I Received an IRS Collection Notice: What are My Options?

The July 2012 issue of WTAS’ For the Record described the Internal Revenue Service (IRS) audit process and various options available to taxpayers to bring an audit to a successful close. This article will focus on the IRS collections process and measures that a taxpayer can take to minimize the sting of a collection action initiated by IRS.

IRS describes the collection process as "a series of actions that IRS can take against you to collect the taxes you owe if you don’t voluntarily pay them. The collection process will begin if you don’t make your required payments in full and on time, after receiving your bill." The existence of an unpaid tax liability triggers the onset of the collection process.

Typically, tax liabilities are self-assessed (i.e., the voluntary filing of a tax return) or are the direct result of a tax return review/audit by IRS. In either case, if there are unpaid tax liabilities, IRS will send the taxpayer a bill that includes the tax, interest and penalties. If the taxpayer does not respond to this first bill, IRS will send a second one. If the taxpayer still does not respond, the collection process will begin in earnest.

IRS has 10 years from the date of the assessment to follow through on collection, although this can be extended by such actions as bankruptcy, a Collection Due Process (CDP) Appeal petition or the taxpayer moving abroad. IRS has several tools at its disposal to collect the debt, including the issuance of a federal tax lien which can escalate to a levy, or seizure of property.

A federal tax lien is a legal claim made by IRS against the taxpayer's current and future property. A tax lien automatically comes into existence when an unpaid balance is due to IRS; however, it becomes public when a Notice of Federal Tax Lien (NFTL) is filed. This filing secures IRS' priority as a creditor and, unfortunately, makes the lien publically available. This makes it accessible by consumer credit reporting agencies and can have a negative effect on the taxpayer's credit rating and ability to obtain credit. The most powerful collection tool IRS has is the power to levy. Types of property that can be seized include wages, salary and other types of income including partnership and trust distributions. Additionally, IRS has the authority to seize funds in the taxpayer's personal bank accounts or pending state tax refunds. IRS will seize as much property as is necessary to satisfy a taxpayer's liability, and in some cases, will seize physical property, including houses and cars, to satisfy these debts.

Taxpayers have the option to appeal a NFTL or a Notice of Intent to Levy at a CDP hearing. This program can provide the taxpayer a little breathing space, particularly in the case of a proposed levy, to seek administrative and judicial relief. These measures include innocent spouse relief,  an Installment Agreement, an Offer in Compromise or even bankruptcy. Note that bankruptcy may only eliminate the debt in certain circumstances.

An Installment Agreement (Form 9645) is IRS' version of a payment plan. IRS realizes that due to circumstances beyond a taxpayer's control he or she may not be able to pay the liability off in full. If an agreement can be reached with IRS all applicable interest and penalties will still be charged until the balance is paid in full; however, IRS will not proceed to seize any of the taxpayer's property, and could release or withdraw any tax liens filed against the taxpayer. To be eligible to pay-off a tax liability through an Installment Agreement, the taxpayer must be current with all of his or her tax filings. For agreements of a significant size, the taxpayer can expect to be asked for proof of his or her financial status. The taxpayer should be prepared to create a personal balance sheet and income statement. They will also need to provide their day-to-day cash flows and have supporting records to validate all of this information.

If the tax liability cannot be paid in either one lump sum or through installments, the taxpayer might consider submitting an Offer in Compromise (Form 656) petition. By filing a request for an Offer in Compromise, the taxpayer is asking IRS to consider full settlement of all unpaid taxes for an amount less than the tax owed. IRS may accept an Offer in Compromise if the taxpayer can prove that they have insufficient assets and income to pay the amount due or that paying the amount due would cause economic hardship to the taxpayer.

In general, IRS is looking to collect what they are owed and sometimes a case can be made that its ultimate collection efforts will be enhanced if IRS delays enforcing collection through a levy action. Consider a case where the taxpayer has little equity in the assets he or she holds title to, but has a stable future income potential. By delaying enforced collection, IRS may realize greater collection from future payments. Making this case to IRS could be useful when trying to prevent a levy and reach an Installment Agreement. Alternatively, in order to protect future cash flows, the taxpayer could seek an Offer in Compromise and settle for less than the full amount owed using the little personal equity available. While this may cause some short-term turmoil as the taxpayer's current assets are depleted, it could preserve his or her income over the long run.

There is much more that can be said about the collections process and the various approaches to handling a collection action. It can oftentimes be confusing and overwhelming. Taxpayers should consult a tax advisor when dealing with any IRS action as professional guidance can provide a solid strategy for working through the IRS collections maze.