Tax Law Blog: Seeking Justice in Administration

How to Get an Offer in Compromise With IRS

2010-07-12T05:33:00.023-05:00

Offer in Compromise With IRS: Part 1

[The matters summarized below are available in depth and detail at Federal Tax Collection Rules and Procedures. At Chapter 12 in the documents at that web site researchers will find a huge number of electronic links to the full text of governing rules and discussion of the details involved in the OIC process.]

This Part 1 provides a general introduction to the things that will occur before an Offer in Compromise becomes the focus of attention. Taxpayers should be aware that an Offer in Compromise will not be accepted where there is any other way to collect more than the Offer proposes. This Part 1 summarizes the processes and considerations that will be followed in a collection case.

When a taxpayer submits an “offer in compromise” (“OIC”) to the IRS the taxpayer is asking the government to accept less than the whole tax debt. It enables taxpayers to close this chapter and start fresh without an impossible tax debt hanging over their heads. It enables IRS to close the matter by collecting what can be prudently expected and to stop applying resources to extract every last farthing. Like all creditors, the government will not easily accept an offer to compromise the liability. Most taxpayers cannot qualify because the financial facts support the conclusion that a greater portion of the debt can be collected. All financial facts must be gathered and analyzed in order to construct an OIC that bears a reasonable possibility of being accepted by the government. This Part 1 summarizes things to be gathered and analyzed before an OIC is ever submitted.

Think of OIC as a process -

It helps to understand that an OIC is the product of a lengthy, detailed process in most cases. There is no way to establish an OIC by filling out a form, offering to pay a smaller amount, and complaining about the size of the debt as compared to resources. A much more detailed, fact-based and analytic foundation is required. Everything depends upon a complete financial analysis. If a taxpayer has not paid the balance due when the IRS demand letters started arriving, the IRS will move toward taking property from the taxpayer if necessary. IRS begins that process with a financial analysis. Don't wait on the IRS to show up at the front door – do a complete financial analysis and be ready to advocate a taxpayer's position before engaging the IRS agents.

Prerequisites

Like all creditors, the government prefers to collect the entire debt. An offer in compromise asks the government to accept less than the entire amount due to dispose of the matter – a request the government does not favor or prefer. There is a specific sequence of preferences the government will follow. In general, this is the sequence:

Letters arrive demanding full payment of the entire debt, warning the IRS can file liens and take property through the levy processes.
If the bill remains unpaid IRS will require a fully supported “Collection Information Statement” ( a “CIS”) from the taxpayer.
Taxpayers are obligated by law to list absolutely every property or interest in property. Concealing assets can constitute a federal crime. Every asset is to be given a value. IRS does not necessarily accept a taxpayer's CIS without investigation. Usually the IRS will conduct a search for omitted assets (they are very good at that) and will also make determinations of value. Mostly, IRS is looking for cash resources to take by levy.
Taxpayers must disclose all potential future assets – raises, bonuses, trust distributions, inheritances, judgment recoveries and etc.
All monthly expenses and all debts are to be listed in detail.
Every source of income must be disclosed.
The CIS is to be signed under penalty of perjury. Don't even think about concealing assets or making false statements.
All financial information will be analyzed to determine everything a taxpayer can gather immediately to pay the debt.
IRS will require cash resources to be exhausted. Taxpayers can be required to -
Completely drain all bank and brokerage accounts
Cash in or borrow against life insurance
Borrow using credit cards or otherwise
Sell assets that have equity and etc.

Next step: Installment plans

Where the analysis clearly reveals taxpayers cannot pay the whole debt through exhausting available resources, IRS will extract everything possible immediately and then move to the next preference: an Installment Agreement (“IA”).

“Expedited Agreements” are often available to taxpayers where the debt is less than $25,000 or where the taxpayer can reduce the balance to less than $25,000. There are two programs: (1) “Guaranteed Installment Agreements” and (2) “Streamlined Installment Agreements.” Where taxpayers qualify for such programs it is best to use them. It avoids lots of work and difficulties. There won't even be a financial analysis required.
Regular Installment Agreements:
Not acceptable unless and until taxpayers exhaust immediately available cash, borrow to make payments and sell equity-assets.
Amount of payment is measured by the “ability to pay.” Simply stated, the ability to pay equals all income a taxpayer receives reduced by “allowances” the government follows. The National Standard limits the amount a taxpayer will be allowed to keep to pay for medical, food and clothing. The Local Standard limits the amount a taxpayer will be allowed to keep to pay for housing (includes taxes, utilities, repairs and etc.) and transportation. These tables establish very low allowances. It does not matter if a mortgage payment exceeds the housing allowance. Taxpayers can find themselves having to sell the house and move to another residence.
If these requirements are met, then the IRS will recommend acceptance of a regular installment agreement.

Partial Payment Installment Agreements (“PPIA”):

Where the financial analysis shows the taxpayer cannot reasonably be expected to pay the entire balance during the 10-year collection period then the IRS will move toward a PPIA.
PPIA's are not accepted where a taxpayer has cash, borrowing power and/or equity-assets that can be applied. Those resources must be applied before any kind of installment agreement will be accepted including a PPIA-type.

Offer in Compromise

This is the last resort. Where the financial analysis shows a taxpayer simply does not show any likelihood of being able to meet the requirements of a meaningful PPIA then the government will accept an OIC.
No OIC will be accepted until a thorough financial analysis has been done. This will usually (but not always) have been completed by the IRS earlier.
No OIC will be accepted unless it equals a taxpayers “Reasonable Collection Potential.” Broadly described, a taxpayer's RCP is the same as the taxpayer's “ability to pay” and will also be measured after application of the National and Local standardized allowances. Determining RCP also requires application of all available cash resources, borrowing power, and selling equity-assets. The components will be described in more detail in PART 2 of this series.
When taxpayers submit an Offer they must also immediately pay 20% of the proposed “lump-sum” amount. If the IRS rejects the proposed offer the 20% will be retained and will not be refunded.
When taxpayers proposed an installment-type of OIC they must immediately pay the amount of the proposed payment and they must continue to make every single proposed payment during the entire period the IRS considers the proposed OIC. None of the payments will be refunded if the IRS rejects the taxpayer's proposal.
Taxpayers have two ways to appeal if IRS rejects the proposed OIC. Those are discussed in PART 2 of this series.

Currently Not Collectible (“CNC”):

Finally, where the evidence shows that there is absolutely no way to extract payment from a taxpayer by any means, the account is to be designated as “CNC.”
HOWEVER, in some cases the IRS will periodically return to collect updated information on CNC accounts to know whether a taxpayer's situation has changed to enable the government to collect some part of the debt.

Part 2 of this series will discuss other important considerations including the 4-types of OIC's and the submission requirements.

Trust Fund Recovery Penalty (100% penalty) - Part III - Protest the Proposed Assessment

2010-01-26T16:15:00.007-06:00

[The matters mentioned in this article are governed by statutes, regulations, and detailed descriptions published by the U. S. Government in the Internal Revenue Manuals ("IRM's"). The full texts of those resources can be reached by various means on the internet. Also, the governing rules and texts can be researched at Chapter 13, Trust Fund Recovery, at https://IRScollectionlaw.com.]

In Part I of this series of articles the broad reach of the Trust Fund Recovery Statute (i.e., IRC 6672) was summarized. Part II summarized the concepts of "responsible persons" and "willfulness" and listed resources that should be studied to understand how the government determines the identity of individuals who are subject to assessment of the "penalty" under 6672. Identifying appropriate persons to target for the assessment is a process that is wholly dependent upon the evidence, and most of the evidence will tend to be documentary. Part II lists the resources that guide IRS employees through the processes of collecting and analyzing evidence.

This Part III will summarize considerations involved in constructing a targeted person's ("target") position to contravene IRS' proposal to assert the penalty against the target. When should the process of preparing a "defense" begin? Every potential target should go to "red alert" at the very moment it is learned the employer did not pay the required tax. Though some few weeks might pass before a Revenue Officer appears on the premises to commence the investigative processes, unless the entire amount due is paid immediately all potential targets should be alerted to the fact that something has gone dreadfully wrong. Potential targets should learn answers to questions like these:

Why wasn't the whole trust fund paid?
Does the employer have sufficient resources to immediately pay the full amount?
Does the target have power to apply company resources to pay the full amount? If so, failure to do so will constitute strong evidence of willful failure to fulfill the obligation they owe the government.
Does the potential target occupy a role that will automatically place them under IRS scrutiny (e.g., officer, director, authority to pay the bills, power to decide who shall be paid and etc.)? If so, what evidence supports the conclusion that the target (1) was not "responsible" for paying the tax, and/or (2) did not "willfully" fail to fulfill the duty to collect, truthfully account or pay over the required amount?

While it is preferable to commence the process of gathering and analyzing all the evidence that tends to exculpate the target, it is a fact of life that most people don't prepare their own defense and don't seek help in the process until IRS serves Letter 1153 - Notice of Proposed Assessment. It is almost always a very serious error to wait until IRS has concluded its investigation of the matter and served its determinations before a defense is constructed. Be aware that under the law there are only 60 days from the date of that notice to complete the construction of a case sufficient to contravene the proposed assessment. No extension of time is available under the law. Targets who fail to commence preparation of their case long before that stage have placed themselves (and their representatives) in an extremely weakened position. By that stage the government will have gathered all the documents, conducted all the interviews, and deliberated the evidence for an extended period. Conclusions reached through that process are not easily displaced no matter how strong the exculpatory evidence seems. The lesson here is that potential targets are wise to construct their "defense" and to present the details of all the supporting evidence BEFORE the government decides to serve the Letter 1153. Avoiding receipt of Letter 1153 is the most prudent way to handle these situations.

Form 4180 - the IRS' interview form: This Form 4180 is used to interview officers, directors, employees and etc. It is designed for only one purpose: to record an interviewee's statements that tend to identify potential targets. There are several problems with the physical characteristics of the Form. More important, many people are eager to cooperate with the Revenue Officer and too often tend to make statements that are not absolutely complete and accurate. As a result, the Officer may quite easily be induced to form incorrect conclusions about the identity of targeted persons. ALWAYS study Form 4180 before being interviewed by a Revenue Officer. Know the facts and the supporting evidence for answers that will be given before responding to the Officer. Be aware of whether there is sufficient space provided on the form to record the complete and accurate responses that will be given. If there will not be sufficient space, prepare written attachments that will be provided to the Officer and appended to the Form. Targets should not respond to any inquiry if they do not know an answer is absolutely accurate and complete. An analysis of Form 4180 and concerns involved in the interview process are discussed at Chapter 13, Paragraph III at https://IRScollectionlaw.com.

