Federal Problems, Delinquent or Past Due Tax Returns and Sales Tax Audits

The tax code [law] states that tax returns must be filed. No statute of limitations applies, they simply must be filed UNLESS there is not enough earnings to require filing. If you have a business 1099 with earnings and have not filed, the IRS will file a return for you. It will be a single taxpayer return with Self Employment tax and income tax due on the total. The bill will go out in the mail to you and wind through several long steps of response and recourse until it reaches into your paycheck and bank account. They have access to both through checks written to them in the past and quarterly employment returns filed by your employer. They will also knock on your front door if your address is current.

There are two kinds of taxes owed by individuals and businesses. The first it Trust Fund money. This is money collected from employee withholding plus the other payroll taxes that are filed quarterly. This is separate from income tax, which is an individual matter. The trust fund money is not the employer’s money. It is money collected FOR the government and should be remitted promptly with the payroll reports as required. Non-remitting results in immediate collection efforts by the IRS with house calls, bank liens, padlocks on the business doors, attachment of all assets including emptying bank accounts and moneys due the business individual or entity.

Horror Story: Client decided to do own payroll reports for his little business. He sent off the 941 report but forgot to send a check. The next month there was a knock at the door and a Revenue Officer flashed a badge to come in and talk about his tax problem.

Another Horror Story: A not-for-profit agency ran out of money and failed to pay quarterly taxes on time. The IRS Revenue Officer showed up. A meeting was held the next day with the Board of Directors, who were mostly just nice people trying to do some good. At the meeting the discussion ensued over who was responsible for filing the reports [signing] and who was responsible for signing the check [before electronic transmission]. After that was determined, the Officer advised that two staff people were responsible personally for the taxes owed [the CEO and Treasurer] and that everybody in the room must complete a detailed financial statement on their personal earnings and expenses for back-up. The members of the board, other than the two active officers, really had no responsibility running the business but still had to submit the required paperwork. I was there at the invitation of a client, but I never joined any Boards of Directors of anything afterward.

Trust Fund taxes are not excusable in a Chapter Seven bankruptcy so there is a lot at stake with this matter. Like the old saw about death and taxes not being escapable.

A Better Horror Story: Wheeling and dealing entrepreneurs borrowed tons of money to manage a business which was floating on hot air for a long time. Finally, it came down to earth and the payroll taxes of $15,000 were still due. They got out of a big corporate loan but couldn’t cover the taxes which was mostly for officer’s salaries [which is the case in most corporate defaults]. They went to the television tax actor who promised and guaranteed that for only $15,000 he would wash it all away with his magic potion. The bill was up to $50,000 with penalties and interest. I talked to them but had no promises to make. Since they didn’t have the money to pay the television dealer or taxes they let the IRS go after the only corporate officer who had any net worth.

A Terrible Horror Story: A client had a successful construction business until he went on drugs. Payroll tax reports were not mailed and taxes not paid. The IRS computed taxes on the largest payroll he ever filed earlier, even though he had gone out of business, and sent a huge bill for non-existent employee wages. The client got divorced and his family moved on. When the house was sold the IRS took all of the equity.

The Worst Horror Story: This client worked himself almost into the grave by buying old manufacturing equipment to extrude plastic products. He and his family worked night and day rebuilding and repairing the huge machines to keep the low margin business going. One senior family member worked himself into a heart attack and ended up in the hospital. Cash was always short and in desperation they went to a lawyer who was going to save them $30,000 in payroll taxes…for a payment of only $10,000 in legal fees. They paid the lawyer the lesser amount. We met up with them later when they showed up for past accounting information for their business bankruptcy. They admitted the lawyer had no idea what he was doing and nothing was ever done about the payroll tax problem.

The Other Taxes:

The biggest problem is with the ongoing recession. Especially for people with businesses. The economy had been humming along until suddenly everything slowed down, then collapsed in 2008. Many people forgot to file returns and they ignored letters from the IRS to do so. Year after year passed with many people in a state of economic depression or unemployment with no end in sight. The IRS computer continued to compile returns for the people and always with the worst case mantra of single and standard deductions for all against all 1099 and W-2 wages reported.

Finally, the people came to us and other preparers. We filed the old returns [even to ten years ago], took steps to reduce penalties [which doubles the real bill because they also assess interest on penalties], and helped create installment plans for the IRS. The pain and suffering for all those years was intense for many but there are some solutions.

One solution is that after ten years from the actual filing date [for those who filed but didn’t pay] the unpaid taxes and fees will fall off the IRS computer. This is akin to passing the seventh year of a bad debt and having it fall off your credit reporting agency. It pays to keep in mind though, that this is from the filing date and if it was filed late or audited later the ten years is extended.

