measure; the IRS can take action immediately to seize property to satisfy your tax debt. Often levies are intended to be a wake-up call to delinquent taxpayers, the idea is to encourage the taxpayer to take immediate steps to address their tax liability. I can tell you from personal experience that a levy does indeed get a client’s attention.

Under what circumstances can the IRS levy my assets?

As I said earlier, the IRS uses tax levies to either get assets to pay any taxes due or to force the taxpayer to enter into some payment arrangement to address the delinquency. So in deciding whether or not to levy a taxpayer’s assets the IRS will consider the following circumstances:

  • The taxpayer’s financial condition, including whether the levy will create an economic hardship for the taxpayer
  • The taxpayer’s responsiveness to attempts at contact and collection
  • The taxpayer’s filing and paying compliance history
  • The taxpayer’s effort to pay the tax
  • Whether current taxes are being paid

As you can see, you are more likely to face a levy if you have not been reactive to prior attempts to settle your tax debt. Even more so if you are in the habit of not being compliant with filing your tax returns and paying any taxes due.

Once the IRS has identified a taxpayer who is fit for a levy, the IRS will take certain steps to encourage the taxpayer to get compliant and avoid the levy. First, the IRS will ensure that were sent CP 501, a Notice and Demand for Payment regarding you tax liability. Second, the IRS will confirm that you either failed or refused to pay the tax due. Finally, the IRS sent you CP 90, a Final Notice of Intent to Levy and Notice of Your Right to A Hearing (levy notice) at least 30 days before the levy.

TIP – Often taxpayer will tell me that they had no idea the IRS intended to levy their assets. It is a very rare circumstance that the IRS levies on a taxpayer without prior notice. So don’t ignore any IRS notices! Attempt to resolve your tax debts and make sure to do your taxes on time and pay any amounts due. This will significantly reduce the likelihood of a levy. You can see a sample notice here.

What happens after the IRS determines my assets should be levied?

After the IRS determines a levy is appropriate and it confirms that it has followed all the required steps, the IRS will send paperwork to your employer or bank informing them that there is a levy in place.

Where the IRS garnishes your wages, the IRS will take a portion of your wages each pay period until you make arrangements with the IRS, the taxes are paid in full or the levy is otherwise released. Your employer will receive information on how much should be withheld from your paycheck and forwarded to the IRS.

To properly determine the amount to withhold, your employer is required to provide you with a Statement of Exemptions and Filing Status to complete and return within three days. Failure to return the statement within the required time frame means the employer is required to withhold the maximum amount possible. You also need to be aware that if you are to receive a bonus then 100% of the bonus may be payable to the IRS! This depends on whether or not you were paid in the same pay period as the bonus payment.

In the case of a bank levy, your bank will receive a levy notice from the IRS, requiring it to hold the balance of your account for 21 days. The reason for the hold is to allow you, the taxpayer, time to make payment arrangements or contest the levy. After the 21 days have passed the bank will pay the funds seized, as of the date of the levy, to the IRS. Funds subsequently deposited into your account, after the date of the levy, are not seized and so you can use the funds as you did before the levy. For example, if you have $1,000 in your account on the date of the levy, with another $1,000 deposited the following day, then the bank will hold the first $1,000 for 20 days; the remaining $1,000 is free to use by you.

What can I do to have the levy released?

The IRS will release the levy under the following circumstances:

  • You pay what you owe
  • The time period for collection ends
  • You enter into a payment arrangement with the IRS
  • The levy creates an economic hardship
  • The value of the seized asset is sufficient to cover any tax due and releasing the levy will not hinder the collection of the tax due

Economic hardship requires some explanation. It does not mean you are inconvenienced by the levy or that you can’t pay all your bills. Instead, economic hardship means the IRS has determined the levy prevents you from meeting basic, reasonable living expenses. Emphasis on the IRS determination. You will need to provide proof that you qualify for economic hardship before the levy will be released.

The best way to have a levy released is to not allow the levy in the first instance. The notice of intent to levy provides appeal rights, which means you have an opportunity to work something out with the IRS or challenge the IRS’ determination to levy your assets. The key is to be proactive before the levy is filed.