Preparing the Protest: If the case has not been thoroughly prepared prior to the arrival of Letter 1153, there will ensue a wild scramble to prepare a protest to the proposed assessment. Why a "wild" scramble? It becomes "wild" because the Revenue Officer will have gathered and analyzed corporate records, minutes, correspondence, bank records, signature cards, resolutions, intra-company writings of every species and etc. They will have completed interviews and will rely upon the statements provided by interviewees. And where the volume of the documentary evidence is formidable, the Officer will have taken all the time required to carefully scrutinize the evidence. What evidence does the Officer rely upon to support issuing the Letter 1153? There is nothing in the notice that expresses an answer to that question. Did the officer happen to locate exculpatory items in the mountain of evidence? There is no way to know the answer to that question. Representatives will be forced to review that same mountain of evidence in the search for exculpatory evidence, research the law, and construct the entire written brief to support a target's protest in oly 60 days. There can be a massive amount of work to be done, and 60 days creates time-pressures that can be quite severe.

Where does the protest go? The target's protest does not first go to any neutral party for any sort of review. The protest is to be submitted to the Revenue Officer who has been working the case from the beginning. That person has invested a very substantial amount of time in the case and has formed views about conclusions compelled by the evidence. It is difficult to change the thinking of a person who has completed that kind of process. Therefore, being aware that the protest must change the view of such a person, representatives must succeed in assembling every shred of evidence and articulating a persuasive contrary conclusion. Is there strong evidence sufficient to compel the conclusion that the target was not actually a "responsible" person under the law? If so, exhaustively prepare the protest to express the evidence and the case law that compels that conclusion. Is there strong evidence sufficient to compel the conclusion that the "responsible" target did not willfully fail to perform the tax-related obligations? Thoroughly identify and articulate the evidence and the supporting authorities. Serve the protest on the Officer within the 60-day period.

10-day Conference opportunity: If a target will move quickly upon receipt of Letter 1153, there is a 10-day period in which to confer with the Officer. That conference opportunity can be of enormous assistance to representatives. One can learn about the evidence the Officer found particularly persuasive. One can learn much about all of the sources of evidence relied upon and whether the Officer was provided ALL the evidence - especially exculpatory evidence. One can learn whether the Officer may have overlooked the significance of evidence. The conference can sometimes provide an important opportunity to objectively discuss these critical matters.

Know what the IRM's prescribe: Sometimes Officers fail to request (and are not provided) all the important evidence. The 10-day conference will provide the opportunity to identify with particularity the evidence possessed and enable representatives to analyze whether the Officer complied with the guidance provided in the IRM's. Where an Officer for some reason failed to complete the guidelines expressed in the manuals and as a result failed to collect exculpatory evidence, there is a substantially increased likelihood that a protest might result in a withdrawal of the proposed assessment. The requirements expressed in the manuals and the full text of several important provisions can be researched at Chapter 13, https://IRScollectionlaw.com. In that same Chapter 13, researchers will find the provisions of the IRM's that authorize Officers to reverse prior conclusions, and how to process the withdrawal. It is wise to cite that IRM-based authority because TFRP determinations are so rarely reversed that many officers do not know the processes. Provide the basis for reversal in the brief, and supply the exact IRM-provisions that express the processes to be followed.

Strong assertions of evidence coupled with references to "Attorney Fee Cases" is prudent: Another objective in preparing a meticulous reference to exculpatory evidence and the case law is to create a very strong record of the evidence available to the government. In some situations the protest will not persuade the Officer to withdraw the proposed assessment, and Appeals will sustain the proposed assessment. When that happens the target's final resort is refund litigation in federal court. If that becomes the outcome it may be very important to also seek to recover attorney's fees on behalf of the taxpayer. Where the brief clearly articulates exculpatory evidence that was supplied to the government, and the history of the case establishes the government took a position contrary to that evidence, an attempt will likely be made to recover attorney fees. When the taxpayer's meticulous protest is placed in evidence it can become highly persuasive evidence that the government's position was not substantially justified. Lay the groundwork for recovering attorney's fees. Meticulously describe the exculpatory evidence and its significance. Assure that there is a record that expresses such evidence to facilitate the burden to prove the details that were made available to the government and why such evidence exposes the government's position as "not substantially justified." As a place of beginning, a couple of attorney's fee cases are cited in the cases at Chapter 13, Paragraph IV, items C and D at https://IRScollectionlaw.com.

Things to do while working on the protest: The rules and resources governing the following are accessible at the same web site linked above.

Apply the employer's resources to pay the debt immediately.
With each payment, it is permissible to "DESIGNATE" the payments to be applied in reduction of the trust-fund-portion of the tax debt. ONCE an INSTALLMENT ARRANGEMENT is made, no payments can be so designated. Therefore, if the company does not have resources sufficient to address the whole debt, immediately apply all available resources to extinguish as much of the trust-fund portion as possible.
While IRS observes policies that may result in delaying assessment of the TFRP, there is no point to enduring the costly processes of developing the TFRP case when the entire issue could be dissolved by fully paying the trust-fund-portion.

Trust Fund Recovery Penalty (100% penalty) - Part II - Responsible Person and Willfulness

2010-01-20T00:36:00.006-06:00

[This Part II continues the discussion of the application of the provisions of IRC section 6672 - the Trust Fund Recovery statute. The matters mentioned in this article can be researched in substantial detail in the materials provided in Chapter 13 at https://IRScollectionlaw.com. This Part II does not discuss the construction and presentation of a protest to a Notice of Proposed Assessment. Those matters will be posted in the article at Part III of this discussion.]

Elements of IRC 6672 - "responsible person" and "willfulness" required: Where the government seeks to collect the unpaid balance of the trust-fund money from individuals, the statute requires that the evidence establish that the targeted individual ("target") was a "responsible person" and that the target "willfully failed to collect, truthfully account for, or pay over (to the government) the withholdings required by law. The Internal Revenue Manuals ("IRM's") provide many expressions about the processes and procedures that Revenue Officers ("RO's") should complete in the course of identifying specific persons who were "responsible" to collect, account for, or pay over the money.

A good place to start when researching how the IRS proceeds in these cases is to study IRM 5.7.3.3.1. It provides -

lists identifying potentially "responsible persons" according to their roles,
lists revealing the kinds of duties, offices (status) and powers indicating a responsibility to assure taxes are paid
lists of fundamental documentation to be reviewed to reveal the identity of potentially responsible persons

IRM 5.7.3.3.1 and the sub-parts that follow are very instructive and can be located at the IRS' official web site. In addition, the full text of those resources is provided and discussed at Chapter 13, para. II, in the materials at https://IRScollectionlaw.com. In particular, the manuals also correctly express the current state of the law by including these points at 5.7.3.3.1.1:

The full scope of authority and responsibility is contingent upon whether the person had the ability to exercise independent judgment with respect to the financial affairs of the business.
If a person is an officer or owns stock in the corporation, this cannot be the sole basis for a responsibility determination.
If a person has the authority to sign checks, the exercise of that authority does not, in and of itself, establish responsibility.

The key to identifying "responsible persons" is in the first bulleted-item above. It is the person with power to control who shall be paid and who fails to treat the government as the top priority who will be easily identified as a responsible person for purposes of 6672. There are several cases that explore the indicia of responsibility. A good discussion is published by the Fifth Circuit Court of Appeals at Commonwealth National Bank v. U.S., 665 F.2d 743 (5th Cir. 1982). There, persons who were not shareholders, officers or employees of the non-paying employer were determined to be "responsible" because they had power to control who was paid. And where a person possesses such authority but is ordered by a superior to NOT pay the taxes, there is authority that suggests that failure to pay the obligation without regard to the orders of a superior is required. In other words, subordinates with power to pay the taxes can, under certain circumstances, be held liable under 6672 even though they might be fired for paying the government. See Brounstein v. United States, 979 F.2d 952, 956 (3rd Cir. 1992). Links to several other opinions from various courts are provided in Chapter 13, para. IV, at the same web site linked above.

Evidence of willfulness: 6672 is not applicable to any person - even a "responsible person" - unless they WILLFULLY failed to perform any one of the three duties listed in the statute. Willfulness for purposes of IRC 6672 means conduct that is intentional, deliberate, voluntary, reckless, knowing, as opposed to accidental. Though the IRM's state that willfulness can also be established by proof that a person "should have known" taxes were not paid, the courts have rejected that government assertion. For example, study the opinion published in Kalb v. US, 505 F.2d 506 (2d Cir. 1974), cert den., 421 US 979 (1975). It is very useful to study the IRM's at 5.7.3.3.2 and especially at the Legal Reference Guide for RO's at 5.17.7.1.3. The full text of those resources is available both at the IRS' official web site and at Chapter 13, para. V, at https://IRScollectionlaw.com. Where a person having ultimate authority and power to pay the tax has delegated the duty to a subordinate, that delegation does not insulate the person from a finding that such person was a "responsible person." HOWEVER, where the person had absolutely no knowledge that the subordinate had failed to discharge the duty, then it cannot be said that the delegator willfully failed to pay the tax. Notice, however, that where the delegator learns that the taxes were not paid, they must immediately commence to apply the resources subject to their control to pay the tax. Failure to do so usually supports the conclusion that the failure to take immediate action constitutes a will failure to discharge the obligation and 6672 is applicable. Furthermore, where that same subordinate continues to be obligated to make all future payments after the delegator has been previously put on notice that the person has shown themselves to be unreliable, the failure to closely monitor and supervise all activity to assure payments are made as and when required is received as evidence of willful failure to pay. These matters and the resources expressing the applicable principles are provided at Chapter 13 at the web site mentioned above.

After the RO has gathered all the evidence and formed conclusions, responsible persons exhibiting willful failure to pay the tax will be informed in writing that the IRS proposes to assess the trust-fund amounts against the responsible person. That notice commences two important periods. First, there is a ten-day period in which the RO can be contacted and a discussion held to present evidence contravening the proposed assessment. Second, and MOST important, the date upon the notice is served commences the 60-day period in which the taxpayer MUST file any intended protest with the same RO who issued notice of intent to assess the tax. THERE ARE NO EXTENSIONS OF TIME AVAILABLE. The processes and procedures that must be followed to construct and present a proper protest to the proposed notice of assessment are discussed in "Trust Fund Penalty - Part III."

Trust Fund Recovery Penalty (100% penalty) - Part I

2010-01-18T22:30:00.004-06:00

[The statutes, regulations, Internal Revenue Manuals and cases governing matters discussed in this article are gathered, organized and presented at https://IRScollectionlaw.com. There is also a "Plain Language Library" providing non-technical discussion of the rules and procedures that govern the collection of unpaid federal tax at that web site.] Readers may enlarge the text on this page using the browser's "zoom" or by either "ctrl +" or "cmd +."

