“Pennies on the Dollar” Tax Scams

It seems as though this is an issue that I need to address at least every few months. The IRS or the FTC will crack down on a company advertising this, and the airwaves will be silent for a few months, and then the radio ads will start again with a new company doing the same thing.

The phrase “pennies on the dollar” was actually determined several years ago by the IRS to be a form of deceptive advertising, and they explicitly instruct licensed practitioners that the the use of this phrase is a violation of Circular 230, which is the practitioner behavior handbook for working with the IRS. However, since the IRS doesn’t have jurisdiction over firms that just market these services, it comes into the FTC’s purview to look out for these deceptive marketing practices.

What exactly does “pennies on the dollar” refer to? It is a reference to the IRS Offer in Compromise program, which allows eligible tax debtors to pay the IRS an amount of money that is less than what they owe in order to wipe out their entire tax liability.

In advertising, you’ll hear companies talk about settling for 20%, 10%, or even less. These ads, and the sales people you talk to on the phone, are trying to sell you an Offer in Compromise service package. Many of their web sites even have little interactive calculators where you type in how much you owe the IRS, and it’ll spit out a, “You may only have to pay $xxx” message.

These ads, web sites, and slick salesmen are trying to convince you that what you settle for is some fixed percentage of your tax debt. However, this simply isn’t true! These ads and sales people are LYING TO YOU!

I’ll repeat that, in case in didn’t sink: These people are LYING to you!

The amount of your Offer in Compromise settlement is calculated using a very, very strict formula…And the formula is NOT secret — it’s available on a worksheet in IRS publication 656B. Or, head over to the Wikipedia article on the Offer in Compromise that discusses the “Doubt As To Collectibility” calculation — I wrote that section.

Here’s the bottom line on the pennies on the dollar sales and advertising con: If you have equity in assets that exceeds your tax debt, you simply don’t qualify. Period. End of story. No matter what a sales guy on the says. For most individuals, the common thing is going to be equity in your house or rental properties, or perhaps equity in a collection of classic cars, stamps, coins, guns, art, etc. If the value of ANY of that stuff is greater than your tax debt, you do not qualify for the Offer program. A sales guy telling you otherwise is either a liar, an idiot, or both.

In the same vein, if you are a high income earner, it’s also highly unlikely you will qualify for the Offer program in general. The reason for this is that the IRS only allows certain amounts of money every month as “eligible expenses” for housing, cars, food, etc. If your lifestyle exceeds these amounts, the IRS doesn’t care — they will only allow you to claim the National Standard expenses. Any monthly income over those amounts gets multiplied by either 48 or 60, and THAT number goes into your offer amount.

Federal Tax Lien Help

When you owe back taxes to the IRS, it is inevitable that they will file a Form 668-Y, Notice of Federal Tax Lien, with your local county clerk and/or Secretary of State. A Federal tax lien is public record, so anybody can look it up. Also, a de facto tax lien exists under Federal law as soon as a tax bill is assessed, even if they haven’t actually filed the lien notice against you.

In this article, my goal is to give you a solid overview of the lien process, including what a lien is, how it impacts you, and the most common options for dealing with the lien when it creates a problem.

What does a lien do?

A tax lien works just like any other lien. Basically, it is a claim against your property. A tax lien takes a higher priority over most other kinds of liens, and after 180 days jumps ahead of some lien types it doesn’t automatically supercede. A Federal tax lien will not jump in front of a mortgage, or a local property tax lien, but it can jump ahead of just about everything else.

What this really means in practice is that if your possessions end up being sold off by a court, or in a bankruptcy proceeding, whomever has highest lien priority gets paid first. Then, if there’s anything left, the second place lien gets paid next, etc.

When a Federal tax lien exists, it covers ALL of your property. Whereas the mortgage on your house is usually only secured by the house itself, rather than your car, tools, collections, paycheck, etc., a Federal tax lien is “secured” by everything you own. This means the clothes on your back, the money in your checking account, your retirement accounts, even your paycheck. That’s correct, a Federal tax lien provides the government with a claim over your paycheck. That doesn’t mean they’re going to take it, it just means that they can.

A Federal tax lien also shows up on your credit report. This can impact your credit score, and make it difficult to obtain employment, as many employers will use this information in their hiring decisions.

It is important to understand that a lien is NOT a levy. A levy is an administrative order directing a 3rd party to physically hand over cash or property to the government that is covered by the lien. The vast majority of levies take one of the following forms:

  1. Ordering your employer to hand over the majority of your paycheck.
  2. Orders your bank to take all the money out of your bank accounts at that bank, hold it for 21 days, then send it all to the IRS.
  3. If you are a business, directs your customers to send any money they owe you to the IRS instead of to you.