Is there anything else I can do?

Yes, call a tax professional immediately. If you owe taxes and the IRS has filed a levy against your wages or bank account you are at risk of future levies. Quick action is demanded to obtain the return of your money or to stop any wage garnishments. You should not take a levy action lightly!

Being Audited? What are the Chances?

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Good question. On average you have less than a one percent chance, as an individual, of being audited by the IRS. Don’t get complacent though, that figure is only part of the story. Only when you crunch the numbers does a more nuanced picture emerge regarding your chances of being audited.

First, you have to understand that the IRS does not do audits at random. The IRS does not consult tea leaves or throw darts against a list of taxpayers to select a return for audit. Instead the IRS uses two major methods of choosing individuals for audit: information provided by third-parties and by use of a computer algorithm.

Information provided by third-parties is easy enough to explain, if the IRS learns that a taxpayer may be hiding income or taking excessive deductions then it may select the return for audit. The classic example is an ex-spouse informing on his or her former partner but it can also include an audit triggered by information provided by banks or other financial institutions. For example, banks are required to report cash transactions exceeding $10,000 which may indicate potential tax evasion.

The other and far more prevalent method of identifying returns for audit is the use of various, and undisclosed, algorithms. The IRS is very tight lipped about what goes into its software but it has said that these algorithms use data gathered during audits and from other sources to develop a norm against which a taxpayer’s return is compared. The taxpayer’s return is scored based on how it deviates from the norm; the higher the score, the greater the chance of being audited. The algorithm also is weighted to increase the rate of audits where the IRS perceives certain types of returns have a higher potential for abuse or for positive audit adjustments. As you will see below, taxpayers who claim the earned income tax credit have an increased chance of being audited which is a response to a recent flood of fraudulent returns claiming the credit.

Regardless of the method of selecting a return for audit, once a return is selected an examiner will review the return to determine if there are grounds to  hand the return off to an IRS agent to be audited. The IRS only wants to audit returns where there is the potential to recover money for the Treasury; the IRS does not want to waste valuable time and money handling low-return audits, it would rather concentrate on audits that will justify its efforts.

Here are some stats from the IRS’ latest report, based on tax returns examined during 2015:

  • Overall, taxpayers face a 0.8% chance of being audited.
  • This rate increases if the tax return includes the earned income tax credit, up to 1.7% for those tax returns with gross receipts of less than $25,000; this decreases to 1.0% if gross receipts are $25,000 or more.
  • Tax returns that have total positive income under $200,000 and which do not include any income from operating a business and which do not claim the earned income tax credit have a 0.3% chance of being audited.
  • Tax returns that have total positive income under $200,000 and which include income from operating a business and which do not claim the earned income tax credit have between 0.3% and 2.0% chance of being audited, depending on the type of business and total gross receipts from the business. The breakdown is:
    • 0.3% for tax returns which include a Sch. F (farming activity)
    • 0.9% for tax returns which include a Sch C with gross receipts less than $25,000
    • 2.4% for tax returns which include a Sch C with gross receipts of at least $25,000 but less than $100,000
    • 2.5% for tax returns which include a Sch C with gross receipts of at least $100,000 but less than $200,000
    • 2% for tax returns which include a Sch C with gross receipts of $200,000 or more
  • Tax returns with a total positive income over $200,000 but less than $1,000,000 have a 1.8% of being audited, which increases to 2.9% chance if the return includes income from operating a business.
  • Tax returns with total positive income $1,000,000 and up have a 9.6% chance of being audited

Note: total positive income is the sum of all positive amounts shown for the various sources of income reported on the individual income tax return and thus, excludes losses.

As you can see, depending on your taxpayer profile, for lack of a better term, you may have a higher risk of audit than the average would lead you to believe. This doesn’t take into account your particular return which may deviate further from the norm than other returns in your category which can make it even more likely your return is audited. Like the old G.I. Joe cartoon always said, now you know and knowing is half of the battle.

You can read the full report here: 2015 IRS Data Book. There is a great deal of other interesting information on this report and it is worth perusing.

Image courtesy of 401kcalculator.org