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Tuesday, February 14, 2012

Unfiled Tax Returns: Why You Should Not Represent Yourself

Whether you are delinquent on filing your taxes, or you haven't filed at all, you'll often find that your tax returns have been filed for you automatically by the Internal Revenue Service. These are called a "Substitute For Return" (SFR). The IRS will give official notice of this action by sending a letter to the taxpayer’s last known address. However, in my experience, most taxpayers have no idea that the IRS prepared a tax return for them until the IRS is actually collecting on the balance due.

Unrepresented taxpayers often fail to replace the SFR returns or quickly (and carelessly) prepare and file tax returns due to IRS pressure. They overestimate the task of resolving their tax problem. A tax professional can research the taxpayer’s record and win additional time to prepare and file proper tax returns which benefit the client.

A qualified tax professional can help you by handling all contact with the IRS. IRS representatives will frequently tell you that you do not need to file an actual return of your own if an SFR return has been filed. Do not take this advice from the IRS. A taxpayer loses many rights, and money, by failing to replace the SFR tax return.

In fact, I recommend that you always prepare and file your own tax return – even if it does not reduce the amount that you owe. Here is why:

1.  The IRS can collect the balance on a Substitute for Return forever. 
The statute of limitations for collection by the IRS does not begin until taxpayer files his own tax return. Generally, the law limits the time within which the IRS can only collect to 10 years. However, this does not apply to taxes due from an SFR. For this reason alone, you should file the return.
IRS Code §6501(b)(3), Return Executed By Secretary: “The execution of a return by the Secretary pursuant to the authority conferred by such section shall not start the running of the period of limitations on assessment and collection.”

2. SFR returns will almost always be inaccurate or missing key information. 
An SFR return almost always lacks the information a taxpayer would have included on a return he prepared and filed himself – including deductible interest payments and taxes, business expenses, allowable tax credits, dependents, proper basis for capital gains, and other important information. The SFR program does NOT allow any of these reductions in your taxes until your own paperwork is submitted. 

3. The tax due on a SFR return is usually much higher than a return filed by you. 
This is because of the missing or inaccurate information mentioned above.

4. The tax due on these SFR returns cannot be eliminated through bankruptcy. 
 The bankruptcy law requires you to file your tax return before it can be “discharged” (eliminated) in bankruptcy. SFR returns do NOT counted as filed returns and the tax due will NOT go away if you ever file a bankruptcy.

5. You may lose your right to a refund if you fail to replace an SFR return. 
 Sometimes, the balance shown in an SFR tax return is paid by the taxpayer or through offsets and levies. But when a return is actually filed, the taxpayer will discover that he overpaid and is due a refund. If the tax is adjusted and a refund is due, you will lose your right to the refund after three years (this is called forfeiture).

Finally, a tax professional will allow you to avoid unnecessary contact with the IRS and give you the time to pull together your documentation so a package can be prepared by you and your attorney and submitted to IRS before the situation accelerates and spins out of control.

In short, a situation with unfiled returns has too many pitfalls for you to try to go it alone.


Thursday, January 26, 2012

IRS Audits: Why You Should Not Represent Yourself

An audit is a review by the IRS of your financial records and information to make sure that the information that you reported to the IRS on your tax returns are correct and accurate. The audit may be completed by mail or through an in-person interview – but your records are always reviewed.

The following nightmare occurred with one of my clients:
“Tom” is a small business owner who runs a successful small manufacturing business. Although he was great at his work and his clients loved him, he wasn’t as good maintaining his business records. One day, he received a notice from the IRS that he was being audited. During the audit process, the IRS requested that Tom provide copies of his bank statements.
Tragically, Tom believed that some relatively large deposits from his clients would draw the attention of the auditor, so he altered a few of the paper statements before handing them over to the IRS. When the IRS compared them to the records that they had received from the bank (the IRS can obtain these records by a “summons”), they discovered what Tom had done.

Eventually, Tom’s case was referred to Criminal Investigations and he was criminally charged for this act and is awaiting sentencing to Federal prison.

The tragedy of this story is that Tom never consulted with a professional during the audit process. Instead, he acted out of fear and ignorance – to devastating consequences.

What makes an IRS audit so daunting is that the burden of proof is on YOU to show that you have included all of your taxable income and provided receipts for all of your tax deductions. It is not enough that your return is accurate. You must be able to prove its accuracy. However, the process of proof is both time-consuming and difficult; the process sometimes leads people to make grave mistakes.

