Tax Workouts and Procedures During and After the IRS Restructuring
The Internal Revenue Service Restructuring and Reform Act of 1998 (the "RRA") called for a reorganization of the management and operations of the IRS, required the IRS to balance tax enforcement with "customer service," and enacted a third Taxpayer Bill of Rights ("TBOR3"), which makes significant changes to the powers and procedures by which the IRS collects delinquent tax liabilities. This outline summarizes the short term impact of the RRA on the IRS Collection function, discusses the long-term role of Collection in the restructured IRS, and describes the procedures that have been adopted by Collection to implement the TBOR3 rules and the RRA's customer service reorientation.
I. IMPACT OF RRA ON THE IRS COLLECTION FUNCTION
The RRA will result in changes throughout the IRS, but its effect on the collection function has been the most immediate and profound. The IRS' Collection Division has been forced to modify its procedures, restructure its operations, and redefine its role.
A. Substantive Changes to Collection Rules.
Many of the TBOR3 provisions were aimed at curbing actual or perceived abuses by Collection. The new rules, most of which went into effect immediately, curtailed the IRS' enforced collection powers and expanded taxpayers' rights to administrative and judicial review of revenue officers' decisions to exercise those powers.
1. Advance Approval of Liens and Levies.
Congress instructed the IRS to develop and implement procedures for advance approval of all revenue officers' decisions to file liens or execute levies. Beginning in 2001, the same requirement will apply to liens and levies initiated by the Automated Collection System ("ACS").
2. Installment Agreements.
TBOR3 requires the IRS to enter into installment agreements under certain circumstances, prohibits enforced collection actions while a taxpayer's offer to enter an installment agreement is pending, and limits the IRS' discretion to modify or terminate an installment agreement. (IRC §§ 6159(b)&(c), 6331(k)(2))
3. Offers in Compromise.
Congress instructed the IRS in the RRA to develop and publish guidelines for the evaluation of offers in compromise. TBOR3 limited the IRS' authority to reject offers under certain circumstances and prohibited enforced collection action while a taxpayer's offer is pending. (IRC §§ 7122(c), 6331(k)(1))
4. Limitations on Levies and Seizures.
TBOR3 included numerous procedural and substantive restrictions on the IRS' levy power, including liberalization of the categories and dollar value of property that are exempt from levy, procedural safeguards against below-market sales of seized property, and, in effect, a prohibition against seizure of a taxpayer's personal residence. (IRC §§ 6334(a)(2), 6331(i)&(K), 6323(b), 6335(e), 6340(A)&(c), 6334(e))
5. Expanded "Innocent Spouse" Protection.
TBO3 dramatically liberalized the standards under which a person liable for an underpayment or deficiency on a joint return can avoid liability. Section 6015(b) expands the traditional "innocent spouse" rules to include substantially all understatements on a joint return that are attributable to erroneous items of one spouse. Section 6015(c) allows a separated or divorced spouse to elect after the fact to divide the income, expenses and credits on a joint return and to have his or her liability determined essentially on a separate return basis. The IRS' failure to grant relief under section 6015(a) or (b) is subject to Tax Court review under section 6015(e). Section 6015(f) gives the IRS discretion to provide equitable relief for joint return filers who do not qualify for relief under section 6015(b) or (c).
B. Collection Due Process.
Prior to the RRA, taxpayer had very limited rights to advance review of the legality or appropriateness of enforced collection actions. There were non-statutory procedures for Appeals Office review of the rejection of an installment agreement or offer in compromise and certain other Collection decisions. Only in the rarest of circumstances could taxpayers obtain advance judicial review of IRS enforced collection actions, and in many cases even post-Collection judicial review was not available.
The RRA made advance administrative and judicial review generally available. New sections 6320 and 6330 give every taxpayer the right to initiate a Collection Due Process ("CDP") proceeding in the Appeals Office immediately following the filing of a tax lien or prior to the execution of a levy. In addition, taxpayers now have a right to immediate judicial review of an adverse determination by Appeals in a CDP proceeding.
C. IRS Restructuring.
The modernization program adopted by the IRS in response to Congress' mandate in the RRA will involve restructuring the agency into four "operating divisions" that are defined by categories of taxpayers. Each operating division will presumably require its own collection resources, tailored to the characteristics and collection issues of the division's taxpayer group. So far, the IRS' descriptions of its restructuring proposals have focused primarily on the responsibilities of the four divisions for compliance, customer service, and audit. However, it is inherent in the restructuring plan that the collection function will be to some extent apportioned among the four divisions and comprehensively reorganized.
1. Tax Exempt and Government Entities Division.
The TE & GE operating division will have relatively little need for a collection function. The Collection caseload will consist largely of delinquent information returns and unpaid penalties. Relatively few TE&GE cases will involve substantial delinquent tax liabilities.
