When Internal Revenue Service Commissioner Doug Shulman recently announced a new round of collection initiatives to help taxpayers buffeted by the economic downturn, it was telling that he also promised that the new steps would be "revenue-neutral." Could it be that the IRS seems to be recognizing that you can't get blood from a stone and that some delinquent taxpayers simply can't pay, no matter what collection methods are used, while some others will be more likely to pay eventually if draconian short-term measures are not used?
Irrespective of the degree to which the new IRS collection initiatives alter the landscape, taxpayers looking at these changes should not be lulled into the belief that strategic responses are no longer necessary. The IRS Taxpayer Advocate and the collective experience of many practitioners indicate that a collections problem with the IRS, especially for the small business, remains a minefield of troubles that has the potential of getting out of hand quickly, and irretrievably.
TAX LIENS IN GENERAL
If a tax liability remains unpaid after the IRS makes notice and demand for payment, a tax lien automatically attaches under Code Sec. 6322 to all property owned by the taxpayer. Property may thereafter be seized and sold by the IRS. Certain property is exempt from seizure. The IRS can also issue a notice to collect the tax owed by levy after the tax liability has been properly assessed and a notice and demand has been made.
While a general tax lien attaches to all the delinquent taxpayer's property automatically after notice and demand for payment, that lien does not operate against third parties without the IRS taking the additional step of filing it, in the form of a notice of federal tax lien. The NFTL makes public a specific claim on a taxpayer's property as security for the payment of a tax debt.
The IRS typically wastes little time in filing an NFTL and does so routinely. Its rationale is that, rather than a question of kicking the taxpayer while down, it serves to protect the government's security interest against other creditors that will otherwise take the taxpayer's property anyway.
The filing of an NFTL pursuant to Code Section 6323(f) generally follows state filing rules for real and personal property. Some practitioners make it a policy to inspect the notice of lien carefully, often finding clerical errors that may invalidate the lien filing. Nevertheless, this strategy usually provides only temporary relief, since the federal tax lien remains valid and the IRS need only refile against specific property.
Once a lien is filed, even full payment does not necessarily put things back immediately as they were. Code Sec. 6325(a) sets an absolute deadline for the IRS "subject to such regulations as the secretary may prescribe" for the release of an NFTL within 30 days of payment of the tax due, including interest and penalties, or within 30 days after the IRS accepts a bond that guarantees payment.
NEW IRS COLLECTION INITIATIVES
After a year of study, Commissioner Shulman announced at a news conference in February, "We are making fundamental changes to our lien system and other collection tools." The changes basically revolve around IRS lien practice, and to a lesser extent a revised, streamlined installment agreement program and updated offers-in-compromise.
New lien procedures. Notice of federal tax liens will not be generally filed if the underlying tax liability is less than $10,000. Automatic filing had been set previously at a $5,000 level.
Tax liens can now be withdrawn immediately once full payment of taxes is made if the taxpayer requests it. The 30-day waiting period has been removed.
A direct-debit agreement with the IRS now will also help remove liens. The commissioner has instructed IRS personnel that liens are to be withdrawn for taxpayers entering into a direct-debit streamlined installment agreement, converting an existing installment agreement to direct-debit payments, or continuing direct-debit payments on existing direct-debit installment agreements upon taxpayer request. The IRS will withdraw the liens "immediately after a probationary period demonstrating that direct-debit payments will be honored."
Streamlined installment agreements. Installment agreements between the IRS and a taxpayer allow the satisfaction of a tax debt over time through monthly payments. Streamlined installment agreements are available without the requirement of showing a financial statement. Small businesses already underwater on their tax liabilities are hard pressed to incur the additional expense required to work up financial statements for the IRS. The IRS has raised the ceiling for streamlined installment agreements from $10,000 to $25,000 or less in unpaid tax. Small businesses must elect direct-debit payments and commit to a 24-month payment schedule to come under this provision.
