FAQ 1: Foreign Account Tax Compliance Act (FATCA), Report of Foreign Bank and Financial Accounts (FBAR)
Q: What should I do if I receive a Foreign Account Tax Compliance Act (FATCA) letter from my foreign financial institution?
A: The foreign financial institutions send FATCA letters to account holders because they are required to share with the IRS the information of US persons (i.e. US citizens, residents and domestic businesses). These FATCA letters request the account holders to confirm whether they are a US person. Even if the account holders do not reply to the FATCA letters, the foreign financial institution will share the account information with the IRS. If a taxpayer has not fully reported his or her worldwide income or reported the foreign accounts on an FBAR, the taxpayer should speak with a tax attorney to discuss resolution options upon receipt of a FATCA letter.
FAQ 2: Tax Planning
Q: When does tax planning require a tax attorney?
A: A well-executed tax plan can reduce your tax burden. It will also give you peace of mind that any future audit examination will not contain any mistakes in the application of tax law. Both individuals and businesses can benefit from tax planning as tax law is always changing. We advise on complex federal, state and international reporting laws. We frequently work with our clients’ accountants on technical issues.
FAQ 3: Unfiled Returns
Q: What should I do if I have unfiled individual or business tax returns?
A: Depending upon the amount of unreported income and the years of unfiled returns, the taxpayer could be at risk per tax year for willful failure to file a tax return that is punishable up to one year in prison or tax evasion that can carry a five-year prison term. The attorney-client privilege prevents the government from compelling the attorney from sharing confidential communications related to the legal representation. This privilege is very important for taxpayers at risk for criminal prosecution. Typically, the IRS will send a letter to the taxpayer if the tax return was not filed. Even if the IRS has not yet contacted the taxpayer about unfiled tax returns, the problem will not go away. The preparation of old tax returns is a time-consuming process as the records may no longer be easily accessible. Late-filed returns are closely scrutinized by the IRS.
The risk of criminal prosecution significantly increases if a former spouse or employee plans to or has already contacted the IRS with allegations of tax fraud. In this situation, a domestic voluntary disclosure could be the best way to file the old tax returns without a criminal investigation. There are several requirements to be eligible for a taxpayer to make a domestic voluntary disclosure. The taxpayer notifies the IRS of the unfiled tax returns. The taxpayer cannot already be under an IRS audit examination or criminal investigation. The unreported income must be from legal sources. The taxpayer must cooperate with the IRS to determine the correct tax liability. Lastly, the taxpayer must make a good faith effort to fully pay the tax, interest, and penalties.
FAQ 4: Tax Lien Release
Q: The IRS has filed a tax lien against me, how do I get it released?
A: The IRS filed the tax lien to secure the IRS’ creditor interest in collecting unpaid taxes. The lien is subject to a 10-year statute of limitations. Outside of waiting 10 years, the IRS will generally only release a valid lien once the tax debt is fully paid. A tax lien hurts the taxpayer’s credit score and prevents many taxpayers from qualifying for a home mortgage. To help a current homeowner access his or her home equity to pay the tax debt, the IRS will subordinate the tax lien to the lender. Additionally, taxpayers with a tax lien will find it harder to sell their current house. The IRS will discharge a tax lien on a home if the taxpayer agrees to transfer the proceeds of the sale to the IRS to the extent of the lien.
FAQ 5: Tax Levy Relief
Q: The IRS has garnished my wages and seized money from my bank account, how do I get the IRS to stop?
A: The IRS is legally required to send written notification to a taxpayer before initiation a tax levy (i.e. seizure) of a taxpayer’s assets. Thereafter, the IRS has many tools to collect the taxes during the 10-year statute of limitations that begins after the assessment of tax from a tax return, substitute for return or audit examination. If the taxpayer cannot fully pay the tax debt, he or she can request a collection alternative along with a complete Form 433, Collection Information Statement. Form 433 contains a list of the taxpayer’s assets along with monthly income and expenses. The IRS will not consider collection alternatives if there are unfiled tax returns or if the current year’s estimated tax payments have not been made.
If the IRS determines that the taxpayer can fully pay the tax debt during the collection period, the IRS will approve an installment agreement to fully pay the taxes.
If it appears unlikely that the taxpayer will be able to fully pay the tax balance, the taxpayer could propose an Offer in Compromise to settle the tax debt for less than the full amount due. The IRS will review the Form 433 along with the supporting financial statements to determine the taxpayer’s reasonable collection potential. The IRS calculates the reasonable collection potential by adding the value of the taxpayer’s assets to the monthly net income multiplied by the remaining number of months the IRS has to collect the tax debt. If the reasonable collection potential is less than the total tax balance due, then the taxpayer is a good candidate for an Offer in Compromise which can be calculated two ways.
- If the taxpayer chooses to fully pay the offer within 5 months of acceptance, the offer amount is calculated by taking the value of the taxpayer’s assets and multiplying the monthly net income by a factor of 12.
- Alternatively, if the taxpayer needs 6 to 24 months to fully pay the offer, the offer amount is calculated by taking the value of the taxpayer’s assets and multiplying the monthly net income by a factor of 24.
