WHY YOU SHOULDN’T WAIT TO ADDRESS YOUR TAX BALANCES
By: Elizabeth Gonsalves, Esq.
You have just received notice of a certified mailing waiting for you at the post office. You haven’t had a chance to pick it up yet. Perhaps you should just ignore it? You’ll get to it tomorrow or Saturday… Fast forward a few months and all the money in your accounts has been absorbed by a tax levy. More embarrassing is the morning you come in to work to find a wage garnishment order has been issued to your employer, now you’re trying to avoid the eyes of co-workers in the payroll department. Worse still is learning a professional or driver’s license has been suspended. It does not pay to wait, it costs much more when one procrastinates with the IRS, the FTB, the Board of Equalization and the EDD.
LEVY RELEASES If you are fortunate enough 1) to contact my office for help, and 2) happen to fall within one of the many criteria I can work with to obtain a release, you are still looking at a bill for the time I spent working to release the levy, which on the high end can take many hours over several days. Money comes back and your reputation can be restored but money is also lost and a lot of anxiety ensues in the interim. If you are not fortunate, a mini financial crisis occurs in your immediate household. It is not pleasant. I do not recommend it to my clients and I do not protect my clients from new problems this way.
AVOIDING COLLECTIONS ACTIVITY On the other hand, if you had picked up that certified mailing right away and accepted it was there to notify you of the IRS or state’s final notice of intent to levy, a collections hold would have been something I probably would have been able to obtain before a levy issued and a lot of scrambling was suddenly the order of the day. When I am retained before forced collections occurs I can usually buy us time long enough to produce information the agencies require in a strategic manner that keeps an eye on the outcome while tempering the damage now. Sometimes we have to work together quickly to circumvent a complete emergency but at least we’re working on a long term solution to the problem, fees are saved and levy activity is avoided.
A second complication to waiting is that you, as the taxpayer, do not look so good when I contact the agency to argue a release is in order. Instead, it looks as though the levy did its job, which was to bring the unresponsive taxpayer forward. The agency and its staff are thinking, “Now you want to work with us? You want something from me?” It’s an uphill battle just to get back on track and back to normal life activities. Levies are very disruptive to work and cash flow.
I CAN’T AFFORD PROFESSIONAL ASSISTANCE RIGHT NOW Of my clients that come in and retain me to address their levy or licensure issues (as opposed to hiring me before the levy or suspension issued), most of them provide a very reasonable explanation for their delay, which is that they are having trouble financially and didn’t feel they could afford to hire an attorney to help them. Days turn into weeks, weeks turn into months and boom! Catastrophe! Now, the taxpayer can’t afford to wait because waiting means up to 25% of their earnings or 100% of the funds in a levied bank account will be lost forever.
It’s the wrong way to look at the problem. Waiting means paying more, it does not mean paying less. Waiting also means stressing out the entire time I’m working to get you some relief. Further, you’re distracted from what it is that we really need to do, which is to gather up your financial information and talk about your goals so I can form a strategy for resolution and get it going for you.
There’s another important reason feeling you can’t afford professional assistance is not a good reason to wait, I get far better results more quickly when you are in a financial hardship. When times are tough, resolutions are far more straight forward and there are more options available to you. I can buy time and lock in something low before the agencies figure out you have turned the corner on your tough spell. My fees are lower because less time is needed to resolve your problem. Time is only on your side with regard to the collections statute and then, only if you have a strategy in place. The IRS has ten years to collect, the state has at least twenty years. If I am retained early we can reach an agreement with the agencies that is more favorable to you. At the same time we can now take advantage of allowing time to pass in a way that works for you, paying lower payments without worrying the whole time. Being direct about solving the problem with my help puts you in the best position to comfortably watch your account move closer to the time when other options for relief are available, such as bankruptcy or an expiration of the collection statute.
WORRY WITTLES AWAY AT HEALTH The last and most important reason not to wait is your health and peace of mind. The worry that comes with an unaddressed tax balance is not worth the toll on your health nor the strain on your relationships. Financial trouble is the primary reason people break up and part ways. It causes health problems and breaks you down from the inside. Financial trouble muddles your perspective and appreciation for the good stuff in life. Every client tells me pretty soon after I’m retained that they’re relieved, they’re comfortable, they can see they’re going to be okay. Hand me the problem and let me help you with it. It’s not fun, but facing it with me will be worth it. You’ll be able to breathe again.
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How to Operate a Business (or Your Life) with a Sales Tax Liability
Installment Plans for Operational Businesses
While a business operates, any outstanding sales tax owed remains a liability of the business and the business only. Generally speaking, the first, most important ingredient necessary to a smooth resolution is to immediately focus on filing and paying current sales tax returns and payments (what is referred to in the industry as “compliance”). If compliance is established, the urgency and severity of the Board’s response to your liability will be lessened long enough to get financials gathered and a strategy formulated. Some clients want to eliminate the balance as quickly as possible and seek an aggressive repayment strategy. Other clients have business expenses in the pipeline which put pressure on their ability to make large lump sum payments to reduce the balance due or which are already causing cash flow risks to the business which are not desired. As a general rule, there is no penalty for paying more than the amount the Board agrees to; therefore, I recommend pursuing the lowest installment payments for the business while strongly recommending to my clients that they pay as much as they can when gross receipts are up or business expenses have stabilized. Financial data about the business’s income and expenses are gathered, reviewed then analyzed. There must be a way to make the financial package reflect the outcome desired, otherwise the desired outcome must be adjusted.