Streamlined offers-in-compromise. The IRS has also raised the dollar limits for streamlined offer-in-compromise agreements, allowing taxpayers with annual incomes of up to $100,000 and tax liability of less than $50,000 to participate, effectively doubling the dollar ceiling from its previous $25,000 level. While the IRS mentioned that qualifying taxpayers will enjoy a "streamlined" OIC process, it has not yet explained the details of how it works. It has also been short on explaining what's changed, especially in light of repeating in its announcement the traditional OIC standard: "The IRS looks at the taxpayer's income and assets to make a determination regarding the taxpayer's ability to pay."
The new collections initiatives are expected to be fleshed out further as the initial guidelines introduced by Commissioner Shulman are given more detail and put in more formal directives to IRS personnel. It is anticipated that those details may take several months to become fully operational.
WHAT'S STILL WRONG
The IRS Taxpayer Advocate has gone on record stating that, as helpful as the new IRS collections initiative will be, it is not nearly enough to solve the problems of many more well-meaning but financially strapped taxpayers now struggling with tax debt. The Taxpayer Advocate complained that the new IRS lien policy falls short in several respects:
1. Raising the dollar tax liability threshold for filing liens begs the underlying problem: Taxpayers unable to pay their tax liability generally don't have adequate assets. The IRS needs to investigate streamlining data collection on ability to pay before using otherwise damaging collection tools.
2. Doubling the tax liability for which liens are filed, from $5,000 to $10,000, does not adequately address the exponential increase in the number of liens filed in recent years. The statistics are sobering:
Lien filings increased 550 percent from 1999 to 2010 and 28 percent alone for the first quarter of fiscal year 2011 when compared to a year ago.
The IRS filed liens against 1.1 million taxpayers in FY 2010, as compared to 168,000 in FY 1999.
Over the past seven years, the IRS has filed a total of over 5 million tax liens.
During FY 2010, the IRS also issued over 3.6 million levies attaching to financial accounts, wages and other sources of income.
3. The IRS's Automated Collection System is good at systematically generating levies - 2.9 million of them issued in FY 2010. The TA also reports that the IRS now generates a majority of its liens through the ACS. The Taxpayer Advocate sees this automated approach as part of the problem. The IRS's machine-like process leaves no room for "thoughtful judgment" that evaluates each taxpayer's unique circumstances and discusses with them collections solutions better suited to both the taxpayer's and government's interests.
Overall, the Taxpayer Advocate maintains that the IRS is not proactive in avoiding the need for liens. She rhetorically noted that it is not being proactive on the IRS's part to set up a process in which a taxpayer suddenly finds a lien filed on his property because he missed one or two pieces of IRS correspondence and incorrectly assumed that the IRS had been backing off.
The Taxpayer Advocate noted that the mere filing of a tax lien can have a devastating impact on the taxpayer's credit rating. Tax liens are picked up by all three major credit rating agencies and remain in their reports for seven years from the date the tax liability is resolved (and longer if unresolved). Credit reports are used by employers, mortgage lenders, landlords, and vehicle financing and credit card companies, thereby throwing the taxpayer into a worse financial tailspin. Small businesses that need credit to survive are especially hard hit.
The Taxpayer Advocate's Report to Congress this past January concluded that the current IRS lien policies "torment" taxpayers. It was also critical of the IRS's "one-size-fits-all ... assembly-line" approach and recommended developing a working model of the "will pay, " "can't pay" and "won't pay" distinctions in developing appropriate collection treatments. It reiterated the need for personal contacts.
The IRS commissioner recently has tried to put some brakes on the "lien machine" that automatically generates tax liens and with it a host of financial headaches that typically ensue for the taxpayer. While commendable, his new collection initiatives should also be cautionary in warning what the "lien machine" can do once it gets rolling.
Early intervention by taxpayers and their representatives is key to stopping the IRS lien process in time before it ties up assets and constricts credit and possibly destroys the taxpayer's ability to come out whole. Monitoring outstanding tax liabilities and related correspondence is essential. Searching the public records from time to time, for tax and other liens, is always good business practice. So is putting as high a firewall as possible between personal and business assets.
If all else fails, a taxpayer might even quote Commissioner Shulman's recent promise in regards to collections to the IRS agent: "We will continue to walk in taxpayers' shoes and look for ways to help."
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.
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