This Part I is the first of several articles that will discuss the Trust Fund Recovery Penalty ("TFRP"), often called the "100% Penalty." The processes and procedures that are to be followed by the IRS to develop the evidence, propose appropriate assessments, protesting such a proposal, the appeal of a rejected protest and other matters are discussed in a separate article (Part II).

Technically, this collection rule provided by 6672 is not a penalty - it is a procedural device that expedites the collection of "trust fund tax" from individuals instead of the employer that was required by law to withhold and pay over the amounts withheld. "Trust Fund" is the term applied to the sums withheld from employees' paychecks. Under the law, amounts withheld are to be held in trust for the government. If a person becomes subject to assessment of the Trust Fund Penalty under section 6672 of the Internal Revenue Code ("IRC") then liability is limited to the amount of the withholdings. Liability under the 100% penalty does not include liability for any other penalty amounts or for any portion of the employer's required contributions.

This Part I will broadly summarize the elements in these cases. The other parts will discuss separate elements in more detail. As a place to begin, understand that 6672 operates on the requirement that an employer must have been liable to collect, truthfully account for, and pay to the government sums withheld from employee compensation. Unless an employer is liable nobody else is liable. Employer liability is usually established when the appropriate return is filed with the IRS - usually Form 941. Based upon those quarterly forms IRS will immediately and automatically assess the amount reflected on the filed forms. It is only when the amount shown due on the return is not fully paid that the IRS will establish an open, assigned case to collect the unpaid amount. Where employers should have filed such a return but failed to do so the IRS Collection Division also has full authority to prepare a Substitute For Return ("SFR").

Collecting from the employer is the first point of focus for the IRS. Be aware that the law does NOT require the IRS to collect from the employer. The law permits IRS to pursue individual liability by application of 6672. The case begins when the IRS sends its letter demanding full payment of the entire unpaid balance. This letter is sent after an assessment is made, and it does not matter whether the assessment is made from a form filed by the employer or a "SFR" prepared by the government. Unpaid assessment trigger the sending of the demand letter. Where the employer pays the full demand the case is over. It is only when the IRS best efforts to collect from the employer have not resulted in full payment that the IRS will pursue individuals for payment under 6672.

Where employer makes installment arrangement: If the employer makes an arrangement with the IRS to pay the balance under an installment arrangement then sometimes the IRS will delay pursuing individuals who may be subject to the reach of 6672. The Internal Revenue Manuals ("IRM's") provide that a revenue officer can secure an in-business installment agreement rather than recommending immediate assertion of the TFRP, as long as: the employer makes an installment agreement, the TFRP latest date to assess against the “target” (responsible person) is extended appropriately, and the evidentiary compilation supporting TFRP assessment is documented and preserved. That means the Revenue Officer ("RO") will develop the evidence of a person's liability under 6672 ("development" is discussed in a separate article), but where the employer makes and faithfully performs an installment agreement then 6672 will not be used to assess against individuals. Note: IRS will not be permitted to withhold 6672-assessment against individuals unless there remains the required amount of time on the 3-year assessment statute AND the employer's installment arrangement will fully pay the entire balance within that time. Unless targeted individuals agree to extend the 3-year statute for assessing under 6672, then IRS will not delay to pursue assessment. The procedures are briefly described in the Part II-article.

Designated Payments: If the employer is able to extract cash from any source and pay its Form 941 liabilities, the employer is permitted to designate how such payments are to be applied. Where is seems appropriate to reduce the potential 6672-liability of individuals, the employer may designate that the payments shall be applied to the trust-fund-portion. It has the effect of reducing the unpaid trust fund and diminishes potential individual liability for the balance of that portion remaining unpaid. NOTE: once the employer makes an installment agreement designations are not permitted. Instead, under the law, the payments will be applied "in the best interest of the government."

Employer Offer in Compromise: It should be noted that where an employer is so thoroughly without assets that it can submit an acceptable Offer to compromise its liability, then IRS will not even proceed upon the offer until 6672 assessments against all responsible parties have been completed OR the supporting developed cases have been forwarded for assessment. In addition, if the employer's offer is accepted, the measure of the individual's liability under 6672 is NOT reduced by that offer. The IRS will proceed to assess and to collect the WHOLE unpaid balance from persons subject to 6672. Individuals cannot block assessment pursuant to 6672 by filing bankruptcy. The resources governing these processes and procedures are available at https://IRScollectionlaw.com.

Requirements to assess under IRC 6672: The requirements mentioned below are discussed in much more detail at the web site identified above. It provides access to the statutes, regulations, some case law, and the governing IRM's. Broadly described, these are the persons who can be required to pay the employer's unpaid trust fund tax under IRC 6672:

ANYONE with significant control concerning payment of the employer's financial obligations (it is NO DEFENSE to argue one would have been fired from a job if they had applied power to pay the government in violation of a superior's orders to the contrary), and
such person "WILLFULLY" failed to perform any one of these three duties - collect, pay over to the government, or truthfully account for the entire unpaid portion of the withheld amount impressed with trust in favor uf the U.S. Government.

Before IRC 6672 can be applied to assess against an individual that person must be a "responsible person" (i.e., having the requisite power to pay creditors), and that person must have "willfully" failed to fulfill the duty owed to the government under the law. Consider these examples concerning responsibility:

Authorized to sign checks: This is not sufficient for applying 6672 unless accompanied by authority to determine which creditors shall be paid.
Not authorized to sign checks: This will not insulate a person from 6672 where they possess power to determine which creditors shall be paid.
Hold corporate office, board member, shareholder: This is not sufficient for 6672 where the evidence happens to show that the power to control the finances is not part of that person's scope of authority.
ANY PERSON having significant control over application of the corporation's resources can be subject to 6672 even where such person is NOT an employee, a shareholder, an officer, or a director. The main focus is whether the evidence indicates the person had such finance-controlling power, and other persons were paid instead of the IRS. These rules and several judicial opinions are accessible at https://IRScollectionlaw.com.

"Willfulness" is the second element that must be proven by the evidence before an individual can be subject to IRC 6672. Under the law, it is defined as the deliberate, intentional violation of the known legal duty. "Gross neglect" is sufficient for purposes of 6672, but "negligence" and stupidity are not sufficient to support an assessment. And while the IRM's indicate that 6672 can be applicable where a person having power to pay IRS "should have known" the taxes were not being paid, the courts have rejected this as a measure of willfulness. Consider these simple examples:

A corporate officer is lied to by an employee charged to pay the 941-taxes about whether taxes have been paid. It means the officer did not "knowingly" fail to cause the employer to pay the taxes where such officer had no actual knowledge of the failure.
Assume the matter is discovered and the officer learns of the situation. If the officer does not take immediate steps to apply the corporation's resources to pay the tax in preference to other creditors and debts, the officer has "willfully" failed to pay the sum to the government.
Furthermore, if the same employee is still charged with responsibility to pay the tax and then fails to do so, the officer who failed to adequately supervise the employee with the known bad record will be subject to assessment under 6672.

The next article on the Trust Fund Penalty (Part II) will describe the steps and processes the government will follow to determine the applicability of 6672 to an individual. Also, the processes of developing an individual's "defense" and protesting any assessment the IRS may propose by issuing Letter 1153 will be summarized.

How to Subordinate Federal Tax Liens

2010-01-15T21:15:00.001-06:00

[The rules and procedures relating to the matters discussed in this article may be researched at https://irscollectionlaw.com. There is also a "Plain Language Library" of articles available at that site that can be studied at no cost.]

Federal Tax law and regulations establish that the federal tax lien can be made subordinate to another lien that is brought into existence after the Notice of Federal Tax Lien ("NFTL") is filed. NFTL's are filed by the government for the purpose of preserving a superior status. The general priority rule is that liens filed in the public record take priority over later-filed lien. Therefore, the IRS, like any other creditor, takes steps to preserve its priority as far up the chain as possible. Creditors will not tend to voluntarily relinquish superior position to late-arriving lien interests unless they are compensated for agreeing to become subordinate to later-filed liens. IRS is no different.

Treasury Regulations at section 301.6325-1(d) contain the following provision:

"The appropriate official may, in his discretion, issue a certificate of subordination of a lien imposed under chapter 64 of the Internal Revenue Code upon any part of the property subject to the lien if there is paid over to the appropriate official an amount equal to the amount of the lien or interest to which the certificate subordinates the lien of the United States. For this purpose, the tax lien may be subordinated to another lien or interest on a dollar-for-dollar basis. For example, if a notice of a Federal tax lien is filed and a delinquent taxpayer secures a mortgage loan on a part of the property subject to the tax lien and pays over the proceeds of the loan to a appropriate official after an application for a certificate of subordination is approved, the appropriate official will issue a certificate of subordination. This certificate will have the effect of subordinating the tax lien to the mortgage."

This regulation demonstrates by the example provided that where a taxpayer has concluded that borrowing to address the unpaid federal tax debt is in their own best interest, IRS will facilitate the opportunity to borrow. But the arrangement must result in payment being made to the government. Otherwise, there is no benefit to the government in relinquishing its priority and the rights possessed under that superior lien.

Furthermore, at section 301.6325-1(d)(2) the regulations provide as follows:

"The appropriate official may, in his discretion, issue a certificate of subordination of a lien imposed under chapter 64 of the Internal Revenue Code upon any part of the property subject to the lien if the appropriate official believes that the subordination of the lien will ultimately result in an increase in the amount realized by the United States from the property subject to the lien and will facilitate the ultimate collection of the tax liability."

The meaning of this provision is illustrated in several examples expressed in the regulation. Here is one such example:

"E, a manufacturer of electronic equipment, obtains financing from F, a lending institution, pursuant to a security agreement, with respect to which a financing statement was duly filed under the Uniform Commercial Code on June 1, 1970. On April 15, 1971, F gains actual notice or knowledge that notice of a Federal tax lien had been filed against E on March 31, 1971, and F refuses to make further advances unless its security interest is assured of priority over the Federal tax lien. Upon examination, the appropriate official believes that ultimately the amount realizable from E’s property will be increased and the collection of the tax liability will be facilitated if the work in process can be completed and the equipment sold. In this case, the appropriate official may, in his discretion, subordinate the tax lien to F’s security interest for the further advances required to complete the work."

There are so may situations where a subordination would provide benefit both to the government as superior lien holder as well as the taxpayer. But the government will not relinquish the power of its position without compensation. It is particularly useful when taxpayers do not own assets reched by the NFTL, and IRS is dependent upon an income stream for collection of the tax. When the evidence compels the conclusion that an IRS-subordination would increase taxpayer's income by, for example, borrowing at low rates to pay off high-rate lines of credit, the IRS may seriously consider the subordination. This is PARTICULARLY TRUE where the taxpayer is paying under a "Partial Payment Installment Agreement." These matters, and the rules and procedures that govern the situation, are also discussed in Chapter 10 and the "Plain Language Library" at this website - https://irscollectionlaw.com.

