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Key Moves in Difficult Times: Options for Taxpayers Facing Economic Uncertainty

We are in tough economic times.  A record number of Americans have filed for unemployment benefits, and business owners are forecasting a significant drop in profits, as they seek to cut costs and penny-pinch to make it through the year.  The near-term outlook is tight, as we work together to help fight and pull out of a health crisis.

Despite the difficult times, taxpayers should remain calm, stay focused, and take advantage of the procedural relief offered by the IRS and the Franchise Tax Board to keep your head above the water and eventually get back on your feet.  One procedural move is to timely file your federal and state tax return by the new date of July 15, 2020.  Unbeknownst to some taxpayers, timely filing positions you to avoid civil penalties and obtain further administrative relief from the taxing agencies.  A vital tax controversy strategy is to always to wear that “white hat,” which means making every effort to “get it right,” and that means timely filing tax returns.  IRS agents, and Tax Court judges, look favorably on taxpayers who exercise ordinary business care and prudence and make a good faith effort to do the right thing.  This can go a long way on penalty relief.

Once a taxpayer timely files a return, new doors open, that include, for example, favorable terms on a payment plan, relief from penalties, stopping collection action, and possibly even discharging taxes in bankruptcy.  The IRS generally will not negotiate unless you have filed your tax returns.  So, do not get left out in the cold by not timely filing, even if you lack the means to pay right now.  Things will eventually improve, and so take steps now to avoid a potentially larger tax bill.  Read the following example, so you see where I am going.

I.  Example

Consider John, who was recently laid off from work and has applied for unemployment compensation.  John was counting on his salary to help pay for his 2019 federal and California income tax bill.  Even with the extended deadline of July 15, John is unsure whether he will have the ability to pay and would instead hold on to the cash to pay rent or other necessary living expenses. John wonders if it’s better not to file until he has secured new employment, and then file and pay.

Although some taxpayers may choose to wait, the prudent course of action is to maintain your composure, push forward, and timely file federal and state tax returns.  By taking this action, John sidesteps a potentially steep civil penalty for failing to file by the due date.  Both the IRS and Franchise Tax Board impose a penalty for late-filed tax returns, the penalty can be substantial (up to up to 25 percent of the tax due).  See § IRC 6651(a)(1); Cal. Rev. & Tax Code 19132.  Knowing to timely file a tax return can save significant dollars upfront.

II.  Common Sense Options

Often, when money is tight, taxpayers instinctively do not want to file because they fear a large tax bill in the mail, which they will be unable to pay.  However, the timely filing of a tax return is the key to unlocking other doors, which would be otherwise unavailable to taxpayers, and can provide needed financial and emotional relief.  For example, continuing our example from above, once John has timely filed his tax return, he positions himself for the following options:

A.  Installment Agreement

Otherwise known as a payment plan, this is a written agreement with the IRS (and Franchise Tax Board) to pay the taxes you owe within an extended timeframe.  IRC § 6159.  The advantage of an installment agreement is that it stops all collection action, which means that the IRS cannot seize and sell a taxpayer’s property.  In our example, an installment agreement would give John time to get back on his feet without worrying about the taxing authority levying the money in his bank account.  The catch is that the IRS will not approve an installment agreement if there are unfiled tax returns, and so John’s timely filing of his return positions him this collection alternative.

B.  Penalty Relief

Both the IRS and the Franchise Tax Board impose a penalty when a taxpayer pays late or doesn’t pay at all.  IRC § 6651(a)(1).  In our example, above, if the IRS or Franchise Tax Board imposes late-payment penalties, John should consider filing a request for penalty relief. Given the unprecedented times, the IRS and FTB may be more willing to grant relief, which directly benefits John, because he has a legitimate reason for not being able to pay (financial hardship). The IRS also has a First Time Penalty Abatement policy, which may provide administrative relief to John. See Internal Revenue Manual 20.1.1.3.3.2.1 (11-21-2017) for further details. If the IRS or FTB grants penalty relief, this can be significant savings for John.

C.  Offer in Compromise

Some taxpayers may qualify for relief by filing an offer based upon doubt as to collectability.  An offer in compromise is an agreement between a taxpayer and the Internal Revenue Service that settles a taxpayer’s tax liabilities for less than the full amount owed.  IRC § 7122.  John should consider this option if he cannot pay the liability through an installment agreement or other means (over the life of the 10-year collection statute).  The IRS has helpful information on its website about offers, and there an Offer in Compromise Booklet, Form 656-B, which is worth reviewing. Similar information is available from the Franchise Tax Board.

D.  Currently Not Collectable Status

Taxpayers who lack the means to pay without facing economic hardship may be eligible for currently not collectible status.  If the IRS grants relief, the IRS reports the account currently not collectible and temporarily delay collection until the financial condition improves.  John may want to consider this option, and the IRS has further information on its website.

E.  Bankruptcy

Finally, certain taxes are dischargeable in bankruptcy, and this may be another option to explore; however, taxpayers should timely file their tax returns to position themselves for relief.  Bankruptcy courts do not look favorably on taxpayers who are non-filers.  See Bankruptcy Code § 523(a)(1)(B); Van Arsdale v. IRS (In re Van Arsdale), 2017 Bank. LEXIS 13888 (no discharge of a Chapter 7 debtors’ taxes where debtor filed 2001 federal tax return in 2005, and after IRS had prepared a substitute for return).

III.  Parting Thoughts

In summary, taxpayers should make every effort to timely file by the filing deadline and seek a workout solution with the IRS or Franchise Tax Board. In the long run, taxpayers will be better off financially and can implement a plan to get back on their feet and move forward with their lives.  Taxpayers who have questions or are facing difficult situations would be wise to contact competent tax counsel, who can review the facts of their case, explain the options, and formulate a defensible strategy.