Deconstructing Clients’ IRS Liabilities — Know When to Hold ‘Em, Walk Away or Run Published November 1, 2013
When it comes to the Internal Revenue Service (IRS), its 94,516 employees and some 73,954- plus pages of U.S. Federal tax code, it’s no wonder there are more than a handful of misconceptions about how the service operates. However, by understanding a few basic principles, lenders and consultants can provide better advice to their clients, which may be the difference between a business that survives (and ultimately thrives) versus a business that ceases to exist.
Many, if not most, lenders and consultants upon learning of a substantial tax liability with the IRS will either a) turn and run or b) immediately recommend filing Chapter 11 bankruptcy. While there’s absolutely a time and place for both of these strategies, the vast majority of situations involving the IRS can be better resolved by simply negotiating a reasonable repayment arrangement. As such, it is important to address some common misconceptions.
My client owes too much to the IRS to continue operating, right?
Many lenders and consultants, even business owners themselves, put too much emphasis on the total amount owed to the IRS. They see a substantial liability and conclude there is no way the IRS will allow the business to continue operating. An understandable, but frequently erroneous, conclusion may be reached that the business is not viable based solely (or primarily) on one factor — the amount owed to the IRS.
Focusing primarily on the overall liability ignores a more fundamental question — can the business become and remain current and compliant with its federal tax depositing requirements in the future? Yes, the first question — the sexier question — when analyzing an IRS liability is always going to be, “How much is owed?” However, the more important question is much more basic and fundamental: “Is the business current and compliant with its filing and depositing requirements? If not, can it quickly get into compliance?”
The number one priority by far when dealing with an IRS liability is to a) ensure all returns are filed and b) the business is making its current withholding (941) and unemployment (940) deposits in full and on time. If the business is current and compliant, an Installment Agreement can be negotiated that can include all of the unpaid liability, regardless of whether the amount owed is $100,000, $1 million or $10 million. A business that cannot become and remain current and compliant with future federal tax depositing requirements is not viable. However, if a business is making its current deposits in full and on time, a resolution can be negotiated with the IRS that will allow the business to service its debt and continue operating long term.
A large IRS liability will require large monthly payments, right?
Generally, when business owners (or their consultants and/or local attorneys and/or local accountants who don’t deal with the IRS Collections Division on a regular basis) first speak with an IRS Revenue Officer, the first question is typically, “What is it going to take to make this go away?” At that point, the IRS has the opportunity to frame the issue. Frequently, the revenue officer will respond with something similar to, “We need 25% down and the rest paid within two years.” The business owner (who makes stuff, builds stuff or services stuff, but does not deal with the IRS on a regular basis) may agree to those terms because there is the perception or belief there is no other alternative. That perception is incorrect.
Ninety-five percent of all Installment Agreements with the IRS fail. Sometimes, they fail because the business simply was not viable. However, more often than not, IRS agreements fail because they were set up to fail in the first place. A large down payment combined with a large monthly payment will frequently create problems with cash-flow. If the business pays a large sum up front, the business owner soon faces a conundrum: “I don’t have enough to pay all of my current obligations. Do I make my current federal tax deposits or the monthly installment payment on the back taxes?” If the business cannot do both, the agreement will terminate and the business is in worse shape than before.
There is no basis for the idea that the IRS requires 25% down and the remainder paid within two years. In fact, it’s the exact opposite. The Internal Revenue Manual indicates, “Installment agreements must reflect taxpayers’ ability to pay on a monthly basis throughout the duration of agreements.” The amount of the monthly installment payment should not be based on an arbitrary timeframe or the size of the liability. Instead, the monthly payment should reflect an amount the business can afford, which will substantially decrease the likelihood that the agreement will be defaulted and terminate.
If my client enters into an “affordable” agreement, they’ll be paying the IRS forever, right?
The IRS’s ability to collect delinquent taxes is not infinite. Rather, it’s limited by a statute of limitations, which is generally ten years from the date of assessment. Once the statute of limitations expires, the IRS can no longer collect the debt. At that point, the taxpayer can stop making monthly installment payments.
There’s no need to panic once a liability with the IRS, even a large one, is uncovered. There is a solution. The business needs to ensure all of the required returns are filed. If not already, the business needs to become and remain current and compliant with its depositing requirements. Assuming the business is current and compliant, a resolution can be negotiated to address the delinquent liabilities. It is absolutely critical that the monthly payment be based on a figure the business can actually afford.
If the business can afford a monthly payment that will resolve the liability within the statute of limitations (even two years), great. However, if the business can only afford a smaller payment that will not resolve the liability within the statute of limitations, that’s an acceptable outcome as well. The business can a) remain current and compliant, b) make the affordable monthly payment and c) pay off as much of the liability as possible within the statute of limitations. Once the statute expires, the business no longer makes the monthly payment.
My client cannot obtain funding with an IRS liability, right?
Lenders and consultants are understandably and rightly concerned about IRS liabilities. Lenders want and need to protect their collateral. Once a federal tax lien is filed, the IRS moves into first position on any revolving assets — inventory and receivables — upon actual knowledge of the lender or 45 days from the date the lien is filed, whichever is earlier. The lender’s potential exposure is the total amount of the liability subject to the federal tax lien. Again, the first question in such a situation is always going to be: “What’s the total amount owed?” While this question is reasonable and understandable, it should not encompass the entirety of the analysis.
After determining the federal tax liability and the extent of the lender’s exposure, there are two more questions that should be asked. First, what happened that led to the creation of the federal tax liability? Second, has the problem been fixed? If the answer to the second question is in the affirmative, the total amount owed is much less important. Rather, the lender’s attention should shift to whether the business has entered into a formal Installment Agreement with the IRS.
The Installment Agreement is important on several levels. So long as the business can remain current and compliant and service its debt, regardless of the size of the liability, the business is viable (at least, relative to the IRS). The IRS cannot levy bank accounts or receivables while the Installment Agreement is in effect and in good standing. More importantly, the Installment Agreement is a perquisite for a subordination of federal tax lien, which can put the lender back into the first secured position relative to the inventory and receivables, despite the existence of a federal tax lien. So long as the business has an Installment Agreement in place with the IRS and the lender has secured a subordination of federal tax lien, the lender has nothing to fear from the IRS.
The existence of a federal tax liability with the IRS, even a large one, does not spell doom for the business. The lender or consultant need not turn and run. Chapter 11 bankruptcy, which can be prohibitively expensive and damage cash-flow, is not the only alternative. This is especially the case when the primary justification for filing bankruptcy is the IRS liability. By negotiating an affordable Installment Agreement with the IRS, a) the business can continue to operate, b) the IRS is paid in full (or a substantial portion is paid over the statute of limitations), c) the business can avoid costlier alternatives and d) the lender and/or consultant have a happy and healthy client. In short, everyone wins, which these days is rare (see Congress’ (in)ability to work together and the government shutdown).
Jason S. Peckham, Esq., is vice president of Resolutions for Tax Guard, Inc. Tax Guard monitors federal tax compliance, identifies risks before federal tax liens are filed and resolves federal and state tax liabilities. He can be reached at firstname.lastname@example.org or 303-953-6325.