TAXPAYERS SEEKING SUBORDINATION must apply to the IRS for that arrangement. Use IRS Publication 1153 - how to apply for a certificate of subordination. The publication can be obtained from the IRS official web site at this link.

How to Stop an IRS Levy

2010-01-11T22:23:00.011-06:00

[The matters mentioned in this article can be researched in detail at https://irscollectionlaw.com]

Summary: Stop IRS levies in the following ways -

pay the debt in full
establish an installment agreement
enter a "Partial Payment Installment Agreement"
establish an offer in compromise
establish that a levy will create a defined "Economic Hardship"
Bankruptcy (not discussed in this article)

IRS does not immediately launch into taking property when taxpayers owe the government. "Levy" is the term associated with obtaining payments of money owed by third parties to the taxpayer. "Seize" is the term associated with physically taking possession and control of tangible property. There will be no taking of any property belonging to a taxpayer until the end of a detailed process. IRS will analyze a taxpayer's financial situation and determine whether taxpayer's resources that can be applied to the debt are sufficient to resolve the entire debt promptly. Where taxpayers do not possess sufficient assets to pay the debt immediately, IRS will move the case toward applying as much cash from those resources as possible. IRS can compel taxpayers to apply cash deposits. IRS will not even consider installment arrangements so long as taxpayers have access to assets that could be used as collateral for borrowing or that could be sold to raise cash. IRS will allow taxpayers time to sell or borrow. In fact, the law requires such conduct. Absolutely all other possible alternatives to IRS levy and seizure must, according to the law, be considered before levies can be used. This is discussed in detail in Chapter 6 and also in the articles contained in the "Plain Language Library" at https://irscollectionlaw.com.

Long before IRS takes property taxpayers will have the opportunity to apply their own assets to address the debt. It is always better for taxpayers to sell assets rather than wait for IRS to take it away and dispose of it through forced sale. The "Minimum Bid" the IRS will fix will fall somewhere between 60% and 80% of the fair market value of the property. The law requires IRS to fix that discounted price because the sale is not conducted in the ordinary market where such property is bought and sold. Rather, these are forced sales - quick sales - more in the nature of a distress-sale situation. The processes IRS is required to follow in determining the amount of the "Minimum Bid" are also discussed at Chapter 6 and the resources provided at https://irscollectionlaw.com.

Under the law the IRS is not allowed to cause an "economic hardship" through the levy process. "Economic hardship" exists only when a levy deprives a taxpayer of the ability to provide a family's basic living necessities. The amount of money needed to provide "Basic living necessities" is by law to be determined by reference to "Standardized Tables." Those tables determine the maximum amount taxpayers are allowed to keep from their monthly income to pay for food, clothing, housing, transportation and the like. There are ways to increase the amount of income taxpayers are allowed to keep, but the burden to prove necessity is placed on taxpayers. It does not matter that taxpayers will be forced to reduce their style of living, no matter how inconvenient such reductions might become. The rules relating to all these matters are discussed in detail in Chapters 4 and 6 and in the "Plain Language Library" that can be perused at https://irscollectionlaw.com. The "Plain Language Library" available at that web site offers helpful articles that can be reviewed without necessity of signing up to use the full resources available at that site.

What is the purpose of considering a taxpayer's "ability to pay" after the standardized tables are applied? It is to determine the taxpayer's ability to service an installment agreement - that's the next place the IRS will go to resolve the debt. Taxpayers are provided the opportunity to enter an installment agreement based on the "ability to pay" computed after application of the standard tables. And if the "ability to pay" is not enough to fully pay the tax debt during the remaining portion of the so-called 10-year collection period, the IRS will next move toward establishing a "Partial Payment Installment Agreement" - a PPIA. The technical requirements and procedures are discussed in the chapter on "Partial Payment Installment Agreements" at https://irscollectionlaw.com. For taxpayers who owe less than $25,000 there are simplified and expedited programs to set up an installment agreement. Those "expedited" programs are also described at that web site.

If the taxpayer cannot realistically service a PPIA, IRS will move toward an Offer in Compromise. These alternatives are discussed in the twelfth chapter at https://irscollectionlaw.com. There are many technical rules and procedures that must be observed and they are discussed at that web site.

If any of the options mentioned above could be used by a taxpayer to address all or part of the debt but the taxpayer refuses to join in the process of using those alternatives, it is only at that point that the IRS will commence the levy process. Only at the end of this long and cumbersome process will the IRS take assets when taxpayers will not join the process. And throughout the journey the law provides various opportunities to appeal their disagreements with IRS' conclusions and demands. Those alternatives are discussed in detail in Chapter 8 and also in articles contained in the "Plain Language Library" at https://irscollectionlaw.com.

WHEN does IRS take assets?

2009-12-17T23:30:00.012-06:00

[All of the matters summarized below are discussed in detail at https://irscollectionlaw.com/. At that FREE research resource taxpayers and professionals can obtain thorough information and direct access to the government resources that govern the collection of unpaid federal tax.]

Under the law the government can take assets of almost every kind to apply toward an unpaid tax bill. But the important thing taxpayers should understand is when will assets be taken. IRS Manuals clearly state "Seizures will not be conducted on taxpayers who 'will pay' or 'can't pay.' These categories include taxpayers who:

Do not agree with the assessment and are working with the Service to properly adjust their account
Will full pay their liability within a reasonable time frame
Require a reasonable period of time to sell an asset or secure a loan
Qualify for and submit an offer in compromise
Have no ability to make payments and have no distrainable assets (currently not collectible)
Request and qualify for an installment agreement."

IRS does not operate wildly and without first gathering the evidence. Notice the manuals talk about "can't-pay" taxpayers. What is not being declared in that short characterization is that before the government moves toward taking property there is a long and sometimes cumbersome string of processes and procedures that will be followed. Until those processes are completed there is no way to know whether a debtor can or cannot pay the debt. So, just because taxpayers owe federal tax and have not paid it that doesn't mean the government is going to roll in with the trucks and start carting away the assets. There is a thorough and meticulous process comprised of many steps that must be fulfilled. And so long as taxpayers remain in the categories listed above, there will be NO levy. ("Levy" is the legal term for the processes applied to take possession of property. The term "levy" is associated with the processes for taking bank accounts and obtaining cash payments from various other persons who may owe money to a taxpayer. The term "seizure" is associated with taking physical possession of tangible property.]

It starts with a complete Financial Analysis:

IRS doesn't do anything without relying upon evidence and applying the rules. With regard to rules that govern the taking of property, the federal statutes specifically mandate that alternatives to "levy" be explored. IRS very closely adheres to that requirement. Here, the evidence gathered includes a disclosure of every part of the taxpayer's financial condition. Taxpayers will be required to complete a "Collection Information Statement" identifying every income source, every asset of every kind, debts, monthly expenses and etc. And the IRS has very sophisticated process that are followed to verify the completeness and accuracy of the information provided by taxpayers. It is not prudent to attempt to omit or conceal assets - that sort of conduct may result in a referral to the Criminal Investigation Division and a prosecution for violation of various provisions of the federal law.

Determine Ability to Pay:

Based upon a thorough analysis of a taxpayer's financial condition, the government will compute a taxpayer's ability to pay. Are there sums on deposit? Unless a defined "economic hardship" (see the resources at the website posted above) would result from requiring exhaustion of the accounts, the law permits IRS to require taxpayers to apply the account balance(s) to the tax debt. Are there assets that can be either sold or used an loan-collateral by a taxpayer to produce case? The same rule applies - the government can require those actions as a prerequisite to moving toward ANY of the alternatives available to address the unpaid balance. (Those alternatives include installment agreements, a partial payment installment agreement, an offer in compromise, or classification as "currently not collectible." Taxpayers who qualify for "expedited installment plans" do NOT have to endure the disclosure and analysis processes. See https://irscollectionlaw.com/.)

When application of taxpayer's assets still does not pay the bill, an individual taxpayer's "ability to pay" will be computed to determine how much monthly income must be used to pay the bill. Here, the law requires the IRS to apply standardized tables. Those tables set the maximum amount a taxpayer is allowed to spend for "basic living necessities." IRS has authority to "allow" taxpayers to keep more of their income where there are special needs involved. See the web site above for details. The difference between the "allowed" sums required to pay for basic living necessities and monthly income is the amount IRS will require a taxpayer to apply toward the debt.

Taxpayer must decide:

After working through the determination of "ability to pay" and all of the applicable rules and discretionary allowances IRS will permit, the time to decide the following has arrived:

Agree with IRS' payment requirements.
Propose an installment plan that does not match IRS' "ability to pay" computations and appeal any rejection.
Propose an Offer in Compromise with the same subsequent appeal options.
Propose a partial payment installment agreement and pursue an appeal where necessary.
Consult bankruptcy counsel. (Most taxes are not "dischargeable" - discuss with bankruptcy specialists.)

The rules governing these considerations are discussed in some substantial detail at the web site above. Something important to be noted from those materials is that by law NO TAKING shall transpire while (1) an alternative proposal is under consideration, or (2) during the period than any rejection of taxpayer's proposal is pending on appeal.

When does the IRS "take" property?

It is only after coming to the point that a taxpayer's ability pay is known that the case might start moving that direction. It is only after taxpayers have exhausted (or failed to request) appeals, their proposed alternative plan has not been sustained, and they still refuse to apply available assets that the IRS will take property. It starts with the bank accounts. If that doesn't produce a more cooperative response from the taxpayer the government will be left with no choice but to proceed with other "taking" processes. The rules governing all of these complicated matters can be obtained at https://irscollectionlaw.com.

IRS Tax Liens - Fundamental Information

2009-11-15T22:35:00.182-06:00

[All of the remarks below are addressed in substantial additional detail at "Federal Tax Collection Rules and Procedures." That is at present a free website dedicated to publishing fairly thorough information about tax collection. It contains a HUGE number of embedded links to federal statutes, regulation, Manuals, cases and etc.]

When Liens affect the wrong person:

Assume IRS has filed a lien in the public record against John Smith. Another person bearing the same name has applied for a loan and was rejected because there is a lien of record against a "John Smith." There is a remedy for the person wrongly affected. Under the rules the wrongly affected person can apply for a "Certificate of Non-attachment." The certificate will be provided by the IRS to distinguish the two persons Application for the Certificate is to be made following the guidelines provided in IRS Pub 1024.

