Bankruptcy

Bankruptcy is designed to give individuals and businesses a chance to start over, without the burdens of debts they’re unable to pay.  Bankruptcy proceedings operate under the assumption that debtors have made a good faith attempt to pay creditors.  To meet the varied needs of entities filing for bankruptcy, there are several categories, called chapters, under which to file.

When debtors approach a court to file for bankruptcy, the filed petition creates a bankruptcy estate that usually includes all the assets of the person or business filing for bankruptcy.  However, details vary depending on the bankruptcy chapter used to file the petition.  Typically, when a debt is canceled due to bankruptcy, the canceled amount is not charged as income for tax purposes.  Below is a general summary of different options for bankruptcy.

Chapter 7

Under Chapter 7, the debtor filing for bankruptcy has expenses that exceed income.  The debtor may have become insolvent for various reasons, including unemployment, medical bills, lawsuits, or economic hardships.  When debtors reach this point of insolvency, it means that they’re unable to pay back their debts.  A Chapter 7 filing is essentially a liquidation that enables the debtor to discharge certain debts while still protecting some assets.

Once Chapter 7 is filed, an Automatic Stay is granted, preventing creditors from collecting debts without the permission of the bankruptcy court.  If the court ends up granting a final discharge, then the creditors will be forever barred from collecting on debts incurred prior to bankruptcy.  Assets that were deemed protected and exempt from bankruptcy will remain with the debtor as well.

Chapter 11

Chapter 11 bankruptcy allows businesses to reorganize and institutes an automatic stay, which is essentially a government-mandated order to prevent creditors from acting to collect debts.  When an entity enters Chapter 11, it can begin negotiations with creditors and develop a plan to reorganize.

Chapter 11 is appropriate if the entity in question is not an individual, or if an individual’s is greater than the statutory limit of a Chapter 13 Bankruptcy

Chapter 13

Chapter 13 bankruptcy can only be filed by individuals and acts as a means of reorganization.  Individuals who have an income that would allow repayment of debts will typically use Chapter 13 as a way to institute a 36 to 60 month payback plan.  Individuals who are behind on their mortgages or have debts that aren’t dischargeable in Chapter 7, such as student loans or child support, often choose Chapter 13.

If the Chapter 13 filing is successful, individuals will be able to force creditors to accept their terms of repayment and avoid penalization in the form of wage garnishment, liens, and IRS levies.

Because bankruptcy law and taxation implications are complicated topics, it’s best to enlist professional counsel should you consider starting proceedings.  For the right person or business, bankruptcy can offer a clean slate, but it’s important to know all the facts before seeking a court date.

Frivolous Anti-Tax Arguments

Although payment of federal taxes is a well-established precedent in the United States, sometimes individuals and groups claim that taxes are illegal.  These groups often lure unsuspecting taxpayers into agreement with their schemes.  Unfortunately, taxpayers who refuse to pay the taxes owed may incur penalties and legal action on the grounds of tax evasion.

Anti-tax groups pursue their cause by filing frivolous tax returns or bringing such cases to court.  They’ll often cite specific reasons to support their claim that taxes are illegal.

• The Sixteenth Amendment was not properly ratified: This argument is false.  The Sixteenth Amendment was ratified in 1913 and courts have upheld it.
• The Fourth and Fifth Amendments:  Some people have claimed that disclosing financial information violates the privacy right of the Fourth and Fifth Amendments. However, courts have rules otherwise.   Disclosing financial information on your tax return is completely legal and required by law.
• Offshore bank accounts aren’t subject to federal tax: Foreign banking arrangements are not a way to avoid taxation.  By law, taxpayers must disclose the funds in their foreign accounts.
• Tax law shouldn’t apply to wage income:  Some people have claimed that taxes aren’t applicable to wages and tips.  However, the law proves otherwise.  In Reese v. United States the court concluded that “gross income means all income from whatever source derived.”
• I’m not a “citizen” or “person” according to the IRS Code: The IRS Code clearly says that citizens of all 50 states and the District of Columbia are also citizens of the United States and thus obliged to pay federal taxes.
• Taxes can only be assessed if you voluntarily file a return:  It’s true that the IRS has used the word “voluntary” in its publications.  However, “voluntary” does not exempt individuals from taxation.  Rather, “voluntary” simply describes the IRS’ system in which taxpayers independently fill out their returns to arrive at their taxation rate, instead of the IRS filling out the forms and determining the tax rate for them.

