BY GREG MERMEL, C.P.A.
Most people never deal with any part of the Internal Revenue Service except what is known (perhaps euphemistically) as Taxpayer Service. They handle the inquiries about forms and refunds and mailing addresses–all the general and miscellaneous questions and requests. These folks are generally polite and helpful, within the limits of their knowledge. Their reputation for often giving wrong answers reflects the complexity of U.S. tax law and the IRS’s inadequate training budget rather than any lack of caring.
A few taxpayers (less than one percent each year) get to deal with the Examination Branch, which does audits. While undergoing an audit is no fun, most auditors are not combative and want to hear what you have to say. They are looking for accuracy, and are open to a give-and-take dialogue.
What, then, makes people so afraid of the IRS? It is the parts of the IRS that demand money.
Be Scared. Be Very Scared
The IRS’s collection branch has a fearsome reputation: mean, rude, implacable, nasty people who will say and do anything to collect money. Partly, this reputation mirrors the guilt that almost anyone feels when called about money they owe. But to a large extent, that reputation was earned. Ten years ago, I shuddered when a client’s case got sent to collection. Particularly if it went to one office that handled much of Chicago, I knew there was a good likelihood I would be snarled at, lied to and accused of almost anything this side of President Kennedy’s assassination–and it wasn’t even my tax debt.
What came out during later Congressional hearings about IRS abuses was a management problem. IRS collection personnel were evaluated almost exclusively on how much money they collected. Not how many cases were properly closed, or how many taxpayers were brought into long-term filing and payment compliance, or how the taxpayers were treated. Money collected, by whatever means, was all that counted.
The IRS Restructuring and Reform Act of 1998 led to drastic reorganization of the agency. What had been a region-based structure was changed to a functional one: These centers handle individuals, those handle small businesses, these others handle large businesses, and so on. Doing this broke up old structures and fiefdoms, making a change in organizational culture possible. The IRS now has a congressionally-mandated mission of fairness and open communication. They have made a mammoth effort and have made good progress, though they are nowhere near done.
Since then, the IRS has tried to step lightly in collections. Bad reputations die slowly, though, and the IRS still has a powerful array of legal tools available. Lately, I have seen stepped-up collection activity. The pendulum, I suspect, is about to swing the other way.
Your Number Could Be Up
Not every IRS communication asking for money comes from the collection branch. For example, suppose you filed an extension; when you later filed your tax return, you owed money and sent the payment with the return. You would, in due course, get a notice asking for interest and a late-payment penalty. This does not come from collections; neither will the second, third or fourth such notice. But if you do not pay the balance, it will eventually go there.
Similarly, the under reporting notices do not come from collections. These result from the matching program, where the IRS’s computers compare the income you reported on your tax return with the W-2s and 1099s that payers submitted. If it appears you did not report all of your income, you get a scary, multi-page notice recomputing your tax and asking for that, along with penalty and interest. You can explain why you are right, or agree with the change and pay. Ignore it, and they will assume they are right. After enough notices, this, too will land in collections.
Collections is involved when you answer the phone and the voice says, "This is Mr. X from the Internal Revenue Service, employee number so-and-so. I need to talk to you about your unpaid taxes." Or when the mail carrier brings a copy of the notice sent to the bank, seizing your bank account. Or when you answer the doorbell, and the person standing there hands you a business card identifying herself as a Revenue Officer.
R.O.s are the elite troops of collection, with broad discretion to act. If one appears on your doorstep, you should seek professional tax help immediately.
Can’t Get Blood from a Turnip...or Stone...or Whatever
The IRS is generally reasonable about making installment payment arrangements for most kinds of taxes. Their stated policy is that they will automatically approve any agreement that pays off a debt of $10,000 or less in a year, and in practice, $20,000 and two years are almost always approved. Bigger amounts, or longer periods of time, require some negotiation and submission of detailed financial data to prove you cannot pay the taxes any other way. They will, of course, be much less reasonable if you have a history of broken installment agreements.
If you really have nothing, but might next year after you get off unemployment/recover from surgery/resolve the SEC litigation, the IRS may classify your debt as "temporarily not collectible." Unlike years past, when this category was a dumping ground for the truly uncollectible, you will hear from them regularly and they will watch the income you report each year.
The only way the IRS will permanently settle a debt for less than the full amount is through their Offer in Compromise program. To avoid abuses of discretion by IRS field workers (a former problem in this program), they use a strict formula to determine what is an acceptable offer, either as a lump-sum payment or over five years of installment payments. Any amount above that will be written off, provided you stay in strict compliance–file on time, pay on time–for five years from the date your offer is accepted.
Or if you are completely swamped in debts, you could consider bankruptcy. Not all taxes, however, can be discharged in bankruptcy. The rules are complex and confusing, but you can safely assume that any income tax debt less than five years old will not be wiped out.
Are there money or tax questions you would like to see discussed in this column? Let me know, at 2835 N. Sheffield, Suite 311, Chicago, IL 60657, or 773/525-1778 (888/525-1778 outside the Chicago area).
Greg Mermel is a certified public accountant whose clients in the arts range from individual performers to major theatre companies and suppliers. He also sometimes produces theatre.