The Board is a government agency and as such the taxpayer has rights when tax is due. Professional representation is certainly advised to oversee what documents should be produced, how best to produce them (over what look back period, how to provide information that must be disclosed without divulging incriminating information, etc.), and how best to spin the story of what the taxpayer’s allowable expenses are such that allowable expenses are paid first and deducted from the calculation of the taxpayer’s disposable income. Disposable income is a key indicator when evaluating what the business can afford to pay for past liabilities. Negotiations circle around what figure for disposable income is accurate and what figures for expenses are reliable. Each business is different, some businesses are seasonal, others collect substantial gross receipts but carry very high operational costs that absorb most income earned. It is important that your representative take interest in and understand the business that owes the liability to line up a strategy that will bring results that provide the taxpayer with the buffer it needs to handle its past missteps while still providing room for survival and growth.
Responsible Person Assessments
If a business terminates operations, dissolves or is abandoned, the Board will begin the process of assessing the unpaid sales tax against a “responsible person” associated with the business. Pursuant to Part 1, Division 2 of the CA Rev & Tax Code, any responsible person who willfully fails to pay or to cause to be paid any taxes due from a corporation, partnership, limited partnership, limited liability partnership, or limited liability company shall be personally liable for any unpaid taxes and interest and penalties on those taxes not so paid upon the termination dissolution, or abandonment of the business of the corporation, partnership, limited partnership, limited liability partnership, or limited liability company.
To assess an incorporated business’s sales tax liability against an individual as a personal liability, the Board must establish that while the person was a responsible person the corporation, partnership, limited partnership, limited liability partnership, or limited liability company:
1) sold tangible personal property as a part of its business and collected sales tax on the sale and failed to remit such tax when due; or
2) purchased personal property and failed to pay the sales tax to the seller or the Board; or
3) issued a receipt for use tax and failed to report and pay the tax.[1]
Responsible person sales tax assessments are assessments of the business’s outstanding unpaid sales taxes against an individual owner or operator of the business. In common practice, the individual who is at risk of being personally assessed is someone associated with the business or associated with the business’s sales permit who is deemed by the Board of Equalization to have been responsible for foregoing the payment of sales tax when it was due. To successfully establish that a particular individual should be assessed personally, the Board must find that the individual had access to business funds and directed these funds somewhere other than to payment of the tax when the sales tax was due. If the business had no funds at the time sales taxes were due and therefore did not divert funds to another obligation instead of using them to pay the tax, there may be grounds to protest quarterly business sales tax assessments against that individual during such periods. If the individual did not have decision making authority for the business and did not make decisions about what business expenses to pay, there may be grounds to protest assessments against the named individual. An officer or owner cannot be “responsible” for failing to pay tax when there were no funds available to pay any expenses and none were paid. These are among the arguments that may be made if circumstances surrounding how the liability arose are conducive. Careful attention to the timing of receipt of income and the timing for paying out business expenses must be given before protesting an assessment.
Often, the responsible person assessed business sales taxes on their personal account was in fact a responsible person for the business who, due to cash flow issues or late payment from accounts receivables, made an executive decision to pay a business obligation before paying the sales tax. In these cases where assessments against the business or a responsible person for the business are high and bankruptcy is not possible (which is most often the case) the most important strategy to employ is that of cooperation with the Board. This does not mean that an individual should simply turn over their records to a demanding collections agent. This means the business (or the liable individual) must agree to provide disclosure and should do so in a timely fashion, but they must be tactful about their disclosure and take advantage of historical data in conjunction with recent events to argue the lowest payment possible. Of the California state agencies, the Board of Equalization is often the most aggressive about collections. The Board is short fused and impatient about being paid back when sales tax is owed and a liable party has been identified. To that end, installment agreements are feasible and can be accomplished such that an individual can dig themself out of the debt or establish an installment agreement long enough to line up a different exit strategy for addressing the liability. The key to a good financial disclosure is to be cooperative with the agency while maintaining razor focus on the strategy employed to reach your payment goal.
If you are faced with an outstanding sales tax liability, I am available to discuss your matter for purposes of representing you before the Board. A plan can be created together, with my expertise and your intimate knowledge of your business. We will form an informed plan, then we execute, together, and as a team.
[1] Business Taxes Law Guide, Revision 2013, Article 18, Regulation 1702.5
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LEARNING HOW TO PREPARE A PROFIT & LOSS AND LOVING IT
By. Elizabeth Gonsalves, ESQ.
