Offer in Compromise: Don't Get Caught in a Scam

If you owe taxes to the IRS, the IRS has an amazing program through which you can settle your tax debt for much less you owe.  Does this sound too good to be true?  For most people it is.  Although there is a program called the offer in compromise (OIC), very few people qualify to actually settle their debt.  The IRS will accept a settlement if you can prove that the IRS will not be able to collect the full amount of your debt before the statute of limitation for collection expires (this is known as your "reasonable collection potential" and it must be less than the amount of taxes you owe).  

Nevertheless, there are many companies out there who market themselves as being able to "settle your debt for less." These companies abuse the OIC program by reeling in consumers with deceptive promises and failing to qualify taxpayers for an OIC.  An example of one these companies is the Roni Deutch Tax Center (RDTC).  After being prosecuted by state agencies, Tax Attorney Roni Lynn Deutch (A.K.A the "Tax Lady"), closed her law practice and resigned from the California State Bar in May 2011.  

Deutch had an extremely promising start.  After obtaining her law degree, she opened her own tax practice in 1991.  After several years of success, she launched RDTC, a tax preparation franchise company. By 2009, RDTC was named on of the fastest growing franchise companies in the US.  In addition, Deutch was also a popular author, blogger and television show guest.  

Her downfall began in 2006 when the New York City Department of Consumer Affairs (DCA) sued her for misleading television advertisements.  The DCA argued that she failed to disclose eligibility requirements when advertising the OIC program, thereby concealing the fact that a majority of people do not qualify for the OIC.  Deutch settled this lawsuit for deceptive advertising practices in 2006 by agreeing to pay $300,000.  

In August 2010, the Attorney General of California filed a $34 million lawsuit against Deutch for her fraudulent scheme.  According to the lawsuit, "only 10% of her clients ever [got] their tax debts resolved.  Most quit or [were] terminated by Deutch's firm and [were] denied refunds after Deutch's staff bills them for work that wasn't performed." In the end, Deutch filed for bankruptcy, surrendered her bar license and closed her doors.  

Deutch's story should be a lesson to consumers: Be careful who you hire to resolve your tax problems and be particularly careful about companies advertising themselves as being able to settle your tax debts for less.  If the company is a fraud, an internet search may uncover its deceptive practices through customer complaints.  When you are hiring a representative for an OIC, be skeptical of guarantees made before your finances are reviewed. 

Also, be aware that the OIC process is difficult and time consuming.  It could take anywhere from 1-2 years for an offer to be resolved.  Nevertheless, many OICs are accepted every year.  In order to determine whether you qualify, a tax professional should consider your reasonable collection potential.  This amount is equal to the liquidation value of your assets (which includes 100% of your cash and investments) plus your monthly disposable income over a period of 48 months.  If this amount is less than what you owe to the IRS, you qualify for an OIC and must offer this amount as settlement.  

This content is not intended as legal advice, and cannot be relied upon for any purpose without the services of a qualified professional.  

Final Notice of Intent to Levy and Notice of Your Right to a Hearing

If you owe money to the IRS, you will receive a consistent stream letters that become progressively more threatening.  There is one letter, in particular, that may be the most important one you receive from the IRS. If you agree with your liability but have not yet paid it, this letter is titled "Final Notice of Intent to Levy and Notice of Your Right to a Hearing" ("Final Notice").  Do not ignore this letter or else you will soon find your bank account empty and your wages garnished.  The other important letter is the "Notice of Determination" which gives you 90 days to petition the Tax Court in order to dispute your liability. 

