It’s not unusual for CPAs to encounter clients delinquent in filing individual, corporate or payroll returns. CPAs can establish a rewarding practice niche if they are prepared to offer a full range of tax resolution options and be a trusted ally to clients who need to atone for their lapses and get right with Uncle Sam.
This work often involves preparing a number of prioryear tax returns. It requires knowledge and research of changing tax laws, the use of tax software from prior years, the interpretation of IRS taxpayer transcripts, and the ability to reconstruct income using various sources such as Freedom of Information Act (FOIA) requests. It requires CPAs to understand administrative tax law and learn new ways of client management. Thus it demands specialized skills that should command higher-than-usual hourly rates and often requires many billable hours.
The CPA must be vigilant for any indications that clients are involved in willful tax evasion other than by not timely filing or paying their taxes (for example, not reporting illegal income, using fictitious Social Security numbers or filing as a tax protester). If there is even the slightest suggestion that the client has committed an illegal act, immediately stop the interview and have the client call a tax attorney. You must prevent the client from revealing any potentially incriminating information. The client needs legal representation, and if you are to continue working on the case, you need to be retained by the attorney under a “three-corner agreement.”
Before representation begins, it is imperative that an engagement letter be completed and signed. The letter should address which current and past-due tax returns will be prepared and which tax resolution procedure—such as a payment plan, a request for an abatement of penalties, innocent spouse relief or an offer in compromise (OIC)—you expect to pursue. It should also state your estimated fee and that:
- The fee will be based on the actual hours worked.
- You will provide progress billings.
- A retainer of a certain amount (as large as possible) will be required before any work is performed. You should also complete an IRS power of attorney, Form 2848, covering the current year and all open years. You must indicate on it which tax forms you are representing the client on. It may be advisable to include forms that might later need to be added. A separate power of attorney should be completed for corporations and other entities with a federal identification number.
- A positive retainer balance must be maintained at all times for you to continue representing the client. Even though it may take months for the IRS to start working on the taxpayer’s case, once it does, you will be required to respond quickly.
- If any required retainer payment is not timely received, your power of attorney will be promptly revoked.
The engagement letter should also include a statement that while you will represent the taxpayer to the best of your ability, you cannot guarantee favorable results. While IRS decisions may be subject to appeal, the final results are beyond your control.
You will need to obtain transcripts of account (also known as a record of account or summary record of assessment) and “payer transcripts” (which include forms W-2, 1099, 5498, etc.) for at least the prior 10 years. To the extent there has been any prior audit or collection activity, a FOIA request should be used to obtain copies of IRS files so that the CPA is aware of the IRS’ prior interaction with the client. If the client has filed a tax return for the three prior processing years, the CPA should request a “return transcript,” which reflects summary information from the return.
The IRS usually has 10 years from the date of assessment to collect delinquent taxes by levy or proceeding in court (IRC § 6502(a)(1)). Assessment does not occur until the returns have been filed and processed by the IRS and the assessment appears in the Transcript of Account, which is a computer-generated or manually prepared register that is signed by an IRS assessment officer. However, a new 10-year assessment period commences on the date of the assessment of the audit liability, if the return is examined within the applicable statute of limitations for examination and assessment (generally three years—Treas. Reg. § 301.6502-1(a)). In addition, the 10-year collection period is tolled during the offer-in-compromise (OIC) period from the date of filing until the date the offer is accepted or rejected (section 6331(k)(3); Treas. Reg. § 301.7122-1; also see Form 656). Moreover, the collection statute is suspended when the taxpayer’s assets are in the control or custody of any court, during any bankruptcy proceedings and for six months after bankruptcy proceedings have terminated (Treas. Reg. § 301.6503(b)-1). The exact date that the statute of limitations commenced, both for assessment and collection, as well as the date of all assessments, may be ascertained from the taxpayer’s transcript.
Once the transcript is received, you will need to:
- Compare the tax liability stated on the returns provided by the client to the assessed tax liabilities shown on the transcript and note any differences.
- Compare any amounts shown as paid per the transcript to the amounts shown as paid per the client’s tax returns, plus any additional amounts paid after the returns were filed. Note any discrepancies, including the correct application (to the appropriate year) of payments made subsequent to filing.
