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Dealing With the IRS
Here are some tips for dealing with what might seem like an impossible situation
By Thomas G. Dolan
There’s nothing more likely to send chills down your spine than receiving a letter from the Internal Revenue Service (IRS). Of course, once you’ve ripped it open in a blind panic, you may find yourself giddy with relief for it contains a check for your accidental overpayment. More likely, however, your first tuition was accurate.
If the matter is serious—such as an unexpected demand for back taxes or notice of audit—you will sense (with ominous dread) that you’re in for a long, expensive, time-consuming battle, which, for you, represents a lose/lose situation. You will feel this even if you don’t believe you have done anything wrong—especially if you don’t think you’ve done anything wrong.
As has been often said, everybody is guilty of something. You’re afraid that the IRS might ferret out something you’ve done wrong that you’re not even aware of or (almost as bad) construe sets of facts which reflect badly on yourself. And what can you do about it?
Perhaps the first point that should be made is that we all have a legal and moral obligation to pay taxes. We shouldn’t cheat. One obvious reason is that we stand a good chance of getting caught, especially if there is any pattern.
In some respects the IRS is a huge, lumbering, often inefficient bureaucracy. Yet be that as it may, the IRS has time on its side and a vast array of resources, so even on the premise that crime may sometimes pay, it’s certainly not worth the risk (moral and legal considerations aside) to cheat on your taxes.
Along these same lines, be aware that any third-party payments made to you can be easily accessed by the IRS, so make sure you include them all.
Another obvious point is always file your tax returns. If you’ve failed to do so, file them or notify the IRS at once. The result may not be happy, but you may find you have some positive options, and (at the very least), you’ll have removed yourself from the criminal category.
A final preliminary: Never state “you don’t believe in paying taxes on principle.” This automatically puts you into a category of “tax protester,” which can connote a violent, anti-government misfit. Judges respond mostly unkindly to a taxpayer so characterized. Unfortunately some IRS personnel (especially lawyers) find that smearing you with this label is a convenient way of bolstering their arguments. So it’s always good, at the start of any correspondence which looks like it might lead into a long battle, to put into moral and legal duty of a citizen to pay taxes, though in this particular instance, you disagree with the IRS.
Obviously such a huge topic as dealing with the IRS cannot be encompassed in a single article. It would take a book. In fact, several books have been written on the subject, and here are three that have drawn upon for this article: What The IRS Doesn’t Want You To Know by Martin S. Kaplan and Naomi Weiss, (Villard, NYC); Stand Up To The IRS, by Frederick W. Daily (Nolo, Berkeley); and How To Settle With The IRS by Arnold S. Goldstein (Garrett Publishing, Deerfield Beach, FL). Other primary resources drawn upon for this article includes the Taxpayer Bill of Rights, which has been incorporated into the IRS Restructuring and Reform Act of 1998 (RRA)—which will be discussed more in-depth later on in this article.
Some of the above authors mention that the tax laws are so complex that many within the IRS don’t even understand them. This being the case—along with the fact that each individual and/or company’s tax situation is unique—clearly means that for any serious tax matter you should search out a good tax lawyer and/or accountant.
That said, there does emerge from the labyrinth of legalese and bureaucratese some key points that many people don’t sufficiently understand and which can be stated in plain English. These points are the subject of this article.
First of all, why not avoid the audit at the start?
“The first contact between your 1040 and the IRS is a computer,” writes Kaplan. “You can’t reason with computers, so long before you get ready to fill out your 1040 or business tax return, there are certain steps to take so that your return is ‘prepped’ to escape selection by the IRS’s first technology go around. Preventive medicine up front or covering your books’ (CYB) can help you avoid an audit.”
What follows, in somewhat edited form, are Kaplan’s suggestions of the most effective measures for avoiding an audit or reducing its scope if you are selected.
1. Make sure that any third-party income and reports agree with your records. Verify that:
*W-2s from all employers match your declared salary.
*Interest and dividend reports from your banks and securities firms match the actual interest and dividends you have received and entered on your return.
