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Taxing, Briefly: The IRS Collection Process

The Basic Principles of Collection

In our previous post, we discussed how audits are performed and your available options throughout the examination process.  Once the audit is complete, and all administrative and legal remedies are exhausted, how does the IRS actually collect taxes?  The first step in the IRS collection process is assessment.

The IRS cannot collect a tax until it has assessed it. There are a bevy of rules surrounding assessments.  In general, the IRS has three years to assess tax after a return was filed.  If the return was fraudulent, or the taxpayer substantially omitted income, then the IRS has six years to assess.  If no return was filed, then the IRS has carte blanche to assess at any time.  However, it’s the IRS’s stated policy not to look back further than six years. Although this time frame is not absolutely set in stone, it’s a good rule of thumb.

The “Silent” Lien

This next bit comes as somewhat of a nasty shock to taxpayers. At the moment that the IRS assesses a liability against a taxpayer, a lien on all of the taxpayer’s property arises—even if the IRS has not officially recorded it. That being said, this “silent” lien, as it is known, must be recorded to have priority over other creditors. The IRS may send you a Notice of Federal Tax Lien (NFTL) giving you notice that a lien has been recorded—generally in the county where you live.

Twin Rights to a Collection Due Process Appeal

The receipt of a NFTL gives you the right to a collection due process (CDP) hearing with Appeals, which I’ll discuss in a moment.  If the taxpayer does not request a CDP hearing, or if the CDP appeal is not successful, then the IRS can collect an assessed tax through a “levy.” Before levying on the taxpayer’s property (garnishing bank accounts and the like), the IRS must send the taxpayer a Notice of Intent to Levy.  Once again, this notice provides the taxpayer with the right to request a CDP hearing.

What is a CDP Appeal?

Terribly good question.

A CDP appeal is your opportunity to dispute the appropriateness of a lien or levy.  You may raise any relevant issue relating to the unpaid tax or the proposed levy including innocent spouse relief, appropriateness of the collection actions, and you may request a collection alternative (such as installment agreement or an offer in compromise—more on these in a moment).  Importantly, if you did not challenge your underlying liability after receiving a notice of deficiency, you cannot raise it in a CDP appeal.  If you did not receive a notice of deficiency, or otherwise did not have an opportunity to challenge the liability before it was assessed, then you can raise it for the first time in a CDP appeal.

When might you not have been able to challenge a liability before assessment?  Another terribly good question.  The IRS can automatically assess certain penalties without issuing a notice of deficiency.  The easiest way to think about this is that if the IRS believes that you are liable for a penalty, and there is no underpayment or underreporting of tax (which is all a deficiency is), then the penalty is an “assessable” penalty.  This means that the IRS can move past “Go,” and seek to collect its $200 without a notice of deficiency being issued first.

During the hearing, Appeals will verify that all legal and administrative procedures have been followed. Most importantly, Appeals must determine “whether any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the person that any collection action be no more intrusive than necessary.”  Thus, if the IRS is proposing to levy your business’ bank accounts, and you cannot make payroll to pay Bob Cratchit, this likely does not pass muster.  Think of Tiny Tim, you’ll argue.  Appeals’ discretion is rather wide, but most settlement officers don’t have hearts two sizes too small.

The Tax Court Petition

If you still do not reach a resolution through your CDP appeal, the Appeals will issue a “notice of determination” sustaining the lien or levy.  At this point, you will have 30 days to petition the Tax Court to review the determination, most commonly arguing that Appeals abused its discretion in sustaining the collection action.

In complete candor, the vast majority of taxpayers who file a tax court petition at this point are not successful.  Proving abuse of discretion is difficult, if for no other reason than Appeals has such wide discretion.  Nevertheless, if Appeals failed to consider a collection alternative, failed to verify that all legal and administrative procedures were followed, or failed to weigh the legitimate concerns of a taxpayer, etc., the Tax Court may overrule Appeals’ determination.  As with CDP appeal themselves, you may not challenge your underlying liability in a Tax Court petition if it wasn’t raised in the CDP appeal.

A Note on Collection Alternatives

Although you may propose a collection alternative at a CDP hearing, such as an offer-in-compromise (OIC) or an installment agreement (IA), you must make a “concrete” proposal. Appeals is not obligated to create a collection alternative for you.  The IRS (unlike an unrequited lover) need not wait indefinitely for the taxpayer (true love) to submit requested documents (to return on the morrow).  You must also be current with your tax obligations, meaning that you must have filed all of your returns, and you must be current with your estimated tax payments (if any).

Qualifying for a collection alternative is not a painless process.  The IRS will require a financial disclosure (a Form 433-A, for individuals, and a 433-B for businesses) and all of the bank records and other financial documents to support the figures on the disclosure.  This is a time-intensive and laborious process, but a collection alternative—especially an installment agreement—is a far better option than having the IRS levy against your assets.

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