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  • Robert Nath

Real World IRS Issues

Updated: Mar 14, 2022



1 - Sell your home even though a tax lien is on file

Here are the real world scenarios. Each assumes the first and additional mortgages pre-date the filing of the notice of federal tax lien (carefully check this), that each mortgage was properly perfected; that the tax lien was filed according to state law requirements; in other words, no procedural, technical slip-ups. Note: These are only the most common ways to deal with the lien. The law allows others.


Tenancy by the Entirety; positive equity; tax owed less than the equity.

You (two spouses) contract to sell your home. It has $100,000 of equity (assume this is after normal closing costs, as projected on the HUD-1). A federal tax lien is on file. Call the IRS or field agent; obtain a payoff figure to the closing date (if you are going to use certified funds (or equivalent) for the IRS at closing), or 30 days later (if not), ask the agent to prepare a Certificate of Release of Federal Tax Lien. Inform the settlement attorney or agent of everything. Have that person include IRS on the HUD-1 disbursements. At closing, the settlement agent will exchange a certified check to IRS for the Certificate of Release. Alternatively, you or someone can bring the check to the IRS office and obtain the Certificate. If you don’t use a certified check, the IRS will wait until the check clears, then file the Certificate in the place where the lien notice was originally recorded. Watch out for accruals of penalty and interest between closing date and that date the IRS actually files that Certificate. Note: Check out http://www.irs.gov/pub/irs-pdf/p1450.pdf for help in obtaining a certificate of release of federal tax lien.

Real World Problem:

The title report reveals (a) duplicate liens, (b) expired liens, (c) inconsistent liens.

Call the IRS agent or the new centralized lien desk 1-800-913-6050; fax: 1-859-669-3805.

Ask the IRS to clean up any expired liens (but note many of these are now “self-releasing” by notice in the original lien itself – banks and other lenders are really not used to this yet; you will have to point out the language and explain it to them).

As for duplicate liens, ask the IRS to prepare Certificates of Release of Federal Tax Lien for each and every IRS notice of lien that is on file. Each filing must be matched by a release, or else the title company will balk at the deal.

As for inconsistent liens, that is, liens that don’t seem to match to similar ones, ask for IRS to fix these, or more likely, to prepare certificates of release for each one.

The IRS will NOT over-collect; the agency will collect only the taxes, penalty and interest that are in fact due, and only once. The agency has a centralized record of what is due and will normally have no problem in eliminating the above problems.


Tenancy by the Entirety; negative equity.

Here, the mortgages that have priority over the IRS lien (because they were filed first) exceed the market value of your home, or exceed the amount you can expect to receive at settlement. So the IRS’ lien is worthless as to this property.

Request a release of the lien on grounds the lien is valueless. Form 14135 and associated instructions tell you how to do this. Go to irs.gov and search on “understanding a federal tax lien” for a comprehensive list of forms, publications and guidance.

Tenancy by the Entirety; one spouse owes taxes, positive equity.

See #1 above. However, the IRS will presume that each tenant is entitled to one-half of the net proceeds; therefore, it will release the lien for that amount. If you believe one tenant has more than 50% of the equity, and state law allows such unequal division, assemble proof of this and make the argument to the IRS.

Tenancy by the Entirety; one spouse owes taxes, negative equity.

Same as Item #2 above.

Joint tenancy – above scenarios.

The general rule is that the sale of property held as joint tenants (not as tenants by the entirety) will follow the same procedures as above. While joint tenancy for residences is rare, it can occur, such as where one spouse has remarried and has not re-deeded the home to the couple “by the entireties”, or where this cannot be done because the tax lien was filed after the divorce (which severs the entirety) and before the re-marriage.

In a joint tenancy situation, depending on state property laws, it may be possible to show that one tenant has a greater or lesser than 50% interest in the property.

2- Refinance your home where tax lien is on file

Among the many reasons for refinancing are: you want to refinance to obtain a better interest rate, or some cash for other uses, or to consolidate several mortgages.

The refinancing can work if the tax lien is (1) removed from the home, or (2) subordinated to the new lender. Note: If the new lender buys the prior loan, then legally the new lender steps into the prior lender’s priority shoes. The tax laws then give it the prior lender’s priority. However, this feature of the tax laws is rarely used.

To remove the lien, the refinance either fully pays the tax lien, or full-pays the equity from the home even if less than the amount of the tax lien. The IRS will then “discharge” the property from the tax lien, giving the lender first priority position.

To subordinate, you must convince the IRS that collection of the taxes will be “facilitated” by the refinance. Normally this means offering to pay some part of the refinance proceeds toward the taxes as a sweetener. Check out Publication 784 for a complete review of how to apply for a subordination of federal tax lien. http://www.irs.gov/pub/irs-pdf/p784.pdf. Discharges of property are discussed in http://www.irs.gov/pub/irs-pdf/p783.pdf.

