A Streamlined Guide to Tax Returns

tax return

The tax return season usually causes headaches to many individuals, self-employed and corporations alike. Buzz words like tax returns, Form 1040, Form 1040X, Form 1120S, and Schedule A only come to confuse things some more. This comprehensive guide sheds light to key must-knows so you begin to have a clearer idea of tax preparation, tax returns, and what is required from you. 

 

What Is a Tax Return?

A tax return or income tax return is a document that you need to file with either the state tax board or the IRS (Internal Revenue Service) which reports your income, as well as your deductions (i.e., your business profits and losses) and other details about your tax liability or tax refund. A tax return allows you to:

  • Request a refund for tax overpayment.
  • Schedule tax payments.
  • Calculate your tax liability. 

Tax returns are filed annually for any business or individual with capital gains, interest, wages, and other reportable income/profits for the previous year, with the deadline being April 15. A tax return has the following three major sections:

  1. Income – It lists all your income sources. You need to report royalties, self-employment income, dividends, and wages, usually using a W-2 form. 
  2. Deductions – Things like interest deductions on specific loans, alimony paid, and contributions to retirement plans are typical examples of deductions that decrease tax liability. The final list, though, varies among jurisdictions. In general, the majority of business operations-related expenses are deductible (for business owners). You can also choose to itemize your deductions instead of using the standard deduction for your filing status.  
  3. Tax credits – These refer to the sum of the owed taxes or the amounts that reduce tax liabilities. More than often, education, pensions, and the care of dependent seniors and children are also attributed tax credits. However, they, too, vary among jurisdictions. 

At the end of the fiscal year and after filing your tax return, you will be able to tell whether you owe taxes or have overpaid taxes (hence, need to be refunded). If you choose not to get your overpaid taxes amount back, it will roll into the next tax year. Now, if you owe taxes, you can pay your debt in monthly (or quarterly) installments or as a single payment. As for self-employed individuals, most of them can reduce their tax burden by making advance payments every quarter. 

 

What Types of Tax Returns Are There? 

Of the many federal income tax return forms, the most commonly used ones are:

Form 1040 (for Individuals) 

Form 1040 is a long form, which means additional paperwork needs to be filed due to the many tax credits that show up only there. You can consider choosing this form if you (1) itemize deductions, (2) have other income to report, (3) have more complex investments to report, and (4) your earnings are larger. Nevertheless, this extra work that needs to be done with Form 1040 is offset by the extra savings specific credits can produce for you (i.e., taxes paid on a foreign country). Plus, you have a wealth of deductions ready to be claimed directly on the form (no adjustment needed) which enables you to reduce your gross income (i.e., alimony payments, incurred moving expenses, and self-employment taxes). This, in turn, can help you lower the income sum that will be eventually taxed. 

You should file Form 1040 if:

  • You have received income from a property sale.
  • You are self-employed.
  • You itemize deductions. 
  • Your combined incomes (for joint filers) or your personal income is over $100,000.

Important note: If your current situation is different from that of the previous year(s) (i.e., you can make itemizing more profitable for you because you now have more deductions), you will probably need to file a different form. There is no obligation to continue using a particular income tax form just because it suited you in the past. 

Form 1040X (for Individuals)

This is a form you need to file if you (1) found out that you qualify for credits or deductions you didn’t take or (2) have spotted an error on a tax return or (3) your tax return is missing some income. In other words, Form 1040X can be considered your formal claim for a refund. 

Preparing a Form 1040X does not necessarily require the completion of a new tax return. You only need to update the numbers that should be altered. Remember that you can amend your taxes if you have prepared your original tax return using Form 1040, 1040-SR, 1040A,1040NR-EZ, 1040NR, 1040EZ-T or 1040EZ. For business owners with net operating losses in one of the next two tax years, Form 1040X can help carry back these losses. Any refunds will show after 8-12 weeks from the time you made the amendment. 

To prepare Form 1040X, you need any documentation that relates you to the changes you have made (i.e., proof of payment for a newly claimed deduction) and a copy of your original tax return (the one you wish to amend). Beware, though, that you can file an amended tax return either within 24 months of actually paying the tax for that year or within 36 months of the original filing deadline. Depending on the circumstances, you may have more than three years, though (i.e., incapacitated individuals). 

Form 1040EZ (for Individuals)

The Form 1040EZ is the simplest IRS form (a single page), but limits your options when it comes to ways you can save on your tax bill as it restricts you to claiming the tax break called EITC (earned income tax credit), which has been designed to help out individuals with a low income. That being said, you should file it if:

  • Your interest income is below $1,500.
  • Your combined incomes (if a joint filer) or single income is no more than $100,000.
  • You are married but filing jointly, or single.
  • You have no dependents.
  • You are younger than 65. Note that in case you file a joint return, your spouse should also be below 65 years old. 
  • You are not legally bound during the previous tax year (this applies to your spouse, as well, if filing jointly). 

Form 1120 (for C-Corporations)

C corporations, as well as LLCs that file as corporations need to file their income taxes via the Form 1120. After successfully completing Form 1120, you will have a pretty good idea of how much the corporation will be called to pay in taxes. Remember that you will be required to pay quarterly estimated taxes rather than all the money in one lump sum. 

To file Form 1120, you need to enter:

  • Your total income.
  • The date you incorporated.
  • Your EIN (Employer Identification Number).
  • Your capital gains and earned royalties. 
  • The COGS (Cost of Goods Sold).
  • The gross receipts.
  • The total assets held by your corporation.
  • Any interest and dividends earned.
  • Your tax deductions. 
  • The business tax credits for which you want to apply. 

Form 1120-S (for S-Corporations)

If you are a corporation with an elected S status, you need to file a Form 1120-S tax return annually. In this case, the reported income usually flows through directly to you, the business owner. This means that these companies do not need to pay tax at the corporate level since any reported income is taxed on the business owner’s Form 1040 tax returns. For that reason, the individual does not pay additional taxes on their Form 1040 returns. 

Form 1065 (for Partnerships) 

This is typically filed by partnerships once a year and contains information related to their income, credits, deductions, losses, and more. The particularity of Form 1065 is that it has no federal tax (most of the time, at least). This is because the partners report income flows on their personal tax returns. 

 

What is a 1040 Schedule A?

Those considering to itemize their taxes will need to attach an IRS Schedule A to their Form 1040 so they can claim itemized deductions on their tax returns. For those not familiar with what itemizing taxes is, let’s say that instead of taking the flat-dollar standard deduction, you can choose from the many individual tax deductions out there at tax time. If the amount of your itemized deductions exceeds the standard deduction sum, you save money. for your reference, the standard deductions for 2020 tax year were as follows:

  • Single filing status ($12,400).
  • Married or filing jointly ($24,800).
  • Married or filing separately ($12,400)
  • Head of household ($18,650)

Schedule A is divided into the following sections (each having several subsections):

  • Medical and dental expenses.
  • Casualty and theft losses (in a disaster area declared as such by the federal government or of certain property that produces income).
  • Gifts to charity.
  • Interest you paid.
  • Taxes you paid.
  • Other itemized deductions (i.e., gambling losses, amortizable bond premiums, etc.).
  • Total itemized deductions.

As soon as you have tallied the itemized deductions you wish to claim, you should enter them (the total sum) on your Form 1040. Also, expect to be asked to provide:

  • Form 1098 to show the interest you paid for the year (ask your mortgage lender for it).
  • Your sales tax records.
  • Your state income tax records.
  • Your property tax bills.
  • Any charitable donations records.
  • Receipts for medical expenses that have not been reimbursed. 

 

What is a Schedule C? 

An IRS Schedule C (headlined Profit or Loss From Business (Sole Proprietorship)) is usually filed by self-employed individuals who need to report how much money they lost or made in their business. Schedule C must be completed and then attached to your income tax return. In the majority of cases, you will also be required to fill out Schedule SE (Self-Employment Tax) along with the five-part Schedule C. 