IRS will withhold from filing liens to facilitate collection:

Every creditor has the same objective - to make sure their priority against other creditors is superior to others who should get in line behind them. IRS has the same objective. The way IRS protects it rank among competing creditors is by filing a Notice of Federal Tax Lien ("NFTL") in the public record. Federal tax liens reach all property owned or acquired by tax debtors. They can't transfer property to another free from the lien. IRS can go after ALL property that is subject to the lien no matter who owns it. There are some exceptions mentioned below. Clearly the filing of the NFTL has significant effect on a taxpayer's ability to transfer ownership of property to anybody else. It makes no difference whether taxpayer transfers the property by sale, as a gift, through their estate or otherwise. Once it attaches, the lien never goes away. There are some limited exceptions mentioned below.

Situations where filing NFTL might be deferred:

Taxpayer is actively pursuing a loan that will pay taxes (TP must demonstrate the effort is actually being made).
Provide a bond a d seek to establish a "Collateral Agreement."
Paying the debt always works.
There is no statute that requires IRS to give advance warning a NFTL is about to be filed. However, IRS administratively requires its agents to provide advance notice in addition to the warnings that appeared in the demand letters sent to TP. When the advisement is given, if the evidence supports the conclusion that there is some reason why the lien should not be filed under the rules taxpayers can make use of the "CAP" program to pre-empt the filing. This procedure is discussed thoroughly at the website for Federal Tax Collection Rules and Procedures.

The Federal Tax Lien Reaches ALL Property:

Absolutely all property and interest in property falls under the lien. Where payment is not made on demand the lien automatically comes into existence. IRS doesn't have to file anything for the lien to reach assets. The filing merely advises the world of the lien and nobody can acquire the property free from the lien thereafter. There are exceptions. The lien dates back to the date of assessment and continues until the debt is paid or it expires by reason of time. Understand that the so-called "10-year collection statute" does NOT cut off IRS' power to collect after the expiration of ten years. The statute only require the IRS to "make-levy" within that period. If IRS serves a levy, for example, on a retirement fund within the 10-year period then even if payments don't begin for another 20 years the IRS has the power and right to collect something from those payments. There are limitations concerning levy on retirement accounts discussed at the web site named above. And even though IRS can't file lien-renewals, the right to receive something from those future payments never goes away until the entire debt is paid in full.

After-acquired property:

All property acquired after the lien arises (whether the NFTL has been filed or not) is encumbered by the lien. New purchases, inheritances, additional deposits to bank and retirement accounts - everything becomes subject to the lien.

"Super-priorities" and the lien-free transfers:

There is a statute that exempts a very few kinds of transfers from the general rule. Some things CAN be sold and the buyer acquires ownership free from the tax lien. Retail merchandise, a car, marketable securities - some things are free from the lien upon sale provided the purchaser has NO KNOWLEDGE of the lien-situation. The subject is discussed at the website linked above.

Selling property when the lien is imposed:

Trying to sell assets (e.g., real estate) impressed by the lien is a problem. However, the law provides a few kinds of relief to remove the lien and its effects from property. One of those ways is to agree to escrow the sales proceeds where the fund will remain subject to the IRS full rights as a secured creditor. A "Discharge Certificate" can be obtained. There are other ways to obtain a discharge certificate to permanently relieve property (or parts of it) from the effect of the lien. There are three other ways under the statute to obtain a "Discharge Certificate" and those are likewise discussed in the materials posted at Federal Tax Collection Rules and Procedures.

Another way to defer filing of the NFTL:

Taxpayers can make a "Collateral Agreement" and secure performance of the promises made to the government with a bond or other acceptable security. Actually, the agreement is thoroughly one-sided. The government doesn't have to do anything except NOT file the lien. The proposed agreement submitted by the taxpayer must be very specific about exactly what is going to be done to pay the tax bill. The government is NOT obligated to accept what is proposed. But sometimes this approach will provide sufficient security to the government to permit the NON-filing of the NFTL and thereby liberate the taxpayer to begin doing the things expressed in the agreement. It's sometimes a way to establish a more realistic time-frame for liquidating assets to pay taxes that has been proposed by Revenue Officers.

Notice of Intent to Levy: What Taxpayers can do

2009-11-14T21:52:00.003-06:00

[All of the alternatives discussed below are discussed in detail at “Federal Tax Collection Rules and Resources.” Electronic links to the resources that govern these matters are provided at that web site.]

If the IRS sent a letter declaring a Notice of Intent to Levy, the agency is doing what the statute requires - providing taxpayer (“TP”) with an advance 30-day warning that property is going to be taken to pay the taxes. It is only at the end of a string notices that this particular letter arrives. Other demands for payment will have already been mailed before this kind of notice is ever issued. When the string of written demands for payment does not resolve the liability the case is transferred to a Revenue Officer. Notice of Intent to Levy is issued by that Officer – the earlier notices were computer-generated. If TP paid in response to one of those earlier notices but the IRS still issues the levy notice there are things that can be done. First, call the contact person on the Notice of Intent to Levy. That person has all authority to put the brakes on taking the bank accounts etc. Proof of payment must be provided to that person. Second, if the contact person is not accessible or responsive, contact the Taxpayer Advocate Service (TAS). Taxpayers can reach the main TAS index and obtain help through this link. IRS changes the addresses on its file locations with some frequency. If this link ceases to operate the information needed to contact the TAS can be obtained easily through the IRS' official web site. Furthermore, where TP has proof the assessed tax is erroneous and has not previously provided that evidence to the IRS a Request for Reconsideration may be very appropriate before things go any farther. This procedure is discussed in the second chapter of the resources at the “Federal Tax Collection” web site linked above.

To Avoid “Taking” through the Levy Processes

TP’s fundamental choices are listed below. All of the technical requirements and processes relating to these choices are discussed at the same web site listed above.

Be seriously focused on doing what can be done to pay the tax. Taxpayers who fall into the “will pay” category will not experience a levy.
Make an expedited installment agreement (“Streamlined,” “Guaranteed” or “In-Business Trust Fund Express” agreement). There are strong benefits to qualifying under these programs.
Where TP doesn't qualify for those special "expedited" programs, it may be possible to qualify for a regular installment agreement. Installment agreements stop levies.
If IRS is correct about TP's ability to extract cash through sale of property or borrowing, then do those things. It will assure taxpayers remain in the “will pay” zone
If losing assets to pay the tax bill will cause a defined “Economic Hardship” then seek classification as “currently not collectible” or work toward either a Partial Payment Installment Agreement or an Offer in Compromise.
Use a secured Collateral Agreement to acquire more time to extract cash from resources.
File a bankruptcy to discharge some debts in order to be able to address non-dischargeable taxes – to help conserve some part of TP’s resources. Consult bankruptcy counsel to examine how a bankruptcy might fit into the picture.

Requesting a CDP Hearing:

Usually the Notice of Intent to Levy provides two notices required by law. Under the law TP must be provided Notice of the Right to a Collection Due Process Hearing. The letter usually provides both of the required 30-day notices. Under the law the government cannot take property (“levy”) until TP has been provided at least 30 days to request a hearing before IRS Appeals. The purpose is to enable TP to demonstrate that taking property by levy should not occur and there are appropriate alternatives to levy. When a request is filed all collection activity is halted during the period the matter is pending before the Appeals Office. At the hearing TP must provide the evidence that supports TP's proposal that an installment agreement should be made or that the government should accept a specific Offer in Compromise. Filing a request for a CDP Hearing will bring all collection activity to a halt. Under the rules IRS cannot proceed to take anything during the entire period the CDP request is pending before Appeals.

Taxpayers should know that there are very specific guidelines imposed by law on whether TP qualifies for installments or that an Offer in Compromise should be accepted. Technical processes and procedures that govern such determinations are accessible at the same web site.

Penalty for CDP Requests to Delay or Impede Collection:

Under IRC 6702 a $5,000 Penalty can be applied where CDP request is frivolous or the request reflects a desire to delay or impede the administration of federal tax laws. Therefore, if a request is going to be made to obtain a CDP Hearing TP should be able to propose specific alternatives to levy and to support those proposals with facts. For access to the technical requirements of the CDP request and the processes and procedures that apply see Collection Due Process.

Help where the CDP Request is not filed within the 30-day period:

Where the request for a CDP hearing is not filed within the 30-day period IRS will resume collection activity. Levies can be served where no CDP request was filed within that 30-day period. There are some things that can be done where the evidence supports the conclusion that a levy is not appropriate. Making use of the Collection Appeal Program (“CAP”) is one of those alternatives. CAP is very expedited and levy activity is suspended where a CAP request is filed. The requirements and processes of the “CAP” program are also provided at Federal Tax Collection Rules and Resources. Also, there is the “Equivalent CDP” approach so long the request is filed within the defined one-year period. IRS is not obligated to suspend collection while an EqCDP request is pending, but the policy is to suspend collection so long as the government's ability to collect is not jeopardized. And if taxpayers meet the case criteria the matter can be submitted to the Taxpayer Advocate - the “TAS.” Also, entering into an installment agreement will terminate all other forms of collection activity.

IRS liens, levies: Collection Rules and Processes

2009-11-12T21:03:00.005-06:00

Rules governing the processes and procedures involved in the collection of unpaid Federal tax are complex and not well-known. Not even the lawyers and accountants know much about the governing authorities and the resources that must be consulted. Several statistical compilations published by the IRS' "SOI" function very strongly suggest that the number of taxpayers that fall into the studious gaze of the IRS Collection Division will explosively increase. There is going to be a need for taxpayers and their representatives to be able to locate and comprehend the statutes, regulations, case law, and other published resources governing the tax-collection process. Therefore, this blog will begin the process of publishing some non-technical articles on various issues and processes to help fill that growing need for knowledge. Meanwhile, there is a web site where taxpayers and their advisors can obtain answers. The service provides an enormous number of electronic links directly into the full text of the governing authorities. "Federal Tax Collection Rules and Procedures" is at present an absolutely free service. Go to -

https://IRScollectionlaw.com

During these last few weeks of 2009 several new items will be posted to this blog to begin providing some exposure to the complex rules, the government's power to collect, and the rules that govern (and limit) taxpayers' options.

When can IRS take a taxpayer's residence?

2009-11-12T16:01:00.019-06:00

When can IRS take a residence?

Some of the statutes and detailed information expressed in the IRS Manuals related to this subject can be located through the research site on Federal Tax Collection Rules and Procedures located at the following web site:

https://irscollectionlaw.com/.

The answer is complicated because residential seizures only come at the end of ALL of the collection processes and procedures required by the law. Usually, residential seizures arise in situations where a taxpayer's conduct is self-defeating and unreasonable under the circumstances. No residential seizure can occur without the express authorization of a Federal District Court, and the evidence must be thoroughly persuasive. The law provides that when the debt is under $5,000 a residence can never be taken away. But just because any larger sum might be owed, there is a very complicated group of processes that must be completed before a taxpayer's residence can be taken to pay a federal tax debt.

