Try as one may to hide from the IRS it’s usually only a matter of time until the dreaded notice arrives or there is an unexpected knock on the door.  As penalties and interest mount a vast and complex financial reporting system ticks away – matching income and deductions to tax returns, uncovering those who don’t pay or who underpay their taxes.  Maybe a W2 was reported by an employer or a 1099 by a vendor.  Maybe a contractor who paid his subcontractors cash got audited and had to substantiate his expenses.  Maybe a taxpayer consistently pays his mortgage even though his tax returns show very little income.  These are just a few scenarios we see at HBS Tax.  It really doesn’t matter how is happens.  Once it does, the taxpayer is pulled into IRS collections.

Today I will discuss some basics tools the IRS uses in the IRS collection process.  My goal is provide those facing IRS collection an idea of what to expect while clarifying some IRS terminology.

The IRS generally has ten years to collect taxes once it has been assessed.  The term “assessment” simply means the IRS has determined that a tax is due.  An assessment occurs most commonly on the date a tax return is filed.  If a return is not filed the IRS may use its financial reporting system to create a return on the taxpayers’ behalf based on information received from employers (W2s), vendors (1099-misc), banks (1099-Int), and brokers (1099-div and 1099-B).  This return is called a Substitute for Return (SFR).  The amount of tax due determined through an SFR is nearly always to the taxpayer’s disadvantage as it is based primarily on reported income information and lacks many deductions, exemptions, or credits.  Although the IRS can use an SFR to start the collection process, the creation of an SFR by the IRS does not begin the ten year statute mentioned above.  The ten-year clock generally does not start ticking until the taxpayer files a signed return.

Once assessed the IRS has two basic tools to collect past due taxes: the federal tax lien and the federal tax levy.  A federal tax lien is a claim to all property a taxpayer owns at the time a lien arises or obtains thereafter.  Liens arise automatically when taxes remain unpaid ten days after the IRS sends its first notice of taxes due and demands payment.  If the tax due exceeds $10,000 the IRS may file a formal tax lien, notifying the public of its claim to a taxpayer’s property (in February 2011 the IRS announced it was increasing the formal lien threshold from $5,000 to $10,000).  A lien that is formally filed will negatively affect the taxpayer’s credit, harming their ability to buy, sell and refinance properties.  A tax lien remains in effect until the tax is paid, the collection statute expires, or the IRS removes the levy.

The second tool the IRS uses to collect past due taxes is the Federal Tax Levy.  A levy occurs when the IRS physically takes a taxpayer’s property to pay past due taxes.  The IRS can levy both income and property including wages, payments from customers, retirement income, social security payments, state and federal tax refunds, savings and checking accounts, vehicles, real estate, or other valuables.

Although the filing of a tax lien may be more-or-less automatic, the IRS must follow certain procedures before it can take a taxpayer’s property.  The IRS will send a 30 day notice that it intends to levy a taxpayer’s assets.  When this notice is received the taxpayer still has the opportunity to make payment, enter into an installment agreement, or attempt an offer-in-compromise.  The taxpayer may also appeal the levy if they believe the amount due is incorrect or improperly issued.  This appeal must be made within 30 days of receiving the notice of intent to levy.  An appeal can still be made after the 30 day deadline has passed but the taxpayer will be bound by the decision and lose their right to further appeals.

This article has reviewed the basic structure of the IRS collection process and is for informational purposes only.  It has not discussed more specific details including IRS timelines, specific IRS notices regarding past due taxes, or circumstances under which the IRS may remove a lien or forego a levy.  As always, if you find yourself caught up in the IRS’s collection process or would like assistance with any tax situation, please feel free to contact our office to talk with a tax professional.

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