What does the Final Notice" mean? Lets go back to the beginning.  When you initially owe money to the IRS and your rights to dispute your liability in Tax Court have expired, you will receive a notice stating something along the lines of "according to our records, you have an amount due on your income taxes."  This notice will encourage you to pay your balance in full or set up an installment agreement.  This notice is polite because, at this time, your account with the IRS is not yet in Automated Collections.  Collections is the branch of the IRS that deals with actively collecting a liability due from taxpayers. If you do not respond to this notice, you may receive several other notices prompting you to pay.  Again, even though these notices appear increasingly more threatening, your account is still not in Collections.  Eventually, you will receive a notice titled "Intent to Seize your Property or Rights to Property" (CP-504).  The CP-504 is your final notice before your account is transferred to collections.  If you don't pay the amount due, the IRS may seize your state tax refund and file a Notice of Federal Tax Lien on your property.  

This is also the notice before the IRS sends you your Final Notice. When you receive the Final Notice, you have to request a Collection Due Process Hearing ("CDP Hearing") by filing out and sending in Form 12153 (please read this form carefully when you are filling it out).  When you request a CDP Hearing, the IRS will assign your account to an agent who will contact you directly through the mail or phone in order to set you up on an installment agreement or, if you are experiencing hardship, place you on Currently Non-Collectible Status ("CNC"). Otherwise, if you ignore this notice, there are no more protections between your assets and the IRS.  The IRS can and will go after you.  

In conclusion, when you receive mail from the IRS: read it and look carefully for any deadlines that the IRS has imposed.  If you don't, you may be in for a much bigger hassle then you orginally thought.  

This content is not intended as legal advice, and cannot be relied upon for any purpose without the services of a qualified professional. 

Understanding IRS Penalties and Penalty Abatement Requests

FAILURE TO FILE AND FAILURE TO PAY PENALTIES

When you own money to the IRS, there are two common penalties that the IRS can tack on to your liability in addition to interest.  If your tax return is filed late, the IRS will impose the "Penalty for Filing Tax Return After the Due Date (failure to file)" which is up to 25% of the net tax due.  This penalty is imposed at a rate of 5% per month, for every month that your tax return is not filed, subject to the 25% ceiling (reaching its maximum at 5 months)

The second penalty is the "Penalty for Late Payment of Tax (failure to pay)." This penalty is imposed at a rate of 0.5% per month, subject to the 25% ceiling (reaching its maximum at 50 months).  When both penalties are imposed together, the 5% failure to file penalty will be offset by the 0.5% failure to pay penalty.  This means that if you fail to file a tax return and pay the tax due on time, you will be subject to a maximum penalty of 47.5% of the net tax due (this is assuming that the failure to file and pay is not fraudulent).  These are very hefty penalties and it's best to try to avoid them if possible. 

This year, you have until April 17, 2012 to file your taxes (individual).  In the alternative, if you cannot file your taxes by April 17, you can submit to the IRS the "Application for Automatic Extension of Time To File U.S. Individual Income Tax Return".  By filing this form, you will get an additional six months to file your tax return, thereby avoiding the late filing penalty if the return is filed by October 17, 2012.  Nevertheless, this form does not extend the time to pay any taxes owed.  All taxes owed must be paid by the April 17, 2012 deadline or else the IRS will assess the late payment penalty.  

If, on the other hand, you can show that undue hardship will be suffered if payment is made on the payment due date, the IRS may grant an extension to pay.  In order to apply for this extension,  you should submit "Application for Extension of Time for Payment of Tax Due to Undue Hardship."

PENALTY ABATEMENT

If you can show reasonable cause for failing to pay and file on time, the IRS may waive the failure to file and pay penalties. In order to request abatement, you should send a letter to the IRS (either with a delinquent individual tax return or after penalties have already been assessed) describing the penalties involved and providing an explanation for why reasonable cause exists.  In the Internal Revenue Manual (IRM), the IRS states that "reasonable cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining their tax obligation but nevertheless failed to comply with those obligations." 

The IRS also lists several defenses that may satisfy the reasonable cause standard.  These include 

• Death or serious illness of the taxpayer or a member of his immediate family 
• Fire, casualty, natural disaster or other disturbance and
• The taxpayer's inability to obtain records through no fault of his own.  

Even if your specific situation does not fall into one of these three categories of defenses, you should still submit a request for abatement.  

