Has Taxpayer Bill of Rights Turned IRS into a Paper Tiger?

Originally Published on forbes.com on September 5th,2011

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I just wrote a post on this in the breezy humorous style you all love so much.  It earned me a comment questioning whether I was advocating tossing IRS notices in the trash and waiting out the 10 year statute of limitations on collections.  I’m not advocating that course for two reasons.  One is that it is not something that good citizens do.  The other is that tax evasion is a crime.  Somebody who has reason to know about such things has told me that you have to avoid 100 grand a year for three years to get CID (Those are the IRS folks who carry guns and can arrest you) interested in you.  That does not mean that they won’t turn on a dime and make an example of some small fry to put the fear of God in the rest of us.  I am concerned, however, about what will happen to ill advised people who adopt that course.  I believe that the answer is not nearly enough.  This is primarily based on my study of collection cases.

Now people worry a lot about being audited.  It can be a painful process.  Worst case at the end of an audit – and I am including here all the various levels of appeal within the IRS and the courts, when I say the end – you get a bill.  You can also send in your return without sending in money (I don’t recommend that, but if you don’t have the money it can be smarter than not filing at all).  In both those instances you are out of the hands of the people whose job it is to figure out how much tax you owe.  Assuming CID isn’t interested in you (They processed 4,325 cases last year.  Seems like a lot until you consider there are something like 138 million taxpayers) you are now in the hands of Collections.  Collections doesn’t carry guns and can’t arrest you.  They can do two things besides sending you annoying mail and calling you.  They can file liens and levy your property.  Liens will louse up your credit rating and make it hard to sell your property.  Levies are when they actually take your stuff or tell people that owe you money, including your employer, to pay them instead.  Besides losing your stuff the levy can be an embarrassment.  Before they can do either of those things they have to send you a notice of a right to a Collection Due Process Hearing.

You get your hearing by filing Form 12135.  Although you can raise “doubt as to liability”, that is generally not an issue.  Collections is about RCP – reasonable collection potential.  Based on their assessment of your ability to pay (and there are standards involved), the IRS may accept a lower amountand/or stretch out the time you have to pay.  They may also just write the debtoff as being noncollectable.  Usually getting into current compliance is part of the deal.  Go now and sin no more.  The determination from the hearing officer can be appealed to the Tax Court.  Consider John Churchill – see my postPennies on the Dollar – Too Much-.  He owed  $250,000 accumulated over 13 years.  IRS offered to settle for about half paid over 8 years.  He wanted to settle for $2,500.  The Tax Court sent the case back to IRS for reconsideration, because he had gotten divorced in the interim.

IRS collection activity plummeted after the Taxpayer Bill of Rights passed.  It froze them.  Collections used to be the Wild West of tax practice.  Most IRS horror stories came out of Collections activities.  When I heard about them I always had this “yes, but”.  You generally aren’t dealing with Collections without already having had a lot of opportunity for due process.  A whole new due process system is in place now to determine how much of the correct tax will actually be paid.  It gave rise to an industry, not all of whose members are on the straight and narrow.

The most recent development outside of court case that I have noticed isIRSIG SBSE-05-0311-039. Don’t ask me what the acronym stands for.  It is how they update their manuals.  Here is the key sentence in the notice:

Generally NFTLs will not be filed when the UBA is less than $10,000, but they may be filed if they will protect the government’s interest, such as pending bankruptcy or other exigent circumstances

That is up from $5,000.  I read that to mean that if your balance is not over $10,000,  Collections, generally, will not  do anything other than send you annoying mail, which brings me to a scenario of someone I’ll call Joe.  Joe is an all together bad citizen.  The only thing that keeps Joe compliant is a credible threat of punishment.  Joe is not afraid of CID going on a small fry crusade.  Joe has been filing timely, if not accurately, and paying.  He gets a notice that he failed to include a 1099 that one of his “cash cusotmers” issued.  After some process, how much is unimportant, it is established that he owes $1,500.

He doesn’t feel like paying the $1,500.  So he doesn’t.  He reads his mail carefully.  He never gets a notice of his right to a collection due process hearing.  He does nothing.  Just for the sake of example, let us say that in 10 years the $1,500 grows to $4,000 (It will depend on interest rates.)  Barring ”exigent circumstances” that trigger a lien the statute of limitations on collections will expire.

Now I don’t like that scenario and I don’t recommend that course of action, but I believe that  is the way the system works currently.  Much as I hate to eat crow on forbes.com, I’d be happy to find out I am wrong.  The case of Susan Ray Mostafa is another good illustration of the system.  She did not file a 1996 return.  She had blown an IRA rollover deadline by a few days without an explanation.  She took the case to Tax Court and lost.  When she got billed she wrote a check for less than the full amount on which she wrote “paid in full”.   The IRS threatened to levy her bank account so she filed Form 12153 (If you have ever played the Wizards of The Coast game called Magic, you can think of Form 12153 as a counter spell).  The hearing officer didn’t buy her argument so she went to Tax Court again and lost, again, in 2010.  That is nearly 15 years after the event that gave rise to the tax liability.

My own thought on this is that collection due process should be integrated with the tax determination due process.  If you are fighting an audit and you lose and you are not writing a check the offer in compromise or installment agreement should be negotiated then with the right to appeal.  You should not get two trips to Tax Court on the same deficiency – one about the deficiency and the other about whether you can afford to pay it.  You should not be able to not file for many years dispute the liabilities in Tax Court, lose and then request a collection due process hearing and go to Tax Court again, lose again, and then file for bankruptcy and argue that the tax debts can be discharged because they are so old like a kid who murders his parents and then asks for mercy because he is an orphan.

I don’t know how much of the tax gap is created by this type of activity, but I believe that the system is unfair to compliant taxpayers.