Where did your tax debt come from?

When I look back on how I ended up nearly 100 pounds overweight a few years ago, I really can’t identify how it happened. I definitely remember hitting 180 lbs and thinking, “Hmmm, I’ve gained a little since I left the Navy.” But when did that become 260 pounds? I honestly don’t remember.

Tax debt can be very similar, especially payroll tax liabilities for small business owners. For individuals, it’s a bit more shocking, since tax time is generally only once per year, rather than four (or even more). The reality, however, is that your tax liabilities didn’t just suddenly appear out of nowhere, just like all my extra weight didn’t suddenly appear while I slept one night.

For the vast majority of taxpayers, both individuals and businesses alike, their very first tax bill stems from a series of events.

For individuals, it can be that you simply don’t pay attention to your tax situation throughout the year (hint: you should!). You think of your taxes as a once a year affair, rather than taking a proactive approach to regular tax planning. Perhaps you got a bonus, a raise, or a gambling win at some point in the year that boosted your overall income for the year into a higher tax bracket, and didn’t adjust your withholding at that time to compensate. Or perhaps you had a large debt forgiven or took money out of an IRA early, and didn’t plan for the tax consequences. Failing to take into consideration a significant life change, such as no longer being a homeowner or losing an exemption and tax credits because of a child growing too old to claim, can also have a major impact on your tax situation.

For businesses, it can start with a rough month, and simply not having the cash laying around on the 15th to make the payroll tax deposit for last month’s payroll. Essentially, it becomes a matter of convenience to skip that Federal Tax Deposit one time. Well, in my experience, that one time becomes an expedience for the entire quarter, then two quarters, with no warning or anything from the IRS. Then, suddenly 8 straight quarters have gone by and you get a tax lien notice and a call from IRS Collections, not to mention you are suddenly informed of the massive penalties, which can double the size of your initial tax debt.

Whenever you have a “life event”, be sure to take into consideration the potential tax consequences. What is a life event? Anything to do with large asset acquisition or disposal (such as a home), anything to do with children, marriage, divorce, bankruptcy, foreclosure, job change, moving, or anything that drastically changes your bank account balance. If you are self-employed, there are even more definitions for a “life event”.

For business owners, don’t fall into the “it’s easier not to pay this month” trap, especially with payroll taxes. The long term consequences simply aren’t worth it. In fact, it’s cheaper to raid your personal retirement plan and pay the 10% early withdrawal penalty than it is to pay the penalties that add up for not paying payroll tax deposits. If you have a short-term cash crunch, it’s also better to put off paying OTHER bills, rather than the IRS. It’s simply cheaper to catch up on rent, utilities, vendors, and other business bills, rather than paying the IRS’ extortion-level penalties.

If your business is experiencing a longer term cash crunch than just one month, than you need to take a serious examination of your business. Cut costs wherever you can. If you have insufficient revenue coming in to cover the complete costs of maintaining an employee (their salary, benefits, worker’s comp, payroll taxes, etc.), then you need to start cutting hours, considering temporary layoffs, and letting some employees go entirely. Yes, it sucks to cut somebody’s hours or lay them off, but you’re running a business, so run it like one.

You should also look at ways to increase revenue. I do not discuss business growth and marketing on this particular blog, as it is not the place for it, but I do substantial marketing consulting and coaching for a number of businesses in various industries, and the most fundamental thing I tell each and every business I work with is this: As a business owner, you are first and foremost a marketing and sales professional, and a contractor, trucker, baker, childcare provider, or chef second. If you don’t embrace this concept, your business won’t survive, pure and simple, so invest the time and money into better marketing your products and services, and you will make more money.

If you take a proactive approach to tax planning, you will never have an unexpected tax liability. Discuss with your professional tax advisor any potential consequences of a life event. Business owners, keep your books up to date and be sure to review your financial statements every month. The vast majority of businesses that I have helped resolve tax problems for over the past four years kept their business records in a drawer, if at all, and failed to properly maintain accounting records (which is required by law, just for the record).