2. Large and Mid-Size Business Division.
The L&MSB operating division should also have limited need for a full service collection function. Although its 210,000 large and medium size corporate "customers" incur substantial tax liabilities, they typically have delinquent accounts only in the case of insolvency. The L&MSB collection caseload will therefore consist primarily of bankruptcy proceedings and occasional trust fund recovery penalty cases.
3. Small Business & Self-Employed Division.
The SB&SE operating division will serve the taxpayer group that traditionally accounts for most enforced collection activities. It will require a full spectrum of collection resources to investigate failure to file cases and trust fund recovery penalty cases, obtain voluntary payment of delinquent accounts, and pursue enforced collection where voluntary payment is not forthcoming.
4. Wage and Investment Division.
The W&I operating division will have the largest number of taxpayers, but most of the taxable income earned by those taxpayers will be subject to withholding and/or information reporting. The collection function caseload will therefore consist of a large number of delinquent return and delinquent account cases, relatively few of which will involve substantial amounts of liability. The collection resources of the W&I division will likely be concentrated in the Automated Collection Service ("ACS"). A relatively few revenue officers should be sufficient to conduct field investigations, make face-to-face collection contacts, and take enforced collection actions.
D. Emphasis on Customer Service.
Perhaps the greatest short-term impact of the RRA on the IRS collection function has resulted from Congress' mandate that the IRS act less like a law enforcement agency that determines and collects tax liabilities and more like a service organization that assists taxpayers in their voluntary compliance with the tax laws. Even before the restructuring began, IRS management had been taking steps to improve its image by enhancing taxpayer service functions and curtailing aggressive collection activities. Since the enactment of the RRA, a substantial portion of the field personnel in Collection have been redeployed to customer service duties and restructuring assignments, while enforced collection has languished.
E. 1999 Collection Statistics.
The impact of the RRA, the TBRIII restructuring, and the IRS' customer service reorientation on Collection is evident from statistics in the TRAC 2000 IRS study recently published by researchers at Syracuse University:
During 1992 through 1996, the IRS filed an average of about 800,000 new notices of federal tax liens per year. Lien filings have decreased steadily since 1996, and fell to 167,867 in 1999 -- approximately 12% of the number filed in 1992.
During 1992 through 1998, IRS levies averaged more than 3,000,000 per year. In 1999, the number of levies fell to 504,403 --approximately 14% of the number in 1997.
During 1992 through 1998 the IRS averaged about 10,000 seizures of tangible property per year. In 1999 there were a total of 161 seizures -- less than 2% of the 1992-98 average.
II. COLLECTION PROCEDURES AFTER THE RRA
No voluntary compliance tax system can function for long without a credible threat of enforced collection. Although a majority of taxpayers may be honest and willing to comply with the rules, the integrity of the system requires that effective enforcement action be taken against taxpayers who fail to file returns or fail to pay assessed liabilities. The RRA and TBRIII left intact most of the extraordinary collection powers given to the IRS in Chapter 64 of the Internal Revenue Code. Once Collection has worked through the restructuring and absorbed the TBRIII changes, it will have to get back in business.
During 1999 the IRS published a comprehensive revision of its Collection Handbooks (Part 5 of the Internal Revenue Manual). The new handbooks describe the procedures and standards under which the IRS proposes to exercise its collection authority during and after the restructuring process. Those new procedures are summarized in the Handbooks and in IRS Publication 594 -- What You Should Know About the IRS Collection Process. See Appendix A.
A. Risk Scoring.
In order to make more effective use of Collection resources, the IRM establishes a Resource and Workload Management System ("RWMS") that assigns priority to collection cases based on a risk scoring system. (IRM 5.1, § 1.16) The RWMS scoring procedure applies to Taxpayer Delinquent Account ("TDA") cases involving unpaid liabilities on filed returns as well as Tax Delinquent Return Investigations ("TDI") cases involving failure to file returns.
1. Risk Factors.
The factors considered in the risk scoring system, in addition to the size of the unpaid liability are:
--Income and tax reported on prior returns,
--Data from information returns (e.g., W-2, 1099),
--Payment history, including present and prior delinquencies, and
The RWMS risk score for each collection case is computed when the file is opened and is recorded on the face of the TDI or TDA. As the case progresses, the risk score is updated to reflect payments received or additional delinquencies. The RWMS risk score is used to decide whether and when the case should be transferred from ACS to Field Collection. It also determines what priority the case will be assigned in the Field Collection queue.
3. High Risk Cases.
Certain TDA or TDI cases are designated "high risk" under the RWMS. Those cases automatically bypass ACS and are assigned directly to Field Collection. (IRM 5.1, § 1.16.1) They include:
--Form 1042 (nonresident alien withholding tax),
--Form 706 (estate tax),
--Form 730 (wagering tax),
--Form 706GS (generation skipping tax).
