As a general rule, one should always file their tax returns regardless of that person’s ability to pay their taxes. That said, failure to file will not automatically result in a criminal investigation. According to the IRS, the average late filer has failed to file for three years or more and owes approximately $70,000. Furthermore, keep in mind that the IRS tends to prioritize public figures, athletes, movie stars, and similar late filers before going after late filers of a lower profile, and in fact the latter group may be able to get away with a lot more in terms of how much can be owed prior to the initiation of a criminal investigation.
According to the IRS, “IRS special agents must follow strict procedures to initiate an investigation and recommend prosecution to the Department of Justice.” Internal Revenue Service, What a Criminal Investigation Does, available at https://www.irs.gov/uac/What-Criminal-Investigation-Does. Among such procedures is a requirement that special agents seeking to initiate an investigation provide several high-level IRS officials with evidence and documentation supporting the theory that a financial crime or fraud has occurred, but this is preceded by a “primary investigation.” During the “primary investigation,” special agents analyze relevant financial information to determine if a financial fraud or crime is occurring. Ultimately, the information uncovered goes through two levels of approval before the criminal investigation is initiated.
Investigations typically fall into one of four categories: legal source tax crimes, illegal source financial crimes, narcotics-related financial crimes, and counterterrorism financing. Once the criminal investigation is initiated, a variety of techniques are employed by the IRS special agents including “interviews of third party witnesses, conducting surveillance, executing search warrants, subpoenaing bank records, and reviewing financial data.” Id. The special agent or agents, aided by the IRS Chief Counsel Criminal Tax Attorneys, eventually come to a determination as to whether the evidence obtained substantiates a criminal investigation. If so, a “special agent report” is compiled and reviewed by several different higher-ups in the IRS. If it passes these levels of review, the case will be referred to the Department of Justice, tax division for prosecution, and in some cases the U.S. Attorneys Office for non-tax matters.
Prosecution can end in a conviction, plea or acquittal, but it should be noted that the IRS is amenable to pleas, depending upon the seriousness of the crime. More importantly, keep in mind that notwithstanding the leeway that one might have with respect to the lengthy time between failure to file a return and initiation of a criminal investigation, one should always do their best to file on time, regardless of whether or not they can pay their taxes.
Filing a Late Tax Return
There are several implications associated with filing a late tax return, some of which involve the invocation of the IRS’ sweeping enforcement powers. For example, the IRS has the power to “ask” a taxpayer to “take action,” by selling or mortgaging any asset you own, or even by taking out a loan in order to pay your taxes. If this is ineffective, the IRS can levy on bank accounts, garnish wages or other income, or seize assets. This is called an “enforced collection action.” Internal Revenue Service, Filing Late and/or Paying Late, available at https://www.irs.gov/businesses/small-businesses-self-employed/collection-process-for-taxpayers-filing-and-or-paying-late.
Such actions typically will arise not only where taxes are owed, but where the IRS has not been notified why the taxes cannot be paid. Internal Revenue Service, Filing Late and/or Paying Late, available at https://www.irs.gov/businesses/small-businesses-self-employed/collection-process-for-taxpayers-filing-and-or-paying-late Indeed, the law requires that an “enforced collection action” take place where the taxpayer has failed to remit the amount owed the IRS and has also failed to inform the IRS as to the reason for the delay.
In addition to the aforementioned Notice of Levy on assets and income, the IRS can issue a summons to the taxpayer or a third party in order to obtain the information necessary to prepare unfiled tax returns, or at the very least determine whether the taxpayer is able to pay. The IRS can even garnish federal benefits and payments, including social security and federal salary for government employees, through the Federal Payment Levy Program. With respect to businesses, the IRS can assess a Trust Fund Recovery Penalty for certain kinds of unpaid employment taxes. Id.
That said, probably the most common “enforced collection action” emoployed by the IRS is the federal tax lien placed on accounts and assets. While the simplest way to remove a lien is to pay the underlying debt, there are a number of other approaches to lessening the negative effects of a lien, which the IRS may agree to if in the interests of both the IRS and the taxpayer.
A Discharge of Property allows property to be sold free of a lien. Internal Revenue Service, Publication 783 Instructions on How to Apply for Certificate of Discharge From Federal Tax Lien, available at https://www.irs.gov/businesses/small-businesses-self-employed/understanding-a-federal-tax-lien. Subordination of a federal tax lien will not remove the lien, but it will deprioritize as against other creditors, potentially allowing the delinquent taxpayer to get a loan or mortgage. Internal Revenue Service, Publication 784 Instructions on How to Apply for a Certificate of Subordination of Federal Tax Lien, available at https://www.irs.gov/businesses/small-businesses-self-employed/understanding-a-federal-tax-lien. Finally, a withdrawal will remove the federal tax lien from public notice, assuring other creditors that the IRS is not competing for your property. Internal Revenue Service, Form 12277, Application for the Withdrawal of Filed Form 668(Y), Notice of Federal Tax Lien, available at https://www.irs.gov/businesses/small-businesses-self-employed/understanding-a-federal-tax-lien
Taxpayer Assistance Orders
Taxpayer Assistance Orders (TAO) are designed for those who would experience substantial financial hardship by complying with their federal tax obligations. They are most useful for situations where an IRS Operating Division or Function does not agree with the Taxpayer Advocate Service (TAS) with respect to initiating, ceasing, or refraining from taking a particular action, but also where a financially burdened taxpayer seeks to have his or her case reviewed at a higher level. Internal Revenue Service, Internal Revenue Manual, available at https://www.irs.gov/irm/part13/irm_13-001-020.html.
