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Friday, August 8, 2014
Paper Tiger - Real Tiger - Fire-breathing Dragon - Three Faces of the IRS
Originally Published on forbes.com on September 9th,2011
My piece Has The Taxpayer Bill of Rights Made the IRS a Paper Tiger ? has attracted some comments. Some of the comments make me believe that there is a very important practical point, that I am not expressing clearly enough. Some of the comments go into the heartache, misery and frustration that the IRS can elicit from people. I should say right here that my overall impression of the people who work for the IRS is pretty positive and I believe that they have a fairly complex job which their bosses, which when you think about it are us, make pretty difficult. For purposes of this discussion, whose fault it is is not important. This is a practical discussion.
Basic Compliance – The Black Box
One part of the IRS is faceless. You send in returns that show a certain amount of tax due and you pay that much. Or you send in a return that says you are due money back and after a reasonable interval you receive it. I’m sure it is all quite complicated but when that is what is happening there really isn’t anything else for us to be concerned about as a practical matter in living our lives. We might have a lot of drama around return preparation and getting the tax money together but the IRS role in that drama is that of a black box that we put money and returns into and sometimes get money back out of. Put that aspect aside and also things ancillary to that, like people who might tell you what the proper form to file is, or where to send your check, or how soon you will get your refund. Let’s move on to the three faces of the IRS that can be stress inducing.
Exams – The Paper Tiger
You may hear from people who work for the IRS that they either disagree with your tax computation or that they want you to substantiate the items on your return. This can be a source of endless mental anguish. They will ask for things and tell you you should get it to them in ten days, then you won’t hear from them for months. They might then contact you and ask for the same things again. More months can go by. Ultimately after much delay on their part they might ask you to extend the three year statute of limitations to give them even more time to mentally torment you. The thing about these people is that they can’t actually do anything to you. They are the paper tiger. When you talk to the paper tiger to get it to not bite you it might tell you one thing one time and something else another time. It can be extremely crazy making. Ultimately though the paper tiger can only do one thing. It can send you a bill, usually in the form of a Statutory Notice of Deficiency. When you get that you have 90 days to appeal to Tax Court or you can pay the bill and sue for refund. Assuming you have either decided not to appeal or you have gone through the process what you end up with is a bill – a piece of paper. Those people can’t do anything to make you pay the bill. Once you have the bill they are done with you.
Collections – The Real Tiger
Collections can do two things to you besides sending you annoying mail like Exams did. They can file liens which will make your life miserable since you won’t be able to sell your property without addressing the liens and yourcredit rating will get loused up. They can also levy your property – take your stuff or tell people who owe you money to pay them instead of you, including your employer. There are some exceptional circumstances where people end up in collections without really belonging there. Dr. Donald Byk in 2007 received a notice that he had not filed one of his 2000 quarterly payrollreturns. His accountant sent in a copy of the originally filed return which the Service processed as a newly filed return. Since it was payroll taxes it went straight to collections. His case illustrated how fouled up things can get inside the black box. The various print outs that the IRS submitted to show Dr. Byk owed money were incomprehensible to the agents testifying about them. That is pretty unusual though. Normally you don’t get to Collections unless there is no question about the correct amount of the tax.
So Collections is a real tiger that can bite you with its liens and levies. It is a tiger on a leash though. That leash is the Taxpayer Bill of Rights. It says that before it bites you it has to growl. The growl is a notice that you are entitled to a collection due process hearing. You have 30 days to file Form 12153. Then you can have a hearing and offer a plan to pay off the tax over time and possibly at a reduced amount. The hearing is about your ability to pay – Reasonable Collection Potential. You have the right to appeal the outcome of the hearing to the Tax Court, which will determine whether there was an abuse of discretion by the hearing officer. The most important thing for you to understand about this is that collections practice is entirely different than exams. Do not take it for granted that your tax preparer understands it well. Do not think a preparer who can’t answer your questions about collections is inept. Sometimes I will handle a collection issue for an existing client because my familiarity with all the clients circumstances makes up for my lack of very deep knowledge of collections, but often I call an expert. Tax preparers should form relationships with practitioners who are expert in collections where they can refer their clients when there is a need.
There is one particular issue where tax advisers routinely give bad advice, because they fail to understand the distinction between tax determination and collections. If someone is not going to be able to pay the full tax it will not matter how big it is. They will end up paying based on RCP – Reasonable Collection Potential. A married couple will usually have a lower tax by filing a joint return than if they each file separately. So from a tax determination perspective the decision to file a joint return, which is an irrevocable election, is almost always the right answer. If there is not going to be full payment going in with the return, though, it is almost always the wrong answer. Consider Robin and Terry. They are married. Robin had income last year, but doesn’t have much in the way of assets. Terry didn’t have income last year but has some assets. Robin computes a married filing separate return and comes up with a liability of $25,000. Terry has no liability. On a joint return the liability would be $20,000.
Unless Robin can and does cut a check for $20,000 to go in with the return, Terry should not sign a joint return. As a matter of fact, Terry should make a point of sending in a separate return so that the IRS can not contend that Terry consented to Robin signing both their names. A large number of innocent spouse cases have fact patterns like this. There is no point in Robin getting the liability down from $25,000 to $20,000, if the whole $20,000 is not going to paid. Robin is lowering the tax, but raising the Reasonable Collection Potential by pulling Terry’s assets into the equation. Divorce attorneys seem to routinely make this error of thinking that joint filing is a simple computation matter without considering the effects of joint and several liability.
CID-The Fire Breathing Dragon
Tax evasion is a crime. I read cases concerning people who go years without filing and engage in obstructive behaviour to avoid paying. Sometimes the cases are appeals of collection due process hearings. Sometimes they are bankruptcy cases where the government is arguing that tax debts should not be discharged. There are others like US v Ultra Dimension that concern clarifying the beneficial ownership of property so it can be levied. Those people are all wrestling with the tiger. Then there is an entirely different type . They are brought by people residing in Federal housing, who would like to check out a little earlier. They might be arguing that the means they used were not that sophisticated so there should not have been a sentence enhancement under the guidelines. I usually don’t find the issues that interesting, but the story behind the story might be. Wesley Snipes was just in court arguing to overturn his conviction.
I might write more about CID (Criminal Investigation Division) in the future. The concept of armed tax accountants has a certain fascination for me that is probably in no way reality based. Somebody once told me about a CID old timer who thought concerns about maintaining weapons proficiency were a little silly – that he had put away more criminals with his pencil than most cops do with their guns. Through research and inquiry I have never been able to discern exactly what it is that makes a case go criminal. It happens infrequently enough that many people ignore the possibility, but I know that it is there. I think there are policy shifts over time. Sometimes CID is called into fight other types of crime where the tax charges are incidental, but perhaps easier to prove – “That’s how they got Al Capone” as the saying goes. The treasury inspector general has actually criticized this tendency since IRS CID is the only law enforcement agency that will pursue someone whose only crimes are tax crimes. One of these days they will go on a small fry campaign. At least, keep that possibility in mind if you think that flat out lying is a reasonable tax saving strategy.
If IRS CID is interested in you, there is one thing you need to do. Hire a lawyer. If there is need for an accountant, your lawyer will hire the accountant.
The organization of the IRS is much more complex than the simple model I have constructed here, but I think the model can be useful conceptually. In dealing with one part you should not forget the other parts exist, but you need to tailor your expectations and behavior to