Those processes begin when the IRS obtains a taxpayer's statement under penalty of perjury disclosing all assets and liabilities- all income sources, and property and interests in property, the values of all such items, all debts, all monthly expenses - EVERYTHING about a taxpayer's financial condition. Then, in many situations, the IRS will "verify" a taxpayer's statement with its own search of internal and external records. See "How IRS Finds Assets" at the same web site. Once IRS is satisfied that sufficiently complete and accurate information has been collected it will proceed to collect. If the aggregate debt is $25,000 or less, taxpayer's automatically qualify for one of the faster, simpler installment arrangements. See "expedited installment programs" at the same site.There won't be any seizures of any kind while an installment agreement is in place.

But even where taxpayers don't qualify for an expedited installment program IRS does not immediately start taking things without warning. If a taxpayer is communicating with IRS there will be discussion about the taxpayer's apparent ability to pay. Determining an individual's "ability to pay" follows very specific guidelines and processes. See "Determining Available Income" at the "Federal Tax Collection" website for access to the statutes and rules that govern the process. Taxpayers are given the chance to reach into their resources on their own and to apply the cash to the debt. Next, IRS will motivate taxpayers to sell or borrow against assets that bear inherent equity. Taxpayers refusing to extract equities and pay cash to reduce the debt will likely find themselves facing seizures and forced sales - a situation that is not in a taxpayer's best interest because property can be lawfully auctioned at as much as a 40% discount from fair market value. The various notices and processes IRS must follow are complicated.

When available cash through all means is insufficient to pay the debt the IRS will clearly consider a taxpayer's installment propoal. That doesn't mean taxpayers get to keep all their assets and make all the payments they have been making from income. Rather,the law requires the IRS to "allow" taxpayers to keep amounts of income based on standardized tables. The tables are applied to determine a taxpayer's "ability to pay." And where taxpayer's monthly expenses are greater that the standard amounts, taxpayer's will be faced with the prospect of having to reduce costs and expenses whether they like it or not. If taxpayer's refuse then the forcible taking process - the "levy and seizure" processes - will be followed. IRS can and will start taking property. IF levies and seizures deprive a taxpayer of the ability to provide basic living necessities as measured by the standardized tables then the law will BLOCK takings. Infliction of that kind of economic hardship is forbidden by law - but it is all governed by those standardized tables. It is possible to obtain increased "allowances" to retain a greater amount of income; but only when the excess amounts are absolutely required to provide necessities. There are a many things that people pay for that do not constitute "necessities" and the law will not permit them to pay those expenses instead of paying the government. The rules are discussed in detail at https://irscollectionlaw.com.

There are several other components of the processes, and when the processes end at the point where the government has no other way to obtain full payment, it will look to a residence. If taking the residence will not inflict "economic hardship" defined by reference to the ability to meet basic living necessities, and there is no other alternative because taxpayer will not succumb to the requirements of the law, IRS can proceed. It requires that IRS authorize the US Attorney to file a suit in Federal District court for an order authorizing the seizure of the residence. The IRS must produce a very substantial amount of evidence to obtain such an order; but when the required evidence is introduced the court has power to authorize the seizure and sale of a personal residence. The IRS Manuals describing the requirements and other resources can be accessed through the technical discussion relating to "principal residence" at that same web site.

Foreign Earned Income Exclusion: Testing for "Abode"

2007-10-28T22:32:00.002-05:00

The Judicial Test for “Abode” – Should it be sharply modified?

Summary: “Abode” is not defined in the tax code or regulations. The “Comparative Domestic Ties” test fashioned judicially to probe for the existence of a US abode is too poorly developed. In its present state, that test does not enable taxpayers to know if they qualify to exclude foreign earned income in too many cases. Example: US citizens returning from Iraq and Afghanistan.

To exclude income earned abroad from a return under IRC §911 these requirements must be met: (1) The taxpayer must have a foreign “tax home” (i.e., it’s the place where for purposes of IRC §162 the taxpayer is living and working), and (2) the taxpayer must meet either the “bona fide residence” or the “physical presence” requirements. This provision of the law is very confusing and complicated – probably unnecessarily so. There are confusing rules about how many full days the taxpayer has spent in a foreign country under the “physical presence” test. And since most folks don’t live in a foreign country for the exact period of 1/1 through 12/31, they will likely have earned income in two taxable years. As a result, they will become entangled with the process of trying to proportionalize the income earned in two separate years. Even the wordy, lengthy explanations offered in IRS Pub 54 do little to clarify the requirements and provisions of §911. And the regulations do not resolve some of the existing confusion. For persons who take their families, relocate to another country, become thoroughly submerged in that new culture, open accounts, send their children to foreign schools and etc. for an extended period, it is easier to meet the requirements. For those who take a job in another country, and who maintain significant contacts with the United States during the period, you might need a crystal ball and some good luck to meet the first requirement: having a foreign tax home.

“Abode” is not defined in the statute or regulations:

It is §911(d)(3) that raises a very significant and confusing barrier to being able to establish a foreign tax home. Under that provision, the statute and the regulations state that an individual shall not be considered to have a tax home in a foreign country for any period for which the individual's ABODE is in the United States. This provision lays a sharp slap on the face of persons who, for example, have met the “physical presence” test by living away from their families and US soil for at least 330 days out a consecutive 12-month period. Ordinary humans often form the impression that when they have been away from the US for so long as to meet that requirement, they can exclude all the income they earned abroad during that period. In fact, some I have spoken with think of it in terms of “fairness” – being gone so long, they feel they should be entitled to exclude the income. Like cold water, the “abode” limitation seems to shock the senses of many.

How does a US citizen living abroad establish a non-US abode for purposes of §911? The answer is not found in any definition for “abode” in the statute or the regulations. And Pub 54 does not provide much of an explanation. So, we turn to case law to find out what the courts say about a person’s “abode” for guidance. In those cases, we find the courts noting that there is no definition for “abode” expressed in the statute or the regulations. Therefore, the courts fashioned a very loose and poorly defined probe that is applied to determine whether a taxpayer had a US abode while they were living abroad.

Testing for Abode: Comparative “Domestic-type” Contacts

It was the U.S. Tax Court that first ventured into the difficulty of ascertaining whether a person living abroad had an abode in the US. Once the court had fashioned the test it became the standard applied as the probe in other forums. For example, in Harrington v. Comm’r, 93 TC 297 (1989), the Tax Court writes:

“In prior section 911 cases, we have examined and contrasted the taxpayer's domestic ties (i.e., his familial, economic, and personal ties) to the United States with his ties to the foreign country in which he claims a tax home in order to determine whether his abode was in the United States during any particular period. Lemay v. Commissioner, TC Memo 1987-256 affd. 837 F.2d 681 (5th Cir. 1988); Bujol v. Commissioner, TC Memo. 1987-230, affd. without published opinion 842 F.2d 328 (5th Cir. 1988); Hummer v. Commissioner, TC Memo. 1988-528; Bosarge v. Commissioner, TC Memo. 1989-15; Benham v. Commissioner, TC Memo. 1989-215; and Moudy v. Commissioner, TC Memo. 1989-216. Even though a taxpayer may have some limited ties to a foreign country, if his ties to the United States remain strong, we have held that his abode remained within the United States, especially where his ties to the foreign country were transitory or limited. In Lemay v. Commissioner, 837 F.2d 681 (5th Cir. 1988), affg. a Memorandum Opinion of this Court the Fifth Circuit to which an appeal in this case would lie, adopted and applied this domestic ties analysis.” (emphasis supplied) Harrington, supra @ 308, 308.

It is the Tax Court’s test that is being applied in other forums; and that test is conducted by examining the evidence of a taxpayer’s “domestic-type” ties with the US as compared and contrasted to the taxpayer’s connections with the foreign jurisdiction. The continuing problem for taxpayers is that the test is not well-developed judicially – and until many cases presenting wide variations in facts are decided, the uncertainties of this “domestic-ties” test will remain.

For example, in the Fifth Circuit’s Lemay opinion mentioned by the Tax Court above in Harrington, the Fifth Circuit considered the relative contacts between the taxpayer and the two jurisdictions. There, the taxpayer worked on an oil rig in the territorial waters of Tunisia. After working 28 days, Lemay returned to the US to be with his family for 28 days. In Tunisia, he was provided living quarters by his employer, and had very little contact with local citizens and the culture. Commenting with approval upon the Tax Court’s application of its domestic-ties test, the Fifth Circuit writes:

“In the instant case, the tax court . . . determined Lemay to have strong economic, familial and personal ties to his residence in Lake Charles and, therefore, concluded that Lemay's "abode" remained in the United States in 1982. We do not perceive error in this conclusion. While the regulations do provide that the maintenance of a dwelling in the United States does not necessarily mean that an individual's abode is in the United States, Lemay did more than merely maintain his dwelling in Lake Charles, Louisiana. Lemay spent approximately half of his time with his family in Louisiana. He voted in Louisiana, maintained a bank account in Louisiana, and possessed a Louisiana driver's license. The combination of these factors, when contrasted with Lemay's transitory contacts with Tunisia, support the conclusion that Lemay's "abode" remained in Louisiana in 1982.”

Okay. Maybe Lemay looks like an easy case. There was much more significant “domestic-type” contact with the US than with Tunisia. The problem with Lemay is that the court could not tell us anything about how it would tend to compare and contrast situation where taxpayers show greater contacts with the foreign jurisdiction. And we still know nothing about what happens where there are domestic-type ties with both jurisdictions. We do not have a clue as to what happens when the domestic ties to both jurisdictions appear equal. Does that mean that the tie goes to the US abode? We don’t know what happens where foreign ties are greater in number. Are ANY significant domestic ties to the US the trump card that will always establish a US abode? Lemay looks easy because this taxpayer had little to do with Tunisia, and both courts found the following to be significant evidence of “abode” in the US while he was working outside this country: (1) 28 days away, 28 days home – so there was apparently significance in “frequency” of returns to the US. (2) Bank account maintained in the US. (3) Voted in the US. (4) Had a state driver’s license. (5) He maintained a dwelling in Louisiana where his family lived and where he returned every 28 days.