Obviously, all three of these things are on the “really, really bad” list. However, the lien itself doesn’t do any of these things.

For 99% of people, a Federal tax lien is actually harmless, and has zero impact on their life or business. Sometimes, however, the lien itself creates a bad situation. In those cases, there are things that can be done with the lien that can help put you in a better position.

Lien Withdrawal

In extremely rare (and I mean EXTREMELY rare) circumstances, it may be possible to obtain the complete removal of a Federal tax lien. In order to achieve this, we must demonstrate two things:

  1. The lien is creating an undue economic hardship upon the taxpayer.
  2. Removing the lien will help facilitate collection of the tax debt.

Remember, the legal definition of “undue economic hardship” is very specific, and it does not mean “an inconvenience”. Basically, it must be demonstrated that the pure existence of the lien will cause a dramatic loss of income. For a business, a lien may interrupt a factoring agreement or a line of credit, which is required for them to operate. For a person, the existence of a lien might mean the loss of a security clearance, and therefore loss of a job.

Typically, if the hardship case can be made, so can the 2nd part. If a business continues to operate, and you get to keep your job, then you can make payments to the IRS, which is what is meant by “facilitate collection”.

Lien Subordination

Another tactic that we can sometimes take is to keep the IRS tax lien in place, but subordinate the government lien to some other lien. What this means is that we get the IRS to place themselves in second priority position, underneath somebody else.

The most common reason for doing this is to place the IRS lien secondary to a bank financing lien, such as a factoring agreement, line of credit, or an operating capital loan. Many banks will cut off funding on a loan or line of credit if they are not in first position. Thus, subordinating the tax lien keeps the bank happy by keeping their lien in first priority over the IRS. This keeps you operating, and thereby “facilitates collection”.

Lien Discharge

It is not uncommon for somebody to have one particular asset that is worth a bit of money. Selling that asset can bring in money to help pay down the tax debt, or selling the asset will eliminate the monthly payment on the asset, thereby allowing you to put that money towards the IRS bill each month (see how this keeps coming back to “facilitating collection”?).

Here’s an example: Let’s say you own a vintage 1965 Ford Mustang. It’s $60,000, and you still owe $30,000 on it, and are making $500 per month payments. You obviously don’t want to sell this car, but it will make life a lot easier if you did, since you owe the IRS $100,000 and they are going to start taking your paycheck via wage garnishment if you don’t do something.

So, you decide to sell the Mustang. The problem is that the IRS lien prevents you from selling it. Not only does your loan company have a lien on the car, the IRS lien covers it, too. So, we need to remove the IRS lien in order to sell the car. The process of removing the IRS lien from this one piece of property is called a lien discharge, and you obtain a Certificate of Discharge releasing this one asset only from the lien. That Certificate is proof to everybody else that the lien won’t follow the asset.

With the Certificate of Discharge in hand, you can sell the car, pay off the loan without the IRS making a stink about that $30k going to the car loan company, and then you have $30k profit from the sale that you give to the IRS, plus free up $500 per month to pay the government. This is not an ideal scenario for most people, giving up a beloved possession, but it’s better than the IRS seizing 70% of your paycheck every month.

Conclusion

Remember, an IRS tax lien itself really has no teeth. It’s the things that come several months after the lien filing that really cause trouble. However, since the lien is there, if the path to resolving the tax debt itself involves doing things with assets, or banks, keeping financing open, or preventing loss of your job or business revenue, there are options available to address the lien.

IRS Penalty Abatement Requirements and Reasonable Cause Criteria

Many people come to us for help with eliminating penalties on their IRS debt. The combination of Late Filing Penalties, Late Payment Penalties, and Failure to Pay Penalties can add up to a painful 65% of your entire IRS liability. Fortunately, if your back tax liability is more than two years old, then you have already hit the maximum on these three particular penalties. However, it also means that more than half of your IRS bill is penalties!

The penalty abatement application process is fairly straightforward. Penalty abatement applications can also be appealed if initially denied, so you can always get a second set of eyeballs on the issue. The thing to keep in mind is that the IRS has very strict guidelines for granting penalty abatements, and these guidelines are referred to as “reasonable cause criteria“.

It should be noted up front that “we didn’t have the money” is NOT a reasonable cause criteria. A drop in revenue, by itself, is insufficient argument for obtaining penalty relief. Any request for penalty abatement simply citing the economic recession will be immediately denied.