Note that sole proprietorships are companies that do not have a Partnership or Corporation status. They are small businesses operated and controlled by their owners rather than a legal business entity. It does not matter if you have employees or not (or even an office). As long as you get paid for work that you do, you run a sole proprietorship, provided that you earn at least $400 of net profit annually. 

 

What is a Schedule E? 

Schedule E is prepared by those that have income reported on a Schedule K-1 from an S corporation or partnership, receive royalties, build their own home, or earn rental income. You will need to report both your personal tax return and the gross income and losses from these activities. Depending on the type of activity you do, you should include different things. 

For example, for rental income, you need to report prorated rents when you bought the property, the refunds you have received for utilities, and the rental income. As for some of the expenses, these can include marketing and advertising costs (i.e., the cost to advertise on certain publications or sites), travel costs needed to maintain your rentals, cleaning and maintenance costs, repairs, depreciation expenses, and more. 

 

How Long Should You Keep Your Tax Returns? 

According to the IRS, just how long you need to keep your tax returns depends on several factors, such as the event, the type of expense, and the action the document records. Generally speaking, it is best to maintain a record of your tax returns for three years after you filed the return or, at least, until the period of limitations for the particular tax return (the item of credit, deduction income shown on the tax return) ends. 

However, we strongly advise taxpayers to keep records of their tax returns indefinitely if they have filed a fraudulent return or do not file a return at all. That being said, keeping copies of your filed tax returns will make preparing future tax returns much easier for you, in case you want to file an amended return. 

 

Understanding Tax Penalties

dealing with tax penalties

Tax Day is the date by which you need to submit your individual tax return to the IRS (usually April the 15th each year). If you have all the money to pay your debt, then all is great. But, what happens when you lack the necessary funds? In this case, the IRS may charge tax penalties. The same applies to some other occasions.

All of that will be discussed in depth here, so you know exactly what to expect and what to do if you are called on by the IRS to pay tax penalties. 

 

What is a Tax Penalty?

The IRS charges both interest and penalties in several different instances. For example, you will be called to pay some additional costs for:

  • Failure to file – This means that you did not manage to file your tax return by April 15. Do note, though, that you can request a deadline extension. If it is approved, you won’t be charged any failure-to-file tax penalties. 
  • Failure to pay – You don’t have the money to pay the taxes on your return or are unable to make the needed payment before the expiration of the due date (April 15). Beware, in this case, because you will still have to pay your taxes within the given deadline even if your deadline extension (to file your tax return) request has been approved. 
  • Failure to pay tax – If you don’t make tax payments as you earn income (quarterly), you are penalized for late estimated tax payments. 
  • Dishonored check – You have submitted a preferred payment form (i.e., check), but your bank does not honor it.  Or in other words, your check bounces. 

If you owe money to the IRS, the Internal Revenue Service will send you a Notice of Tax Due and Demand for Payment, which includes not only the owed taxes but also the penalties and interest. 

 

What is The Penalty for Filing Taxes Late?

There are two different scenarios here, according to the Internal Revenue Code §6651(a)(1). 

If you owe taxes and fail to file your tax return on time, the IRS will start charging 5% of every unpaid tax you have to report on your return for every month you are late to file (0.5% for not paying and 4.5% for not filing). The total penalty you may be asked to pay for not filing taxes on time can add up to nearly 48% of the tax owed, plus interest. 

So, basically, the IRS begins to accumulate charges in your name. If you are more than 60 days late, the minimum penalty you will be called to pay equals to the lesser of two sums – either a specific dollar amount (for 2020, it is set at $435) or 100% of the tax required to be paid on your return (plus interest). 

Now, if you are expecting a tax refund and do not file your tax return within the due date, you won’t be charged any fees. However, you won’t be able to receive your refund until you do file your tax return.

Bear in mind that the late filing penalty is NOT the same as the penalty you get for making late payments. You are charged a late filing penalty when you don’t turn in essential tax documents on time, such as your Form 1040. The late payment penalty is applied when you are late in making your tax payments and is 0.5% of your unpaid taxes for every 30 days you do not pay your outstanding taxes. 

 

What is the Penalty for Not Filing Taxes?

If you fail to file, the IRS may file a substitute return for you, which will NOT include your standard deductions included in your return. The only exception to the substitute return is married filing separately or single filing. Under IRC § 6651(a)(1), the penalty is 5% of the due balance, plus an extra 5% for every 30 days (or a fraction thereof) during which you continue to fail filing taxes. The maximum penalty is 25%. 

Notes:

  • As soon as you pay your balance, both interest and penalties stop accruing. 
  • Even if you pay your tax in full before the month ends, the IRS will still apply full monthly charges. 
  • If you cannot pay your balance in full, you could apply for an Installment Agreement to help repay the remaining debt. 
  • You may be eligible for penalty relief if you have complied with the law requirements but were not able to meet your obligations toward the IRS. 
  • If you disagree with your balance, you can call 1-800-829-1040. Make sure you have all the required paperwork ready (i.e., amended return, canceled checks, etc.) when you make that call to the IRS. 

 

Do You Have to File Taxes?

You must file a tax return if you:

Note that for individual taxpayers under 65 years of age, the standard deductions are $12,000 (single filers), $24,400 for joint filers, and $18,350 for single parents (2019 IRS rules). For single filers over 65 years old, the amount climbs to $13,850 or $20,000 if you are the head of the household. For joint filers where one or both spouses are over 65, the deduction is $25,700. 

 

How is the Tax Underpayment Penalty Calculated?

Taxpayers in America pay taxes the moment they make money rather than a lump amount. And, they can pay taxes either by making estimated tax payments or via withholding. The penalty for underpayment of estimated tax is usually applied to individuals that have skipped some tax payments the previous fiscal year. To put it simply, a tax underpayment penalty is a penalty that you owe if you fail to pay enough in estimated tax payments or through withholding during the year. 

Failure to pay proper estimated tax usually comes with a penalty if you owe at least $1,000 when you file the return, per the Internal Revenue Code §6654. You might be able to make unequal payments and annualize your income as a means to lower or even avoid the penalty, though. This typically happens when you receive your income unevenly during the year. 

In some instances, you can waive this penalty:

  1. Your tax payments were (1) 90% or more of the tax liability during the year or 
  2. Your tax payments were 100% of the tax liability of the previous year. 
  3. You did not make a payment due to an out-of-the-blue event, such as a disaster or casualty. 

The IRS may also waive a tax underpayment penalty for retirees over 62 years of age or individuals that became disabled either during the current or the previous tax year. Some exceptions apply for some household employers and fishers. Ask us to give you all the details or read the IRS Publication 505. 

The IRS calculates your penalty for every installment separately, where they first determine the number of days you are late and then multiply that number by the interest rate that is effective for the installment period. However, you may also check whether you owe a tax underpayment penalty by using Form 2210 (Underpayment of Estimated Tax by Individuals, Estates, and Trusts) or Form 2220 (Underpayment of Estimated Tax by Corporations) depending on your case – look for the flowchart. 

If you do owe a penalty, you will need to figure out what you owe in taxes per quarter (and what you have paid in taxes during this time) to calculate the per-quarter penalty sum. Then, you will get your total penalty amount by totaling your quarterly penalties. According to the IRS, the following interest rates on underpayments apply:

  • 2.5% for the portion of an overpayment over $10,000 (for corporations).
  • 5% for underpayments and overpayments (not for corporations).
  • 4% for corporation overpayments.
  • 7% for large corporate underpayments. 
  • The federal short-term rate + 3% for taxpayers besides corporations (for underpayments).
  • The federal short-term rate + 2% for taxpayers besides corporations (for overpayments). 

Remember that all rates are determined on a quarterly basis. 

 

How Much Is the Penalty For Not Paying Estimated Taxes?

The estimated tax penalty is, at its core, an interest charge for not making estimated payments throughout the year (or sufficient estimated payments). The IRS-set quarterly rate for underpayments was 5% in the first and second quarter of 2020 and 3% in the third. This shows that taxpayers were called to pay a higher percentage quarterly rate on the first two quarter balances in 2020. It should be noted that interest is accumulated on a daily basis and is usually added to any tax you have not paid from the time of the due payment to the date you eventually pay the tax. As for the rates, they are set every three months and range around the federal short-term rate plus 3%. 