*Mortgage interest statements from your bank or lender match your mortgage interest deduction.
*Income from 1099 forms matches the appropriate income items on your return.
*If you discover an error on any of these forms, contact the issuer and request the corrected information as quickly as possible. Get it to the IRS before it gets the incorrect version.
2. Make sure you select the right forms and schedules. Don’t stretch the situation but don’t overlook credits whose forms you haven’t included but could.
3. Make sure you record all payments. This is especially true if you make estimated payments throughout the year.
4. Keep track of bank deposits so all items are easy to trace. The first thing auditors request are your checking, savings, and investment accounts. They then proceed to do a total cash receipts anaylysis, comparing the total to the gross income shown on your tax return.
5. Keep your checking and savings accounts free of irregularities. Be sure you can explain big or unusual changes.
6. Keep business and personal bank accounts separate.
7. If you’re going to take a business deduction, pay for it by check. It’s always wise to pay for routine personal items (such as bills for electricity, telephone, rent, and clothing) with a check or credit card.
If you have severe tax problems and are afraid you’ll be chased by an over-zealous tax collector, you must quickly learn how to protect your assets from lien, seizure, or levy, says Goldstein. Your goal is to achieve “poverty on paper.” What you don’t have the IRS can’t seize. There are many legal ways to do this, as well as illegal. Of course, you want to avoid the latter. Hire an asset protection professional.
Here are five of the most powerful asset protection strategies suggested by Goldstein:
1) Transfer your assets to family limited partnerships. This is one of the safest ways to protect assets from creditors and to save yourself taxes. As a general partner, you can still maintain complete control, while the majority of the interest in the partnership can be safety owned by other family members, corporations, or trusts as limited partners.
2. Transfer your assets to an Offshore Trust, a special trust established in a foreign country with strict laws. They will not cooperate with the IRS. Taxpayers with serious tax problems frequently sell or mortgage their assets and transfer their liquidated wealth to their Offshore Trust, often steps ahead of a tax lien. As with bankruptcy, all asset transfers must be legal and honestly disclosed to the IRS when it attempts enforced collection.
3. Encumber the equity of your property. Can you borrow another $50,000 on your home, $10,000 on your car, or $100,000 on your business? When the IRS is after you, borrow heavily so the smallest possible equity remains exposed. Your goal is to encumber the equity in your assets until there is none left for the IRS to seize.
4. Liquidate your life insurance cash value, savings, CDs, IRAs, Keoghs, stocks, bonds, annuities, and other securities. These are sitting ducks for the IRS.
5. Solve your other financial problems. Collect what you are owed, even if you have to heavily discount. (The same with settling lawsuits—even at a bargain price.) Your claims against others lose all value once you’re levied by the IRS.
6. Set up a corporation to hold your personal funds. From this account, pay your personal debts. You may transfer money to the corporation as a loan and withdraw it as repayment without incurring a tax. But do keep good records to properly report all income at tax time. When the IRS finds out, do it again. It’s legal.
7. Transfer your money to banks the IRS doesn’t know about, especially to small banks outside your area. Since the IRS periodically makes you submit a new financial statement and
disclose new bank accounts, you must do so. Then immediately open new accounts. This is strictly legal.
8. If you own your own business, you can divert your income to your spouse or adult children who work in your business. They can then gift or loan the funds back to you. Make sure you can prove your spouse and children actually perform services.
9. Take cash proceeds from a non-exempt asset and buy an exempt asset.
10. Pay “friendly” creditors. Do you owe your father for your college education or a brother for a past loan? If it’s a bona fide debt, the IRS can’t complain.
10. Prepay expenses. You can prepay your child’s education (even years in advance), as well as alimony, child support, insurance, medical care, and even the legal fees necessary to combat the IRS. Your lawyer will like that.
11. You can give a gift up to $10,000 per year per donee without a gift tax. It should go to family members, which is legitimate. A gift to hinder creditors is a fraudulent transfer.
Kaplan points out that partnerships, limited liability companies, and S corporations may have advantages is avoiding audits.
