Collections - Part V

The Collection Information Statement - Form 433

Undoubtedly, if you spend more than a few casual minutes representing clients in tax controversies, you will become very adept at filling out this Form, as it will be routinely requested just about any time you make a request for either an installment agreement or an offer-in-compromise (barring the exceptions for a streamlined agreement, O-I-C based upon doubt as to liability, etc.).

How does the Government use these Statements?

These statements require the signature of the taxpayer under the penalty of perjury. While these statements are the representations that are made by the taxpayer (your client), beware - there is an implicit understanding that you are making the submission on the client's behalf.

Accordingly, there is a responsibility for due diligence. You never want to knowingly make a false statement to an IRS employee or submit a false document.

Revenue Officers, offer specialists and other service employees will investigate everything on the Collection Statement. Be very careful not only to be truthful in what is submitted, but equally careful to ensure that EVERYTHING is included. Failure to disclose assets or liabilities could cost YOU "demerits" in your credibility and effectiveness in representing this particular client (at best)... At worst, let us not even go there...

Collection Standards

"Allowable Expenses" are claimed on Form 433. The Bureau of Labor and Statistics has helped to develop a series of Collection Financial Standards, as follows:

a. National Standards for food, housekeeping supplies apparel and services, personal care products and services, and miscellaneous.

Taxpayers are allowed the total National Standards amount for their family size and income level, without questioning amounts actually spent.

Find these standards at: http://www.irs.gov/businesses/small/article/0,,id=104627,00.html

b. Local Standards: Unlike the National Standards, the taxpayer is allowed the amount actually spent or the standard, whichever is less

i. Housing and Utilities Standards http://www.irs.gov/businesses/small/article/0,,id=104701,00.html

The housing and utilities standards are derived from Census and BLS data, and are provided by state down to the county level.

ii. Transportation http://www.irs.gov/businesses/small/article/0,,id=104623,00.html

The transportation standards consist of nationwide figures for monthly loan or lease payments referred to as ownership costs, and additional amounts for monthly operating costs broken down by Census Region and Metropolitan Statistical Area (MSA). Public transportation is included under operating costs. A conversion chart has been provided with the standards which shows which IRS districts fall under each Census Region, as well as the counties included in each MSA. The ownership cost portion of the transportation standard, although it applies nationwide, is still considered part of the Local Standards.

The ownership costs provide maximum allowances for the lease or purchase of up to two automobiles if allowed as a necessary expense. The operating costs are derived from BLS data.

If a taxpayer has a car payment, the allowable ownership cost added to the allowable operating cost equals the allowable transportation expense. If a taxpayer has no car payment, or no car, only the operating costs portion of the transportation standard is used to come up with the allowable transportation expense.

Some Practical Advice

1. ALWAYS have your clients complete the Collection Statement (at least in draft mode). I typically give the statements to a client and tell them to bring them back to me in a week or so when we will go through them thoroughly.

2. The completed statement (in your clients handwriting) should remain in your file together with your own notes/impressions written in a different color on the Forms. These will be your working papers if your practice is to type the statements prior to submission.

3. Consider including detailed back-up schedules or narratives to help explain any item on the Form that lends itself to explanation - think of these as footnotes on a financial

statement or tax return. Even minor details become important if the reviewer believes you failed to include them.

4. Remind your client to include items that he/she may not think are taxable. This is not a tax return so whether something is taxable or tax deductible is not important (with respect to disclosure).

5. Remind your client to include credit cards that he/she may have access to even if he/she is not primarily liable to the creditor. If there is doubt, insist that your client obtain a copy of his/her credit report. The IRS employee will do exactly that, and you do NOT want to be blindsided.

VI. Innocent Spouse

Have You Ever Met an Innocent Spouse?

People may sometimes walk into your office claiming to be an "innocent spouse", but the truth is, as a practical matter, the IRS can (and often will) still turn you down, even when you think you have the "perfect" innocent spouse.

"Historical" Innocent Spouse under the Internal Revenue Code

In the evolution of the "Innocent Spouse", the original elements for relief were:

1. Joint return must have been filed;

2. Substantial (i.e., in excess of $500) understatement of tax attributable to grossly erroneous items of one spouse;

a. A "grossly erroneous" item is is one in which there was no basis in fact or law for the deduction or omission of the item from income.