 

What Is the Tax Penalty For an Early Pension Withdrawal?

Tax breaks such as the Retirement Savings Contribution Credit comes with penalties for early withdrawal. This is the government’s measure to prevent individuals from using their retirement savings for things other than their retirement income. Generally speaking, an early withdrawal or distribution of your retirement plan is any money you cash out before you reach 59 ½ years of age. 

Note that qualified retirement plans do NOT include local or state government 457 plans, rather than:

  • A 403(b) plan (or anything similar) for public school employees and organizations that are tax exempt. 
  • A 403(a) or similar employee annuity plan.
  • A 401(k) or similar employee plan.
  • A Roth IRA
  • A Traditional IRA

The amount you withdraw from your retirement plan (a qualified one, that is) is added to your gross income. This means that you will owe the normal income tax PLUS an extra tax 10% tax penalty on the amount you have withdrawn from your retirement plan. Of course, there are exceptions for early withdrawal as well, where this is not applied. 

Note that not all distributions are taxable and subject to the 10% extra tax penalty, such as the ones you roll over to another retirement plan. Also, the following exceptions to the 10% additional tax penalty for early pension withdrawals apply (these are only some of the existing exceptions – contact us for more details):

  • You made a series of periodic and equal payments over your life expectancy, and the distribution was an installment in them. This provides that you have left employment before starting the payments if your retirement plan is not an IRA. 
  • You made a series of periodic and equal payments over the life expectancy of your beneficiary (or beneficiaries) and yourself, and the distribution was an installment in them. This provides that you have left employment before starting the payments if your retirement plan is not an IRA. 
  • You made the distribution to pay for an IRS levy.
  • You made the withdrawal to cover deductible medical expenses.
  • You made the withdrawal to cover post-secondary education expenses (applies to IRAs only).
  • You made the distribution due to permanent or total disability.
  • A beneficiary made the distribution after your death. 

Note: Reporting your withdrawal is income is still required even if you qualify for any of the exceptions. 

Here is the current tax regime of penalties for withdrawing from 401k and IRA accounts:

For distributions of up to $100,000 related to the coronavirus, the 10% is waived. The same applies to higher education expenses, first-time home purchases or new builds, medical expenses or insurance, or family circumstances (i.e., provide funds to a divorced spouse). The distributions may still be considered as income, though. Early withdrawals from these accounts are expensive unless you are over 59 ½ years old. In any other case, you may pay a 10% penalty on the account you cashed out money and federal income tax. Exceptions apply to the 10% penalty rule, though. Ask us for more details. 

 

Civil Tax Penalties

Taxpayers that are late on filing tax returns and paying tax, not prepay a sufficient sum of tax liability, or face accuracy-related problems are called to pay penalties for not meeting the given deadlines. 

In detail, the penalty for late filing applies to both non-filing and late filing and is the rate of 5% per month of the tax due (up to 25% max). For failing to pay the tax shown on the return by the due date of the payment and not paying an asserted deficiency within a short time frame after notice and demand, taxpayers face section 6651(a)(3) and 6651(a)(2) penalties, which are 0.5% per month of the sum shown as tax due (up to 25% max). Finally, taxpayers that do not prepay 90% of their tax liability via applying a prior year’s tax refund, making voluntary installment payments throughout the year, or withholding fall under Section 6654. The estimated tax penalty, in this case, applies automatically unless you can prove that you qualify for an exception (i.e., the paid sum during the subject year was greater than or equal to the tax liability for the previous year).

The failure to file penalty depends on the net tax sum required to be shown on the return, the penalty period, and the penalty rate (usually 5%). Plus, it is imposed according to the number of months during which the taxpayer has not filed, with the maximum being 4 months and one day. 

As for time extensions to file or pay, they do not affect the period for calculating the penalty for the late payment as they do not extend the due date to pay. Nevertheless, if you have paid at least 90% of the tax shown on the return by the due date, an automatic extension of time to file a tax return is treated as a time extension to repay the tax (Form 4868). This also entails that the balance is paid with the tax return as well. In any other case, the penalty applies to the total balance due from the initial due date. 

Lastly, if the IRS decides that you need to pay an additional tax that was not shown on a return. You will receive a notice that the Service has assessed an extra sum on top of what you have paid. Failure to pay this tax is subject to additional tax (0.5% for each month that the assessment is unpaid) for failure to pay (it should be paid within 21 days after your notice was issued).

Exception to Apply – General Requirements 

You can demonstrate an absence of willful neglect (reckless indifference or intentional failure) and reasonable cause for the failure to file a return.  The IRS considers the following factors, among others, to decide whether to abate the penalties or not:

  • The length of time between the event incident that was regarded as reason for noncompliance and the following compliance.
  • The taxpayer’s penalty history.
  • The taxpayer’s payment history. 
  • Whether the reasons of the taxpayer address the imposed penalty. 

Note: Record unavailability is usually not considered a reasonable cause, nor does ignorance of the law. You can also NOT claim things like unavailability of the needed information to complete the return, invalid extension, time or business pressures, forgetfulness or mistake, or a belief that no tax was due. The IRS might consider the following as constituting reasonable cause:

  • Unavoidable absence
  • Serious illness or death of the taxpayer
  • Natural disasters
  • Fire
  • Casualty

Accuracy-Related Civil Penalties

These are a group of civil penalties, including those imposed for substantially misstated valuations, those for reporting positions without adequate disclosure or substantial authority, or those for negligent reporting positions. In these cases, the taxpayer is called to pay an accuracy-related penalty. However, exceptions apply while there are several possible defenses tax practitioners can raise to help avoid these penalties.

 

Are Tax Penalties Tax Deductible?

According to the Code, no deductions can be taken for a penalty or fine that is issued for any law violation, including claiming false tax credits or deductions or misreporting income. It should be noted that a fine refers to both civil penalties and sums paid in settlement of potential liability for a penalty or fine that is not deductible. Compensatory damages paid to the government, though, is not considered as a penalty or fine. The IRS usually assesses penalties along with interest (not tax-deductible) on the due balance owed by the taxpayer. 

Let us note, at this point, that taxpayers may qualify for relief despite the fact that they cannot deduct penalties. For extenuating circumstances, and only if the IRS approves it, taxpayers may see some or all of their penalty being relieved. Nevertheless, until the due amount is paid in full, they will have to pay interest. 

What is also known is that legal expenses incurred in trying to collect or produce taxable income are not deductible anymore, according to IRS Publication 529. You can, however, fill out Schedule C to deduct expenses related to resolving tax problems linked to loss or profit from your business, or Schedule E for farm expenses and income, or Schedule E for royalties and rentals on the appropriate schedule. Nonbusiness-related expenses used to resolve tax issues are no longer deductible. 

 

How to Get a Tax Penalty Waived

Taxpayers that fail to file, pay, or deposit penalties may qualify for the first-time penalty abatement (FTA) waiver (only applies if there is reasonable cause for not paying or filing taxes on time). The IRS may grant relief to relieve this administrative waiver if certain criteria are met, such as having a clean compliance history (no penalties owed) for at least three years. You may also be eligible for the FTA waiver if you have:

  • Paid all tax due.
  • Made arrangements to pay all tax due (i.e., via an installment agreement – applies to current payments). 
  • Filed all necessary returns and cannot file an outstanding claim for a tax return.
  • Filed a valid extension for the necessary returns and cannot make an outstanding request for a tax return. 

To request penalty abatement over the telephone, you need to provide your tax practitioner with a Power of Attorney authorization to request the penalty on your behalf, especially if your case is being handled by a specific compliance unit. If you don’t receive a letter from the IRS indicating that you meet the FTA criteria and that your penalties have been removed within 30 days from the day you (or your tax practitioner) called them, it is strongly advised to follow up with the IRS. You may, nevertheless, request a penalty abatement by letter or mail, provided that you attach all relevant documents and information, such as transcripts that prove payment or filing compliance and/or a valid power of attorney, among others. 

