Resolving a serious tax liability, whether by way of an Installment Agreement, Offer in Compromise (OIC), or Currently Not Collectible Status, is often a painstakingly difficult, time-consuming, and stressful process. So, the last thing anyone who survives this process needs is to wind up defaulting their agreement. It’s really bad news. Not only will the defaulting taxpayer likely have to go through the entire process all over again, there’s no guarantee they will succeed on the 2nd go around. The IRS or state taxing authority may be reluctant to grant another agreement after a default, and the chances of enforced collections, such as bank levies and wage garnishments, can go through the roof after default.
Unfortunately, tax resolution agreements have a surprisingly high rate of default. If you succeeded in getting an agreement approved or if you have a tax debt that needs to be resolved, read on. I’m going to explain what you absolutely must know so that you won’t wind up with a defaulted agreement. Almost all defaulted tax resolution agreements result from one of five major causes. In no particular order, here’s what you need to know.
1. EMPLOYER WITHHOLDING TAX DEPOSITS AND LATE PENALTIES
Resolution of outstanding back tax liabilities require that no additional liability is accrued. This is the case because one of the IRS’s primary objectives, aside from collecting the tax debt, is to fix the problem once and for all. Thus, all required ongoing tax deposits must be made on time and in full. A missed deposit results in the accrual of an additional liability, which in turn is grounds for the default of the resolution agreement.
A bounced tax deposit may seem similar to a missed deposit, but it is arguably slightly worse as not only is the deposit missed, but the IRS will also assess a bounced payment penalty. The bounced payment penalty is either 2% of the payment or, if the payment itself was less than $1,250, the bounced payment penalty is the lesser of the actual payment or $25. Thus, if the amount of the bounced payment is between $25 and $1,250, the penalty is $25. This may not seem like a big deal, but if one is not aware of the penalty, even if the bounced payment is replaced, a little $25 penalty could default the entire agreement.
Unexpected expenses or inconsistent cash flow can happen even to the most diligent of taxpayers, so the reality is that late deposits can and do happen. For taxpayers who are in a tax resolution agreement with the IRS (e.g. Installment Agreement, OIC, etc.), a late deposit, if not addressed properly and promptly, can result in default. This is because the late deposit results in a late deposit penalty, which is, in and of itself, an additional liability. Your best bet is to avoid late deposits if at all possible. However, if you can’t avoid making a deposit late, it is critical that the late deposit penalty be paid as soon as possible in order to minimize the chances of a default.
Keep in mind that the amount of the late deposit penalty increases as time passes. The late deposit penalty starts at 2% of the deposit amount for deposits that are one to five days late. The penalty then increases to 5% of the deposit amount for deposits that are six to fifteen days late. If the required deposit is more than fifteen days late but paid by the tenth day after a notice and demand for payment notice is issued, the penalty increases to 10% of the deposit amount. If the deposit is still not paid by the tenth day after a notice and demand for payment notice is issued, the late deposit penalty becomes 15% of the deposit amount. Understand that when this penalty reaches the 15% level, the agreement is on seriously thin ice—that is, if it hasn’t defaulted already.
Again, it is absolutely imperative to pay the late deposit penalty as soon as possible but certainly before the return itself is due, not just to minimize the penalty amount, but because once the return is processed the IRS will be made aware of the late deposit (hence the demand for payment notices). It is best to be proactive and resolve any additional liability (including penalties) before the IRS officially assesses it.
2. INCOME TAX: ESTIMATED DEPOSITS AND FILING EXTENSIONS
Quarterly estimated personal income tax payments are often overlooked by taxpayers. The IRS requires that any taxpayer who files a 1040 income tax return (i.e. individual, sole proprietors, or single member LLC) with a liability in excess of $1,000 to make quarterly estimated payments toward the next year’s return in order to minimize the chances of the next year being filed with a balance due. Alternatively, they require an individual taxpayer to increase their W4 withholding amounts to accomplish the same objective.
The due dates of quarterly estimated payments are April 15th, June 15th, September 15th, and January 15th of the following year. If a quarterly estimated payment is not made, the IRS will assess a penalty when the return is processed (even if the tax liability is paid in full), which in turn could default a payment agreement if not paid immediately.
Similarly, C corporations that filed an 1120 tax return with a liability of over $500 are required to make quarterly estimated payments toward the next year’s return to minimize the chance of the next year’s return being filed with a balance due.
Lastly, beware that an extension to file an income tax return is not an extension to pay. The money is due on April 15th regardless of whether an extension is filed. This is confusing to many taxpayers as many do not know what the tax liability will be until the return is prepared. Nonetheless, if the liability is paid subsequent to April 15th, a late payment penalty will be assessed.