- Check the dates filed, the dates of tax assessment, collection expiration dates, etc. It is possible that some of the taxpayer’s liability may be close to expiration of the 10-year statute of limitations for collection by the IRS.
- Summarize by year the remaining tax liabilities and the interest and penalties added by the IRS. The payer information will give you information as to employment, income, investments and deductions/liabilities.
Before you can begin most tax resolution negotiations with the IRS, clients must have filed all open tax returns and have paid their estimated tax liability for the current year. This determination will usually require preparing a current-year tax projection. For clients who have not fully paid their estimated tax liability, establish a plan that will not only bring them current as soon as possible but will also keep them current during the negotiation period. For example, the client may need to make a lump-sum estimated tax payment with Form 1040-ES, Estimated Tax for Individuals. Clients also may need to increase their payroll withholding or increase their quarterly estimated tax payments.
Self-employed taxpayers may need to make estimated tax payments more often than quarterly to coincide with their cash inflows. For instance, self-employed real estate agents might be instructed to pay their estimates each time they receive a commission check.
According to the Internal Revenue Manual (IRM 22.214.171.124.1), penalties and the interest computed on penalties may be abated if the taxpayer can demonstrate a “reasonable cause” (such as mental illness, medical problems or the death of a spouse) for failing to file or pay. Frivolous tax return filers and clients under criminal investigation should be handled by a tax or criminal attorney.
IRC § 7122 permits the IRS to settle a taxpayer’s liability for less than the balance due if the taxpayer submits an OIC. The OIC process, which may take many months, involves submission of completed IRS forms 656 (Offer in Compromise), 433-A (Collection Information Statement for Wage Earners and Self-Employed Individuals) and/or 433-B (Collection Information Statement for Businesses). Form 433 is used to determine how much the taxpayer can afford to pay, as well as the availability of assets that can be seized. The form requires the client to submit receipts for the last three months’ living expenses.
A taxpayer whose offer is accepted must remain in compliance with all future tax filings for five years, beginning with the calendar year that follows acceptance of the offer (see Form 656, Section V(d)). If taxpayers default in their compliance obligation, the statute of limitations renews and the IRS will begin a collection action to collect the original assessment plus interest and penalties.
Remember that the assessment and collection statute of limitations doesn’t apply to unfiled tax returns. Thus, while the IRS may administratively require the taxpayer to file only the last six years of past-due returns, clients who do not file all open returns may be exposed to subsequent IRS collection efforts and may not be able to file an OIC, since they will not be considered “current.” To “clean the tax slate,” file all open returns and include in the OIC all amounts owed. With an OIC, generally all unfiled returns must be filed.
If the client is not eligible for an OIC, you may want to consider filing a request for abatement of penalties and interest on such penalties. The IRS cannot abate the interest or penalties computed on unpaid taxes except through an OIC or pursuant to one of the reasons stated in section 6404. Generally, for interest, there must have been an unreasonable error or delay by an IRS officer or employee acting in his or her official capacity in performing a ministerial or managerial act. For penalties, incorrect information must have been given in writing to the taxpayer by the IRS office or employee who assisted the taxpayer with the return, and the taxpayer must have relied upon that information.
Have the client provide you with a copy of all tax returns filed during the past 10 years. If the client filed a return but failed to keep a copy, use Form 4506, Request for Copy of Tax Return. A $57 fee is charged for each return.
Once you have helped a client resolve his or her IRS tax problem, you often have a loyal, long-term client and a great source of referrals. After all, prior to your assistance, the client felt like a criminal.
The next time you are confronted with a client who needs help with a tax problem, consider entering this interesting and financially rewarding area of tax practice. Tax resolution representation provides a valuable, much-demanded client service. Let’s not leave this important tax work to some of the advertisers of such services who may lack the necessary competence to effectively resolve the client’s problem.
By Donald L. Ariail, CPA, DBA, Michael M. Smith, Esq., CPA, and L. Murphy Smith, CPA, DBA. They can be reached, respectively, at firstname.lastname@example.org, email@example.com and firstname.lastname@example.org.