Articles
The Rock or The Hard Place?: Dealing with Federal and State Tax Debt
By Michael P. Duffy on March 30, 2021Taxpayers with both federal and state tax liabilities often find themselves between a rock and a hard place. After all, both the Internal Revenue Service (IRS) and the Massachusetts Department of Revenue (DOR) have extensive collection powers and can impose harmful interest and penalties on delinquent taxpayers.
In general, when a taxpayer does not have the funds to pay both jurisdictions, there is no automatic “right” approach to dealing with back taxes. Instead, multiple considerations need to be taken into account in determining the best path forward. This article is a short summary of issues to consider in resolving liabilities to more than one revenue authority.
Collection Powers
As a matter of course, once the total debt owed exceeds $10,000, the IRS will normally record a lien against a taxpayer personally at the location of their primary residence to put creditors on notice. If the taxpayer has other interests in real property, these will also be hit with a lien. The lien has an adverse effect on the taxpayer’s credit score and frequently disrupts their ability to access any equity in the property. The IRS typically does not move to foreclose on liens, but the filing gives the IRS significant leverage to get the taxpayer to come forward with some sort of workout proposal.
The IRS in some cases will pursue remedies such as garnishments and levies, as well as offsetting any refunds the taxpayer will potentially receive for later periods. Garnishment of wages can be embarrassing for employees with tax problems, as it requires the employer to withhold funds and remit them to the government directly. A levy is probably the most invasive action the IRS can take. A levy is a written order the IRS can issue to a third party who is in possession of the taxpayer’s funds or property. This can be funds held by a general contractor to be paid to the taxpayer, but usually it takes the form of the IRS requesting the taxpayer’s bank to empty the account and turn the proceeds over. Although levies can be reversed, the stress and immediate financial damage to taxpayers can be immense. When tax debt exceeds $50,000, the IRS may also move to revoke a taxpayer’s passport.
The Massachusetts DOR has similar powers compared to the IRS. It can and will file liens, impose levies, and approach employers for garnishments. The Massachusetts DOR does not have the power to mess with a taxpayer’s passport, but it has the power to block the renewal of – or outright revoke – state-issued licenses. This is a general power that applies to pretty much every license that can be issued to a taxpayer, including state professional licenses and certifications. It also encompasses Massachusetts driver’s licenses.
Installment Agreement Offset
Although the IRS and Massachusetts DOR can pursue any number of aggressive actions in collections, these powers normally aren’t exercised if the taxpayer comes forward and enters into a voluntary agreement to make periodic payments. The issue with multiple jurisdictions is this: Which revenue authority should be given priority?
A voluntary agreement to pay taxes is called an installment agreement. Installment agreements with either the IRS or the Massachusetts DOR follow the same general principles in that the revenue authority will look at the taxpayer’s available equity in assets, available monthly income, and regular expenses. The installment agreement monthly payment is based on an analysis of these numbers which more or less reflects the taxpayer’s ability to pay.
In an installment agreement, the IRS’s internal procedures require it to give some allowance for the taxpayer to pay state debt. How much of this debt can be counted as part of the allowable expense formula sometimes depends on when the debt is formally assessed. If the IRS lien has priority that is equal to or greater than any state lien – which is often the case – it may only give a partial expense credit for a state installment payment obligation. If the state has priority, however, the IRS may allow the entire state installment plan payment to be treated as a qualifying expense. This means if the IRS has priority over the state liens, it may be advisable to first approach the IRS with an installment agreement offer to avoid both revenue agencies trying to collect the same available funds.
Although there is some published guidance in Massachusetts, the DOR does not have as much in terms of guidelines relative to the IRS in how installment plans are evaluated. For this reason, it is somewhat unclear whether the Massachusetts DOR will give full credit to an IRS installment plan obligation in computing a taxpayer’s ability to pay.
Statute of Limitations Considerations
Both Massachusetts and the IRS are constrained by something called the statute of limitations on collections which bars them from being able to collect debt after a certain number of years. Assuming a tax is assessed, the IRS and Massachusetts only have ten years to take various collection actions against the taxpayer personally.