A profit and loss is simply a spreadsheet setting forth your gross receipts (gross income) against your categorical business expenses for purposes of arriving at your net income, or “taxable income.” “Profit” is the gross income or gross receipts, the total of all raw income you received, while “Losses” are the costs of doing business, the “operating expenses.” I have seen complicated Profit & Losses and simple Profit and Losses, neither is better than the other. What counts is 1) that the gross income claimed is accurate (matches reported income and/or deposits into bank accounts), and 2) that all business expenses claimed are legitimate business expenses that are permitted deductions or expenses that a business can claim to arrive at net business income.
Don’t bother beating yourself up if you have commingled accounts, take the time to avoid commingling going forward. Stated simply, commingling is the act of mixing personal income and/or personal expenses with business income and/or business expenses or any combination thereof. The strongly advised practice is to keep business income and business expenses completely separate from personal income and personal expenses. The primary reason to separate them is not only because the IRS or state will judge you poorly as a business person – the primary reason is simple, keep them separate so you can track them separately and know where you stand with each, respectively. It goes without saying, you can only analyze your business, its earnings, its operating expenses and its return on investments, if you know what your business makes and what its spends. Only then can you determine how to optimize profitability. Further, knowing your taxable business income is imperative to calculating estimated tax before taking income for personal expenses. Commingled accounts require far more work from a tax representative and make it more difficult for the revenue agencies to determine what business expenses are incurred, what personal income is received and how personal income is used to pay necessary personal expenses. It is the government’s job to find income and in doing so, tax owed. It is the taxpayer’s burden to prove their deductions (i.e., legitimated business expenses) against income. Keeping a clear record of your income and the expenses you incur to earn that income are your responsibility as the taxpayer and bring you the benefit of reducing your taxable income. Keep these records organized for yourself. Its empowering.
Personal Income Distinguished Personal income can be wages (which do not belong in a Profit and Loss) or pension income, or some other source of income that should be included on your personal income tax return in the income section of the tax return (page 1). Distributions from a corporation of which you are a shareholder are not personal business income. They are personal income from a partnership, corporation or entity and are claimed on line 17 of a federal income tax return. Business income is income earned by a sole proprietorship (which is a non-entity) or income received by a disregarded entity such as a single member LLC, or income earned by you – just you by yourself in your name. Line 12 is for reporting income from a personal business such as a sole proprietorship or a single member LLC. Personal business income is income reported on Schedule C (or Profit & Loss which is a part of a personal income tax return) the net income of which flows over to Line 12 on a personal income tax return. If you operate as a DBA or a single member LLC or just as yourself, then the income received is “business income” and is reported on Schedule C. For purposes of reporting income on a personal income tax return and for simplicity’s sake, “business income” when defined in relationship to a personal income tax return does not include income received from an incorporated entity. Business income, for our purposes of speaking about self-employed individuals is the income received from clients, patrons, vendors, employers, etc. in exchange for your goods or services or both when your business is not incorporated. A “doing business as” or “DBA,” or “Fictitious Business” is an example of a business that is not incorporated. As previously stated, a single member LLC is also a disregarded entity for tax purposes. A single member LLC is also reported on a Schedule C in a personal income tax return. No corporate return is required to report “business income.” This type of income is subject to estimated tax requirements and maintenance of records to track both income “profits” and business expenses “losses” for purposes of determining taxable income, which is that income you net after reducing your profits by your losses. If the IRS or state only receives reports of your gross earnings as an independent contractor it assesses tax based on a figure that has not yet been reduced (via a Schedule C) by business expenses. The tax assessed on gross income is almost always more than it would be if assessed against net income (profits left over after paying all business expenses).
New Income v. Re-Deposits of Income Previously Received If you withdraw income from your business, then put it in a personal account (or keep it in cash in a safe place) and later re-deposit it into your business’s accounts due to cash flow issues, the re-deposited funds are not new income and should not be included in your tally of gross receipts. Gross receipts are only the original income received in exchange for your goods and services.
Business Losses/Expenses All businesses are not made the same. All business do not pay for the same expenses. The expenses your business can claim relative to the next business are roughly the same but vary depending upon your industry. Generally speaking, what you must spend to earn business income is a business expense – with several exceptions.