Shifting the abode: What it takes is still a mystery

Even if this taxpayer had traveled to other foreign countries rather than return to his family every 28 days, we don’t have a clue from the courts as to whether that would have had any significant effect upon the outcome. He would still have had a house, family, accounts and a voting registration inside the US – factors that we can reasonably expect the Fifth Circuit and the Tax Court would have found sufficient to establish an abode in the US. Would it have made a difference if he had set up an offshore bank account to receive paychecks and automatically transfer support to his family? Probably not. He would have still been sending his money home to care for his family – clearly a “domestic” tie with US soil. What if he had surrendered his driver’s license? That too would probably have made no difference because he wasn’t driving in Tunisia – the man worked offshore and lived in company-provided quarters. Perhaps the abode can be shifted by constructing many sorts of “domestic-looking” contacts with the foreign jurisdiction. However, where US ties are continued the courts may still hold that the US-abode continues and the §911-exclusion is not available. We are left wondering if reducing ties with the US to some lower number than ties to the foreign country would tip the balance. The test is not yet sufficiently developed by the courts. Until the judicially-developed test is more thoroughly explored and applied by the courts, the test will remain unclear. At present, it is not useful as a tool to help us predict with any certainty how the courts will stack up the comparative contacts between the jurisdictions.

Example: U.S. Citizens in Iraq and Afghanistan

Thousands and thousands of Americans have been paid for services performed while they live in those countries. It is clearly safe to generalize their domestic contacts: (1) They have homes and families in the US they will return to. They have absolutely no intention of staying in those dismal places any longer than required. (2) They return to homes and families in the US on R&R. They do not take R&R in war zones. (3) Their paychecks are direct-deposited into US banks and not banks in those countries. (4) They vote in US elections as absentees. They do not vote in any foreign elections. (5) They still have driver’s licenses, and they still own cars that are in the US. If they drive anything in those countries, it is equipment belonging to their employers, and it is driven only in connection with their jobs. Are these domestic-type activities sufficient to compel the courts to conclude that there is US abode because of the continuing existence of those domestic-type ties to the US?

Let’s create a list of things US citizens in those countries might be doing, and examine if such activities are domestic-type activities. Military and civilian personnel perform an enormous array of duties while the live and work in Iraq and Afghanistan. They jeopardize their own lives to protect the lives of citizens of those nations. Arguably, that “protection” is something that connects them deeply and intimately with the citizens of those nations. Protecting the lives of the humans around you seems to have a “domestic” flavor even though the task is completed also as a matter of vocation-related requirements. They distribute “humanitarian” items like food, medicine, health care and the like to local citizens. They form strong, life-long friendships with other US citizens they serve with as they live in those foreign jurisdictions – that seems like a “domestic” as distinguished from a “vocational” tie even though the task is performed as part of a job. They become acquainted with, and sometimes form friendships with, local citizens in areas where they serve or patrol as they perform those functions. Again, that seems to exude deep personal connection with the foreign nation and its citizens – a condition that seems clearly more “domestic” and personal than “vocational.” They apprehend criminals and remove them from among the citizens of those nations. Doesn’t that seem like a profound connection with life in those nations that is associated exclusively with the well-being of all humans in the vicinity – a “domestic” sort of connection? They rescue injured children and provide protection and treatment for them. They build schools, keep the electricity on, deal with water and sewage treatment, re-build homes, set up crime-watch programs for neighborhoods, provide critical training of all kinds, and otherwise become thoroughly entangled in the lives of the citizens of those countries. And though such things are done as a matter of duty – it’s all job-connected – the entire list of contacts and connections with those foreign countries seems to simultaneously display a “domestic” quality because of the intertwinement with the citizens of those foreign nations.

But those contacts may not be sufficient to negate the existence of a US abode. Under the law, an individual shall not be considered to have a tax home in a foreign country for any period for which the individual's ABODE is in the United States. This law seems to operate on the assumption that an individual cannot have two abodes. They can have only one abode at a time. And the way the law in this matter developed, it seems clear that from now on the courts will operate on the view that an abode is identified by probing for “domestic” contacts as distinguished from “vocational” contacts. As expressed by the Fifth Circuit in Lemay, and also expressed in the various Tax Court opinions:

“'Abode' has been variously defined as one's home, habitation, residence, domicile or place of dwelling. Black's Law Dictionary 7 (5th ed. 1979). While an exact definition of 'abode' depends upon the context in which the word is used, it clearly does not mean one's principal place of business. Thus, 'abode' has a domestic rather than vocational meaning, and stands in contrast to 'tax home' as defined for purposes of section 162(a)(2).

“. . . The Bujol court reasoned that the taxpayer's economic, familial, and personal ties to Louisiana, and his lack of contact with the foreign country dictated a conclusion that the taxpayer's ‘abode’ remained in the United States.”

It appears that the courts’ lists of “domestic” things will continue to include property ownership, family location, where you keep your bank accounts, which jurisdiction issued your licenses, where you are registered to vote, where you go to religious services attended by local citizens and etc. In cases thus far decided, such items have remained the most important factors to be considered. Whether we like it or not, the courts will likely continue to ask, “Where are your economic, familial, and personal – as distinguished from ‘vocational’ – ties?” And the answer so far has been determined by reference to asset location, family location, licenses, voting and the like.

A Potential Storm of Cases May be Brewing

As these US Citizens come home and prepare returns claiming the exclusion of their income earned abroad while living in Iraq and Afghanistan, there could emerge a firestorm of confrontation between those taxpayers and the US government. Unless the courts move toward a test that is more focused on defining “abode” as the place where, for the time being, a taxpayer exists to meet the conditions of the daily life encounter outside the US, our jurisprudence will continue to focus on location of houses and other assets, family, voting registration, licenses and the like. The fact that citizens are thoroughly investing their lives in another country for and with another people may be of little significance if the test for a taxpayer’s abode is not modified.

Foreign Earned Income Exclusion: What a Mess

2007-10-27T02:34:00.002-05:00

Foreign Earned Income Exclusion: It Takes a Member of the Priesthood to Understand It

26 USC §911 permits U.S. citizens and resident aliens to exclude more than $80,000 of the income they earn while living outside the United States. An exclusion that big, even if allocated to the number of days abroad in two calendar years, can provide a pretty big tax break. One of the bases for excluding that income exists when a person has a foreign tax home and has been outside the U.S. and physically present in a foreign country or countries for at least 330 full days out of any consecutive 12-month period. Tax Court cases have typically determined that taxpayers whose "abode" remains in the U.S. cannot have a foreign tax home under section 911(d)(3). Therefore, even when a taxpayer lives on foreign soil, the courts are likely to determine that under 911(d)(3) the abode remains in the U.S. where the taxpayer's family lives, where the taxpayer's bank accounts are located, where the taxpayer's residence to which he intends to return after temporary absence is situated in the U.S., continuing to own a car located on U.S. soil and other such connections. However, if taxpayers can clear that initial hurdle, the rest of the requirements prescribed by 911, and the IRS Pub 54 that explains those requirements, are fairly difficult to comprehend.

To illustrate the confusing complexity of the remaining requirements, I offer this account. Recently, there arose a situation involving a close friend who has earned income from employment while living in a foreign country. He needed to know two things: (1) the first full day of the 330-day period so he could compute exactly how many full days he was in a foreign country, and (2) after he returned to the United States, he needed to know when he must again leave the United States and when he could return in order to fulfill the 330-day requirement.

IRS Pub 54 covers the requirements of the exclusion provided in §911, but the language is a little tough to decipher. The problem in my friend’s situation was that by the time that midnight of the day of his departure arrived, the plane was over foreign soil; but during several hours following, the plane was over international waters and finally reached another foreign airspace the day after departure. One interpretation of the explanations of Pub 54 is that the first day in a foreign country did not start at midnight of the day of departure. Pub 54 seems to express the view that since the plane was over international waters in international airspace after midnight, the first day did not start at midnight of the day of departure. Instead, the language of Pub 54 seems to conclude that the first full day of the 330-day period did not start until the second midnight following the day of departure. So, Pub 54 might be understood to say that since the period after midnight of the day of departure was partially flying over international waters in international airspace, the day was a non-foreign day.

For various reasons, that interpretation was presenting a serious problem for my friend in establishing plans to return to the United States. A case was located that supports an opposite construction of the matter. The case is Struck, TCMemo 2007-42. In this case a taxpayer had a job working on a yacht owned by other persons. For purposes of §911, the government treated each day partially spent in international waters as a non-foreign day. The Tax Court disagreed. Interpreting Regs. §1.911-2(d)(2) and (3), the court establishes the view that when a person travels from one foreign country to another foreign country, and part of the day is spent in international waters, the day still counts as a foreign day because the taxpayer was physically present in a foreign country for the full day. The key is that the taxpayer was traveling from the territorial waters of one foreign country, through international waters, and arrived in the territorial waters of another foreign nation within the same 24-hour period.

The Tax Court writes, “Under section 911, a foreign country includes airspace, lands, and territorial waters under the sovereignty of a country, territory, or possession other than the United States. Farrell v. United States, 313 F.3d 1214, 1216 [90 AFTR 2d 2002-7799] (9th Cir. 2002); Arnett v. Commissioner, 126 T.C. 89, 93-95 (2006), affd. 473 F.3d 790 [99 AFTR 2d 2007-492] (7th Cir. 2007); sec. 1.911-2(g) and (h), Income Tax Regs.” Furthermore, the Tax Court writes, “Although section 911(d)(1)(B) states that an aggregate of 330 full days of physical presence in a foreign country or countries is required, the regulations thereunder define a ‘full day’ to include partial days of travel in or on international airspace, land, or waters from one foreign location to another foreign location. Therefore, a day involving travel in international waters between foreign locations in increments of less than 24 hours is treated as a full day in a foreign country. Sec. 1.911-2(d)(2) and (3), Income Tax Regs.”

Based on Struck the first full day started at midnight of the day of departure and not at midnight of the next day. The plane was over foreign soil at midnight because it was in the airspace of a foreign nation. After midnight, the plane left that foreign airspace and entered airspace over international waters. Some hours later that day, the plane re-entered other foreign airspace over foreign soil and finally landed in yet another foreign country. The plane was in a foreign country at midnight, traveled over international waters en route to another foreign country, and arrived there before midnight of the day following departure. Therefore, the first full day in a foreign country started at the first midnight after departure.

Okay. So we solved the mystery of determining the first full day in a foreign country. Next came the problem that my friend was going to return to the United States before he had been physically present in a foreign country for 330 full days out of the consecutive 12-month period. On that point, Pub 54 is crystal clear. “You can count days you spent abroad for any reason. You do not have to be in a foreign country only for employment purposes. You can be on vacation time.” Thus, shortly after my friend returns to the United States, he is going to be able to fill up the 330-day period abroad by applying some of the tax he saves under §911 and taking a nice vacation – just long enough to complete the 330-day requirement.