Another solution is to get an offer in compromise. This requires a complete financial statement and reasonable assumptions of payments. They are not about to give it all away for pennies on a dollar. The financial statement will provide them with all your assets so we are working with payments of future earnings. Naturally, there is a modest charge for them to handle the paperwork. It is really hard to get them to accept these offers because they don’t like giving anything away. I did one once for a lawyer and they accepted it. Maybe the lawyer’s giant six-figure student loan scared the IRS because that is not waived by bankruptcy.

Another way is for bankruptcy. The taxes have to be over three years overdue. A really good BK attorney is needed for this one because they need a statement directly from the IRS for the liabilities and they have to be only for income taxes. I have sent many people that way because if they owe over $50,000 and do not have good earnings, it is impossible to get reasonable installment agreements.

The last way out is insolvency. This will take a financial statement so the IRS knows you have no money or earnings. It will defer the taxes, not vacate them, so if you were to suddenly get a windfall or a good job, it could come alive again like the Zombie that never died.

Before any of the above steps can be considered, all tax returns must be current and filed. We charge reasonable fees for old returns, actually just what we would have normally charged if filed on time. Many tax preparers charge huge fees for old tax returns but we feel that finding future clients is more important. Overall, we love returning clients. However, if we need to do Power of Attorney forms, call the IRS, and wait an hour on the phone for the person to pick up and brake the numb spell of background Music, and fight with them for transcripts or waiving lien notices, etc. there will be other charges.

Last of all. If you are in an engagement with the IRS pay attention to what they demand because you are in a cage with them and have to fight your way out. You cannot surrender or give up. It is like waking up in surgery and wanting to leave before they finish.

Last Horror Story. A new client was in the middle of a field audit. He had been buying motor vehicles at the auction and not keeping good records of the sales. The Revenue Agent lived in our office in a little room for a month before the client gave up. He just waved a white flag and tried to hide. It was costing him a lot of money for a bookkeeper to reconstruct his records and he wanted out. The auditor packed up and left. A week later the new client received a tax bill for over a million dollars. The auditor simply applied all the earnings to the sales for the year with no cost of sales [the dealer’s auction cost]. The client returned to finish the audit and retired. The audit came out okay after all. Besides, the auditor’s mother had a copy of my business book from when she was a client. Income tax accountants.

Problems with Federal Taxes

Some important elements for tax problems are that after ten years from the filing date [not the tax year] any liability will disappear off the I OWE YOU journal that the IRS has maintained under your Social Security Number. The penalties and interest also fall off. California also has a limit rule for collections but you have to live twenty years to benefit.

As a practical matter, the IRS will not perform tax audits or sales tax audits beyond the third tax year from now. They tend to audit the middle year and go back or forward if they find something worth collecting. The auditors are under orders not to go beyond the third year unless there is fraud involved, and that means Tax Court [not Appeals]. Everybody fears Tax Court, even the auditors, because it is a prolonged expensive ordeal with uncertain results for all.

Liens are automatically issued for past due taxes of all kinds. These liens extend to all property. A word of caution for estate planning. An elderly client placed her three children on the title of a real property and forgot about it. Years later she sold the property and found that it had a lien attached by one of her adult children who had not paid his taxes. The IRS took the whole property proceeds and the other beneficiaries got zilch.

Taxes can be scheduled as uncollectible by the IRS if you file the right paperwork declaring insolvency [no bankruptcy here] and give them financial statements showing they cannot attach wages or property. The uncollectible status however puts a hold on the liability and they can come back at any time to collect should you win the lottery, inherit some money, or get a real job. The money is still owed, not washed out.

Record retention should be limited to four years unless there are tax issues that carry around for many years. It's okay to shred If you file ordinary tax returns and they are beyond the audit period and one year beyond the refund period. If you file a late tax return older than three years which has a refund, you will never get the check in the mail. This is a great reason not to procrastinate too long for filing. Returns that have capital gain losses, Depreciable property such as rentals, and business equipment, owners should keep records many years to show the cost and activity which produced these items which can live many years in a tax return. I experienced an audit whereas a client had huge losses carried forward for many years as a capital loss. He had to go back ten years to find the original documents. If he had not produced them, they would have disallowed the whole thing. The IRS makes a lot of money by auditing and disallowing losses.

Bankruptcy is always a way out but most attorney don't handle a BK with taxes. The taxes need to be more than three years old. All returns need to be filed and the attorney sends a special request to the tax agencies to get exact data. As a matter of fact, even to go to jail for murder or jaywalking, you need to have all returns filed as well.

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