Costs of Goods Sold Some businesses sell goods in addition to services, such as a plumber or a mechanic. The patron hires you to fix a broken alternator. They need to purchase an alternator through you, but they also need you to install it. There are parts and labor charges to the patron and in most cases there are parts and labor costs to the business providing the service. Both the parts and the labor are deductible, meaning the money you receive from the patron to pay for the parts and the service you provide are first reduced by your costs to supply the part and the worker you pay to install it, the amount left over is your net income on that particular transaction – your net profit. Obviously, you need to charge such that there is a net profit, unless you are a charity or are otherwise working in a not-for-profit capacity. This means you need to know how much you can obtain the part for, how much you must pay your worker to install the part, all while remaining competitive relative to other mechanics. It is not enough to know you can reduce your taxable income by these expenses, the goal is to profit despite these expenses. If you fail to claim any expenses (i.e., fail to file a return), then the IRS or state assume you simply made $400, without knowing you obtained an alternator for the patron and spent $150 on the part and paid your employee $45 to install the part in order to earn that $400. In this example you were paid $400, but you spent $195 to earn that $400. This means your taxable income on the transaction is $205, not $400. “Cost of Goods Sold” refers to the costs for goods you must purchase to conduct the business that you do. The cost of goods sold is 100% deductible. As a side note, when selling goods in a wholesale capacity there is no sales tax; however when selling goods in a retail capacity, sales tax may also be implicated as an additional “expense” or obligation that you must collect from a patron and deliver to the state. Your costs and the tax on retail goods sold must be built in to every transaction to insure a net profit is realized. Costs of goods sold are a deductible expense and should be carefully analyzed and tracked by maintaining a year-to-date profit and loss.
Salaries and Wages Salaries and wages paid to employees are 100% deductible. An issue which arises with salaries and wages occurs more recently in the case of corporate shareholders taking distributions of income from their business without first paying themselves a “reasonable salary.” There is a trend, particularly with the IRS, of assessing payroll tax against corporate shareholders who have paid themselves distributions (draws from the corporation) only. A corporate shareholder should register themselves as an employee of the business and pay themselves a wage. The reason for these payroll tax assessments against shareholders is to discourage shareholders from paying themselves distributions to bypass employer FICA and FUTA taxes against their income. A shareholder may pay themselves a distribution in addition, but the better practice is to pay a regular wage to a corporate shareholder and pay out any other net profits intended for the shareholder at the end of the year as a single wage or bonus pay check which deducts income tax as well as FICA and FUTA taxes. In the case of sole proprietors, DBA’s and single member LLC, an owner need not pay themselves in wages, they may simply take income from their business provided all income tax and self-employment taxes have been paid first. A sole proprietor may write off as business expenses the salaries and wages they report and pay to staff, but they need not pay themselves as a wage earner.
Rent Business rent is straight forward unless you work from home. This expense is relevant to preparing a Profit and Loss and is tricky in a beneficial way if you work from home.
Business Use of Home Whether you rent your home, your apartment, or own your own home or condo, the calculation is the same and is extremely important to the bottom line. Any part of your personal home (be it rented or owned) that is exclusively used for a business purpose is deductible as a business expense. It is recommended that you establish a distinct area of your personal home that is to be used for business and business only. Put your printer, your fax, your supplies, your storage for the business materials, etc. in this area. If you have a second bedroom in your apartment, or a garage or spare bedroom in your home, it is best to use such a space as your business space. Honor the boundaries, not just for you but for tax purposes. Calculate the total square footage of your home. Let’s imagine its 1000 square feet. Now, calculate the total square footage of your home that is now exclusively used for a business purpose – the “office.” In this scenario, let’s imagine the office is 400 square feet of your home. Divide 400 by 1000 to arrive at the percentage of square footage of your home that is used for an exclusive business use. We come to 40%. This means 40% of your rent/mortgage is now a business expense. Likewise, 40% of your home utilities such as gas or electricity is a business expense and may be claimed as such on your Schedule C Profit and Loss. If you have a fax line, or special internet service for your business operations you can probably claim 100% of it, as you probably would not pay for this service unless there was a business need to have and use such equipment. Business Use of Home is claimed on form 8829 of your personal income tax return and is a business expense deduction on your Schedule C. Now, don’t start abusing this by including Hulu, Netflix and cable as a business expense unless you are in the entertainment industry. Be reasonable, be smart, be ethical, be strategic and you will be okay in claiming these expenses.
Mileage Mileage is a red flag for most revenue officers, collections agents and examiners. The best advice is to carry and maintain a mileage log of travel for business. Track the date you traveled in your personal vehicle, the number of miles you traveled and the purpose of the travel. It is also worthwhile to note that you may not claim travel commuting from home to your office. Business travel is travel to a destination you must visit to conduct business beyond your normal commute from home to office and office back to home. Business travel does not include travel from home to your office to conduct business.
For example, if you have an office but must visit sites to earn new clients, the travel from your office to the prospective client are business miles which should be recorded in a business mileage log. If you have a prospective client that is closer to your home than your office, thus you opt to travel from home to the client then back to your office, the miles to the client from home are business miles. Arguably the miles from the client to your office are also business miles; however, the miles from your office back home are not business miles, nor are the miles from home to your office the following day.