These claims have been repeatedly knocked down in court, but despite the substantial precedents, anti-tax groups persist in creating frivolous lawsuits and in engaging in tax evasion schemes.  Many groups will recruit new members over the web, so be wary of organizations looking to sell packages or services allowing you to avoid taxes through any of the above “legal” means.  Taxes are here to stay, and they’re legally required by the federal government.  If an offer or claim seems too amazing to believe, then exercise caution and skepticism.   Any “legal” scheme to avoid taxes is likely a scam.

IRS Collection Process

When a taxpayer fails to file a return and pay money owed in a timely manner, the IRS initiates the collection process.  The first step in this process is sending the taxpayer an official bill, called a notice.  Along with the notice, taxpayers receive documents explaining their rights and the various options for achieving payment.

At this point, taxpayers must assess the situation and determine whether they can satisfy the debts, or if they feel the notice issued is unjustified.  It’s important to immediately contact the IRS upon receipt of the notice if any questions linger.  Seeking the counsel of a professional CPA or tax attorney at this time is often beneficial and can assist in achieving the most positive outcome.

To facilitate interactions with the IRS, taxpayers should:

• Make copies of the bill, and include a copy with correspondence.
• Save original documents pertaining to the bill, such as canceled checks and money orders.  The IRS may need to reference these documents to determine a ruling.

Sometimes taxpayers might lack the funds to resolve the debt immediately.  In these cases, the IRS extends several payment solution options.

• Delaying Collection: The IRS may choose to delay collection until a taxpayer’s financial situation improves enough to permit payment without causing economic hardship.
• Extension of Time to Pay: If taxpayers know that they’ll be able to pay within the next 120 days, the IRS can issue an extension.  This option should only be pursued if taxpayers are certain they can make full payment within that 120 day time period.
• Installment Agreement: Sometimes it’s not possible to pay the full tax bill immediately, so the IRS may grant a monthly installment agreement for collection purposes.
• Offer in Compromise (OIC): Offers in Compromise sometimes work in the taxpayer’s favor, allowing settlement of the tax bill for an amount less than what was originally owed.  The IRS grants few OICs each year though, as the qualifying criteria are stringent.

Resolving IRS tax payments should be a priority, and not something left to linger at the bottom of the mail pile.  Penalties for failing to pay or respond to notices are harsh.  For example, if the taxpayer fails to respond to the initial notice, the IRS classifies the account as delinquent and initiates the Automated Collection System (ACS).    A representative from the ACS will call the taxpayer seeking payment, or a revenue officer will directly contact the taxpayer.

If the situation escalates, the IRS may file a Notice of Federal Tax Lien or serve a Notice of Levy.  Harsh consequences result from this enforced collection, including seizure of property such as houses or cars.  Damage to the taxpayer’s credit rating occurs, and the negative repercussions could last for years, creating additional financial hardship.

To avoid suffering the negative consequences of a levy or lien, it’s important for taxpayers to swiftly and competently address any outstanding issues with the IRS.  Since tax laws and procedures are complicated, the advice of a professional tax attorney or CPA is valuable in finding a fair resolution and ensuring the situation doesn’t escalate.

IRS Levy

IRS levies are designed to ensure that the government receives payment from individuals owing tax debts.  When a taxpayer fails to render payment due, the IRS can institute a levy to obtain that payment.

An IRS levy might mean:

• Seizure and sale of property such as a car, boat, or house.
• Wage garnishment, levy of retirement accounts, bank accounts, dividends, or cash loan value of your life insurance.

However, there are legal protections in place to protect the wellbeing of taxpayers.  Levies cannot be imposed if they cause “economic hardship” to individuals or businesses, meaning that the levy shouldn’t seize money or assets needed for reasonable basic living expenses.  These basics include food, housing, transportation, medical needs, and any other essential needs.

Although this law exists, in practice IRS levies often cause economic distress.  After receiving pleas for help from constituents, Congress enacted a protective law in 1998, which entitles taxpayers to a “Notice of Levy” and the due process right to appeal that Notice of Levy within 30 days of its receipt.  During this appeal process, taxpayers may offer alternative payment options, such as an Offer in Compromise or an Installment Agreement.  In addition, if they’re financially able, taxpayers may pay all the back taxes owed in a lump payment in order to remove the levy.