That is not to say that getting the IRS to grant your penalty abatement request will be easy.  

• First, it could take three month to a year before your penalties are abated (while this request is pending, you must either pay your liability in full or you must be making payments through an installment agreement).  
• Second, in order to get the late payment penalty abated, you need to, at least, pay the amount of tax owed (excluding interest and penalties) in full. 
• Third, it is best to submit as much proof supporting your reasonable cause defense as possible.  For example, if you are claiming illness (either your own or in your immediate family), you should submit a doctor's note supporting the illness.  

Finally, many penalties abatement letters get rejected and must be appealed before they are accepted.  At the initial stage, your defenses will be inputted into a computer program and, unless the issues are extremely clear cut and well supported per IRS standards, it is likely that you will receive a computer generated rejection letter.  Appealing the rejection is highly recommended because the IRS representative reviewing the appeal has substantially more discretion and leeway to abate the penalties.  Remember, the penalty abatement process is not a simple one but it is worth fighting for considering that you may be assessed penalties up to 47.5% of the net tax due.

This content is not intended as legal advice, and cannot be relied upon for any purpose without the services of a qualified professional. 

The Dispute Over Newt Gingrich's Taxes: What is Reasonable Compensation to an S Corporation's Shareholder-Employee?

An article posted by Forbes last month brought up an interesting dispute regarding Newt Gingrich's tax planning technique.

What did Gingrich do? He treated only $444,327 of his S corporation's earnings as wages and reported the remaining $2.4 million in earnings as profits or dividends.  What is wrong with that?  By reporting only $444,327 in wages, he avoided paying Medicare tax on the remaining $2.4 million.  S corporations are flow through entities which means that they do not pay corporate income tax.  Their income flows through to their owners' individual tax returns.

My interest in this dispute came from a bog post by William M. Funk (RealTaxLaw) criticizing Forbes for not understanding tax planning.  The blogger describes Gingrich's allocation as "vanilla tax planning" and explains that the IRS usually only attacks "extreme cases" in which there is a substantial under-reporting of wages (i.e. a CPA who receive $24,000 in wages and takes $203,651 in distributions).  It is difficult to argue that anyone can be underpaid with $444,327 in wages.

On this issue, the IRS provides that "S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee".  In order to determine what is reasonable, the IRS looks to the sources of the S corporations's gross receipts.  These sources come in three major categories: (1) services provided by the shareholder-employee; (2) services of non-shareholder employees, or (3) capital and equipment.  If gross receipts are from second and third categories, they are not associated with the shareholder-employees's services and should not treated as his or her wages.  If, on the other hand, most of the gross receipts come directly from the shareholder-employee's services, they should be treated as wages.

In addition, the IRS goes on to say that the shareholder-employee should also receive wages for administrative work performed with the second and third categories.

So the real issue is what is the source of Gingrich's S corporation's earnings?  Forbes explains that according to Gingrich Productions' website, there is no suggestion that the company profits from anything or anyone other than the work of the Gingriches.  In fact, as Forbes points out, the "About Us" section of the website states that "together, Newt and Callista host and produce historical and public policy documentaries, write books and newsletters, give speeches, record audio books, produce photographic essays, and make television and radio appearances."

While this portion indicates that Gingrich Production relies upon the work of the Gingriches, it seems a little irresponsible to apply the IRS's reasonable compensation test to a public figure almost entirely on the basis of the above statement.  I would hope that if the IRS chooses to audit the Gingriches, they perform a more in-depth look at the sources of income.

Most likely, RealTaxLaw has a good point.  The IRS will probably not attack Gingrich's compensation as unreasonable.  Nevertheless, it is worth noting that public figures sometimes should go above and beyond to avoid public scrutiny.  For example, Forbes points out that President Barack Obama paid Medicare taxes on all his book profits ($1.4 million).

What will this damaging press cost Gingrich?

This content is not intended as legal advice, and cannot be relied upon for any purpose without the services of a qualified professional.