Important Notes:.

  • If you have paid the penalty, you can file Form 843 and ask for a refund. 
  • First-time penalty abatement applies to one tax period. If you request for penalty relief for more than one year, your penalty relief will apply to the earliest tax period, as long as you meet the FTA criteria. The subsequent tax years may have a penalty relief based on reasonable cause criteria and other relief provisions. 
  • You may take your case to Appeals if you believe that you can receive penalty relief on hazards of litigation on other factors.

 

Conclusion 

Filing your tax returns and paying your tax bill on time is key to avoiding getting penalties. Nevertheless, in any other case, there are always reasonable IRS payment plans that you could consider. These offer significantly lower interest rates and may even allow you to settle your bill for less than the due amount, such as the Offer in Compromise.

Let’s talk about your options and see what is the best course of action based on your individual case so that you can enjoy a happier and more stress (and debt)-free life from now on. Contact us now and schedule your appointment for a free consultation. 

Understanding Tax Liens

IRS tax lien

If you owe back taxes, tax liens (and their siblings, tax levies) can affect you seriously if you don’t take proper action. In this guide, we give you all the details you need to know about tax liens, as well as ways to remove them if you get caught in their net. 

 

What Is a Tax Lien?

In simple terms, a tax lien is a claim the government makes on your financial assets (usually your real estate – see a house or another property) when you have not paid your income taxes on time. A tax lien is the first red flag you will get for failing to take care of your income tax obligations. At this point, you don’t risk having your assets seized. However, if you decide to sell the asset, you can expect the government to claim some of the proceeds (or all of them, depending on the sum you owe). However, do bear in mind that a tax lien may appear on your credit report and could:

  • Affect your ability to get a loan or keep a security clearance. 
  • Stick with you even if you file for bankruptcy.
  • Be a blockage for you when on a job hunt. 
  • Cause your creditworthiness to take a nosedive (the IRS will notify creditors of your financial situation by filing a public notice of the tax lien).
  • Prevent you from refinancing or selling your home (during title searches, things like tax liens do surface). 
  • Cost you a lot of time if you need to go through the IRS automated collection system (ACS) or a revenue officer that requires you to pay them a visit in person. 

A tax levy comes right after a tax lien and has the power to seize your property and bank accounts or even garnish your wages so that the government can eventually get its owed taxes from you. Note that you may receive a lien immediately after the IRS has assessed the tax. Nevertheless, it may take up to several months before the IRS figures out that you have not paid your taxes.

 

What Is a Federal Tax Lien?

Just like a tax lien, a federal tax lien is a federally-authorized lien placed against your assets (or any of them) for back taxes that have not been paid. It gives the US government the right to take or keep your personal property until you pay your due federal taxes. The steps involved from the moment the IRS realizes that you owe money to the government to the point they finally collect their money, are as follows. The IRS will:

  1. Assess the liability.
  2. Notify you with a Notice and Demand for Payment. 
  3. After that comes a public Notice of Federal Tax Lien that all creditors will be able to see. 
  4. Secure your property to secure payment if you continue to have your taxes unpaid, be it an estate, gift, self-employment, income tax, or another.  

Remember that when served a federal tax lien, any assets you may acquire during the lien may also be placed on a tax lien. Overall, a federal tax lien will most likely downgrade your credit score substantially, given that the IRS notifies creditors and individual states that you owe back taxes and that they are the first in line to receive payment for these unpaid taxes. In many instances, you may even be required to pay your due taxes in full so that you can regain your ability to receive any kind of financing. 

 

What Is a State Tax Lien?

This is slightly different from a federal tax lien as it is imposed by the state government. However, it still gives the government authority to secure the owed tax by exercising a legal right over your property, be it personal or real estate. Before any action is taken, the state issues a Notice of State Tax Lien after your tax liabilities are assessed, and a Final Bill for Taxes Due (or a Bill for Taxes Due) is then sent to you. The waiting period between the Bill for Taxes Due and the Notice of State Tax Lien is 35 days. Within that time, you need to reach some sort of appropriate resolution (if you cannot settle your tax debt). Until you do, though, the lien will remain on the property in question. 

Notes:

  • It may take up to three years for the IRS to assess liabilities on federal income taxes (from the date you are required to file or file a tax return). This legal time frame is called a Statute of Limitations, during which the IRS can bring legal action against you. 
  • A statute of limitations can be extended to six years if you underestimate your gross income by over 25%.
  • A statute of limitations can have no time limit if you fail to file a return (fraudulent or not). 
  • Some states follow the 3-year statute of limitations rule (see Ohio, Wisconsin, Michigan, Kentucky, Colorado, California, and Arizona) while others follow the 3-year plan for income taxes owed to the state (i.e., Tennessee, Oregon, New Mexico, Louisiana, and Kansas). 

If you find yourself dealing with a state lien, it is advised to consult with a tax professional to have all your questions about things like the statute of limitations in your state answered. 

A tax professional is undeniably your best line of defense when you want to protect yourself against liens and levies placed on your wages, assets, property, and bank accounts (and get out of the troubles brought by a state or federal tax lien). It is critical that you reach a settlement with the IRS (or appeal a lien) before they place a levy on your property or bank account, to prevent your assets from being seized. 

 

How to Find Out If You Have a Tax Lien

As already mentioned above, the IRS will most likely notify you if a federal tax lien has been filed by sending you a Notice of Federal Tax Lien. In general, a federal lien is effective almost immediately after the IRS issues a written demand for payment of due taxes (within the next 10 days or so). 

Nevertheless, you could find out whether you have a federal lien tax on your own. Given that tax liens are placed with local authorities, we suggest you visit your state’s Secretary of State website. There should be an option that reads UCC Search or Lien Filing. In either case, you will be called to enter some personal details, such as your filing name and other ID information, so you can retrieve the data you seek. 

Other than that, another great resource to figure out if you have a lien is legal databases, which usually offer access to up-to-date information on tax liens for a fee. Now, since your state may also place a lien on your property if you fail to pay the local taxes on time, you may want to check with the county in which your financial asset (the one that a lien may have been placed on) is located. The process varies among states. However, you will need the assistance of your state government offices to help lift your lien and pay your back taxes. In New York, for example, this procedure entails you call (518) 457-5434 or use your online services account to pay your tax bill. Other states offer a wide range of payment options – even provide you with the chance to set up a payment plan for a small fee (see California). 

Note: As soon as you pay your tax debt, remember to request a copy of your credit report so that you can check that the lien has indeed been lifted. If it has not been removed, do contact the relevant credit bureaus to sort this issue out with them. 

 

Can You Sell a House With a Tax Lien?

Yes, it is possible to still be able to sell your home if you have a lien on it. Of course, some conditions need to be met. For instance, you should ensure that you pay your tax lien first and then refinance or sell your home. 

You have two options here (1) pay the lien before you close the deal (you add the lien amount to your expenses) or (2) clear the lien by paying the taxes on your own before selling your house. If the latter is not doable (though, it is the best course of action since a property lien is listed on the title report, which may trouble or worry potential buyers), you could consider the following:

  • File For Chapter 13 Bankruptcy – This is a handy solution that will give you a greater negotiating power. But, that’s all there is to it. Although it will NOT clear your debt, it may open the road for a payment plan that serves you so you can repay your due taxes over a period of time. 
  • Dispute The Lien – Pursue this option if you believe that a lien has been wrongly placed on your property. In this case, the creditor may be willing to lift the lien. In any other case, you can bring your case to the court. If you win, your lien will be released. If you lose, you may be able to work something out with the creditor (some sort of settlement) to reduce the due amount. 
  • Apply For a Subordination – The IRS may discharge the sum of your back taxes so that you can sell or refinance your property or restructure your mortgage.  This means that the IRS will sell (subordinate) your debt to other creditors, who will wait for the closing of the deal to get paid. So, basically, your debt goes from the IRS to another creditor. That way, the title of your home is clear (and is passed on to the buyer clear) while you will still be called to pay the back taxes to the 3rd-party creditor. To apply for a subordination, you could use the services of creditors with liens (i.e., a mortgage company) or apply for a program like the Direct Debit Installment Agreement to have your lien withdrawn after making the needed payments. 
  • Increase The Selling Price – If nothing of the above works, you could add the amount you owe to the IRS to the selling price of your home to cover the property tax lien. Just ensure that the real estate market supports the asked price (the current market value should be around the price at which you are selling your house so that it is attractive to potential buyers). Also, don’t forget to pay your lien before you transfer the ownership of the house. That way, your buyer will get a clear title. 