B. Tax Delinquent Return Investigations.
The only form of collection activity that has increased since 1998 is the investigation of failure to file. Most TDI cases are generated by the information matching program, which cross-checks information returns (e.g., Form 1099 and W-2) against filed returns. According to the TRAC IRS 2000 study, the number of TDI investigations has more than doubled over the past seven years and reached an all-time high in 1999 of 1,577,021 new cases. Chapter 11 of the new Collection Handbook details Collection's TDI procedures. (IRM 5.1, §§ 11.1-11.13)
1. Taxpayer Interview.
The Handbook instructs revenue officers to begin a TDI case by contacting the taxpayer by telephone or in person, providing him or her a copy of IRS Publication 1 (Your Rights as a Taxpayer), and attempting to conduct a personal interview. Absent a summons, the taxpayer may, if he prefers, have his representative attend the interview. (IRM 5.1, § 11.1.1(6))
2. Conversion to TDA Status.
If the revenue officer secures the delinquent returns without full payment, the delinquent liabilities are assessed promptly and the case is converted to TDA status. (IRM 5.1, § 11.3.2)
3. Substitute for Return.
If the revenue officer is not able to secure voluntary filing of the delinquent returns and the taxpayer's file includes a Form W-2 or Form 1099 information returns, the revenue officer may transfer the case to the Service Center's ASFR unit for assessment of tax using the section 6020(b) substitute-for-return procedure. (IRM 5.1, § 11.8) If no income information is available in the file, the revenue officer may request that the taxpayer provide information to prepare a substitute return. If necessary, the revenue officer can issue a summons to compel the taxpayer to appear and provide the necessary information. (IRM 5.1, § 11.9.1)
4. Appeal of SFR Assessment.
The Manual provides for expedited appeals officer review of unagreed section 6020(b) cases. (IRM 5.1, § 11.9.3)
5. Referral for Criminal Investigation.
If a taxpayer who has failed to file one or more returns refuses to cooperate with Collection, or if the revenue officer's TDI investigation reveals indications of fraud or willful failure to file, the manual instructs the revenue officer to refer the case to the Criminal Investigation Division. (IRM 5.1, § 11.6)
C. Statutory Lien.
If an assessed tax is not paid upon notice and demand, section 6221 creates a lien in favor of the United States against all of the taxpayer's property or rights to property. (IRM 5.1, § 11.6)
D. Automated Collection Function.
If an assessed liability remains unpaid following notice and demand, the IRS Service Center sends the taxpayer a series of notices of increasing stridency. The "Final Notice" warns the taxpayer that the Service may record the federal tax lien against the taxpayer's property and, if the tax is not paid within 30 days, the Service may levy on the taxpayer's property to collect the liability. During this notice period, the case is normally assigned to the Automated Collection System ("ACS"), which attempts to collect the liability through correspondence, telephone contact, and levies on bank accounts.
E. Assignment to Field Collection Function.
If a liability with a sufficiently high RMWS risk score remains unpaid after a Final Notice, the case may be removed from the Automated Collection System inventory and assigned to the queue for the relevant Collection field office. Lower scoring cases will be transferred directly to Field Collection if the taxpayer requests an opportunity to meet with a revenue officer. (IRM 5.1, § 1.16.1(2))
F. Decision Whether to File Liens.
1. Notice of Federal Tax Lien.
The Service routinely prevents a delinquent taxpayer from selling property, and ensures its priority over claims of subsequent secured creditors, by filing notices of the federal tax lien under section 6323 in the appropriate offices of the jurisdictions in which the taxpayer's property is located. See IRM 5.12.
2. Alternatives to Notices of Lien.
Because the filing of a notice of federal tax lien may impair the taxpayer's ability to obtain credit or earn funds with which to pay the tax, the Internal Revenue Manual instructs revenue officers not to file liens until they have made a good-faith effort to contact the taxpayer and have given the taxpayer an opportunity to pay the liability or to work out an appropriate deferred payment arrangement. (IRM 5.12, §§ 1.1, 1.12-13, 1.20)
3. Advance Approval of Liens.
Prior to the RRA, a revenue officer was not generally required to obtain supervisory approval prior to filing liens, and after-the-fact administrative or judicial review of the filing of a lien was available only to determine whether the lien was valid or the liability had been satisfied. Section 3421 of the RRA (uncodified) required the IRS to implement an approval process under which all revenue officers' decisions to file liens must be approved in advance by a supervisor. The supervisor conducting the review must personally confirm the IRS liability determination and consider all collection information submitted by the taxpayer.
4. Due Process Review of Notice of Lien.
Prior to the RRA, the decision to file a notice of federal tax lien was not subject to administrative or judicial review. Section 6320 now requires the IRS to provide the taxpayer a Collection Due Process hearing in the Appeals Office promptly after filing its first notice of lien with respect to a delinquent liability. See § IIIA, below.