If your audit is not handled properly, the following might occur:
  • An accuracy related penalty will be assessed (20% of the underpayment); 
  • A substantial understatement penalty will be assessed (20% of the underpayment); 
  • A civil fraud penalty will be assessed (75% of the underpayment); 
  • A referral to the Criminal Investigation Division of the IRS will be made; 
  • The IRS will expand its audit to other tax years; 
  • The IRS will expand its audit to related taxpayers; 
  • The IRS will contact third parties about your tax return. 
My general rule of thumb: in any instance where you are providing financial information to the IRS, you should allow a professional to assist you because you may inadvertently supply information which is unnecessary and may harm you. 

Or you may even be tempted to make up information (as Tom did above).

Hiring a tax professional will save you time and money – and likely bring you a better result. According to IRS reports, “taxpayers represented by counsel fared noticeably better than their pro se counterparts” in audit and tax court matters. Taxpayers with representation received full or partial relief in 58 percent of litigated cases vs. just 34 percent for pro se taxpayers. This is not a time to pinch pennies.

Naturally, the best way to avoid an audit is never to end up there in the first place. But if you’re audited, (when the IRS is knocking on your door) get your tax professional involved early in the process as positioning is everything. Second, listen closely and understand fully the IRS’ concerns. Third, provide the IRS documentation and legal support justifying your positions and addressing the IRS issues. Fourth, exercise your rights for review at IRS appeals and mediation. The IRS has recently been much more open to alternative dispute resolution – something that can save you time and money.

Finally, I am a big believer that you need to be on offense when dealing with an IRS audit. The taxpayer should review the open year under exam closely and determine whether there are any additional tax savings available. This has meant that in some cases we’ve had clients who actually are OWED money by the IRS from an audit.

I have found working with many businesses and individuals that vigorous representation during exam and appeals right from the beginning will carry you a very long ways towards success.

Tuesday, January 24, 2012

Top 5 Reasons You Should Hire Tax Resolution Help

There are some circumstances when you can represent yourself and do not need to hire a professional (i.e. attorney, CPA, etc.). A person who chooses to represents himself does not always have (as the saying goes) a “fool for a client.”

If the situation cannot be worsened, you can initially try to negotiate with the IRS yourself – and only bring in professional help if you cannot get the result that you want.

For example, if you owe a small amount to the IRS (less than $10,000) and you have no unfiled tax returns, it probably does not make sense for you to hire representation. The IRS will allow you to establish a monthly installment agreement without you having to provide any financial information. You don’t even need to speak that much to the IRS. You can call them and simply ask what the minimum amount that they will accept per month.

However, the risk increases when the IRS requires financial information and documents from you. You should not go it alone if you are facing any of any of the following circumstances:
  • You are being audited. 
  • You have not filed all of your tax returns. 
  • Your bank account is being levied or your wages garnished. 
  • You (or your business) owes unpaid payroll taxes. 
  • Your case has been assigned to a Revenue Officer. 
In each of the above, the wrong response could make the situation a lot worse for you, your spouse, or your business.

In the next few blog posts, I will cover the risks of being unrepresented if your situation is one of the above – plus what you can do to minimize any harm.

Friday, September 2, 2011

Don't Be Ashamed of Bankruptcy and Debt: Dispelling Common Myths

From my observations, the biggest hurdle most debtors face is the emotional turmoil of filing for bankruptcy relief.  I have seen clients crying, despondent, and ashamed about becoming a “bankrupt person” or a “deadbeat.”  But most people feel this way because of the myths surrounding debt and bankruptcy.  The following are some of the myths and untruths about debt and bankruptcy:

 MYTH #1: People who file for bankruptcy don’t want to pay their debts. 
In fact, the vast majority of people who file for bankruptcy have been trying to pay their debts for years.  Most debtors have tried debt consolidation, budgeting, payment plans, and other methods to satisfy all of their creditors.  And they have tried these options for years.  In my experience, almost EVERYONE wants to meet their obligations.  People see themselves as true to their word and obligations and therefore will bend over backwards to pay their debts.  Almost every debtor comes to bankruptcy as a “last resort”  -- when the pressure is too high or the debt too insurmountable.  They have long since paid the price of their spending – with interest!