Hear our voice: The tax laws are incomprehensible

Gracious! What a horrendously complicated body of rules exists as a result of §911. It is so complicated that citizens will often tend to forget the benefits of the exclusion and just include the whole amount of foreign earned income on their returns. It is the complexity of the rules and the various computations that are required that scare people away. Many folks fear being penalized if they get some part of the whole complicated mess wrong. The complexity creates fear of becoming trapped even after a good faith effort is made to explore the benefits and to meet the requirements. In other cases, the complexity of the scheme causes some good-faith taxpayers to claim the exclusion when they do not meet the confusing requirements. They often are penalized for negligence when in reality the law is so complicated that an ordinary, literate human can reasonably be expected to misunderstand the statute. How many laymen do you suppose know how to research the tax law in order to find cases that will provide the guidance they need? The whole scheme is so complicated that taxpayers are forced to approach and compensate some member of the priesthood of accountants and lawyers who spend their lives comprehending the mysteries of these scriptures. Is that the kind of system we should have?

Remainder Sales: Still a non-abusive tool

2007-10-10T07:45:00.000-05:00

A View on Remainder Sales - Still a useful, non-abusive tool
The Fifth Circuit Court of Appeals decision in Wheeler, 116 F. 3d 749 (5th Cir. 1997), resulted in the affirmation of what was previously a somewhat controversial estate planning technique. The decision implanted the following principles into our jurisprudence: The exchange of a remainder interest in property for other property of equal value is a transfer for adequate and full consideration for purposes of federal gift and estate tax law. At death, the life interest retained in the exchange is not includable in the gross estate, and IRC §2036 has no application.

Wheeler was decided seven years after the enactment of the new §2702. But the remainder sale in Wheeler occurred years before the enactment of §2702. Congress clearly intended to terminate the use of remainder sales used for the purpose of insulating the entire value of a retained life estate from the reach of the taxing statutes. However, close analysis of the language of the statutes suggests that Congress left alive the opportunity to sell a remainder interest coupled with a marital gift of the life estate. If constructed properly, the front-end-loading effect of §2702 is not activated.

What §2702 does:

This provision operates to create a “deemed” gift of the entire value of a retained life estate. Assume the same situation as in Wheeler. Dad sold the remainder interest in his land to his sons and carried the note. The price was equal to the appraised value of the land multiplied by the appropriate factor promulgated in IRS Publication 1457 based on the §7520 interest applicable to the date of the transaction (plus another $10,000 just to be sure the price was adequate and full). Thus, Dad received absolutely full and adequate consideration for the value of the remainder that was transferred. The sons paid off the debt. According to the Fifth Circuit, the retained life estate was not part of the Dad’s estate.

The government had argued that “adequate and full consideration” had to be the value of the entire fee – i.e., that a price reflecting only the value of a remainder interest was not adequate and full consideration. Clearly, the concern was that the life interest portion still possessed at Dad’s death would completely escape taxation. Rejecting that argument, the Fifth Circuit reasoned that the decision is driven by the function and purpose of the actuarial rules. It was reasoned that under the valuation scheme mandated by the law, the investment of the remainder-sale proceeds at the then-applicable §7520 rate would actuarially restore the value of the life interest to the gross estate. Thus, it could be fairly said, that if both the actuarially-restored value was taxed in addition to the value of the retained life interest, value would be taxed twice.

When §2702 operates upon facts presented in Wheeler, a different result arises. Now, where Dad sells the remainder to sons and retains for himself the life estate, the statute deems that the transaction resulted in the transfer of the entire fee; and, since the value received only equal the price of the remainder portion, the value of the life interest is deemed to have been transferred as a gift. Thus, Dad’s sale is taxed as part sale (the remainder portion) and part taxable gift (the life interest portion). But §2702 is not applicable where Dad does not retain a life interest. §2702 only operates where there is a retained interest. See, Treas. Regs. §25.2702-2(d) example 3. Still remaining is the issue of whether Dad can simultaneously sell the land to sons for the value of the remainder only, and still make a gift to Mom that qualifies for a marital deduction.

Marital Deduction for gift of life estate?

The policy of the federal taxing statutes is to not tax gratuitous transfers to a spouse. That way, when the values are accumulated in the spouse’s estate they are taxed upon the spouse’s demise. So, where assets that will be included in the spouse’s estate are transferred gratuitously (either inter vivos or testamentary) the law provides a marital deduction so that the value transferred in not taxed at the time of transfer. And in general, that is why a gift of a terminable interest such as a life estate is not thought of as being eligible for a marital deduction. A common view is that if the asset transferred will be excluded from the spouse’s estate, then there should be no marital deduction at the time of the gift.

However, the statute that precludes a marital deduction for a gift of a life interest followed by a remainder to any person contains a clear and unequivocal exception. Under §2523 it is provided that no marital deduction shall be allowed where the donor retains or else transfers an interest that will become possessory upon the death of the donee-spouse. But, there is a big parenthetical exception to that rule. Under §2523, there is no deduction if the donor transfers the remainder to any person other than the donee spouse for less than an adequate and full consideration. Based on the language of the statute there is reason to conclude that where the donor gives the life interest to the donee-spouse and sells the remainder to the children, the gift to the donee-spouse qualifies for a marital deduction.

Tax outcomes:

The tax consequences would appear to be favorable to the taxpayer. First, because the donor transfers both the life interest and the remainder, retaining no interest in himself, the provisions of §2702 are not applicable. Second, the sale of the remainder must be taken into account for the seller’s income tax return. Third, the value of the life estate gifted to the donee-spouse qualifies for the marital deduction provided under §2523(a) because the interest that succeeds the donee-spouse’s life interest was transferred for an adequate and full consideration. Fourth, when the donee-spouse dies, the life interest will not be includible in the gross estate.

Not abusive – Wheeler is supportive: Such a transaction should not result in the taxation of the gratuitous transfer of the life interest to the donee-spouse when the reasoning of Wheeler is brought into the analysis. According to that judicial pronouncement, the mathematical assumption underlying the federal valuation scheme is that the proceeds from the sale can grow at the rate presumed by the law for the balance of the seller’s actuarially-presumed life expectancy. Over that period, the growth will compound its way right back to the full equivalent of the value of the entire fee. It’s as though it is to be presumed that is what will happen – that the proceeds will in fact compound to that equivalent value. Thus approached, the value of the life estate should not be taxed because its equivalent value will have been restored to the estate. And not a single authority has challenged or sought to displace that formulation at any time since Wheeler was decided. To the contrary, the reasoning has been expressly adopted and reinforced in the Ninth Circuit. It seems that it is probably unshakably part of our law: the actuarial-based valuation scheme presumes that the proceeds will grow to the point of completely restoring the whole value of the entire fee in the seller’s estate.

In the Fifth and Ninth Circuits there would be no economic basis for asserting that a marital deduction should not be allowed. The assumption is that the proceeds of the remainder sale will appreciate for the balance of the seller’s life and completely restore the value of the life interest to the seller’s gross estate. It will be taxed in that estate. Therefore, there is no economics-based reason to tax the value of the gift to the spouse. Rather, under Wheeler one is compelled to conclude that to do so would result in the unjust taxation of the same value twice – once upon transfer to the spouse and again when the appreciated value from the remainder sale is taxed in the donor-seller’s gross estate.

Tension between 2523 and 2702?:

While §2702 would tax the value of a retained life interest upon sale of the remainder to members of the seller’s family, it would tax it as a deemed gift to the remaindermen. And if the buyer of the remainder is the seller’s spouse, §2702 would require that the transaction be treated as also including a transfer of the value of the life interest – a deemed transfer of the whole. But the application of §2702 should not produce any taxable transfer because the value of the whole should be deemed transferred to the donee-buyer-spouse in this family-only transaction. And since the remainder is not transferred to any person other than the spouse, it is clear that a marital deduction shall be allowed under §2523. There is nothing in §2702 that would conflict with allowance of a marital deduction where a life estate is actually or “deemed” transferred to a spouse. Treas. Regs. §25.2702-2(d) example 3 seems to support that view.

Letter Rulings: None of the letter rulings I have been able to find dealing with issues under §2523 express any thought concerning the parenthetical “consideration-based exception” provided in §2523(b)(1). The rulings briskly pass by the matter because the facts presented do not involve transferring the remainder to other persons in a genuine sale for adequate and full consideration. Of course, that does not unequivocally establish the proposition that the IRS might attempt to deny a marital deduction even where the remainder is sold for an adequate and full consideration to persons other than the donee-spouse. But that is where the reasoning applied in Wheeler seems to constitute such strong support for the proposition that the transaction should be treated as a sale of the remainder (having immediate income tax consequences to the seller-donor) and a tax-deductible gift to the donee spouse.

Wheeler adopted as correct in Magnin (9th Circuit):

Just before Wheeler was published, the Tax Court published its opinion in Magnin, TCMemo 1996-25. There, the Tax Court held that a sale of a remainder is a transfer for less than adequate and full consideration where the value received is less than the value of the entire property. Shortly after the Tax Court released that opinion, the Fifth Circuit published Wheeler which announced a rule that was completely contrary to the Tax Court’s position in Magnin. According to the Fifth circuit’s analysis, every time property removed from a transferor’s estate is joined by receipt of property that has equal value, the transfer is for adequate and full consideration. That set the stage for the appeal of the Magnin case to the Ninth Circuit where there was presented the unequivocal conflict between the Tax Court and the fifth Circuit.

Though Wheeler involved the sale of a remainder in realty and Magnin involved the relinquishment of the remainder interest in closeheld stock in exchange for a life interest in the same closeheld stock owned by the transferor’s father, the Ninth Circuit relied upon and followed the sound reasoning of Wheeler and rejected the principle expressed by the Tax Court in its opinion in Magnin, 184 F. 3d 1074 (9th Cir. 1999). Since that flurry of activity from 1996 to 1999, the issue has never again been raised in any court. Perhaps the government knows that Wheeler – wholly adopted and followed in the Ninth Circuit – expressed the correct view of the law: an exchange of equally valued things is always a transfer for adequate and full consideration.

The clear governing principle that must be met is that the remainder must be sold for a price that is absolutely the full value. Both courts correctly point out that the actuarial tables are built upon the presumption that there the property received for the life estate grows at the rate prescribed under §7520, then the growth reproduces exactly the same value includable in the gross estate that would have been included if there had been no transfer.

Caveat:

Seller-financed sale creates an interest: Where the seller carries the purchase-money note secured by liens against the property, there exists the contingent possibility that the seller-donor might again become the owner in the event of default and foreclosure. It is possible that the existence of that contingent interest is sufficient to remove the transaction from the scope of the parenthetical exception based on transfer for adequate and full consideration. The language of the statute seems to require that whoever owns the remainder must be a person who purchased it for full value, thereby completely cutting off the seller-donor’s interests in the property. For that reason, to make use of this remainder-sale/marital gift technique, it seems quite advisable to arrange for third-party financing by some means.