3. The requesting spouse did not know or have reason to know there was a substantial understatement at the time the return was signed;

4. It would be inequitable to hold the requesting/innocent spouse liable for the deficiency atttributable to the substantial understatement, taking into account all facts and circumstances.

Wider relief under Internal Revenue Code Sec § 6015

Congress passed Code Sec. § 6015 to replace and liberalize the previous provision. New among the provisions was the authority given to the IRS to grant equitable relief to taxpayers who otherwise would not have found relief under the old statute. Claims were separated into three different types:

(1) IRC § 6015(b)

1. a joint return has been made for a tax year;

2. there must be an understatement of tax attributable to erroneous items of one individual filing the return;

3. the requesting spouse establishes that in signing the return he or she did not know, and had no reason to know, of the understatement; and

4. after looking at the facts and circumstances, it would be inequitable to hold the requesting spouse responsible for the deficiency

(2) IRC § 6015(c )

• When an understatement of tax causes a deficiency on a joint return, an innocent spouse may elect to have his or her liability assessed based on his or her own items on the return.

• On the date the tax return was filed, the spouses are either no longer married, or they are separated or are not members of the same household at any time during the 12-month period immediately preceding the election.

• Disqualified IF requesting spouse had actual knowledge of an item that gives rise to a deficiency that is attributable to the other spouse (the nonrequesting spouse).

(3) IRC § 6015(f)

• Equitable relief which applies to both an understatement of tax (i.e. a deficiency) OR to an underpayment of tax (i.e., a balance due tax return);

• Two necessary elements:

1. the requesting spouse must prove, taking into account all surrounding facts and circumstances, that it would be inequitable to require the taxpayer to pay the liability; and

2. relief is not available to such an individual under 6015(b) or 6015(c).

• In deciding whether responsibility to pay the tax would be inequitable, a number of facts weigh against and in favor of granting relief. Factors supporting relief include, but are not limited to: present marital status of the couple; economic hardship; and abuse.

Factors against relief include: knowledge of the deficiency or unpaid tax; lack of economic hardship; education level of the requesting spouse; and business participation of the requesting spouse.

• Rev. Proc. 2000-15 and more recently, Rev. Proc. 2003-61

The practical reality of working with trying to establish Innocent Spouse Relief

In a very worthwhile article in the February-March, 2004 issue of the Journal of Tax Practice & Procedure, authors Larry Jones, Catherine Keith, Emily Jones and Nisha Patel describe the fatal flaw. The statute is still too vague and uncertain.

Recall that under § 6015 (b), an innocent spouse must not have known, or have reason to have known about the understatement. In deciding whether a spouse "has reason to know", courts have considered the following:

1. the requesting spouse's level of education;

2. the spouse's involvement in the family's business and financial affairs;

3. the presence of expenditures that appear lavish or unusual when compared to the family's past income levels, income standards and spending patterns; and

4. the culpable spouse's evasiveness and deceit concerning the couple's finances

These factors are taken into account during a subjective decision process by an IRS employee whose objective it is to collect money.

In focusing on § 6015 (c), an innocent spouse would be granted relief if there was proof that thte innocent spouse did not have actual knowledge of the item giving rise to the deficiency at the time such individual signed the return. The courts have held that § 6015(c) bars relief for all spouses with actual knowledge of the item, even if they lacked knowledge of the incorrect tax retporting of that item. To be denied relief, then, an innocent spouse only needs actual knowledge of the item giving rise to the deficiency.

In focusing on § 6015(f), while we do have Rev. Proc. 2003-61, its application is still vague and uncertain. No bright line test or clear guiding principles exist. Some of the factors used to make a determination include marital status, economic hardship or abuse.

• Should relief be denied to a college graduate living a lavish lifestyle in an abusive marriage because he/she should have known?

• Should relief be granted to a person with only a high school degree, living a middle class life, yet in a nonabusive relationship? Are we to assume that an innocent spouse had reason to know that his or her spouse had made an understatement on the return merely because he or she has a college education vs. a spouse with only a high school education where the family has a higher annual income?

• Is it not possible that the educated spouse may have no indication of the existence of an understatement simply because his or her abusive relationship prevents him or her from making such an inquiry?