G. Levy Source Investigation.
If the taxpayer is prepared to cooperate with Collection, the revenue officer will normally conduct a personal interview and ask the taxpayer to prepare and sign an appropriate Form 433 -- Collection Information Statement -- summarizing the taxpayer's financial situation. See Appendix B. In cases involving substantial delinquencies, the revenue officer may conduct an investigation of the taxpayer's leviable assets and sources of income by examining prior returns and IRS files, reviewing local property records, or making third-party contacts.
H. Installment Agreements.
If the taxpayer cooperates by providing financial information and the revenue officer determines that the IRS' interests would be served by allowing the taxpayer additional time to pay, section 6159(a) allows the IRS to defer payment or enter into an installment payment agreement. Installment agreements are made on Form 433-D. See Appendix C.
1. Elements of Installment Agreement.
An installment agreement will normally require the taxpayer to (a) make an initial payment commensurate with the taxpayer's cash, liquid assets, and available credit, and (b) pay the entire balance of the liability in monthly installments roughly equal to the taxpayer's estimated future cash flow after taxes, living expenses, and other necessary expenses.
2. Appeals Office Review of Rejection of Installment Agreement.
A taxpayer can obtain administrative review in the IRS Appeals Office of a revenue officer's decision not to accept an installment proposal. See IRS Publication 1660F (Appendix E). The appeals officer's decision is not subject to judicial review.
3. Term of Installment Agreement.
Section 6159(b) provides that an accepted installment agreement remains in effect until the tax is paid unless the IRS determines:
a. That information submitted by the taxpayer was inaccurate or incomplete;
b. That the taxpayer's financial condition has changed materially;
c. That the taxpayer defaulted on the installment agreement or failed to pay a current tax liability; or
d. That the taxpayer refused to provide updated financial information on request.
4. Termination of an Installment Agreement.
The IRS can terminate or modify an installment agreement only after giving the taxpayer 30 days notice, and the notice must include a written explanation of the grounds for the proposed action. Section 6159(b)(5). The taxpayer can obtain Appeals Office review of a revenue officer's decision to terminate an installment agreement. See IRS Publication 1660F (Appendix E).
5. Automatic Installment Agreements.
The RRA added new section 6159(c), which requires the IRS to enter into an installment agreement with an individual taxpayer, at the taxpayer's option, if the unpaid tax liability (before interest, penalties, and additions to tax) is $10,000 or less and:
a. The taxpayer has not failed to file a return, failed to pay the tax on a return, or entered into an installment agreement to pay delinquent tax, during the prior 5 years;
b. The taxpayer is able to pay off the delinquent tax in installments within 3 years; and
c. The taxpayer agrees to file timely returns and pay current taxes during the term of the agreement.
d. Under current IRS procedures, the liability ceiling for such automatic installment agreements has been raised to $50,000.
6. Bar on Enforced Collection.
The RRA also added section 6331(k)(2), which bars the IRS from collecting tax by levy while a taxpayer's offer to enter into an installment agreement is being considered, for 30 days following rejection of such an offer, during the period when an accepted installment agreement is in effect, and for 30 days following the termination of an accepted agreement (or, if termination is appealed, during the appeal).
7. Annual Report.
The RRA requires that, beginning not later than July 1, 2000, the IRS must provide every taxpayer that has an installment agreement with an annual statement showing the balance of the account at the beginning of the year, the payments during the year, and the ending balance.
I. Offer in Compromise.Section 7122 of the Code authorizes the IRS to compromise a civil tax liability. Offers in compromise must be initiated by the taxpayer and must be made on Form 656. See Appendix D. Traditionally the only grounds for an offer in compromise were doubt as to liability or doubt as to collectability. The legislative history of the RRA (Conference Report, p.289) created a third --to promote effective tax administration.
1. Collectability Offers.
If the entire tax liability assessed against a taxpayer is not collectable from the taxpayer's assets and reasonably projected future income, the taxpayer can make an offer in compromise based on doubt as to collectability. Such offers are evaluated by offer examiners in the Service Center or the Collection Division.
2. Liability Offers.
If the taxpayer is able to pay the liability but disputes the amount assessed (and would be able to pursue a claim for refund following payment), the taxpayer can make an offer in compromise based on doubt as to liability. Such offers are generally evaluated by the Examination Division unless they involve only collection-related penalties.
3. Offers to Promote Effective Tax Administration.
Where there are not grounds for compromise based on collectability or liability, a compromise may be accepted if
a. Collection of the full liability will create "economic hardship;"
b. Exceptional circumstances exist such that full collection would be detrimental to voluntary compliance; and
c. Compromise of the liability will not undermine compliance by taxpayers with the tax laws.
Temporary Regulation § 301.7122-1T(b)(4)
Prior to the RRA, the offer-in-compromise program was a fine screen through which relati