Key problems exist with the 30 day due process law though, specifically concerning the 30 day time period.   According to another law, levied bank accounts or paychecks must release money to the IRS within 21 days.    Therefore, the IRS is authorized to take the money before the 30 day appeal period is complete.

Wage garnishment also presents a problem to taxpayers whose paychecks are levied, particularly people living paycheck to paycheck who depend on all their wages to meet basic needs.  The 30 day due process period is often too long for these taxpayers.  Deducting money from a month’s worth of checks presents an economic hardship for families who need every dollar of every paycheck to provide food, housing, and other basic needs.

Levies negatively affect businesses as well, and the levy of a business bank account can trickle down to families when that bank account contains money for payroll and other business expenses.

Despite the intent of laws to protect people, an IRS levy often means a disastrous situation for families and businesses.  Many IRS levies violate the regulation prohibiting economic hardship, and continue to levy anyway, taking advantage of lay people lacking the in-depth tax knowledge necessary to successfully  move through an appeals process.

Although taxpayers may represent themselves during the due process appeal to an IRS levy, consulting a specialized tax attorney offers peace of mind for many facing levy situation.  A professional tax attorney can guide taxpayers and businesses through the process and ensure that they’re treated fairly by the IRS.

IRS Liens

What is a lien?

A lien gives the IRS legal entitlement to any property you own, or any property that you acquire after the lien is filed.  The IRS pursues a lien to satisfy payment of outstanding tax debts.

To meet legal requirements, the IRS must follow a certain process when pursuing liens.  First, they must assess the tax debt and issue a Notice and Demand for Payment, which details the amount owed.  At this point, the taxpayer has 10 days to pay the money owed and avoid a lien.

Consequences of a Lien

If the taxpayer fails to satisfy the debts in 10 days, the IRS creates a lien and files a Notice of Federal Tax Lien.  Because a lien is filed publicly and gives notice to all creditors, the affects can be immediate and devastating to the taxpayer.  Liens damage credit ratings, and the repercussions may prevent individuals from qualifying for housing or car loans, or renting an apartment.  Even acquiring a new credit card may become impossible once a lien is filed.

Depending on the taxpayer’s industry, the lien could threaten their livelihood as well.  Employers in the banking, defense and insurance industries value good credit as a prerequisite for employment.

Businesses suffer from damaged credit too, since credit lines are needed to function.  Banks may withdraw credit after receiving notice of the lien, and creditors who ship inventory may require payment in cash.

Releasing a Lien

Because liens have such wide-ranging harm, releasing a lien becomes a priority.  The IRS will issue a Release of the Notice of Federal Tax lien if the taxpayer meets proper conditions.

• If the tax debt is satisfied, the IRS will release the lien within 30 days.  Satisfying this debt includes payment of any associated interest or fees.
• If the taxpayer submits a bond to ensure debt payment and the IRS accept it, the IRS will release the lien within 30 days.  The taxpayer must be sure to pay any interest or fees owed as well, including any fees needed to file and release the lien.
• Liens are usually automatically released ten years after filing, as long as the IRS doesn’t file it again.  However, waiting for ten years is a poor option, as its best to remove the stigma from your credit rating as soon as possible.

Appealing the Filing of a Lien

The IRS must provide written notice of a lien within five days of its filing.  Once taxpayers receive that notice, they may opt to request a Collection Due Process hearing with the Office of Appeals.  The paperwork involved may become tricky, as you must file with the specific office listed on the Notice of Appeal, and you must submit the appeal request by a certain date.  Consulting a tax professional, such as a specialized tax attorney, often helps individuals and businesses facing liens to successfully navigate the process.

At the Collection Due Process hearing, an IRS manager evaluates the lien case, discussing issues including:  proper filing of the lien, errors in debt assessment, spousal defenses, collection options, and any other errors the taxpayer wishes to address.

When the lien hearing is over, the IRS Office of Appeals issues a determination that either upholds the lien, or dictates its release or withdrawal.  If the taxpayer disagrees with the ruling, an additional law instates another 30 day period during which you may request a court date for judicial review of the case.

Again, consulting a professional tax attorney may be the best route in these cases.  The IRS employs full-time professionals to argue their case, so having a professional on your side as well offers an advantage.