Problematic - In most marriages, one spouse typically does handle the finances

This is precisely the reason why obtaining innocent spouse relief can be so difficult. The IRS would suggest that both spouses should prepare their tax return together and be equally involved in understanding every item on the tax return. The authors (of the Article in the Journal of Tax Practice and Procedure) go on to point out that this is too burdensome in most marriages. And if a couple is happily married, there is a trust that should exist and extend to the tax returns. When it comes to tax returns, it should not be necessary to inquire into every financial detail when a spouse has given their word. By imposing a duty to inquire, the IRS is in effect creating nothing more than discord, distrust and anxiety.

VII. Freedom of Information Act Requests - "F.O.I.A." - An Important Tool

The United States Code provides for a citizens' access to information that does not pose any harm to national security and/or does not violate the privacy of another citizen. In particular, when the information sought after involves the Taxpayer, the Taxpayer has a right to request access to that information.

The F.O.I.A. Request, then, is a tool for acquiring information that we need in order to effectively represent a client. I routinely use this tool when I am brand new to a case that has evolved before my having been retained, and the client is not sure WHAT has happened or WHEN they have happened. Typically, this client has either saved very few of the documents, OR more likely, did not receive or does not otherwise have access to the documents.

This can and does happen in cases involving marital disputes [which are ripe for innocent spouse cases], business disputes [which are ripe for Trust Fund Recovery Penalty cases], and in those cases where Audit Reconsideration may be appropriate [records were lost or destroyed]

A sample F.O.I.A. Request is attached to the appendix.

VIII. Ethical Considerations - Remain True to Yourself

Beginning in the Spring 2005, UCLA Extension began offering a course that I wrote entitled: Ethics in Accountancy. This course is now required of all students in the accounting program. In this 6 week, 18-hour course, we devote approximately 4 ^ classroom hours to the topic of ethics in income taxation.

We begin that class session with a discussion of tax fraud vs. tax evasion vs. tax avoidance

FRAUD: Neither the Internal Revenue Code nor the Regulations contain a specific definition of fraud. The Internal Revenue Manual defines fraud as consisting of "... deception by misrepresentation of material facts, or silence when good faith requires expression, resulting in material damage to one who relies on it and has the right to rely on it. Simply stated, it is obtaining something of value from someone else through deceit" [IRM 25.1.1.2]. Tax Fraud requires an underpayment of taxes by the taxpayer with a fraudulent intent.

TAX AVOIDANCE: Avoidance is perfectly legal and must be distinguished from tax evasion, which is illegal (and criminal). All taxpayers have the right to minimize their tax liability by legitimate means [some authors refer to this as

tax mitigation]. "One who avoids tax does not conceal or misrepresent, but shapes and preplans events to reduce or eliminate tax liability within the parameters of the law " [IRM 25.1.1.2.4]

TAX EVASION: "Evasion involves some affirmative act to evade or defeat a tax, or payment of a tax. Examples of affirmative acts are deceit, subterfuge, camouflage, concealment, attempts to color or obscure events, or make things seem other than they are. " [IRM 25.1.1.2.4]

Here is a case study that we spend a fair amount of time discussing:

CASE #1

Miss Hardluck engages your services to assist with her filing an Offer- In-Compromise, based upon doubt as to collectibility. You are careful to review all of Miss Hardluck's financial documents and take the time to carefully ask all of the appropriate questions. After months of painstaking research and document gathering, you are finally ready to submit the Offer-In-Compromise. Together with Miss Hardluck, you determine that the appropriate offer amount is $1,500 - which will extinguish her tax debt in excess of $75,000.

It takes months to go th rough the process with the IRS Offer Specialist, but thanks to your zealous advocacy, the Offer is accepted!

Miss Hardluck stops by your office to thank you for your diligent effort and hard work and off- handedly tells you that she is glad that the Internal Revenue Service did not find out about the $300,000 lottery that

she won two months prior to filing the Offer. She reveals that her sister agreed to cash in the winning ticket in exchange for the taxes that would be due on the lottery winnings, plus $50,000. The remainder of the winnings were held in a bank account with her sister listed as the account holder in order to keep the Internal Revenue Service from tracing the winnings back to Miss Hardluck. Miss Hardluck used a debit card to make withdrawals from the account as necessary, again so the transactions could not be traced back to her.

What advice do you have for Miss Hardluck?

What exposure, if any might you have?

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