PAYING CURRENT TAX AS A KEY TO MINIMIZING PAYMENTS FOR BACK TAX
Perhaps the most important aspect of being self-employed is calculating your estimated taxes and submitting them timely. A key strategy to negotiating an installment agreement or an offer in compromise with either the IRS or the state is making a case for the current tax that must be paid and prioritized before discussing a dollar amount you can afford to apply to your past due balances. If you’re preparing to provide financial disclosure to the IRS or the state, it is probably best to get a professional opinion and strategy for how to proceed, but as a general rule in going through the financial disclosure process to arrive at a monthly payment or offer amount, it’s a good idea to beef up and pay your current estimated taxes, then circle back to calculating how much is really owed for the year once the resolution has been established. This is important for a second reason, any balance owed after the 15th of April the following year will cause any agreement put in place to default. If you’re going to go through the trouble of dealing with the IRS or the state, do everything in your power to make sure you don’t have to do so on a regular basis. Dealing with the IRS and the state is uncomfortable, unpleasant and puts you at risk for enforced collections which everyone knows (or has heard) is no fun.
CALCULATING YOUR ESTIMATED TAXES
Federal & State Personal Income Tax It is really very difficult to calculate current taxes without the assistance of tax software, for this reason the self-employed are required to submit estimated taxes on a regular basis. As a general rule, and specifically for tax year 2014 (tax rates may change annually), a self-employed individual must first calculate at the end of each quarter (March 31st, June 30th, September 30th, and December 31st) their net income, as discussed above. Once you have arrived at your net income on a year-to-date basis (all income over the year must be analyzed on a cumulative basis given tax brackets are derived from total annual income figures), check the income tax table for the current year for both the IRS and the state. Tracking your net income using these tables will give you a sense of the total federal and state income tax you owe against the net income you have earned. Make sure you submit at least this amount (keeping in mind you may have paid a portion of the balance due in a previous quarter earlier in the year when your net income was lower).
Federal & State Self-Employment Tax Yep, you have more tax to pay beyond your income tax. You must also pay self-employment tax to the federal government when you earn 1099 income. Self-employment tax is essentially the employee side and employer side of social security and Medicare tax on the federal level. For self-employment income earned in 2013 and 2014, the self-employment tax rate is 15.3%. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).
For both 2010 and 2011, the first $106,800 of your combined wages, tips, and net earnings are subject to any combination of the Social Security part of self-employment tax, Social Security tax, or railroad retirement tax. The amount increased to $110,100 for 2012, $113,700 for 2013, and $117,000 for 2014.
All your combined wages, tips, and net earnings in the current year are subject to any combination of the 2.9% Medicare part of Self-Employment tax, Social Security tax, or railroad retirement tax.
In 2013 an additional Medicare tax rate of 0.9 percent went into effect and applies to wages, compensation, and self-employment income above a threshold amount received in taxable years beginning after Dec. 31, 2012.
If you use a tax year other than the calendar year, you must use the tax rate and maximum earnings limit in effect at the beginning of your tax year. Even if the tax rate or maximum earnings limit changes during your tax year, continue to use the same rate and limit throughout your tax year.
COMMON MISUNDERSTANDINGS ABOUT FILING AN EXTENSION
An extension to file your tax return only extends the deadline for filing a return. An extension does not extend the deadline for paying the tax owed. When considering an extension in any given tax year, particularly if you are self-employed, it is important to first calculate the tax owed for the previous year so the tax owed can be paid to the IRS and state by April 15th of the following year to insure you are not subject to failure to pay penalties. If you file an extension, then file your return by the extension deadline of October 15th of the following year you can safely forego the assessment of failure to file penalties. The point here is that there are several types of costly penalties which accrue at an alarming rate if left unchecked. Tax is always due for a given tax year by mid-April of the year following the tax year in question. If the full amount of tax is not paid to the federal or state agencies by this date, penalties will be assessed and a default of any payment plan or other resolution put in place prior to that date will automatically default.
LIFE GOES ON EVEN WITH A TAX LIABILITY
Tax is not death or grave illness. Its stressful, its scary and it can put a really good sized wrench in your future financial plans but it is not the end of the world and its not permanent. There is a ten year statute of limitations for collecting a federal tax debt. There is a twenty year statute for collecting a California state tax debt. Balances due will expire, there are several ways to get your problem under control by preventing future assessments and, most importantly, by recognizing there is usually a lot that can be done to make the balances owed manageable for you. An important point to note here is that tax is owed to government agencies, not private lenders like banks, automobile financiers or credit card companies. Because the IRS and FTB collect funds owed to a secured creditor, they are powerful and they can mess with your life far more easily than a private creditor can and they can do so without having to jump through as many hoops as a private creditor must jump to reach your assets against your will. For this reason, its important to be responsive and cooperative with the agencies. Of course, you also want to be tactful and strategic in navigating their collections rules. There is a plus side to dealing with a government creditor. Because they are a government agency, cooperation, even cooperation without an ability to make meaningful payments, is acceptable to the agencies. The IRS and the state are very responsive to a taxpayer who is reasonable and cooperative. There is a lot more that can be done for a cooperative taxpayer who has insufficient funds to pay the balances owed than would be available to a borrower unable to pay their mortgage to a bank. Assets can be preserved, life can be lived with reasonable comfort in most circumstances as long as the taxpayer is being reasonable. The first step is taking the initiative to understand how the liability happened, how it can be avoided in the future, and how to deal with it in between the two.