 MYTH #2People file for bankruptcy as a result of living an extravagant lifestyle.
This is the most destructive and untrue myth about debt/bankruptcy.  The top three causes of bankruptcy are: 
  1. Illness and Medical bills 
  2. Loss of job 
  3. Divorce
 The most common scenario is one where some kind of “financial emergency” forces one to use credit cards or other expensive money (payday loan, Home Equity line of credit, consumer loan, etc.) to cover the emergency.  However, once the emergency passes, the high cost of credit (interest and fees) causes the “rob Peter to pay Paul” syndrome.  Soon debts are out of control even though the debtor has NOT spent extravagantly at all.   This is hardly a scenario in which the debtor can be called “irresponsible.”

MYTH #3: Filing for bankruptcy will ruin your credit forever.
Most people who file for bankruptcy relief already have credit scores at the lowest levels.  A bankruptcy will do little, if any, to make their score worse.  But once a bankruptcy has been filed, the debtor can take steps to quickly improve his credit score by the responsible use of credit.  Although it may take a few years before the debtor can borrow again for a car or a house (which he should be very careful about!), this timeline is often far shorter than the one for the hapless debtor paying the minimum payments on several credit cards.  A bankruptcy usually makes the road to recovery shorter.
 MYTH #4: Filing for bankruptcy is shameful.       
It is undeniable that many people will naturally feel ashamed for filing bankruptcy.  But is this shame any greater than the shame of being sued?  The shame of avoiding your phone and mail?  The fear that you feel when you check your bank account?  Unquestionably, the emotional toll of dealing with insurmountable debt year upon year can be “soul killing” and far greater than the burden of a bankruptcy.  I have personally witnessed divorce, depression, and worse as a result of the debt burden. 
In short, people are ashamed about debt/bankruptcy mostly because of falsehoods and unfounded judgments of others.  The truth is that most people file for bankruptcy for perfectly honorable reasons (see above).  I can assure you that the bankruptcy court will NOT make any ruling about your worth as a human being.  You should forgive yourself and let go of the old-fashioned notions you have about debt.  Instead, you must eliminate the emotional baggage from your decision-making process when assessing whether a bankruptcy is right for you.  

Sometimes, a “fresh start” is just what the doctor ordered.

Do you have questions about this topic? Email or call me for a free consultation and we can discuss your situation. (760) 990-1632

Monday, August 29, 2011

Chapter 7 Bankruptcy, Taxes, and the IRS: Your Retirement Plans

What happens to your retirement funds when you file for Chapter 7 bankruptcy? And what happens if the IRS also has tax liens filed against your retirement funds?

Generally when you file for Chapter 7 bankruptcy, your retirement plans (Individual Retirement Accounts, Roth IRA, 401k, SEP, Keogh plans, etc.) are protected.  Neither the bankruptcy trustee nor any of your creditors can reach the money in these retirement plans.  However, as we discussed in another blog post, “Tax Liens & Your Home,” tax liens survive a Chapter 7 bankruptcy if there are funds/assets/property to which the liens attach.

So what happens when the IRS files a lien which attaches to your retirement funds after you file for Chapter 7 bankruptcy?  This is a situation where an irresistible force (IRS lien) meets an immovable object (retirement funds).  The answer:  The IRS lien stays.  This means that the IRS rights to the retirement funds are unchanged from before the bankruptcy.

However, all is not lost because you have defenses to the IRS seizures of retirement accounts after bankruptcy.

How You Can Defend Your Retirement Money from the IRS

1.  If you can’t touch it, neither can the IRS.  
Your primary defense against an IRS retirement account seizure is that the IRS stands in your shoes as it relates to their ability to take your property, including retirement accounts.  The IRS has the same rights to your property that you have – if you have no rights to an asset, neither does the IRS.  This applies equally to whether the IRS is seeking a post-bankruptcy enforcement of a tax lien or just a straight seizure without any bankruptcy involvement.
 The IRS may have a tax lien on your retirement account, but has no right to enforce if you have no right to the property.  Therefore, you should be aware of which of your retirement funds you cannot touch and which funds you can touch – but with a penalty.  Many 401(k) plans, and all of your IRA/Roth IRA funds can be withdrawn by you – but with a penalty. Because you can withdraw these funds, even if it is with a penalty, the IRS can enforce the tax lien on these accounts.  On the other hand, many pensions (especially for government entities or union pensions) cannot be touched until the occurrence of some event (separation from employment, death, or disability), and therefore the IRS cannot enforce the tax lien against these accounts