If you need assistance getting your books in order, setting up QuickBooks, selecting a payroll service, or need advice about the tax consequences of a personal life event, please contact me.

How To Deal With An IRS Notice

Most people tend to panic when they receive a notice from the IRS. Many, many people think that by stuffing that notice under the mattress, the problem will go away. Unfortunately, it doesn’t work like that. The best way to address a notice from the IRS is to deal with it immediately and head on. Here are some tips for what to do when you receive an IRS notice.

1. Don’t panic, and don’t shred it. Most IRS notices can be dealt with pretty simply. Not quickly, but simply.

2. Be sure you understand WHAT the notice is for. The IRS sends all sorts of notices — bills for overdue taxes, requests for you to file a missing tax return, to request additional information about something, notify you of pending deadline, etc. The notice will ALWAYS thoroughly explain why you are receiving it. READ IT.

3. Every notice from the IRS will explain what you need to do with it. If they want extra information from you, it will explain what information they need. If it’s a bill, well, then they just want your money.

4. If you receive a notice about a correction to your tax return, you should review the correspondence and compare it with the information on your return.

5. If you agree with the correction to your account, usually no reply is necessary unless a payment is due.

6. If you do not agree with the correction the IRS made, it is important that you respond as requested. Respond to the IRS in writing to explain why you disagree. Include any documents and information you wish the IRS to consider, along with the bottom tear-off portion of the notice. Mail the information to the IRS address shown in the lower left corner of the notice. Allow at least 30 days for a response from the IRS.

7. Most correspondence can be handled without calling or visiting an IRS office. However, if you have questions, call the telephone number in the upper right corner of the notice. When you call, have a copy of your tax return and the correspondence available.

8. Keep copies of any correspondence with your tax records. Also keep record of who you talk to, including their IRS employee ID number (they’re required to give it to you), and detailed notes of your conversation.

If you receive a notice that you don’t understand or don’t agree with, then obviously consider speaking to a professional. Feel free to email me back with a copy of your IRS notice attached and I’ll tell you what it means and what you need to do about it, in simple terms.

Washington State Imposing B&O Tax On Out of State Businesses

A recent tax case in Washington state is starting to garner quite a bit of attention, and is raising significant questions about the extent of state taxing authority.

The case involves a processed food ingredient company that manufacturers rice byproducts and sells them as ingredients in other processed foods. The company operates out of three states, and ships it’s products to other manufacturers in all 50 states.

In 2011, the owner of the company was invited to visit the facility of a customer in Washington State, and he did so. This visit triggered an audit by the State of Washington, and resulted in a $180,000 tax bill for 7 years worth of unpaid business and occupation taxes.

While Washington does not have an income tax, it does have a tax on gross receipts of businesses. The tax rate varies based on the type of business, but as an example equals 1.8% of GROSS annual revenue for service businesses. Different product types have different taxing rates.

The manufacturer has no facilities, no sales reps, no offices, not even any registered vehicles in the state of Washington. By any legal definition, the company does not “conduct business” in the state.

However, the state of Washington has determined that, by making ONE business-related visit to the state, the manufacturer established a taxable presence in the state.

Obviously, this is complete and utter BS. However, it is apparently not an isolated case…simply the most egregious.

As state coffers are drained, they are all searching for every dime they can get their grubby hands on. In order to protect yourself, it is important to know the tax laws in regards to any location where you will be doing business.

Understanding the IRS Trust Fund Recovery Penalty

One of the most common points of confusion among business owners that I discuss tax problems with has to do with the Trust Fund Recovery Penalty. I’d like to explain what “trust fund” taxes are, where they come, how the IRS holds somebody personally responsible for them, and, most importantly, what you can do about them. This is probably going to be a long article, so you might want to get comfortable.

What Are “Trust Fund” Taxes?