3- Finance or factor your receivables or assets

You need (or have) a factor for your accounts receivable. The factor will lend only if the IRS is subordinated. To obtain the subordination, send a letter to the IRS Technical Services office in your area. The letter must contain the information required by Publication 784, found at http://www.irs.gov/pub/irs-pdf/p784.pdf.

IRS subordinations normally last 6 months to one year. Then they must be renewed. There is a 45-day window if the tax lien is not subordinated; any new collateral, or any new loan, is protected even against a filed federal tax lien for 45 days after the lien is filed or after the subordination expires.

Office of Technical Services: See Publication 4235, at http://www.irs.gov/pub/irs-pdf/p4235.pdf.

4- Make an Offer in Compromise

Useful links to be reviewed before filing an offer in compromise:

Offer in Compromise:

Is an Offer in Compromise Right for You?:

Filing an Offer in Compromise:

Carefully check before applying for offer in compromise:

Offer in Compromise: Frequently Asked Questions:

First, determine whether you are eligible for an offer (collectibility offer). See above links. Next, complete Form 433-A (or 433-A(OIC). If you own a business (corporation, partnership, limited liability company, or proprietorship), first complete Form 433-B or 433-B(OIC) before you complete Form 433-A. Finally, add your (1) equity in assets to your (2) future income potential to arrive at the offer amount. Then fill out Form 656 (the offer form). Submit with a $205 filing fee to the centralized offer center for your region.

5- Request a Collection Due Process Hearing

“Collection Due Process” and IRS Seizures

The law has always allowed the IRS to take your property for back taxes. The two types of takings are called “levies” and “seizures.” The difference is that a levy is for intangibles, such as bank accounts, stock accounts, etc. A seizure is for objects such as cars, trucks, boats, etc.

Before the IRS can seize any property (under either type), it must give notice to you, the taxpayer. These days, the IRS gives at least two, usually four, pre-levy notices, the final one being Letter 1058 (Final Notice Before Seizure). Don’t ignore those notices. They are your Distant Early Warning system for IRS seizures. It’s best to call and/or write to the address on the notices to let them know you are not ignoring them but are facing up to your tax matter. Then formulate a plan, whether full payment, installment agreement, offer in compromise, bankruptcy, or another plan.

The Final Notice itself allows you to appeal by requesting a “Collection Due Process Hearing.” (Form 12153). However, the grounds for appeal are somewhat limited. This so-called “Collection Due Process Hearing” request is like an injunction, since it prevents further seizure, but only for the time it takes for this appeal to be decided. So the “CDP” is a temporary hold on collection to allow you to argue for collection alternatives.

When you file one, the agent packages the case and sends it to the Office of Appeals. The case agent loses jurisdiction of your case until the CDP appeal is decided. While this is happening, you can still file an offer in compromise, installment agreement request, or other collection alternative. Then you can withdraw the CDP request.

If you decide to go through with the CDP hearing, you can propose any collection alternative, including a full presentation of an offer in compromise (with all financial statements, etc.). Keep in mind if you present your offer at this point, there is no appeal if it is rejected. You may also present spousal defenses, such as innocent spouse, or otherwise contest the accuracy of the taxes, penalty or interest. (The only exception is a case where you already had the opportunity to contest the tax, such as by a Tax Court case.)

CDP hearings are very informal. You travel to the IRS office (or conduct the hearing by phone – a very common alternative). You sit down with the appeals officer, discuss the case, and hopefully arrive at a settlement.

The period of limitations on collection is suspended while the appeal is pending, and for 90 days thereafter. You can appeal an adverse result to the United States Tax Court. Few such appeals are filed; fewer still are successful.

6- Deal with 1099s that are wrong

It happens all the time: the 1099 you received was incorrect in some way. The amount was wrong; the correct amount was in the wrong box. You should have been a W-2 employee. The 1099 results from a legal settlement or damage award that was not taxable (or so you contend). What to do?

First, go back to the issuer; request that a correct Form 1099 be issued. Do this ASAP; often it takes a long time. If that works, no problem. If it does not, assemble ALL evidence showing the error, and be prepared to contest the 1099 on your tax return.

If you exclude the “income” from your return, the IRS will bill you for it and charge a penalty. You can exclude it with a lengthy explanation. That tactic has a better chance of avoiding penalties.

If you include it on your return, then file a claim for refund or abatement, the chances of avoiding the penalties are greater. However, you will still have to pay the tax involved while your claim is pending.

Using either tactic, you will have engaged the agency in a dispute over the tax issue involving the error. That dispute must work its way through the normal audit or collection channels.