Offer in Compromise

When taxpayers fail to pay their tax debts within IRS deadlines, options such as the Offer in Compromise (OIC) exist to facilitate settlement.  The goal of an OIC is to find a tax solution that resolves debt in a way that’s satisfactory to both the government and the taxpayer.  Compromise is key.  Although the IRS may accept payment that’s less than the actual amount owed, there’s no guarantee of this occurring, since the OIC is designed to benefit both parties.

The following reasons may justify an OIC.

• Doubt as to Collectability: Often, an OIC become an option when it’s doubtful that the taxpayer could ever pay the full debt within the remaining legal collection period.
• Doubt as to Liability: If the tax assessed may be incorrect, an OIC could be pursued.
• Effective Tax Administration: Sometimes the tax liability is assessed correctly and the money is owed can definitely be collected.  However, the collection of the debt may cause an economic hardship on the taxpayer.  Taxpayers must support their claim of economic hardship when seeking an OIC for this reason.

In order to qualify for an OIC, the taxpayer must meet all current filing requirements.  This means that taxpayers working as employees need to file all unfilled tax returns, even if payment isn’t possible at the same time as the filing.  Additionally, specific forms are required to submit an OIC.  Form 656, Offer in Compromise, will need to be completed, along with Form 433-A for individuals or Form 433-B for businesses.  In most cases, the IRS charges a $150 application fee as well, unless the OIC was submitted under Doubt as to Liability.

Although the Offer in Compromise exists as a valid option for taxpayers, the IRS reviews them carefully and grants OICs with discretion.  Proper and timely submission of paperwork is essential when pursuing an OIC.  For example, if a taxpayer fails to submit the right supporting paperwork with their forms, the IRS will issue a request seeking the information.  If the proper documentation isn’t received within 30 days, the IRS will close the case and return the OIC.  The taxpayer will not have the option to appeal.

With a financial and legal matter as important as an OIC, it’s preferable to complete the process correctly and efficiently.  Enlisting the aid of a professional tax attorney or CPA will reduce errors and ensure that all the correct paperwork is completed and submitted to the IRS.  The counsel and strong representation of a tax professional often makes the difference in presenting the best possible case to the IRS and reaching a successful Offer in Compromise.

Taxes and Marriage

When it’s time to tie the knot, tax issues are likely the last issue on the happy couple’s mind.  However, it’s worthwhile to sit down after the honeymoon and consider the issues below.  Taking a little time to update information as a new couple will ensure your tax filing goes smoothly.

Some things to consider are:

Name Change

It’s common for spouses to change surnames upon marriage.  Because there’s a good deal of paperwork involved, it’s easy to procrastinate on this legal change.  Tax filing, though, is tied to specific names and identification numbers.  In order to claim personal exemptions on your return and legally file, you’ll need to file form SS-5 to apply to obtain a Social Security card updated with your new name.

Refund Checks and Address Changes

After marriage, many newlyweds reside at a different address and may miss their refund checks if the old address is still listed with the IRS.  To remedy this problem, be sure to register the change of address with the Postal Service as soon as possible.  Although the Post Office will forward this information to the IRS, you can directly notify the IRS by completing Form 8822.

If you’re a little late with officially filing the address change, the IRS web site provides a “Where’s My Refund?” service that allows you to check the status of a tax refund and determine if the refund check was marked as undeliverable.  However, by proactively notifying the IRS and Postal Services, you can avoid the hassle of tracking down an undeliverable refund check and gain access to your refund money sooner.

Change of Filing Status

Couples getting married may joke about how they’re looking forward to enjoying the tax benefits.  While no one seeks a spouse solely for tax purposes, marriage does offer filing options that may prove beneficial.  It’s best to consult with a tax professional to determine the optimal filing status for your individual situation though.

One option, the joint return, includes the combined income of both spouses, and allows them to combine deductions and expenses as well.  Because the joint return is essentially a single return that details the tax liability of two people, both spouses are considered legally responsible for the contents of the return.  Both spouses sign the joint return, indicating acceptance of its contents.

Sometimes married couples may opt for the married filing separately status, which means that each spouse is responsible solely for his/her own return.  Returns are filed separately, so income is taxed for each individual and deductions are made separately as well.  Spouses sign their respective returns separately too.

Choosing the best filing status might be tricky, but a tax professional can assess your individual situation and advise on the right choice.