Bad things happen to good people. Goldstein points out bankruptcy may be an option. A Chapter 7 bankruptcy may rid you of old income tax claims, but you have to move carefully. A Chapter 11 or Chapter 13 may work well for you if you can fully pay your taxes over time. Consult a bankruptcy lawyer.
A more attractive option is the Offer-in-Compromise (OIC) program. In essence, this is an IRS program in which it will accept a nominal sum from a taxpayer it has deemed “uncollectible,” as payment for all his past taxes. From the IRS vantage point, it at least collects something, and the taxpayer has a chance to get back on his feet and start paying taxes again.
One example here is a professional football player who owed millions in past taxes. He was cheated by his agent, and when his career ended, he worked as a common laborer. But his OIC was accepted. He paid “pennies on the dollar,” and the compromise was an obvious positive solution for both sides.
Two factors determine the viability of an OIC. The first is “question of liability.” Since the IRS raised that question, it’s not likely to back down. However, the second factor is a “question of collectibility.” If you have few or no assets (or you have minimized your assets in ways described earlier), you may be a candidate.
The Yellow Pages® are generally filled with ads for tax consultants who will offer to help you with an OIC for a reasonable cost. And many of them are as good as their ad. They’ll help you get all the information the IRS needs in the format it wants.
One such option is the IRS internal appeals court. Daily points out that these personnel are negotiators rather than collectors and score their points by settling. He says that 70 percent of these appeals cases are settled amicably with taxpayers. This internal court is motivated by saving the expense of the IRS going to federal court with a weak case. Daily says attorney costs can be $2,500 up, though you can do this appeal yourself.
If you do go to the U.S. Court, small cases under $50,000 can be heard informally, without a lawyer. This may seem a good thing, on the premise that the judge is not biased toward the IRS (not a good premise to assume). These small cases can’t be appealed.
If you take the case to Tax Court and/or a federal district court, a court of federal claims, or a bankruptcy court—you can do it as a pro se, which is your legal right; however the reality is you’ll be treated with contempt. Keep in mind, attorney fees can be awesome.
Federal courts report that 95 percent of all claims never reach trial. And why is that? Because citizens who went to all of the expense and trouble to go to court changed their minds? Dismissals in these courts allow you to go to the U.S. Court of Appeals. Again you have the legal right to represent yourself.
But, as writes Daily, “A lawyer is needed to handle this highly technical process, and you can expect legal fees upwards of $10,000. Your statistical chance of winning is about 10 percent. If you lose, you can ask the U.S. Supreme Court to hear your case, but your odds are better for winning your state’s lottery.”
In other words, the IRS is almost always right. Does that make sense to you? In fact, serious unconstitutional conduct by the IRS has been encoded into laws for decades. But judges rarely enforce it.
Enter the IRS Restructuring and Reform Act of 1998 (RRA). The RRA offers many forms of taxpayer redress, supervisory reviews, local and national taxpayer advocates, and places to report IRS fraud and abuse, such as the Treasury Inspector General for Tax Administration and the Commissioner. In this law, Congress set out to correct long standing illegal abuses by the IRS. This Act incorporates past laws and adds new provisions with teeth, specifically enjoining reckless or intentional violation of the tax and other laws by IRS agents. These include falsification or destruction of documents, threats of audits for illicit purposes, infringement of taxpayer’s constitutional or civil rights, and harassment/retaliation.
The IRS can no longer walk into your bank and simply gut it. Seizure of property now requires a fifty-four-step process, and a thirty-day notice is required for a lien (giving the taxpayer time to cope). Taxpayers can now sue the IRS in federal court for up to $100,000 and, perhaps more importantly, can recover attorney fees and other costs. Before, just the spectre of the expense was enough to make most people cave in.
In theory and (in fact) in law, the abuses which have come to be associated with the IRS have been removed through the RRA. Is this also the reality? As the Hemingway character says in The Sun Also Rises, “Isn’t it pretty to think so?”
The truth is you want to avoid the IRS at all costs. If you have to engage them, you’re in for a battle. But, if you know your rights and are ready to fight for them, you have a better chance of coping now than ever before.
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