With federal income tax debt, any liens filed against the taxpayer or their property become unenforceable once the statute of limitations is up. In Massachusetts, if tax liens are filed against property owned by the taxpayer, the DOR’s position is that these liens can be refiled after the ten-year statute of limitations on collections has expired. The DOR also will frequently request that a taxpayer consent to extend the statute of limitations on collections as a condition to granting an installment agreement. In contrast, the IRS rarely asks for such an extension when it enters into installment agreements.
It is also important to note that many states do not have a statute of limitations on tax collections at all. In any event, state tax debt may have a significantly longer life relative to federal tax debt.
Settlement Potential
Because the statute of limitations on collections is limited, and because installment obligations are constrained by the taxpayer’s ability to pay, the IRS and Massachusetts DOR have incentive to settle tax debts in some cases for less than the full amount owed. Revenue authorities may settle in this manner by accepting partial-payment installment agreements in which the agreed-upon payments will not cover the entire liability by the time the statute of limitations expires. Alternatively, the revenue authority may consider an up-front payment in something called an offer in compromise. Obtaining either of these workout options can be difficult.
The IRS has more published guidance on its requirements for evaluating offers in compromise relative to the available information put out by the Massachusetts DOR. For this reason, a qualified advisor equipped with the relevant facts should be able to reasonably estimate whether the IRS will accept an offer based on their own internal guidelines. Alternatively, whether an offer to the Massachusetts DOR will be accepted is less certain because the state retains more administrative discretion over cases. Additionally, Massachusetts requires all offers approved by the DOR in which the taxpayer’s liability is reduced by more than half or greater than $20,000 to be personally reviewed by the Attorney General’s Office.
Taxpayers lastly need to take into consideration the type of debt they are looking to compromise. Tax debts supported by federal or state court judgments are not eligible for compromise in almost all cases. Taxes that were originally based on amounts withheld on behalf of others, such as employee payroll taxes or sales tax withholdings, are also not eligible for compromise. FT
©2021. This material is intended to offer general information to clients and potential clients of the firm, which information is current to the best of our knowledge on the date indicated below. The information is general and should not be treated as specific legal advice applicable to a particular situation. Fletcher Tilton PC assumes no responsibility for any individual’s reliance on the information disseminated unless, of course, that reliance is as a result of the firm’s specific recommendation made to a client as part of our representation of the client. Please note that changes in the law occur and that information contained herein may need to be reverified from time to time to ensure it is still current. This information was last updated March 2021.
In general, when a taxpayer does not have the funds to pay both jurisdictions, there is no automatic “right” approach to dealing with back taxes. Instead, multiple considerations need to be taken into account in determining the best path forward. This article is a short summary of issues to consider in resolving liabilities to more than one revenue authority.
Collection Powers
As a matter of course, once the total debt owed exceeds $10,000, the IRS will normally record a lien against a taxpayer personally at the location of their primary residence to put creditors on notice. If the taxpayer has other interests in real property, these will also be hit with a lien. The lien has an adverse effect on the taxpayer’s credit score and frequently disrupts their ability to access any equity in the property. The IRS typically does not move to foreclose on liens, but the filing gives the IRS significant leverage to get the taxpayer to come forward with some sort of workout proposal.The IRS in some cases will pursue remedies such as garnishments and levies, as well as offsetting any refunds the taxpayer will potentially receive for later periods. Garnishment of wages can be embarrassing for employees with tax problems, as it requires the employer to withhold funds and remit them to the government directly. A levy is probably the most invasive action the IRS can take. A levy is a written order the IRS can issue to a third party who is in possession of the taxpayer’s funds or property. This can be funds held by a general contractor to be paid to the taxpayer, but usually it takes the form of the IRS requesting the taxpayer’s bank to empty the account and turn the proceeds over. Although levies can be reversed, the stress and immediate financial damage to taxpayers can be immense. When tax debt exceeds $50,000, the IRS may also move to revoke a taxpayer’s passport.
The Massachusetts DOR has similar powers compared to the IRS. It can and will file liens, impose levies, and approach employers for garnishments. The Massachusetts DOR does not have the power to mess with a taxpayer’s passport, but it has the power to block the renewal of – or outright revoke – state-issued licenses. This is a general power that applies to pretty much every license that can be issued to a taxpayer, including state professional licenses and certifications. It also encompasses Massachusetts driver’s licenses.