Tax Fraud

Our tax system uses voluntary compliance as its method of assessing taxes, which means that individuals are responsible for filing their own tax returns each year.  Happily, most of us are law abiding citizens who diligently file  returns by the deadline and pay the correct amount of tax.  There remains, though, a small portion of the population that commits tax fraud.

The IRS takes tax fraud extremely seriously, since uncollected taxes pose a strain on our country’s economy and on the integrity of the tax collection system.  Individuals who deliberately avoid filing a return or distort their tax obligations face criminal investigation and prosecution.

Some types of fraud include:

Tax Preparer Fraud: Sometimes naïve taxpayers hire fraudulent preparers who exaggerate business and personal expense deductions and credits.  When the illegal return is discovered, the IRS holds taxpayers accountable regardless of whether they had knowledge of the preparer’s actions.  The taxpayer could face payment of additional taxes and possible criminal prosecution.

Therefore, it’s in the best interests of taxpayers to choose their tax preparer wisely, looking for signs of professionalism and trustworthiness.  Reputable tax preparers will:

• Have professional credentials-Certified Professional Accountants (CPAs) and tax attorneys undergo years of training before obtaining their certification.
• Answer your questions in detail-Your tax preparer should explain any and all parts of the tax return to you.
• Review your return with you before you sign it-Before signing the return, a professional should consult with you, ensuring everything is correct.
• Offer an honest price- It’s best to avoid tax preparers who base their fees on a percentage of the refund amount because this structure encourages artificial inflation of the refund, which could land you in hot water with the IRS.

Nonfilers: Despite the complete constitutionality of taxes, some individuals continue to argue that taxes are illegal.  If these individuals fail to file a return, it’s considered tax fraud.  Frivolous arguments against taxes do not hold up in court, and nonfilers are not exempt from the law.

Tax Scams: Some scammers claim that by starting a home-based business, taxpayers can deduct many personal expenses as “business” expenses.  Other schemes involve offshore transactions in foreign countries that have financial secrecy laws.  As a general rule of thumb, taxpayers should be wary of anything that sounds too good to be true.  Even if they are duped, these taxpayers could incur enormous penalties, have to pay back interest, and face possible imprisonment.

In general, the best way to avoid tax fraud is to enlist the services of a trusted and well-qualified tax preparer.  A professional tax preparer will help you understand your taxes, ensure accuracy, and maximize deductions legally.

Tax Shelters

In an effort to avoid paying taxes, some individuals and businesses have sought refuge in tax shelters.  The term “tax shelter” covers a wide range of methods designed to reduce the amount of tax incurred.

The legality of tax shelters varies, and many arrangements are illegal.  Thus, the IRS is constantly on the lookout for entities attempting to utilize tax shelters.  Some questionable methods of avoiding tax include:

Offshore companies: By holding money and assets offshore, in places where ownership is difficult to trace, companies avoid U.S. federal income tax requirements.  Companies also form offshore subsidiaries in order to purchase goods in places with low or nonexistent corporate tax rates.

Financing arrangements: Related individuals often use complicated arrangements involving capital gains taxes to their advantage.  Capital gains incur fewer taxes than other investment income, so one person might decide to pay inflated interest rates to a related person in order to reduce the overall taxable value of the investment.  Then, when withdrawing the investment, a huge capital gain is created, and taxed at a lower rate.

However, legal  tax shelters exist as well.

Tax credit: A tax credit is different than a tax deduction, which reduces taxable income.  A credit, though, reduces your tax liability dollar-for-dollar.  For example, if there were a tax credit of $1000 for using environmentally friendly construction materials, you would owe $1000 less in taxes that year.

Retirement plans: Since retirement accounts aren’t taxed heavily, investing in them qualifies as a form of tax shelter.

Charitable donations: Making charitable donations is a legitimate way to reduce your taxable income, and as a result reduce the overall taxes you’d have to pay.

Limited Partnerships: Because some companies, such as mining or oil drilling ventures, have large start-up costs and substantial risks of going under, the government allows investors to take tax deductions for initial funding of these companies.  Investors receive immediate tax savings, as well as the potential long terms gains if the company prospers.

Conclusion

If you’re looking to reduce your tax liabilities, there are certainly legal ways to do so, and these ways are often called tax shelters.  However, there is a gray area between tax liability reduction and tax evasion, which is punishable by law.  It’s best to consult a financial professional to explore legal, effective options for reducing your tax bill.