Why is this? Here is the IRS’ logic: You made the money, and should have paid the taxes at the time on that money. If you are self-employed and receive a check, then you HAD the money, you simply didn’t give the IRS their chunk of it. Same goes with payroll taxes, particularly trust fund taxes (money you withhold from employee paychecks for income tax and Medicare/Social Security): If you had the expectation to pay some amount of wage, then you theoretically HAD the money sitting somewhere to pay that person, and should have withheld it and turned it over to the IRS. If you couldn’t cover the taxes, you shouldn’t have had the employee and should have laid people off or cut back their hours.

There are ways to argue around this, and we have done so very successfully, but there has to be some other circumstance involved, and it needs to be a really good story. For example, you had the money to pay the tax, but paying the tax instead of something else would have created an “undue hardship”. Examples could include a large medical expense that unpaid would have left a condition untreated, or a court ordered payment that would have resulted in other legal consequences, or a bill such as a large automobile repair which would have left you unable to work and resulted in job loss. These arguments are difficult to make and require significantly more work than standard reasonable cause criteria applications, but they CAN be won, especially in the Appeals process. So even if you don’t meet reasonable cause criteria, don’t let that stop you from applying for a penalty reduction from the IRS.

The primary IRS penalty abatement reasonable cause criteria center around natural disasters, loss or destruction of vital business records, bad advice from the IRS or an accounting professional, criminal activity, medical issues, substance abuse problems, and other serious circumstances.

A couple years ago I developed a standard list of questions to ask clients to assist me in preparing their penalty abatement. This list of questions should be given some serious thought before requesting penalty abatement, as you are more likely to get what you want if it covers one of these areas:

  • Were any business records lost or destroyed?
  • Were there any circumstances that led to a substantial drop in collecting on accounts receivable?
  • Was there any transition in the business that lead to the failure to pay taxes?
  • Was there a death or serious illness that directly affected the business or personal wages?
  • Was there any embezzlement of funds, theft of valuable property, or identity theft?
  • Were there any alcohol or drug abuse issues that affected the business or wage earning capability? Was there a natural disaster that impacted you or your business? Did you rely on the advice of a CPA or IRS employee in making tax decisions?
  • Were there any circumstances that created substantial financial hardship, to the point where your business was close to going bankrupt?

These questions cover all of the IRS reasonable cause criteria to one extent or another, so finding an answer to your personal or business situation that covers one or more of these questions is the key to a successful penalty abatement application.

Note that penalty abatements are not automatic. If you are being guaranteed by a company that they can get a certain amount of your penalties removed, you’re being lied to. Again, there is NO GUARANTEE that the IRS will EVER grant a penalty abatement.

Now let’s consider your actual penalty abatement application. In order to get penalties abated, you have to demonstrate two significant things:

  1. Despite exercising “ordinary business care and prudence”, you were still unable to meet your tax obligations.
  2. Your reason for not being able to pay your taxes on time falls under one of the IRS “reasonable cause criteria”, e.g., answering one of the questions above.

When submitting a penalty abatement application, since there is no form, you’re basically just writing a letter. This letter needs to address both of the items above. It’s basically an explanation, with timelines, people involved, and any and all documentation available to prove your case. In reality, it’s not just a carefully crafted letter — it’s an entire package of “stuff”.

The demonstration of “ordinary business care and prudence” is very important. In short, you have to demonstrate that you did everything in your power to get the taxes paid, but due to circumstances entirely beyond your control, it simply wasn’t possible. If you are a business owner and applying for the elimination of penalties on business taxes, the thing to keep in mind regarding this standard is that the people reviewing your application at the IRS have most likely never operated a business in their entire lives. In fact, most of them are lifelong civil servants, and have little, if any, actual grounding in what “ordinary business care and prudence” entails in the real world. Therefore, your explanation must be written in very simplistic, easy to understand terms, and actually outright explain what is customary for your type of business or a family in your area.

For example, if you are applying for an abatement of penalties for failure to pay personal income tax, you must explain that the average family of four, just like yours, in your hometown lives in certain size and value of homes and drives certain types and values of cars, and that your lifestyle is therefore “ordinary and prudent” for your area and income, rather than lavish in comparison.

Explaining your circumstances to the IRS in your letter that demonstrates reasonable cause then becomes the final part of applying for your penalty abatement, again based on the questions listed above.

We offer complete penalty abatement application service as just one part of our $950 flat fee, full service IRS representation package. The penalty abatement is the last thing that we do, as the IRS is much more likely to grant a penalty abatement request if a resolution to the overall tax debt is already in place, such as an Installment Agreement. We will thoroughly discuss with you the circumstances that created your tax debt, and work to fit your cirucmstances to applicable reasonable cause criteria. There is no guarantee that we can eliminate penalties, but if you meet reasonable cause criteria, the odds are extremely high that we can.