“Trust fund” taxes are any tax that is collected by you, on behalf of somebody else. There are many different trust fund taxes, but the two most common are sales taxes and income withholding taxes.

Most states are very aggressive about collecting sales taxes (North Carolina will physically arrest you for not paying them). Technically speaking, sales taxes are owed by the person making the purchase. However, because they are collected at the point of sale, they are a trust fund tax. This is because the person paying them (e.g., your customer) is “trusting” you to hold that tax money and pay it on their behalf. When you receive sales tax money from your customers, you are supposed to hold it in a separate “trust” account, and then hand it over to the tax man when you it is due (usually monthly, in most states/counties).

Income withholding taxes are also “entrusted” to you by your employees. Specifically, these are income taxes you withhold from paychecks, and the employee’s half of Social Security and Medicare that you take out of their paycheck.

Even though the employee never sees the money that’s taken out of their paycheck, they expect it to exist, somewhere. That somewhere is a trust account (generally your payroll account) where you save that money up and then pay it to the government every two weeks or monthly.

Payroll taxes are the single biggest enforcement concern to the IRS. Part of running a business and having employees is “exercising ordinary business care and prudence”. This is fancy lingo enshrined within the tax code that basically means the IRS expects you to exercise common sense in regards to running your business. Part of this common sense is to understand that your employees cost you more than just the paycheck you actually write them, and if your business doesn’t have the revenue to support those extra costs of having employees, then you shouldn’t have the employee.

So, to recap, trust fund taxes are taxes that are owed by other people, such as your customers (sales tax) and employees (income tax, Social Security, and Medicare withholding), but are held by you for actual payment.

Trust Fund Recovery Penalty Personal Assessment

As mentioned above, the collection of payroll taxes is the single biggest enforcement priority for the IRS. Why? Because those taxes are the actual money that funds the Federal government on a day to day basis. Payroll taxes are the Federal government’s biweekly and monthly paychecks from all of us that are working.

Because this is such an important part of funding government operations, trust fund taxes are the only taxes subject to an extremely powerful collections tool. This tool is special to the IRS, because for them, it does not require going to court. This tool is commonly referred to as “piercing the corporate veil”, and means that the government can come after not just your corporation, LLC, or partnership to collect the tax, but can come after individual corporate officers and try to collect these taxes from them personally.

The IRS is required to follow a procedure before sticking you personally with this tax bill. The process is all administrative, meaning that it is done by your Revenue Officer, and does not go to court, never seen by a judge, and no lawyers are involved.

In order to assess the trust fund against you as an individual, the IRS must determine two things:

  1. That you were the person within the company responsible for paying over the trust fund taxes.
  2. That you were willful in not paying them.

The responsible person is generally considered to be the person in the business that manages the finances, calculates payroll, and signs the paychecks. Even if another employee, such as an office manager or bookkeeper, actually does the physical work of crunching payroll and printing the checks, the responsible person is generally the corporate officer, LLC member, or manager that delegated that task to the employee. For most small businesses, the responsible person tends to be the owner. Also, keep in mind that multiple people can be held responsible.

The IRS must also demonstrate that the responsible person willfully failed to pay the trust fund taxes. What this means is that the person made a conscious decision to use that money for another purpose OR failed to make sure the money existed in the first place. In general, the IRS will look at what other bills got paid instead of the payroll taxes, and use that as sufficient evidence that “willful failure to pay” occurred.

The IRS uses a 4-page interview form to ask all the questions to determine who is “willfull” and “responsible”. This is called a Form 4180, and must be filled out by the IRS employee by telephone or in person. Your representative may use industry lingo and refer to this as a “4180 interview” for short — this is what he is talking about.

After a 4180 interview is conducted, the Revenue Officer will make a determination, and issue an IRS form called a Letter 1153, which is usually accompanied by a Form 2751. The Letter 1153 is the document proposing the assessment of the trust fund against you personally, and the Form 2751 is the form you would sign to skip the appeals process and simply accept the assessment.