 

How to Remove a Tax Lien

If you cannot afford to pay your back taxes, which is the single most effective way to stop a tax lien, you could come to some sort of agreement with the IRS. We suggest exploring options like an Offer in Compromise, which may help you settle your back taxes for less than what you really owe. In this case, though, take note that being accepted is quite a long shot. You will also need to fulfill certain conditions:

  • You have filled all of your tax returns.
  • You are not being audited.
  • You are not in bankruptcy.
  • You have made the needed estimated tax payments for the current fiscal year.

You may use this handy tool to check whether you qualify for an Offer in Compromise or not. 

Alternatively, you could consider getting on an IRS payment plan, such as the Direct Debit Installment Agreement, where you grant the IRS the right to take three or more consecutive payments out of your bank account. That way, you may be able to convince them to remove your tax lien from public records. That being said, you will still have to pay penalties and interest (and your tax debt, of course) until your tax balance is paid off. 

This list could go on forever. So, do reach out to us. Let’s sit down and go through your options together. Our expert tax relief professionals know the way to get you out of debt or at least relieve you of your financial strains considerably. Contact us today for a free tax consultation. 

Tax Relief: What It Is and How It Works

happy business person after tax relief

A relatively recent government study showed that more than 20% of tax filers had a 2018 IRS tax bill. This means that one out of every four Americans may not have had enough taxes withheld in the 2018 fiscal year. Things can get quite challenging for taxpayers who owe taxes but have no money to pay their tax bill(s). When that happens, the IRS may offer several tax relief options to help you get out of this unpleasant situation as pain-free as possible.

In this guide, we give you all the details about what tax relief really is, how it works, how much of your due taxes you might be able to reduce, how we can help you find the appropriate tax relief plan for your particular situation, and more.

What Is Tax Relief?

Tax relief is an arrangement where you either negotiate a settlement with the IRS or set up a payment plan with them. So in the end, you get to reduce the tax amount you pay to the government or break down your debt into payments. However, note that this is NOT about relieving you from your tax obligations. It will NOT eliminate your tax bill, either. Nevertheless, it IS a convenient (and much more manageable) way to pay the tax debt you owe to the government.

The IRS also offers special tax relief to victims of natural disasters, such as wildfires and hurricanes. This could include deadline extensions or enable those eligible for tax relief to claim casualty losses on their tax returns. The recent coronavirus pandemic has also forced the government to take tax relief measures for businesses, families, and individuals.

Some states also have tax relief programs for vehicles locally registered within their state borders. You may also find tax relief programs that offer a deferral or exemption of real estate taxes for qualified homeowners that meet certain eligibility criteria.

How Does Tax Relief Work?

You can get tax relief via several different ways, such as tax deductions (i.e., home mortgage interest), exclusion, and credits. Tax liens may also be forgiven – this is quite rare, though. The goal of a tax relief program is to reduce the tax liability of an individual taxpayer or a business. It may also target specific taxpayers, such as those that have suffered material loss due to a natural disaster.

Some forms of tax relief are:

  • A tax deduction that lowers a taxpayer’s taxable income. 
  • A tax credit that reimburses taxpayers for certain expenditures. It is subtracted from the taxpayer’s overall sum of due tax after making all the deductions.
  • A tax exclusion which reduces the taxpayer’s reported gross income amount.

There is also the Fresh Start Program that enables taxpayers to pay reduced tax amounts over time. This applies to outstanding tax debts. 

Tax Relief Options

Below are three strategies/options to help you manage the taxes you cannot pay in full by the given deadline. 

  • The Repayment Plan

You might be allowed to break your balance down into smaller payments. This could be a short-term (paying over in less than 120 days) or a long-term payment plan, depending on the sum you owe in combined taxes, interest, and penalties. So, for debts $50,000 or less, you may qualify for a short-term payment plan while long-term payment plans can include tax bills that reach $100,000 or more. 

A payment plan is an agreement you make with the IRS to repay your due taxes by a certain deadline. Also, note that the IRS applies a user fee to those that qualify for a long-term installment agreement/payment plan in the following situations:

  • If you enable automatic monthly payments from your checking account, you will be asked to pay $31 for online application and $107 if you apply in-person, by mail, or phone. Low-income individuals are excluded from setup fees. This plan is also called the Direct Debit Installment Agreement. 
  • If you decide you want to make monthly payments from your savings/checking account (Direct Pay), then the setup fee for online applications is $149 and $225 if you apply in-person, by mail or phone. The same applies to monthly payments made using the Electronic Federal Tax Payment System (you will need to enroll first), either by phone or online. For low-income individuals, this fee is set at $43, which could be waived if they meet certain conditions. If you prefer to pay via your credit/debit card, some extra fees may also apply, depending on the card issuer. 

In both cases, you should add accrued interest and penalties to the applicable fees until you pay the balance in full. So, this may, indeed, be a helpful plan to consider if you don’t have the money to cover your entire tax bill. However, you should also take into account the fact that setting up the payment plan involves additional fees. 

  • Offer in Compromise

You might be given the chance to pay less than the due amount with an Offer in Compromise tax relief program. So, you may not need to pay your full tax bill if you meet certain criteria. It is important to be able to prove that paying your full tax liability “creates a financial hardship for you” per the IRS description of the program. To determine whether you are eligible for this particular tax relief program, the IRS will probably go through your assets, expenses, income, and ability to pay. 

You could check out if you qualify for this program by using the IRS Offer in Compromise Pre-Qualifier tool. You can find much more details on the Offer in Compromise page. 

  • Penalty Relief

This is an IRS program that opens the way for penalty relief. In other words, whatever penalties have been imposed on your tax bill can be forgiven if you fulfill some conditions.  Among the criteria the IRS uses to evaluate whether you might be eligible for penalty relief is:

  • Arranging payment for the due taxes.
  • Paying for any taxes owed.
  • Not having any penalties for the past 3 years.

Note that even if you qualify, you will still need to pay your taxes, unlike with the Offer in Compromise program. The difference is that after the penalties are removed from your balance, you will then owe less. You may qualify for it if your inability to meet your tax obligations derives from circumstances that are beyond your control, such as a death in the immediate family, a natural disaster, or a house fire.

Note: Getting a personal loan is also an alternative way to help you pay your taxes. This option should be used as a last resort, though, if you don’t have the money to pay your tax bill. In this case, do ensure that the personal loan you secure gives you the best possible rates and that these rates are less than an IRS payment plan/program. To determine that, make sure you conduct your own research on things like personal loan terms and rates. 

And, don’t forget to check your credit reports so that you know what your financial profile looks like. The tax bill you owe the government will not show on your credit reports (so having unpaid taxes doesn’t affect your credit score), but they may be included in public records reports. 

What Do Tax Relief Companies Do?

A tax relief company negotiates with the IRS on your behalf, utilizing their expertise in the area of taxes and tax laws. Of course, this is not a free service. However, it saves you time and worries since these companies handle hundreds of cases every year and know exactly how to work out the best deal between you and the IRS. 

Struggling taxpayers, therefore, can benefit from the experience of these tax relief professionals. At the same time, though, nothing is guaranteed, and you may end up with an unsuccessful outcome. For that reason, it is best to trust respected organizations with a proven track record of successful negotiations with the IRS.   

