Federal Tax Problems and How to Resolve Them

A federal tax problem describes any situation placing a taxpayer in conflict with the Internal Revenue Service (IRS), from failing to file a return to not paying a tax amount due. Receiving a notice from the IRS is the starting point for correcting the underlying issue. The agency has established structured procedures to help individuals and businesses resolve their obligations and return to compliance.

Deciphering IRS Communications and Identifying the Problem

Receiving mail from the IRS requires prompt attention, as ignoring these communications can lead to more significant consequences. These notices are the agency’s primary method of alerting taxpayers to a potential issue with their tax account. Each notice has a specific code, usually in the “CP” or “L” series, which identifies the reason for the correspondence.

A common notice is the CP14, the first formal notification that a taxpayer has a balance due. Another frequent communication is the CP2000 notice, which is not a bill but a proposal of changes to a tax return. This notice is generated when income and payment information reported by third parties does not match the information reported by the taxpayer, and it gives the taxpayer a deadline to respond.

The CP501 and CP503 notices serve as reminders for an unpaid balance. A more urgent letter is the CP504, a notice of intent to levy. This communication warns that the IRS may seize state tax refunds or other assets to satisfy the outstanding tax liability and is a final warning before collection actions begin.

These notices point to several core problems, such as an unpaid tax liability or unfiled tax returns. Unfiled returns can lead the IRS to file a Substitute for Return (SFR) on a taxpayer’s behalf, which often results in a higher tax liability. Other problems include proposed tax adjustments, often initiated by a CP2000 notice, or an IRS audit to examine a taxpayer’s records.

The IRS Collection Process

When a tax debt remains unpaid after the IRS sends notices, the agency can move into a more forceful collection phase. This process involves legal tools that empower the IRS to secure its interest in a taxpayer’s property and to seize assets to satisfy the debt.

Federal Tax Lien

A federal tax lien is a legal claim against a taxpayer’s property for an unpaid tax debt. The lien arises automatically after the IRS assesses the liability, sends a Notice and Demand for Payment, and the taxpayer does not pay the full amount. The lien attaches to all of a taxpayer’s property, including real estate, personal property, and financial assets.

The IRS can make the lien public by filing a Notice of Federal Tax Lien, which alerts creditors that the government has a legal right to the taxpayer’s property. A filed lien can severely impact a taxpayer’s ability to obtain credit, as it can appear on credit reports. It can also hinder their ability to sell or refinance property.

Federal Tax Levy

A federal tax levy is the actual seizure of property to pay the tax debt. Before the IRS can levy, it must issue a Final Notice of Intent to Levy and Notice of Your Right to a Hearing. This notice provides a 30-day window for the taxpayer to resolve the debt before the levy takes place.

One common form is a wage garnishment, where an employer sends a portion of the taxpayer’s wages to the agency based on their filing status and exemptions. Another is a bank account levy, where the IRS seizes funds from a checking or savings account. The bank must hold the funds for 21 days before sending them to the IRS, allowing a brief period to resolve the issue.

In more serious cases, the IRS has the authority to seize physical assets, including a home or vehicle. The property is then sold, and the proceeds are applied to the tax debt. This is an extreme measure generally used when other attempts to collect the debt have failed.

Resolving Federal Tax Debt

For taxpayers unable to pay their federal tax debt in full, the IRS offers several formal resolution programs. Eligibility depends on the taxpayer’s financial situation and a history of filing all required tax returns.

An Installment Agreement (IA) allows a taxpayer to make monthly payments over time. For those who owe under $50,000, a Streamlined Installment Agreement can often be established without a detailed financial statement. Taxpayers can apply using Form 9465, Installment Agreement Request, or the IRS’s Online Payment Agreement tool.

An Offer in Compromise (OIC) allows certain taxpayers to resolve their tax liability for less than the amount owed, but is intended for those with significant financial difficulty. The IRS considers an OIC based on Doubt as to Collectibility, Doubt as to Liability, or Effective Tax Administration, where collection would create an economic hardship.

To apply for an OIC, taxpayers must submit Form 656, Offer in Compromise, along with Form 433-A for individuals or 433-B for businesses, which provide a detailed financial picture.

For those facing severe economic hardship, the IRS may grant Currently Not Collectible (CNC) status, which temporarily suspends collection efforts. A taxpayer must demonstrate they cannot afford basic living expenses and their tax liability. CNC status is not a permanent solution, as the tax debt remains and continues to accrue penalties and interest.

Correcting Tax Return Issues

Taxpayers may also face issues with the accuracy of their filed returns or a failure to file. Addressing these underlying return issues is often a necessary first step before a taxpayer can qualify for a debt resolution program.

For individuals who have not filed returns for previous years, the process involves gathering income documents, like W-2s and 1099s, and preparing the delinquent returns. It is recommended to file back taxes for at least the past six years to get into good standing. Failing to file within three years of the due date can cause a taxpayer to forfeit any potential tax refund.

When a taxpayer discovers an error on a filed return, they can correct it by filing Form 1040-X, Amended U.S. Individual Income Tax Return. Common reasons include claiming overlooked deductions, correcting dependents, or reporting omitted income. A taxpayer has three years from the date they filed their original return or two years from the date they paid the tax, whichever is later, to file an amended return and claim a refund.

The IRS will often assess penalties for unpaid taxes or inaccurate returns, but taxpayers may have them abated. The First-Time Abatement waiver is available to taxpayers with a clean compliance history for the preceding three years. To qualify, they must have filed all required returns and paid or arranged to pay any tax due.

If a taxpayer does not qualify for FTA, they may request penalty removal based on reasonable cause. This applies when a taxpayer exercised ordinary business care but could not comply due to circumstances beyond their control. The IRS considers factors such as:

• Death or serious illness of the taxpayer or an immediate family member
• Unavoidable absence
• Destruction of records due to a fire or natural disaster
• Incorrect advice from a tax professional that was relied upon in good faith