Installment Agreement Offset
Although the IRS and Massachusetts DOR can pursue any number of aggressive actions in collections, these powers normally aren’t exercised if the taxpayer comes forward and enters into a voluntary agreement to make periodic payments. The issue with multiple jurisdictions is this: Which revenue authority should be given priority?A voluntary agreement to pay taxes is called an installment agreement. Installment agreements with either the IRS or the Massachusetts DOR follow the same general principles in that the revenue authority will look at the taxpayer’s available equity in assets, available monthly income, and regular expenses. The installment agreement monthly payment is based on an analysis of these numbers which more or less reflects the taxpayer’s ability to pay.
In an installment agreement, the IRS’s internal procedures require it to give some allowance for the taxpayer to pay state debt. How much of this debt can be counted as part of the allowable expense formula sometimes depends on when the debt is formally assessed. If the IRS lien has priority that is equal to or greater than any state lien – which is often the case – it may only give a partial expense credit for a state installment payment obligation. If the state has priority, however, the IRS may allow the entire state installment plan payment to be treated as a qualifying expense. This means if the IRS has priority over the state liens, it may be advisable to first approach the IRS with an installment agreement offer to avoid both revenue agencies trying to collect the same available funds.
Although there is some published guidance in Massachusetts, the DOR does not have as much in terms of guidelines relative to the IRS in how installment plans are evaluated. For this reason, it is somewhat unclear whether the Massachusetts DOR will give full credit to an IRS installment plan obligation in computing a taxpayer’s ability to pay.
Statute of Limitations Considerations
Both Massachusetts and the IRS are constrained by something called the statute of limitations on collections which bars them from being able to collect debt after a certain number of years. Assuming a tax is assessed, the IRS and Massachusetts only have ten years to take various collection actions against the taxpayer personally.With federal income tax debt, any liens filed against the taxpayer or their property become unenforceable once the statute of limitations is up. In Massachusetts, if tax liens are filed against property owned by the taxpayer, the DOR’s position is that these liens can be refiled after the ten-year statute of limitations on collections has expired. The DOR also will frequently request that a taxpayer consent to extend the statute of limitations on collections as a condition to granting an installment agreement. In contrast, the IRS rarely asks for such an extension when it enters into installment agreements.
It is also important to note that many states do not have a statute of limitations on tax collections at all. In any event, state tax debt may have a significantly longer life relative to federal tax debt.
Settlement Potential
Because the statute of limitations on collections is limited, and because installment obligations are constrained by the taxpayer’s ability to pay, the IRS and Massachusetts DOR have incentive to settle tax debts in some cases for less than the full amount owed. Revenue authorities may settle in this manner by accepting partial-payment installment agreements in which the agreed-upon payments will not cover the entire liability by the time the statute of limitations expires. Alternatively, the revenue authority may consider an up-front payment in something called an offer in compromise. Obtaining either of these workout options can be difficult.The IRS has more published guidance on its requirements for evaluating offers in compromise relative to the available information put out by the Massachusetts DOR. For this reason, a qualified advisor equipped with the relevant facts should be able to reasonably estimate whether the IRS will accept an offer based on their own internal guidelines. Alternatively, whether an offer to the Massachusetts DOR will be accepted is less certain because the state retains more administrative discretion over cases. Additionally, Massachusetts requires all offers approved by the DOR in which the taxpayer’s liability is reduced by more than half or greater than $20,000 to be personally reviewed by the Attorney General’s Office.
Taxpayers lastly need to take into consideration the type of debt they are looking to compromise. Tax debts supported by federal or state court judgments are not eligible for compromise in almost all cases. Taxes that were originally based on amounts withheld on behalf of others, such as employee payroll taxes or sales tax withholdings, are also not eligible for compromise. FT
©2021. This material is intended to offer general information to clients and potential clients of the firm, which information is current to the best of our knowledge on the date indicated below. The information is general and should not be treated as specific legal advice applicable to a particular situation. Fletcher Tilton PC assumes no responsibility for any individual’s reliance on the information disseminated unless, of course, that reliance is as a result of the firm’s specific recommendation made to a client as part of our representation of the client. Please note that changes in the law occur and that information contained herein may need to be reverified from time to time to ensure it is still current. This information was last updated March 2021.