Note that not all tax relief companies have the authority to become your voice and try to make a financial arrangement with the IRS on your behalf. These tax professionals should either be tax attorneys, certified public accountants, or federally authorized Enrolled Agents that have been given the role of representing taxpayers before the IRS. 

Some of the things you definitely need to pay attention to when considering using a tax relief company are:

  • Any default billing rates that may apply (these are usually activated if you cancel their services).
  • Any upfront fees.
  • The applicable refund policy (some agencies offer unfavorable refund policies for the taxpayer). 

When you book an in-person or over-the-phone meeting with the selected tax professional, feel free to ask as many questions as you feel necessary until you gain a full understanding of your options and the company’s fee structure. Proceed once everything checks out and based on your research you’ve found them to be a trustworthy company.

How Much Tax Relief Can You Get?

How much tax relief you can get depends on your particular case and the program you qualify for. You see, there is a wide range of tax relief programs you might find useful and each one offers a different type of tax relief. For instance, if you are eligible for the Earned Income Tax Credit program (applicable to low-to-moderate income earners), you may have your due tax amount reduced to zero (or even lower and the IRS may owe YOU!). 

So, our advice is to give us a call or request a free tax consultation and have your options assessed by one of our qualified tax professionals. And, if you do qualify for a tax relief program, rest assured that our experienced staff will negotiate the best possible outcome for you with the IRS so that you can finally heave a sigh of relief.

IRS Audits: What Cause Them and How to Handle Them

woman looking at tax bill

Round numbers, deduction overkill, and math mistakes can raise some red flags that may bring the IRS knocking on your door, wanting to double-check your numbers to ensure you don’t have any return-related discrepancies. Whether an IRS or state audit, there is no reason to worry, provided that you are telling nothing but the truth and that you aren’t trying to cheat the system.

However, an IRS audit may also be conducted if you feel that you are paying more than you owe. In any case, this guide will help you understand the fundamental reasons why you could get audited by the IRS, how to deal with an audit, and how to deal with it quickly and effectively. 

What Causes an IRS Audit?

The IRS audits taxpayers as a means to reduce the difference (aka tax gap) between what the IRS receives and the money it is owed. The IRS may conduct an audit if they suspect that the reported amount of tax is not correct, be it for an individual or business. Some other times, though, these audits are random. Below are seven primary concerns/red flags that could put you or your business under the IRS microscope. 

  1. Making math mistakes.  It is paramount that you or the person that files your taxes NEVER make a math error. An “oops, I wrote 8 instead of 3” or “I got distracted and forgot to include a zero” will not help you. Although to err is human, it will be best if you could avoid making one when it comes to filing your taxes. So, always double-check (triple-check if needed) to avoid the hefty fines later on. You can be assured that the IRS will not care the least bit if the mistake was accidental or innocent.
  1. Not reporting part of your income.  If for whatever reason, you decided to keep under wraps an activity of yours that made you money, such as a freelance job, then you are probably asking for trouble. You see, submitting your W-2 form and refraining from including your freelance income from your Form 1099 leads you absolutely nowhere. This is because the person to whom you did the freelance task has probably already sent a copy of your agreement to the IRS. So, the IRS knows about your income, whether you report it or not. It is just a matter of time to discover that you have withheld from reporting non-wage income. The same applies to interest and stock dividends as well.
  1. Reporting false donations.  Making a considerable contribution to charity can get you a significant tax deduction. Claiming too many charitable donations, though, without being able to produce the proper documentation, will put you at a tough spot for sure. The IRS WILL notice that you claim $15,000 in charitable deductions on your $35,000 salary.
  1. Reporting personal expenses as business expenses.  This applies to self-employed, who report too many losses on their Schedule C to hide income. And, if you don’t yet have a clear idea of what business expenses are deductible, you can check out the IRS Publication 535 page.
  1. Reporting too many business expenses.  Deducting too many expenses for purchases you made that are not necessary or ordinary to your business WILL raise some eyebrows at the IRS offices. Better stick to reporting purchases that are (1) appropriate for the business or trade and (2) accepted and common in the business or trade. If, for example, you are a lawyer and feel like painting your apartment, don’t claim paint and paintbrushes. Neither meets the requirements mentioned above.
  1. Claiming excessive home office deductions.  To be eligible for a home office deduction, it is crucial that you use part of your home regularly and exclusively for your business or trade. This means that you can give yourself deductions for home office expenses only if you have a designated section in your home that is strictly used for business purposes.
  1. Rounding up numbers.  Try to be as precise as possible when you make your calculations. Also, steer clear from making estimations and doing things like rounding to the nearest hundred.  A much better practice is to round to the nearest dollar instead. If all of the numbers you enter for expenses are even numbers, it will raise some eyebrows and may force the IRS to request some proof of those expenses.

Other surefire ways to attract an audit if you are a business owner is to try to claim more expenses than justified by filing a dubious expense claim while also reporting a loss. The IRS will probably notice this attempt to have a lower tax liability. 

What Are the Chances of Being Audited?

According to IRS statistics, people who report zero income (but occupy the higher tax brackets) get the most attention from the IRS. However, it should also be noted that in recent years IRS audits have decreased in number. This has to do with the smaller IRS workforce and declining budgets. This, of course, does not mean that receiving an audit letter is out of the question. 

That being said, most audits are conducted for people of income above $200,000, as well as those missing data on their return. The same applies to individuals or businesses whose returns are way above the average or normal, based on the IRS statistical data on the typical amounts for various income levels and professions. 

Another point to consider is that audits related to missing data and math errors are usually initiated by mail rather than in-person by an IRS agent. Our experience has shown that the average payment tied to correspondence audits is below $7,000. More complicated issues may require a field audit, which usually ends up with the taxpayer owing more money to the IRS (around $20,000). 

How to Handle an IRS Audit

The first thing to understand is that the IRS may conduct a field audit, an office audit, or a correspondence audit, based on the severity of the problem. The most thorough type of audit is the field audit, whereas the correspondence audits only require smaller things, such as clarification on a particular area of the tax return.   

In any case, it is paramount to handle the audit respectfully and carefully – always with the assistance of your tax professional, who will know what information should be withheld and what information should be released. If possible, allow your tax professionals to act as a buffer by having the field audit conducted at their offices. 

In the event you receive an audit letter, it is best to forward it to your tax professional, who will then take it from there and deal with the tax auditor(s). After all, they have experience in dealing with the IRS and audits. If though you decide to take matters into your own hands, it is highly probable that you will say something that might trigger the IRS to open up more areas of your return for inspection. 

Do take an audit seriously, without fretting or panicking, and remember that not all audits turn out adversely for the taxpayer. To help minimize any negative impact on your business, you should do the following: 

1. Organize your accounting records from the past 6-7 years with the assistance of your tax professional. This includes everything from leases, hard copies of tax-prep data, and accounting books to canceled checks, expenses, and bank statements. 

2. Only answer to the auditor’s question about your tax return in a clear and straightforward way (not making excuses). Do not volunteer any other information, though, or provide accounting records that have not been requested from you. 

3. Let your tax professional handle things for you. They know exactly what to do, what to say, what not to say, and why. 

4. Only provide copies, not the originals. There is a high likelihood that your original documents get misplaced or even lost if you hand them over to the agent. The IRS will take no responsibility for losing your documents during an audit because this is part of your obligations. For that reason, either give copies or ask the IRS agent to copy the originals and then give them back to you. 

5. Know your taxpayer rights, the law that is supporting the deductions you claim, and the audit process. Although it is advised to try to settle any differences you may have with the agent at the audit level, you could escalate things and ask for a conference with the IRS Appeals Division. Or you could simply hire an experienced tax professional to argue your case in a way that will bring the best results for you. Given how complex the tax code has become, having a qualified tax pro by your side is definitely worth their fee to help you. 

Are you facing an audit or want to act proactively and stay on the safe side? We have your back. Just give us a call or get in touch with us for a free tax consultation. Our team of qualified and experienced tax professionals will help you with your IRS audit, get out of an unpleasant situation and ensure that you never find yourself there again.