IRS Offer in Compromise Requirements

By now, you’ve undoubtedly heard the radio commercials: “Settle your tax debt for pennies on the dollar…”

The program being referenced is called an Offer in Compromise, and it actually does allow you to pay a reduced amount of money as settlement in full of your entire tax liability, including penalties and interest. However, it’s not as simple as the commercials make it sound.

What most of those commercials are implying is that you take your tax debt, multiply it by some percentage, and then you just pay them percentage and walk away. Unfortunately, that is not how it works.

Part of determining whether you are even eligible to apply for an Offer in Compromise has to do with the formula used to determine how much you will need to pay. The formula is somewhat complicated, but an incredibly simplified version looks like this:

  • Add up the value of everything you own: House, cars, furniture, jewelery, guns, stocks, bonds, cash, retirement accounts, tools, goats, art….EVERYTHING. Call this number “A” – it represents the value of your assets.
  • Subtract your allowable expenses (the IRS won’t let you claim all actual expenses) from your total income. Call this number “B” – it represents yours remaining income (this is what the IRS calls it – not your disposable income, which is probably less).
  • Multiply “B” times either 12 or 24, depending on how long you’re going to take to pay off the Offer in Compromise. Call this new number “C”.
  • A + C = Z, where Z is the amount of money you can settle your tax liability for.

Here’s the kicker: If “Z” is more than you actually owe the IRS, then you’re not eligible for the program, and you’re going to end up paying monthly payments on an Installment Agreement.

In addition to this formula, there are some other conditions for Offer in Compromise applicants:

  • You must file all missing tax returns.
  • You must keep your nose clean with the IRS for 5 full years, otherwise they will re-bill you for everything they forgave.
  • You must make the Offer in Compromise payments on time.
  • You must pay an application fee, unless you meet the low income guidelines.
  • If you end up being owed a refund on next year’s tax return, the IRS is going to keep that refund money.

The real problem for most people with the Offer in Compromise application process has to do with the part where they multiply your remaining monthly income by 12 or 24. If you have $1,000 per month left over, and are going to take a year to pay off the Offer in Compromise, then you multiply by 24 to get to $24,000. Well, if you also have $20,000 equity in your home, and no other assets, then your Offer amount is $44,000. If you owe the IRS $35,000, you’re not eligible for the Offer in Compromise program.

It’s worth noting that, in March 2012, the IRS changed some of the Offer in Compromise rules. The single biggest thing they did was to REDUCE that multiplier — it used to be 48 or 60. For taxpayers with no assets, this change effectively reduced the necessary Offer amount by up to 75% — making potentially hundreds of thousands of people eligible for the program that didn’t used to be.

HOWEVER….the IRS can change this back at any time. If you are even thinking about applying for an Offer in Compromise, do it now! Offer in Compromise service is fully included in our flat-fee, full service tax representation program, which is only $950. Many firms are going to charge you a minimum of $2,500 to handle an Offer in Compromise application, so be careful whom you hire.

IRS Installment Agreement Requirements

The IRS refers to a monthly payment plan as an “Installment Agreement”, or “IA” for short. In order to enter into a payment plan to resolve your back tax liabilities, you must meet a number of basic requirements. We assist our clients in meeting these requirements, and then negotiate the actual payment amount after you are eligible.

Here are the basic requirements to be eligible for a payment plan:

  1. File any missing tax returns.
  2. Begin making current estimated tax payments (for self-employed people) or Federal Tax Deposits (payroll tax payments for businesses), if applicable.
  3. Disclose specific financial information, such as income, expenses, and assets.
  4. Demonstrate that you cannot pay off the tax debt from savings, a loan, or other means.
  5. If you owe less than $10,000 in tax, be able to pay off the entire debt in 3 years or less.  If you owe $50,000 or less, you get 5 years.  If you owe more than $50k, there is no time limit.
  6. Not have defaulted on another IA in the past 5 years.

The most difficult part of this process for self-employed and small business taxpayers is #2 — finding the money to begin making payments on their CURRENT tax obligations. This will involve some painful elimination of expenses and changing of priorities that most people don’t like, but is necessary. Remember, the IRS is your most powerful creditor, so it’s best to get them taken care of, even if that means damaging vendor relationships, not paying other bills, etc.

If you are eligible, then obtaining a payment plan is actually pretty straightforward. But as mentioned above, getting into current compliance is a critical first and second step, and is the most difficult part for most taxpayers.

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