Pennies on the Dollar ? Too Much !

Originally Published on forbes.com on August 3rd,2011

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You must have heard about companies that will help you settle your tax debts for pennies on the dollar.  Screw that, saidJohn Churchill.  He didn’t hire anybody and made an offer of $2,500 on over $250,000 of tax debts accumulated over 13 years. Collections used to be the Wild West of tax practice.   Generally the stories you heard that gave you the impression that a team of IRS commandos would parachute into your back yard and burn your house down if you were late with your return were about things collections people had done.  The Taxpayer Bill of Rights brought some order to the frontier.  It also created the conditions for late night TV commercials about settling your IRS debts for pennies on the dollar.  At any rate once you have gone through the process of determining your correct tax, which can be quite lengthy if you use every step in the system, you can just not pay it.  Then it becomes the job of the collections people to collect it.  They will send you notices that they intend to put liens on your property.  Along with the liens you will receive a notice that you are entitled to a collection due process hearing.  If you don’t like the result of the hearing, you can appeal that to Tax Court.  Although you can raise “doubt as to liability” when you request your collection due process hearing, that is generally not in doubt.  Your correct tax has been determined.  Now the discussion is about how much you can afford, your reasonable collection potential (RCP).

When Mr. Churchill went for his collection due process hearing, he was not coming off a banner year.  As a real estate agent, his peak income had been just short of $50,000 in 1996.  In 2005, he earned $1,612.  Hence the rather low offer he made (To qualify as “pennies” on the dollar he would have had to offer something more than five grand).  The officer hearing the case thought he could afford more.  The reason was because he was married at the time.

Sharon Schwarz , Chuchill’s then wife, was a smart enough lady to know better than to file a joint return with him.  Not reflexively filing joint returns has been one of themes of my blog.  If your spouse is not being tax compliant, filing a joint return, even though it seems to lower the “correct tax”, is likely a bad idea.  Ms. Schwarz figured that out without my help.  So if your spouse is not tax compliant is there something else you should not do besides signing a joint return ?  There is.  You should also not live in California.  California is a community property state, so as a matter of state law, IRS can expect you to contribute to pay your spouse’s tax debt.

This is the heart of the case. The Appeals officer calculated Churchill’s RCP by adding Schwarz’s 2005 income to his. Doing so meant Churchill had monthly income of $5,828 and expenses of $4,400, leaving $1,428 available for tax payments. The Appeals officer multiplied $1,428 by 86 (the number of months she thought an offer should last) and found his RCP to be $122,808.

Mr. Churchill appealed the IRS decision.  The Court did not think that the Appeals Officer had abused her discretion by including Ms. Schwarz’s income in computing reasonable collection potential.  That was not the end of the matter, though.  Mr. Churchill also indicated that circumstances have changed.  At some point between the filing of his petition and his day in Court Ms. Schwarz divorced him.  The Tax Court cannot, itself, make a determination on this new information.  They did, however, decide that they could “remand” the case for the IRS to reconsider.

Who says the income tax isn’t voluntary ?  Mr. Churchill didn’t pay for 13 years.  The IRS wanted less than 1/2 paid over 7 years.  Mr. Churchill wanted to pay less than 1%.  The Tax Court has sent the case back to be reconsidered.  What is the incentive to organize your life to live on your after tax income ?  Why don’t you just not pay ?  Well there is an answer.

I read about people who run up huge tax bills in three types of cases.  One is collection due process cases like this one.  Then there are bankruptcy cases like that of Larry Mitchell, where the IRS is arguing that regardless of however many other creditors you stiff, you are not stiffing them.

There is a third type of case, which I see.  I don’t pay much attention to them, because it is totally not my area.  You see willfully not paying your required income taxes is a crime.  So I see cases like that of Gary Harris, who is arguing that his sentence of 115 months is too long.  The IRS people who concern themselves with this aspect don’t look much different then the others, but they do carry guns and they can arrest you.  I asked somebody, who has reason to know about such things, where the distinction lies.  He told me that normally things don’t go criminal for less than $100,000 per year for at least three years.  He was not willing to be quoted and I don’t know that you will find it written down anywhere.  So just not paying does create the risk of being deprived of your liberty.

I still think that it is the course not just of right but also of wisdom to organize your life to live on your after tax income.  I just can’t absolutely prove it.