IRS Offer in Compromise: What It Is and How It Works

IRS Offer In Compromise form

Offer in Compromise is an IRS program that enables taxpayers to get a fresh start with the Internal Revenue Service. In doing so, they have the chance to settle their tax debt for less than the overall amount of money they owe. Therefore, if you are struggling to pay your federal or state tax debt, this could be a useful program to consider. In 2018 alone, the IRS accepted around 24,000 offers (up 24% from 2010) while rejecting just as many.

So, how can you determine if Offer in Compromise (OIC) is an initiative that could solve your tax issues? How can you get an offer accepted? How much should you offer to the IRS? We give you all the necessary details and answer these concerns below.

How Much Should I Offer in Compromise to the IRS?

This is perhaps one of the most challenging parts of submitting an Offer in Compromise. On the one hand, you don’t want to come forward with an unrealistically low offer that could ruin your acceptance chances. On the other hand, you do aspire to pay as little as possible to the IRS so that you can finally settle your tax debt. Given that each case is different, there is really no magic formula. In fact, it requires a lot of experience to be able to recognize when an offer is too low.

That being said, there ARE some ways to get some idea of how much is probably enough when you make an Offer in Compromise. Let’s start with the basics – the bare minimum offer sum. Note that it will NOT guarantee that your offer gets accepted by the IRS. It will, however, give some confidence that your offer is in the right ballpark.

What the IRS is primarily focused on is to receive offers of at least the same amount of the taxpayer’s Reasonable Collection Potential (RCP). This is a number the IRS uses to determine your ability to pay the owed taxes, and takes into consideration several liabilities, such as your:

  • Assets
  • Monthly living expenses
  • Monthly income

So, generally speaking, you can begin with an estimate of 12 months’ worth of your disposable income. Then, calculate any additional cash you can get from selling valuable assets and submit an offer with an amount higher than your RCP. This is critical, especially if you are planning on submitting an Offer in Compromise on the basis that you are unable to pay the due tax (as opposed to Effective Tax Administration or Doubt as to Liability).

The problem lies in calculating your Reasonable Collection Potential. Here are some steps to follow:

  • Estimate the income you have from all sources within a month and then subtract the full sum that corresponds to your living expenses (the necessary ones only, such as car payment, groceries, utilities, rent, etc.). The number you will get is your monthly disposable income.
  • Multiply your monthly disposable income by 12 to get your annual disposable income.
  • Add to that amount any assets that you could sell, such as valuable collectibles, investments, and an extra car. At this point, note that determining how much these assets are worth is a point of negotiation with the IRS for many taxpayers.

The result of these calculations will give you the bare minimum you can offer.

Should You Pay Installments or All At Once?

Many taxpayers wonder if they should pay the offer amount in installments rather than with one lump sum payment. Although the IRS enables monthly payments for this purpose, it is best to pay the offer in fewer than five monthly installments if it is possible. This is because the IRS will use 24 months of your disposable income for anything beyond five installments to calculate your Reasonable Collection Potential (with five or fewer installments, they will use 12 months of your RCP). If that happens, the amount the IRS will want from you will essentially double.

How To Get An Offer in Compromise Approved

As already mentioned, the IRS is highly likely to turn down offers that do not meet (even better, exceed) the taxpayer’s RCP. That being said, some factors play a leading role in making an Offer in Compromise quicker. These include:

  • Low Income W2 Earnings – You make less than $30,000 annually, and your only income source is a wage-earning job.
  • Fixed Retirement Income – You are a 55+ years of age retiree and receive a fixed income.
  • Social Security/ Disability Income – You only get a Disability or Social Security income.

Some factors, on the other hand, can contribute to longer-than-average decisions about your Offer in Compromise, such as:

  • High Balance – Offers with balances $25,000+ usually take much longer to process than those with lower balances.
  • Self-Employment – The IRS conducts in-depth research on your expenses, making sure you don’t mix your personal and business expenses.
  • Initial Rejection – If you have already submitted an offer that got rejected and want to have it reevaluated, you could be adding up to six more months to the overall procedure.
  • Other Circumstances – If you own multiple vehicles, have lots of loans, or many different deposits all over the place, you will need to do some explaining to the IRS. This pushes the process further back in time.

So, is everything lost? Not at all. You can still boost the Offer in Compromise process by doing the following:

  • Ensure you have all the necessary details – The IRS will request things like bank statements. Check that the ones you submit have all the pages, even those that you may find useless (i.e., a blank page). Then, send your Offer.
  • Provide good explanations – If your financials, for some reason, does not look right, make sure that you give a sound reason for it in the cover letter.
  • Reply fast and accurately – It is paramount that you respond to IRS requests for further clarification as timely as you can. The information you provide should also be accurate.
  • Propose the presumed maximum amount of money – The IRS expects to collect some money from you within a reasonable time period. Offering them the max sum of the presumed amount will most likely get your offer approved

To get there, ensure that you have filed all tax returns, made the required estimated tax payment for the current year, and include a bill of one or more tax debt in your offer. Business owners with employees must have made the needed federal tax deposits for the current quarter.

Besides what is reported to Form 433-A, the IRS will investigate several other factors, such as your level of education, age, asset equity, expenses, income, Collection Statute Expiration Date, and, of course, your lifestyle. If something about the way you live is contradictory to the fact that you are unable to pay your taxes, the IRS may reject your offer.

How Can I Submit An Offer In Compromise Application?

To apply for an Offer in Compromise, you will need the following Offer in Compromise Forms:

    • Form 656 – You need this to make your offer.
    • Form 433-A – This Collection Information Statement for Wage Earners and Self-Employed Individuals helps the IRS determine whether you are facing financial strain and to what extent.
    • Form 433-B – This is the same as with Form 433-A with the difference that it is a Collection Information Statement for Businesses. It serves the exact same purpose as Form 433-A.

Common Mistakes to Avoid when Filling out your OIC Application

The IRS will get all the information they need about your financial situation from Form 433-A (see above). It is, therefore, crucial that you ensure you don’t make any math errors on that form, although the form indeed requires a considerable amount of complex calculations. You certainly don’t want to put your OIC process to a halt to have incorrect calculations sorted out.

Other mistakes on OIC forms we usually see and either cause confusion or have a dramatic impact on a case are as follows:

  • Leaving empty/blank spaces – Never leave a field on a 433 or 656 empty. It is best to write “N/A” in these spaces.
  • Writing negative equity – It is essential that any negative equity is reported as zero. Many tax accountants subtract the negative equity from the taxpayer’s NRE (Net Realizable Equity) when the taxpayer’s asset (property, in this case) is worth less than they owe on it, which is wrong.

 

How Long Does It Take To Get a Response From the IRS?

Although there are no set timelines for exactly how long it will take the IRS to decide whether to reject or approve an Offer in Compromise, our experience has shown that it usually requires between 4-9 months. However, some more complex Offers in Compromise may need much more time to get resolved, which could reach 48 months from the day the OIC process was completed, which usually takes roughly 6 months. The most common factors that could drag a response from the IRS are related to self-employment. Regardless, the IRS does respond within two years.

If the IRS accepts your offer, you need to stick to your part of the deal and pay the agreed sums. Now, if your offer gets rejected, know that you can file an appeal via Form 13711 (hence, renegotiate your OIC under more favorable terms) within 30 days of the rejection notice date.

Is an Offer In Compromise the Best Option for You?

Although an Offer in Compromise is an excellent collection solution, it is not the only option you could consider. To determine that, you will need to have a trusted tax professional evaluate your tax situation, the IRS collection alternatives, and your personal finances as a means to develop the optimal approach to repay your debt. Don’t hesitate to call or contact us for a free tax consultation to see how we can help you get out of debt as painlessly and swiftly as possible while negotiating the best terms for you.

Introduction to the IRS Fresh Start Program

tax debt paperwork

The IRS Fresh Start Program is nothing new. It dates back to 2011, and has been designed to give taxpayers and small businesses burdened with first-time tax debt an opportunity to straighten things out and get out of debt while also avoiding tax liens.