2.  You can convince the IRS to leave your retirement funds alone.  
According to the Internal Revenue Manual, the IRS considers three factors when determining whether to enforce its lien against your retirement account (by seizing or levying).  The three factors are:
 1)    Other Collection Alternatives:  Before levying on a retirement account, the IRS is required to first consider collection alternatives before levying on the retirement plan, including monthly payments.  The IRS generally does not desire to take retirement accounts; it tends to make for bad public policy. 
2)    Your Conduct was Not Flagrant:  The IRS is generally interested in taking retirement accounts only if the conduct leading to the tax liability was flagrant. The IRS generally wants retirement accounts to pay a tax liability in cases of egregious behavior. Contributing to the retirement account while the unpaid taxes were accruing and a history of employment tax problems are factors in favor of account seizure. 
3)    Mercy Rule:  The final factor in whether the IRS will take a retirement account is whether you depend on the money in the retirement account, or will depend on it in the near future. Again, the IRS tends to be sensitive to retirement account seizures, and proving that the money in the account is important to meeting everyday living expenses can be a factor to keeping the money.

Again, a tax lien which survives your bankruptcy does not mean that you will be destitute in your retirement.  In practice, the IRS will often just let these liens die away once the bankruptcy case is closed.  However, if they do not, you are usually in a good position to make some alternate arrangement (since your financial situation should be better) or convince the IRS to leave your retirement funds alone. 



Do you have questions about this topic? Email or call me for a free consultation and we can discuss your situation. (760) 990-1632

Friday, August 19, 2011

Chapter 7 Bankruptcy, Taxes, and the IRS: Tax Liens and Your Home

It is very important that you know how Federal Tax Liens (“tax liens”) are affected by bankruptcy when deciding whether to file.  So let’s start with a basic fact: If the IRS has filed a tax lien, a bankruptcy will NOT automatically remove it.  Put simply, a tax lien survives bankruptcy.  So even if the tax is dischargeable (see my blog post entitled:  “Can I discharge my tax debt in bankruptcy?") the bankruptcy might not help you.

Let’s look at how a tax lien affects your home.  I will discuss how your retirement plans are affected in a separate blog post.  In all examples, I am assuming that the taxes are dischargeable.

How a Tax Lien Affects Your Home

1) IRS has NOT filed a lien when you file for bankruptcy:  If the IRS has NOT filed a tax lien prior to your bankruptcy, the IRS will have NO RIGHTS to your home after the bankruptcy filing.  The IRS cannot file a new tax lien after the tax has been discharged.  So you should always check whether a tax lien has been filed if you own real estate.

2) IRS HAS filed a lien:  However, if the IRS has filed a lien, you must determine if your house has any equity.  Liens attach to assets in the order in which they are filed (in legal terms, the lien is “perfected” when filed); liens filed first have first rights to the property.  That means if a tax lien is filed, it attaches to your assets after all other liens which were filed before it.   For example, if your house is worth $200,000 and the mortgage is $180,000, a properly filed tax lien attaches to the $20,000 of equity available in the property. Tax liens don’t jump to the head of the line!

So in order to figure out how the tax lien affects your house, you should first ask yourself: is there any equity in my house?

Is There Any Equity in My House? 
The answer to this question is either "No" or "Yes" but the yes answer has a few other things to consider.  Let's look at the possibilities:

1.  Your House has NO EQUITY:  If the IRS has filed a lien but your home has NO EQUITY, the IRS lien is essentially valueless.  The tax lien is UNSECURED since there is no value to which the lien attaches.  Therefore, the lien will NOT survive the bankruptcy. 
EXAMPLE:  A tax lien of $100,000 was recorded by the IRS.  John and Jane own a home valued at $500,000 with a mortgage of $600,000.  Their home has no equity and the IRS lien is fully UNSECURED.  The tax lien will not pass through the bankruptcy and the tax will be discharged.  Hooray for John and Jane! 
2.  Your House has LESS EQUITY than taxes you owe:  If you have equity in your home, but it is less than what you owe in taxes, the IRS tax lien is PARTIALLY SECURED in the amount of the equity.  Tax liens are secured only to the extent that there is value available to secure the lien.
EXAMPLE:  A tax lien of $100,000 was recorded by the IRS.  John and Jane own a home valued at $500,000 with a mortgage of $440,000.  Their home has $60,000 ($500,000 less $440,000) in equity.  The IRS lien is SECURED in the amount of $60,000  and UNSECURED for the remainder of the tax.  Therefore, a tax lien for $60,000 will survive the bankruptcy and the remainder of the tax ($40,000) will be discharged. 