In some cases, part of the resolution plan worked out by your representative will include simply accepting the assessment, in exchange for something else, such as a payment plan. However, unless your representative explains that it’s part of the plan, NEVER SIGN A FORM 2751!!!

If you did not file an Appeal, the Letter 1153 goes into force, and the trust fund is assessed against you after 60 days. Appeals will be discussed below.

If the Trust Fund Recovery Penalty (the term for the individual assessment) is tacked onto your personal taxes, then you owe it just like you would personal income taxes. At this point, the IRS can come after your personal paychecks, personal assets, personal bank accounts, etc.

Resolving Trust Fund Recovery Penalty Cases

Resolving Trust Fund Recovery Penalty cases can be complicated. The first route usually taken by a tax professional that you hire to help you with this is to fight the “responsible” and “willful” determination. In a larger company, there is often one person responsible, and another willful, but neither is both.

An example of this is a company with a CFO or comptroller that makes financial decisions for the company, and might make the decision to pay rent, utility bills, paychecks, etc., instead of the taxes. However, this person is not the individual that is actually responsible for calculating payroll, signing paychecks, and performing other payroll related functions. In this case, there might be nobody that fits both the “responsible” and “willful” criteria.

Unfortunately, in most small companies, the person that is responsible and willful is generally the same person, usually the business owner. In the case of a small business owned by a married couple, it is fairly common for both spouses to be involved in the financial decision making for the business, which usually makes both of them responsible and willful.

Basically, the smaller the business, the more likely it is that one person, and only person (the owner), is going to get whacked with the Trust Fund Recovery Penalty.

In some cases, the IRS may be willing to delay the assessment of the trust fund against a person. In order to do this, you’re going to need to agree to an extension of the maximum legal length of time that the IRS has for making the personal assessment, which is done by signing a Form 2750 (do not confuse this with Form 2751!). In exchange, the IRS will often accelerate the granting of a payment plan to the business itself, based on the theory that the business will pay off the trust fund over time, and therefore make it pointless to hold you personally responsible.

If the assessment can’t be avoided, then it becomes a personal tax matter. At this point, the other resolution options normally available for personal tax matters come into play, such as payment plans, reduced settlements (Offer in Compromise), and uncollectible status. One thing to keep in mind is that trust fund taxes CAN NOT be eliminated in bankruptcy.

Conclusion

This has been a long article, and probably a lot to digest. However, it explains the entire process of trust fund recovery penalty assessment, where it comes from, and what you can do about it. Hopefully, if you are facing this particular IRS demon, you now have a better understanding of how you can fight it.

While most tax problems really can be resolved on your own, Trust Fund Recovery Penalty cases are one of the few situations where I highly encourage people to obtain professional representation. If you are in this situation, please get in touch with me to to discuss your case.

Do I Need To Include My Wife’s Income In My Offer in Compromise?

Earlier this week, a reader inquired about whether or not he was required to include his spouse’s income when filing his Offer in Compromise. The reason it was in question is because they maintain completely separate financial lives. They file separate tax returns, have separate bank accounts, and don’t even title anything jointly.

Before you question why somebody would do something like that, there are actually numerous reasons for doing so, especially in regards to various aspects of state law. There are also business and asset protection reasons for keeping things separate. For example, if one spouse owns a business or is involved in a profession or activity with a high degree of litigation, then keeping different financial houses can be a good idea.

Here’s the answer to the question: Believe it or not, even if only one person owes the tax liability, the income (and allowable expenses) of everybody in a household must be included in an Offer in Compromise amount. This applies to everybody living in the home — even people just renting a room from you.

Now of course, we work to get the non-responsible party’s income and expenses taken off the reporting requirements, and I’ve never failed in achieving this objective. Under the tax code, the only person responsible for an IRS tax debt is the person against whom it is assessed, and nobody else.

If you need help with your Offer in Compromise, give me a call – (877) 632-5083.