Over the years, it has undergone significant changes. The majority of the provisions outlined in the initiative are designed to make applying for tax relief programs and paying back taxes a far easier process.

So, if you are dealing with back taxes and tax debt, chances are you have seen or heard about the IRS Fresh Start Program on TV or the radio at some point. Do you qualify for it? How can the Fresh Start Program help you get a second chance to get back on track with your taxes? What does it include? All these, and more, will be answered here.

How Does the IRS Fresh Start Program Work?  

The Fresh Start Program, sometimes referred to as the “IRS second chance program”, was created by the IRS to help taxpayers that owe back taxes. In 2011, it was a prerequisite for them (taxpayers) to have no federal tax liens filed against them. The IRS Fresh Start debt resolution program was focused on the following:

  • Making it easier to obtain a Federal Tax Liens (FTLs)release right after paying the debt.
  • Enabling small businesses to obtain Installment Agreements (IAs) easier.
  • Allowing an individual taxpayer that entered into DDIA (Direct Debit Installment Agreement) withdraw Federal Tax Liens more frequently.
  • Making it easier for more taxpayers to qualify and use the Offer-in-Compromise* program by expanding and streaming the qualifications of the particular initiative.
  • Lessening the number of Federal Tax Liens being filed by increasing the dollar amount that caused FTLs being filed from $5,000 to $10,000 (a few months later, it was raised to $25,000).

In 2012, the IRS Fresh Start Initiative was further expanded, allowing even more financially distressed taxpayers to qualify for it. Part of the reforms targeted addressing real-life situations that typically cause individuals to fall behind on their taxes.

The IRS Fresh Start Program revisions included an expansion of the amounts and types of expenses the IRS would consider relevant and reasonable when determining the money a taxpayer could afford to pay every month. Among these were local and state tax debts, student loans, and allowable living expenses.

The reason behind this expansion of the IRS Fresh Start relief program was to enable those struggling financially the most to clear up their debt faster than in the past.

Also, when a taxpayer considers benefiting from an Offer-in-Compromise program, the IRS is now more flexible in calculating the individual’s future income. This makes it easier for a taxpayer to qualify for an Offer-in-Compromise.

About the Offer in Compromise Program & Reasonable Collection Potential

An Offer-in-Compromise is a program that enables taxpayers with due tax debt to come into some sort of an agreement with the IRS so that their tax liabilities are settled for less than the total amount they owe. For a taxpayer to have the chance to clear their debt via the Offer-in-Compromise program, the IRS should first calculate the taxpayer’s income and assets to determine the reasonable collection potential. This refers to the amount of money the IRS determines a taxpayer can pay for his/her tax debts and is basically his/her monthly disposable income and the liquidation value of his/her assets.

Unlike in the past, the IRS now calculates a taxpayer’s collection potential by looking into 12 months of future income (down from four years) for offers paid in less than five months and two years of future income (down from five years) for offers paid in 6-24 months. This gives some taxpayers the opportunity to have their tax issues resolved in 48 months, when, in the past, they would need 4-5 years.

The three prevalent types of Offer in Compromise are:

  • Doubt as to Collectibility – Enacted when you owe back taxes that it is impossible for you to pay even if you sold all of your assets.
  • Doubt as to Liability – You can dispute your tax liability provided that there is a relevant legitimate disagreement in argument, law, or facts.
  • Effective Tax Administration – Applies when the collection of tax debt will generate considerable economic hardship for you in the future. So, you may be able to pay your tax debt, but doing so will put you in financial strain in the long run. In this case, the IRS may settle your tax bill.

Primary Provisions in the IRS Fresh Start Program

Besides Offers in Compromise, the IRS Fresh Start initiative can contribute to delivering further benefits:

  • Tax lien avoidance – Under the IRS Fresh Start program tax liens are NOT filed for debts less than $10,000, except for cases when the penalties and back taxes surpass $10,000. This helps avoid the negative effects of tax liens (i.e., attach the lien to all the assets of the in-debt taxpayer until they repay their debt). The IRS may also help withdraw a tax lien notice if one is filed under specific circumstances: (1) you pay for your debt via a low-user-fees Direct Debit installment agreement, where you agree the IRS automatically makes monthly payment withdrawals from your checking account or (2) pay your debt and remain current with all the estimates tax filings and payments.
  • Installment agreements & penalty relief – The Fresh Start program helps avoid some tax penalties by increasing access to streamlined installment agreement with the IRS. Taxpayers can choose between five types of installment agreements, depending on the tax debt owed (for less than $10,000 to over $25,000) and the repayment period (between 3 years or less and longer than 24 months).

Other important changes in the Fresh Start Program:

  • For on-going businesses, the IRS no longer includes equity in income-producing assets in their calculation of reasonable collection potential.
  • When it comes to the factors that determine when a dissipated asset is included in the calculation of reasonable collection potential, the Fresh Start program comes further refreshed as it narrows the classification and parameters involved.

In the end, it is best to consider the Fresh Start Program more of a tax relief toolbox rather than a singular form and enrollment. The initiative now includes a set of measures designed to help small businesses and individuals rectify their tax problems and get second chance.

Do I Qualify for the IRS Fresh Start Program?  

Some of the general requirements the majority of tax relief applicants must meet are as follows:

  • Small business owners and self-employed workers must make all necessary estimated tax payments for the current year.
  • Business owners with employees need to make all required federal tax deposits.
  • You need to prove that you are unable to pay your tax debt because you lack assets or money.
  • You should not be involved in an ongoing proceeding for bankruptcy.
  • You must file all tax returns as obliged by law, even if you are unable to pay them.

Depending on which tax relief program you wish to apply for, you also need to take into consideration additional requirements. For instance, applying for an Offer in Compromise, you need to complete specified IRS forms (see below) as you will be called to provide detailed financial information.

On the other hand, a streamlined installment agreement requires that you owe less than $50,000 or that you:

  • Can pay a larger liability down to $50,000.
  • Have ensured your tax filings are up-to-date through the current tax year.
  • Have not fallen behind on tax payments with the IRS in the past.
  • Can pay off the remaining debt in up to 5 years (60 months or less).
  • Don’t incur new tax debt during the installment agreement period.
  • Stay current with tax filings and maintain the installment agreement during the time it is in effect.
  • File for an Offer in Compromise and can pay off the settlement amount you have agreed on within 12 months.

IRS Fresh Start Program Qualifications

TaxpayerBusinesses
Owes less than $25,000*Owe less than $25,000. **
Can pay their initial debt down below $25,000 *Can pay the due amount (up to $25,000) within 34 months. **
First-time tax debtorAre current with federal tax filings. **
Are up-to-date with federal tax payments. **
First time falling behind on IRS tax payments. **

*You might also qualify for a federal tax lien withdrawal.

** You might also qualify for the abatement of specific penalties.

How Do I Apply for the IRS Fresh Start Program?

There is a different application route per the IRS Fresh Start program you wish to benefit from. Here are the details required when you apply for IRS Fresh Start:

  • Payment plans – You can download and fill out the Form 9465 (Installment Agreement Request). More details here.
  • Installment plans – The application depends on whether you are a business owner or employee and the total debt owed.
  • Offers in Compromise – You can file Form 433-F, 433-A, and Form 656 to initiate the process.

Note that it may take from a few minutes and up to 48 months to receive approval. Given the many parameters tied to the IRS Fresh Start program, trying to address the issue on your own may compromise your ability to take full advantage of the initiative. So, before you do anything, it is paramount to understand the ins and outs of the program first.

It is also critical that you assess your situation properly so that you can make the most informed and educated decision when choosing a solution.

For that reason, if you have a delinquent tax debt with the IRS or you’re in the midst of an IRS audit, it’s best to consult trusted tax professionals like us who will actively analyze your situation and strategize a plan that will best suit your unique requirements. Additionally, we can become your voice and aggressively negotiate with the IRS (and possibly even settle your debts for much less than what you owe at that given time) on your behalf.

Contact us today for a free tax consultation and let’s see how we can make the most of the IRS Fresh Start program for you.