Should you have additional questions or believe you may need the benefit of professional assistance, please do not hesitate to contact me for a consultation regarding representation before federal or state revenue agencies.
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Taxpayers owing balances to the IRS in excess of $10,000 for past tax years could have a Notice of Federal Tax Lien filed against their social security number or property. The legal effect of a Federal Tax Lien is to give the federal government legal claim to your property as security or payment for a tax liability. A Federal Tax Lien should not be confused with a Federal Levy on Wages or Bank Account. You can learn more about the difference between these two by clicking on our Federal Tax Lien link on our Free Advice page. A Notice of Federal Tax Lien may only be filed after a liability is assessed, a Notice and Demand for Payment is served on you and, you fail to fully pay the debt within 10 days of being notified of the liability.
Once these requirements are met, a Notice of Federal Tax Lien can issue in the amount of your tax liability. The Notice is a way of publicly notifying creditors that the federal government has a claim against all of your property, even property you acquire after the lien is filed. A federal tax lien establishes the federal government’s priority, in relationship to other creditors associated with your account, for use during such proceedings as bankruptcy, and the sale of real or personal property, among others.
Federal Tax Liens can often have an adverse effect on a taxpayer’s credit, as it tends to show a significant creditor (the federal government) has not received funds owed. Federal Tax Liens often create problems for taxpayers either trying to sell a property, refinance a property, or purchase a property. Such transactions implicate possible sale proceeds, loan proceeds, or sums intended for down payments which might be routed to the federal government instead of the delinquent taxpayer.
In each of these transaction situations, the IRS may be willing to cooperate with taxpayers in a way that assists such transactions to process successfully. Of course, the IRS requires a taxpayer’s cooperation in return, as well. You can read more about Notice of Federal Tax Lien here.
Taxpayer Selling a Property Having a Federal Lien on Record
When a taxpayer is attempting to sell real property having a Federal Tax Lien filed against it, the IRS will consider Discharging the Federal Tax Lien to allow the property to be sold free and clear of the cloud on title. A Discharge of Federal Tax Lien releases the effects of the lien against one piece of property. The IRS requires that Form 14135 be prepared and submitted to the Lien Unit with accompanying documentation relevant to the sale. A discharge request will be reviewed for important pieces of information such as, whether the proceeds of sale will provide for some or all satisfaction of the tax liability. In situations where the proceeds are not sufficient to provide for payment of the tax liability, such as a short sale, the IRS may require information about any other property owned by the taxpayer that may be used to secure the government’s interest. To learn more about requesting a Discharge of Federal Tax Lien you may refer to IRS Publication 783 for more information.
Taxpayer Refinancing a Property Having a Federal Lien on Record
In circumstances where a taxpayer is attempting to borrow funds by using collateral having a Federal Tax Lien on record, such as refinancing a property, the federal government may be willing to subordinate the lien in favor of the lender to assist the taxpayer in receiving the loan. A lien subordination involves making the federal lien secondary to another lien, such as that which would attach to property in circumstances where refinancing is approved. Similar to a Discharge request, the IRS would require information about the proceeds of such a loan and whether any sums could be used to pay all or a part of the tax delinquency on file. IRS Form 14134 is used to request a Lien Subordination and requires the inclusion of documents relevant to the transaction for approval. To learn more about Lien Subordination requests, you can read IRS Publication 784.
Taxpayer with a Federal Lien on Credit History Attempting to Purchase a Property
In situations where a taxpayer is attempting to purchase a property, having a Federal Tax Lien on a credit report often upsets the Purchase Money Mortgage loan approval process. Banks typically require a showing that any outstanding federal tax liability has already been accounted for in the form of a formal repayment agreement with the IRS. In other words, banks regularly require a showing that a tax resolution has already been established to account for debt to income ratios in evaluating a buyer for loan financing. While this may make sense from a lender point of view, we find this requirement counterproductive given the IRS Federal Tax Lien rules. Pursuant to Publication 785, and Revenue Ruling 68-57, where Purchase Money Mortgages or Purchase Money Security Interests are sought by a taxpayer having a Federal Tax Lien on file, the Federal Tax Lien is automatically subordinate and a request for Subordination of the Federal Tax lien is not required, nor will subordination be provided if applied for. This is true even in situations where the Federal Tax Lien was filed long before a Purchase Money Mortgage or Purchase Money Security Interest was approved and issued by a lender.
When a delinquent taxpayer attempts to purchase a home, has a Federal Tax Lien recorded against their social security number, and has not yet established a tax resolution with the IRS, a prospective lender that is not familiar with this rule will often require a showing that the liability is in a repayment plan, or has been satisfied in full. The problem here is that the IRS typically requires financial disclosure to approve a payment plan over time to account for back taxes owed. Financial disclosure involves a thorough review of your bank statements, including investment accounts, savings accounts, CD’s, etc. If the IRS is able to see that a taxpayer has sufficient funds to pay some or all of a tax liability owed (i.e., a significant sum of money sitting in a bank account intended to be used as a down payment for the purchase of a home) they will require immediate liquidation and payment on the tax balance, rather than a payment plan over time. Because the taxpayer intends to use that sum for a down payment, forfeiting such funds to the IRS will cause the purchase to fall through.