7- Keeping and maintaining records

Keeping adequate, accurate, proper tax records is arguably the single most important task you can perform to keep your tax life tolerable. Keeping good records – business and personal – not only means less agony when preparing returns. It also means you will keep more of your money, even after taxes.

Here are the common sense, everyday rules that everyone can follow.

Separate business from personal

Consider the universe of taxes to be divided into two baskets, business and personal. (Yes, sometimes it’s not clear, or mixed.) Keep them physically separated, and separated on your records, such as your computer. Keep separate business and personal bank accounts. Transfer business money to personal as the need arises. Pay all business expenses from the business accounts; don’t “borrow” from one for the other. In general, act as if you have two distinct personalities; after all, the law does this; so should you.

No cash; if cash, use receipts

Don’t pay in cash; don’t accept payment in cash. Use checks or electronic transfers, so that you have a paper or electronic record. Of course, everyone uses cash to some extent. If you pay, get a receipt. That receipt should have date, amount, and item, at least. If you receive cash, give a receipt.

These “no cash” rules are especially important in business, and especially where you have a proprietorship (that is, not a corporation, limited liability company, or partnership). If you are audited by the IRS, the lack of receipts means one thing only: you WILL pay more tax, and unnecessarily so, since with a receipt or check, you could have proved your deductions.

So avoid cash.

Computers and software

Computers are your friend; get to know them. These days, they are so user-friendly that no one should be without them. The agony of adding numbers alone should justify the cost. But there is far more. You can know exactly how you are doing, what you are spending money on, and what your profit is. You can keep your taxes straight; pay payroll taxes electronically. The list is endless.

Get good accounting help.

Few businesspeople can or should do their own accounting, or bookkeeping. Yes, you have a computer with a business program (there are many). But you will also need a part- or full-time bookkeeper and/or an accountant, preferably a certified public accountant. Such a professional will save you far more money than he or she costs, and keep you out of tax and other trouble. You do the sales; you are good at it. Let someone whose job is numbers do that for you.

8- Substitutes for Return (SFRs)

Here is how these techniques show up in the real world, and what to do about them:

  1. You get a notice from the IRS indicating that a “substitute for return” investigation has begun.

  2. You get a notice of IRS assessment with Form “1040A” as the operative form, but you had never filed such a return, or any return.

  3. You get a “statutory notice of deficiency” from the IRS, indicating you have 90 days to contest the proposed tax bill in United States Tax Court.

  4. You get a bill in the mail that seems to show up from nowhere.

Which of the above you receive is a function of where in the SFR process you are. In the end, it does not matter; the SFR can be revised in a number of ways.

First, understand that once the SFR investigation has begun, the agent will not stop it; you are stuck with an SFR even if you file a real, true return later on. See article in Learn More About… section on why this is done.

No matter where you are in the process, your task is straightforward: file a true return, or try to.

Preliminaries

  1. Engage a return preparer.

  2. Call the IRS (or the local agent if the case is “in the field”). Tell them you have begun the process of preparing returns to be filed. They will discuss this with you and assign a deadline. Be sure it’s one you can meet.

Your Income

  1. From the IRS, get a “record of account” for each year involved. Also ask for “third party payor” information, such as Forms 1099 and W-2. Then you will know what the IRS knows about your income. The technical term is “Wage and Income” information.

  2. Get your bank statements for all years involved; they are a check on your gross income.

  3. Look for any other records or evidence of gross income – papers in that shoebox in the corner, or a “file somewhere in the house.” Consult prior returns; go back to employers, partners, etc. for copies of documents.

Your Deductions

  1. Assemble bank statements and cancelled checks from business and personal statements; give them to your preparer.

  2. It’s probably best not to “sort them yourself” before giving them to the preparer. In the real world, you did not do this; that’s why you have an SFR problem. Also, the preparer can organize your raw data far more efficiently than you can. Finally, if you “sort” it, you will miss some deductions the preparer can catch up front. You have hired a professional; let him or her do the work.

Once the returns are prepared, send them, certified mail, return receipt requested, to the IRS. Where you send them is a function of where the case is: if with the field agent, ask the agent. If your case is not yet there, ask the IRS office handling your matter. Otherwise, the default choice is to send the returns to the Service Center applicable to your address.

Normally, the IRS will automatically adjust any prior bills to conform to the new returns you have filed. If they do not, you can formally request “audit reconsideration.” See “Audit Reconsideration” in Learn More About…

Future topics:

  • Trust Fund Recovery Penalty

    1. Are you liable?

    2. Should you defend?

    3. How to defend?


  • Fight a tax penalty

  • Innocent Spouse

  • Transferring property (including real estate) where a tax lien is on file.

  • Close one business, open another

  • Divorce and Separation

    1. Getting the other spouse to pay


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