FAQ 6: Trust Fund Recovery Penalty
Q: I am a small business owner and I have several employees. The IRS determined that I was a responsible party who willfully failed to pay my company’s trust fund (employment) taxes. As a result, the IRS assessed my company and me with the Trust Fund Recovery Penalty. The IRS is now aggressively attempting to collect this tax debt from the business and me personally. I am concerned that I am going to lose my business and my home. What do I do now?
A: By assessing the Trust Fund Recovery against the business owner, the IRS now has the legal authority to pursue both the business and the owner for the full balance of the trust fund taxes. If the tax debt exceeds $10,000, it is likely that the IRS will file tax liens against the business and the owner.
Before the IRS will consider collection alternatives, both the business and the owner need to be in current filing and payment compliance. The business and the owner need to ensure that all tax returns for all prior periods have been filed. Additionally, the business needs to make all required federal tax deposits for the current quarter. The owner needs to make all required estimated tax payments for the current year.
The IRS is less likely to shut down a business if it is in current filing and payment compliance.
Only in an egregious situation would a taxpayer be in a situation where the IRS would take his or her home. The IRS will release an IRS levy (i.e. wage garnishment or seizure of bank account) if it is causing an economic hardship.
The business needs to separately provide a collection alternative to the IRS. This typically involves an installment agreement. As long as the business abides by the terms of the installment agreement, the IRS will not pursue tax collection against the business owner.
FAQ 7: Tax Audit Examination
Q: I recently received a letter from the IRS that said my tax return was selected for an audit examination. How can I make this process less painful?
A: The IRS typically selects tax returns for examination based upon red flags such as unreported income or larger than normal deductions. A smaller amount of tax returns is selected at random for audit. Preparation is the key to successful audit defense. The IRS examiner will have many questions about the tax return. It is not recommended that the taxpayer handles the audit on his or her own because anything the taxpayer says could be used against him or her. If the IRS examiner starts to get suspicious about the taxpayer, the scope of the examination may increase for the tax return at issue and may open additional tax years to the audit. Legal counsel will answer the IRS questions and support the positions taken on the tax return to minimize the assessment of additional tax. Taxpayers with substantially underreported income or overstated deductions should stop all communications with their accountant upon receipt of the audit examination letter. In this situation the accountant may be forced to testify against the taxpayer. Attorney-client privilege prevents the government from compelling the attorney from disclosing confidential communications related to legal advice.
FAQ 8: Innocent Spouse Relief
Q: My ex-husband owns a small business. During our marriage, we jointly filed our tax returns that reported the income of my ex-husband’s business. I was not involved with my ex-husband’s business or the tax return preparation. I just signed the tax returns. A few months ago, the IRS examined one of our jointly filed tax returns. My ex-husband handled the audit, but the IRS assessed a large tax bill. Am I eligible for innocent spouse relief?
A: When spouses jointly file a tax return, they assume joint and several liability for the payment of the tax as well as any penalties and interest. Innocent spouse relief removes the innocent spouse from the responsibility to pay the tax, penalties, and interest. All five of the following requirements must be met to qualify for innocent spouse relief. A joint tax return was filed. The understatement of tax was due to erroneous items of your spouse. At the time of signing the joint return, the innocent spouse did not know and had no reason to know that there was an understatement of tax. Based upon all the facts and circumstances, it would be unfair to for the innocent spouse liable for the understatement of tax. The innocent spouse requested the relief within two years of the IRS’ initial collection activity.
FAQ 9: Worker Classification
Q: I am a small business owner. How do I know whether to classify my workers as employees or independent contractors?
A: Employers are required to withhold and pay Social Security and Medicare taxes for employees as well as pay federal unemployment taxes on behalf of employees. However, employers who hire independent contractors do not pay these taxes. The main common law factor for determining whether a worker is an employee or independent contractor is the amount of control the employer has over a worker. When the employer controls the daily work, the worker is more likely an employee. Construction workers are frequently misclassified as independent contractors to save the employer from paying over 7% of the worker’s wages to Social Security and Medicare. If the IRS retroactively reclassifies independent contractors as employees, the employer will be assessed with employment taxes, penalties, and interest.
The IRS provides a safe harbor from retroactively reclassifying independent contractors as employees if the employer meets the following three requirements.
- Reasonable basis for not treating the workers as employees.
- Consistent treatment of workers as independent contractors.
- Filed all the Forms 1099 with the IRS.
For taxpayers that have misclassified their workers as independent contractors, the IRS provides amnesty through the Voluntary Classification Settlement Program (VSCP). Employers are eligible for VSCP if the following three requirements are met. The employer consistently treated the workers as independent contractors. The employer filed all Forms 1099 for the last three years. The employer is not currently under audit by the IRS, Department of Labor or state agency concerning the classification of the workers. Under the VSCP the taxpayer only pays 10% of the employment tax liability that would have been due for the most recent year had the workers been properly classified as employees. Interest and penalties are waived. The IRS is not permitted to audit worker classification for prior years.
FAQ 10: Bankruptcy
Q: Can I discharge my tax debt through bankruptcy?
A: Generally speaking, individuals can discharge their income tax debt if the following four requirements are met:
- Three years have passed since the tax return was due,
- Two years have passed since the tax return was filed,
- 240 days have passed since the tax assessment, and
- The tax returns were not fraudulent.
Before filing for bankruptcy, it is very important to determine if the income tax debt is dischargeable.