IRC 7811 authorizes the National Taxpayer Advocate (NTA) to issue a TAO, as well as Area Directors (ADs), Local Taxpayer Advocates (LTAs), the Executive Director, Case Advocacy (EDCA), and the Deputy National Taxpayer Advocate (DNTA). Id.
Typically, a TAO will only be considered only when all of these four factors are present:
- the taxpayer is suffering or about to suffer a “significant hardship” if relief is not granted; and
- the significant hardship results from the manner in which the IRS is administering the law, and
- TAS does not have the authority to take the actions needed to grant relief to the taxpayer or to resolve a case issue, and
- the Operating Division or Function (OD/Function) does not agree with TAS on the proper resolution of specific case issues, or the IRS fails to perform the actions recommended by TAS.
A significant hardship can be an immediate threat of adverse action, a delay of more than 30 days in resolving taxpayer account problems, the incurring by the taxpayer of significant costs (including fees for professional representation) if the taxpayer is not granted relief, or irreparable injury to, or a long-term adverse impact on, the taxpayer if the taxpayer is not granted relief, or a serious privation caused or about to be caused to the taxpayer as a result of the particular manner in which the revenue laws are being administered by the IRS per Treas. Reg. § 301.7811-1(a)(4)(ii). Id. Note that a “privation” is more than a mere economic or personal inconvenience.
Probably the most concrete example of the effectiveness of a TAO would be in a situation where the IRS has levied on an account or garnished the wage of an individual that cannot survive without some or all of their wage. In such cases, these persons may need to seek a TAO in order to obtain relief. TAO’s instruct the IRS to take a certain action in a specific period of time, for example, to release a levy within 30 days.
Tax Gap
The tax gap is the Internal Revenue Services (IRS) approximation of the total amount of taxes outstanding. The calculation of this figure is a massive endeavor and only occurs every five years or so. As of 2006, the voluntary compliance rate through the U.S. was relatively unchanged at approximately 83%. Internal Revenue Service, The Tax Gap, available at https://www.irs.gov/uac/The-Tax-Gap.
Among the factors contributing to a less-than-perfect voluntary compliance rate, underreporting of taxes is by far the largest factor, and the underreporting of personal income tax is by far the largest underreporting factor. Underreporting of corporate income tax and employment tax are also substantial detractors from expected tax revenues. Internal Revenue Service, Tax Gap Map, available at https://www.irs.gov/statistics/irs-the-tax-gap
In order to undertake this monumental data collection and analysis, the IRS collects 14,000 returns for individual income tax research audits, i.e. random audits on an annual basis. These figures are representative of the larger population, and can then be combined over multiple years to obtain a larger sample.
Various methodologies are employed to collect the data. For example, individual income tax underreporting is collected using Detection-Controlled Estimation (DCE) to account for income that taxpayers do not report on their tax returns, which National Research Program auditors are unable to detect.
Clearly the methodologies are not 100% accurate, but they provide a fair estimate of the efficacy of the revenue collection infrastructure that the IRS oversees. Ultimately, the goal is to improve voluntary compliance, which is by far the most efficient and effective means for increasing federal tax revenues. To illustrate, the IRS collects nearly $2.7 trillion in tax revenues, only about $50 billion of which is revenue obtained through enforcement actions. Internal Revenue Service, Update on Reducing the Federal Tax Gap and Improving Voluntary Compliance, available at https://www.irs.gov/pub/newsroom/tax_gap_report_-final_version.pdf.
According to a recent New York Times article, “[t]he bulk of unreported income is among unincorporated businesses, which can much more easily hide income from the I.R.S. than workers who primarily earn wages from which their employers withhold taxes.” Bruce Bartlett, “The ‘Tax Gap,’” New York Times, available at https://irssolution.com/blog/criminal-investigations/
Whether underreporting of personal income tax or corporate and employment tax, it is clear that underreporting is the major cause of the tax gap, and that issue will be the primary focus of future IRS initiatives to close the tax gap.
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Please keep in mind the information and advice presented in this blog is not intended to be used as formal legal advice. Contact a tax professional for personalized tax advice pertaining to your specific situation. While we try and answer all parts of the question when we write our blogs, sometimes there may be some left unanswered. If you have any questions about your problems with the IRS, SBOE, FTB, or BOE, or tax law in general, call RJS Law at (619) 595-1655.
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