The fact is, a lender contemplating approval of a Purchase Money Mortgage for a taxpayer should simply approve the loan without requiring a payment plan with the IRS. First off, the Federal Tax Lien is secondary to the Purchase Money Mortgage by operation of law. Second, so long as the mortgage is reasonable, meaning the mortgage and utilities expenses do not exceed the national standard for Housing and Utilities as set forth by the IRS by county of residence, the housing and utilities expenses will be allowed. If the housing and utilities total an amount close to the national standard in your area, the IRS will accept a payment plan based on the taxpayer’s ability to pay, or disposable income, which is calculated after allowing the funds needed for the mortgage as a necessary living expense. You can check out the National Standard for Housing and Utilities in your county by number of people in your household here.
The concept behind Revenue Ruling 68-57 which renders a Federal Tax Lien automatically secondary to a Purchase Money Mortgage is that the taxpayer has acquired property or a right to property only to the extent that the value of the whole property or right exceeds the amount of the Purchase Money Mortgage.
Persons seeking to purchase a home are best advised to either resolve their outstanding tax liability owed to the IRS first, before significant sums are accumulating in a personal account, then take steps to purchase a home, or to provide a copy of Publication 785 to their lender for review by the lender’s underwriter. If you have an outstanding tax liability and plan to try to purchase a home soon, contact The Law Office of Elizabeth Gonsalves for assistance in negotiating the lowest possible payment plan first before you solicit lenders to purchase a home. We can assist you and help the transaction to run smoothly.
Prospective clients often ask, “Why should I pay up front fees for tax resolution services? These callers often take the position that fees should be paid once all of the work has been performed.
Turned off by the overwhelming number of commission based, sales driven tax resolution companies that charge high “fixed” fees and make grandiose promises for the outcome, taxpayers owing back taxes often ask this question with more than a hint of skepticism when deciding to hire The Law Office of Elizabeth Gonsalves for professional tax resolution services.
While I would be among the first to vehemently agree that salespeople pitching “their ability to cut your tax debt in half” should be formally banned from involvement in this area of law altogether, there are actually legitimate reasons for charging upfront legal fees for tax resolution services. Below are the five primary reasons licensed tax resolution professionals only offer upfront fee agreements to their clients.
TAX RESOLUTION INVOLVES LEGAL REPRESENTATION OF A TAXPAYER FOR SETTLING A SECURED DEBTOnce a licensed tax professional is hired to engage in legal representation of a taxpayer, most of the work conducted by the licensed individual involves preparing financial disclosure forms for provision to a revenue agency to negotiate a settlement agreement based on the taxpayer’s disposable income after accounting for necessary living expenses. While attorney’s fees, or legal fees for tax resolution services generally, are honored by most industries, a federal or state tax liability is a first position debt that often is only superseded by a Purchase Money Mortgage.Liens filed by attorneys to secure attorney’s fees are most often discussed in relationship to family law cases whereby an attorney is permitted to file a lien against the family home in representing clients engaged in dissolution of marriage. This rule is primarily in place to incentivize attorneys to take the cases of disenfranchised homemaker spouses needing professional representation during a divorce. Liens filed by attorneys against former clients for tax resolution legal services rendered in other matters are not a clear cut way to secure a tax professional’s interest in being successfully compensated. Most tax professionals in tax resolution are not interested in taking on a client only to become yet another creditor in what is often a long list of secured and unsecured creditors vying for funds owed to them by a taxpayer.The bottom line is, tax professionals do not want to start off representation by getting in line to be paid.
PUBLIC REVENUE AGENCIES SEEK TO PERMIT ONLY NECESSARY LIVING EXPENSESWhen preparing financial disclosure forms for purposes of establishing a resolution for repaying taxes owed to a revenue agency, it is contemplated that only current necessary expenses will be permitted as allowable expenses. As public agencies, state revenue agencies and the IRS, are usually not seeking to put a taxpayer out of house and home to recover unpaid taxes. Ultimately, continuous seizure of all assets belonging to a delinquent taxpayer over the long term and without recourse for medical expenses, shelter expenses, food and car expenses, will only render a taxpayer unemployable and dependent on state or federal assistance. Generally speaking, this is not the circumstance most public revenue agencies wish to pursue. Revenue agencies want delinquent taxpayers to work and earn income to pay their delinquent tax liabilities.This is not to say making a case for necessary living expenses is an easy task. In fact it can be quite challenging and frustrating to negotiate with agents of revenue agencies. It can at times be disheartening finding oneself arguing the very rules associated with allowing necessary living expenses with an inexperienced agent new to the rules.When advising clients about how to prioritize financial obligations going forward to avoid defaulting on a settlement once established and to circumvent accruals of new liabilities in future years, they are encouraged to eliminate frivolous expenses, luxuries and unsecured debt obligations, when necessary, to stay in good standing with their secure debt obligations. An ongoing payment towards a retainer fee agreement can become counter intuitive for both client and tax professional. Further, the likelihood that payment plans for tax professional fees will continue to be honored by a taxpayer who has already received the benefit of such representation is incredibly low. A licensed professional who expends valuable resources such as their time and expertise would be better off servicing a paying client, rather than a nonpaying client.