The safest thing to do is to simply file by April 15th. If you absolutely must file an extension and you are going to owe, then overestimate the amount due and pay that amount by April 15th. In the event that you wind up with a late payment penalty, paying it immediately will reduce the chances of defaulting your tax resolution agreement.
3. TAX RETURN FILINGS
The same rational that applied to a missed, bounced, or late deposit applies to tax returns. Complete tax compliance is a requirement to maintain any form of tax resolution agreement, and this includes filing compliance. One may believe that an unfiled or a late filed tax return is not as egregious as a missed payment, and in many respects that would be an accurate belief because at least the tax liability was paid. However, without the actual tax return, the IRS does not know if the deposits made were sufficient to cover the entire liability for the period in question. Furthermore, since the IRS relies on voluntary compliance, if a required return is not filed or filed late, a penalty is assessed, which again is grounds for the default of the resolution agreement. Similar to tax deposits, the amount of the unfiled or late filed tax return penalty is dependent on how late the return is filed. Consequently, in order to avoid a default of any existing resolution agreement, filing compliance is a requirement.
4. CIVIL PENALTIES (USUALLY FOR EMPLOYERS)
The accrual of civil penalties for a business is another common reason for a resolution agreement to default because often these penalties are not assessed for several years after the cause of the penalty. There are many ways for a civil penalty to accrue, but the following are the two most common.
The first most common civil penalty results from failing to file the W-2/W-3 reports to the Social Security Administration. These must be filed by January 31st of the year following the year in which the wages were paid. In the event that a taxpayer neglects to file these, the IRS will eventually send the taxpayer a notice instructing the taxpayer to file the missing information to a specific unit within the IRS. Anyone receiving such a letter would be well advised to follow its instructions ASAP. Doing so may minimize the penalty, but the IRS may require that the taxpayer provide a reasonable cause explanation for the non-filing of the reports to get the penalty reduced or completely abated.
Whereas the penalty, especially if not paid immediately, puts the resolution agreement at a high risk of default, it may be advisable to pay it right away even if you are seeking to get it abated. If you succeed in getting the already-paid penalty abated, the IRS will credit the abated penalty to your tax liability.
The second most common civil penalty is a result of reporting and reconciliation discrepancies with the 941 employment tax returns, the 940 unemployment tax returns, and the W-2/W-3 reports. The figures listed on each of the returns and reports must coincide, otherwise a civil penalty will result. These penalties are frustrating because it typically takes at least a year, if not more, for the IRS, State, and Social Security Administration to reconcile their records. Due to the delayed assessment, it is common for a business to not have maintained its financial records for such an extended period of time. Not having financial records makes it exceedingly more difficult to effectively correct the error by the time a penalty has been assessed. In light of this, it is best to avoid getting into this predicament entirely.
5. PERIODIC PAYMENTS (e.g. INSTALLMENT PAYMENTS)
The final most common reason for a resolution agreement to default is also the most obvious. When a resolution agreement requiring monthly or periodic payments is approved by the IRS, the agreed upon payments must be made in full and on time in order to satisfy the terms of the approved agreement.
It is not sufficient if the payment was mailed by the its due date. Rather, it must be received by the due date. Consequently, it is highly recommended that the payment be mailed at least 5 days, if not more, in advance of the due date.
In the event that the IRS claims that a payment was late, it is the responsibility of the taxpayer to prove that the payment was made on time. For this reason, it’s a good idea to send these payments via certified mail/return receipt requested or, better yet, make the payment online.
Another means of ensuring that a monthly payment is made timely is to secure a direct debit payment agreement. This type of agreement eliminates the chances forgetting to remit payment. The downside of this method, however, is that the taxpayer may forget to ensure that there are enough funds in the account on the date that the payment is drawn.
WHEN TO CONTACT A TAX PROFESSIONAL
For those of you with a serious tax liability that has yet to be resolved, consider having a qualified tax resolution professional assist you in negotiating terms. Do-it-yourselfers all too often feel bullied into accepting payment amounts that they may not be able to afford. They also rarely know how to go about successfully challenging the IRS or state taxing authority when an unreasonably high monthly payment is demanded.
Obviously, unaffordable payments drastically increase the chances of default. An experienced tax resolution professional can very often help negotiate more affordable payments, which can easily mean the difference between an agreement that remains intact and an agreement that is destined for default.
For those of you who already have a resolution agreement in place, it’s a very good idea to reach out to an experienced tax resolution professional in the event that a potential default-causing deficiency has happened or is anticipated. It is usually much easier and much less time consuming to prevent a default than it is to establish an entirely new agreement following default.
Fortress has caring and knowledgeable representatives on staff who can help you navigate the best course of action. All you need to do for a no-cost consultation is pick up the phone.