3.  Your House has MORE EQUITY than taxes you oweIf you have enough equity in your home to pay all of the tax due (if you sold the home), the IRS tax lien is FULLY SECURED.  Therefore, the tax liens will survive the bankruptcy intact.
EXAMPLE:  A tax lien of $100,000 was recorded by the IRS.  John and Jane own a home valued at $500,000 with a mortgage of $300,000.  Their home has $200,000 in equity.  The IRS lien is FULLY SECURED in the amount of $100,000.  Therefore, a tax lien for $10,000 will survive the bankruptcy and the IRS lien rights will not be affected (although the IRS will not be able to collect from you directly. 
Please note the following final points when assessing a tax lien:

Important Note #1:  It is a very good idea to get an order from the bankruptcy court stating how much (if any) of the IRS tax lien was secured at filing.  You will need to hire a bankruptcy attorney to do this for you.  You will then know with certainty which part, if any, of the IRS tax lien you will need to deal with after the bankruptcy. 

Important Note #2:  Even though the IRS holds a tax lien, they rarely enforce the lien by foreclosure (forced sale) of your home.  Instead, they will wait for you to sell or refinance your home at which time they will have their hand out for money.  The tax lien will eventually be removed when the statute of limitations for the underlying tax expires.  The IRS will not be able to go after you personally, nor is it likely that it will force the sale of your home to get paid.  So all is not lost even if the lien survives. 

Important Note #3:  Remember that the tax lien survives as a claim on your home, but not against you personally.


Where Do I Go from Here?
Now that you've the basic facts about tax liens and how they affect your home in bankruptcy, what should you do now?  If possible, you should figure out if there are less drastic ways of dealing with your tax debt.  Bankruptcy is a very powerful tool and should be used only if absolutely necessary.  Next, you should look at your non-tax related debt.  Sometimes, your overall financial situation is sufficiently poor (lots of debts, lawsuits, little chance of repayment) that a bankruptcy that hits "two birds with one stone" (tax and other debt) makes sense.

If both tax and other debt are large and will be eliminated in bankrupcy without a loss of your home, the decision to file may be the only sensible thing to do.

Do you have questions about this topic? Email or call me for a free consultation and we can discuss your situation. (760) 990-1632

Monday, August 15, 2011

Chapter 7 Bankruptcy, Taxes, and the IRS: The Automatic Stay

As soon as you file your Chapter 7 bankruptcy, you are protected by the bankruptcy “automatic stay.”  This stay is one of the most powerful tools in bankruptcy.  It has the same effect as a federal injunction issued against all of your creditors – including the IRS. They must stop and ask for permission from the court to collect debts.  The automatic stay remains in place until your case is closed and the discharge is issued.  Here is how the automatic stay will protect YOU, and other things that you should be aware of.

Current Levies  
If you are being levied/garnished by the IRS (or state taxing entity), they will release the garnishment immediately upon the filing.  The release will occur by law; there are no negotiations or disclosures necessary for this to happen.  This is the quickest and most effective method of stopping a levy.

New Levies or Liens
The IRS is also forbidden from initiating any new levies, or filing any new tax liens.  So if the IRS has not attached your home (or other property) with a tax lien, they cannot do so once you file your bankruptcy.  This result could have immense implications after the bankruptcy (which will be discussed later) because the IRS rights so this property may survive the bankruptcy if there is a lien.

Collection Calls from the IRS
The IRS generally will not contact you after you file your bankruptcy.  They will code your case to be in “litigation status” and the IRS collectors will wait until that status is removed before they contact you again.

What the IRS Can Do
Be aware that the automatic stay will not help you if the IRS wants to audit or continue an audit of you, nor will it prevent the IRS from demanding that you file a tax return.  But whenever possible, you should plan your bankruptcy so that it will discharge as much tax debt as possible.  This planning would entail that there be no audits in progress and no unfiled tax returns.    

 Do you have questions about this topic? Email or call me for a free consultation and we can discuss your situation. (760) 990-1632.


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