The bottom line is, clients are not going to keep paying for a service already rendered when they are faced with staying current with the IRS.
TAXPAYERS OWING TAX LIABILITIES HAVE LOW CREDIT SCORESTaxpayers having delinquent tax liabilities also tend to experience adverse scores on their credit reports. These low credit scores affect taxpayers’ ability to purchase a home, rent a car, or to establish utility accounts, among a variety of other challenges. The reason is because low credit scores tend to provide insight into a given creditor’s ability to receive payment for goods or services purchased. Credit scores show a pattern of behavior with regard to an individual’s or business’s approach to meeting financial obligations in a timely manner.Rather than charge an additional fee to take on the risk of receiving less than their full fee as some vendors do, (i.e., utility accounts, prepaid credit cards, etc.), tax resolution professionals seek to recover their fee upfront or over short payment plans to minimize their risk since their client base is a group that historically struggles to meet its financial obligations.The bottom line is, our client base is being represented to negotiate and resolve the matter of having poor credit. It is not appropriate to establish compensation for services on a credit basis.
RETAINER FEES ARE USED IN THE PRACTICE OF OTHER AREAS OF LAWUnder California Rules of Professional Conduct, and the Model Rules generally, there are several legitimate methods for paying legal fees. The arrangement tends to vary by area and type of case. Contingency fees are often charged in cases involving personal injuries, or insurance coverage. Billable fees are often charged for ongoing litigation, or high-end representation having high stakes. Fixed fees are often charged in the areas of estate planning and contract law. The reasoning often has to do with the situation the client is in when seeking representation and how best to account for the attorney’s fee.With personal injury cases, the client is injured and rushed to the hospital where they receive medical treatment whether they have insurance coverage or not. Hospital bills must be paid and the accident causing the injury may very well be insured; therefore, the attorney takes the case and is willing to be paid contingent upon recovering a settlement. Most legal fees are paid out of the insurance policy settlement.With ongoing litigation, involved research into a variety of obscure areas of law may be required. Long days and nights must be forfeited in preparation for a hearing or trial on docket. Often clients engaged in litigation are suing for the “principal of it,” or for remedies beyond that of compensatory damages, or monetary gain. In situations like these, attorneys will only pour over the matter day in and day out on a billable hour basis. In other words, the client either has got to have a good case for recovery or funds to pay for fees whether they win or lose.
Fixed fees are prevalent for representation that involves an element of repetition with regular modifications by case. These payment arrangements are also common when the taxpayer has limited access to funds for paying their legal fees. Prospective clients must make necessary arrangements to pay the fee in order to acquire professional representation. Examples of areas of law include estate planning services, such as having a will or trust document prepared. Traffic citations, such as DUI’s are often charged on a fixed fee basis. Tax resolution fees are likewise charged as a fixed fee based on estimations for the time required derived from having processed thousands of cases with similar issues. After spending years in the industry, I believe it is a mistake to charge a fixed fee in tax resolution, as some cases take countless hours to resolve, some resolve quickly and do not justify charging the client to pay such a high fee after the hours expended are complete.
The bottom line is, fixed fees are a legitimate form of payment for legal services, but fixed fees are not appropriate for most tax resolution cases.
RETAINER FEES ARE IN THE BEST INTEREST OF THE TAXPAYERIn the majority of tax resolution cases, taxpayer clients receive countless hours of legal representation that they would not be able to afford in a billable hour context. For this reason, The Law Office of Elizabeth Gonsalves charges lesser fees for client communications. Taxpayer clients enjoy countless conversations with the licensed professional, including letters, emails and faxes. Clients benefit from the numerous hours the licensee must spend to review their financial portfolio for submission, the attorney’s time negotiating the case with the revenue agencies. However, it is not appropriate for the licensee to absorb the risk and hit when bureaucratic inefficiencies cause undue delay or error in processing resolution cases requiring resubmission of materials or duplication of work.The bottom line is, retainer fees are fair in that they protect both the client’s interest and the attorney’s investment of time in resolving the tax problem based on time spent. Fixed fees lead to circumstances where the taxpayer pays for work that was never performed and/or the attorney works long hours without receiving reasonable pay.
Liz is regarded as one of the most esteemed and sought after Tax Controversy attorneys in Los Angeles. Her exceptional experience with high dollar clients and complex cases sets her apart as a true professional.
