The IRS collections machinery seizes $52 billion every year from delinquent taxpayers through its enforcement activities. That sounds like a lot until you realize taxpayers underpay the IRS $458 billion in taxes every year. (Tax gap estimate). That leaves a tax gap of $406 billion, which is a chunk of change by any measure. Particularly when you consider the annual federal deficit for 2015 was $439 billion (Source). When you put it like that, it’s no surprise the IRS is such an aggressive debt collector.
What Is The IRS Collections Process?
The IRS collections process includes every measure the IRS can take to collect back taxes. These measures range from allocating future tax year refunds to repay your tax debt all the way to seizing everything you own. There is a fair chance we all will have to face the IRS at least once throughout our lifetime: either through an audit or because of back taxes. It makes sense for all of us to understand what the IRS can and cannot do.
If you already owe the IRS large tax debt or you’re being audited by the IRS, this is not a theoretical exercise. You are facing the biggest and meanest debt collecting outfit in the world, and you need a strategy. Understanding what the IRS’s collection process involves is a great start.
The IRS Collections Process
There are two reasons you could find yourself on the business end of the IRS collections machine:
- not paying your taxes in full when you file a tax return, or
- an IRS audit reveals “errors” in your tax return that increase your tax liability.
In either case, the IRS sends you a tax bill. This bill is the first step in the IRS collection process. The first notice you receive will explain how much you owe the IRS and demands full payment. The letter will also include any interest or penalties added to your initial tax bill. If you pay the bill in full, the IRS will close your case. Problem solved.
After sending a final demand for payment, both through the mail and by telephone, the IRS will start enforcing their legal right to take from you what is owed. The IRS has unparalleled authority when it comes to collecting debts. The methods used by the IRS during the collection process include tax liens, tax levies, asset seizure, bank levies, wage garnishment, and civil tax penalties.
|IRS Collections Method||2014 Data||2015 Data|
|Tax Audits||1.2 million tax returns audited||IRS audited 1.4 million tax returns, 0.8% of all individual tax returns.|
|Tax Liens||535,580 federal tax liens filed||515,247 federal tax liens filed|
|Tax Levies||1,995,987 notices of levies requested||1,464,026 notices of levy requested|
|Criminal Investigations||4,297 investigations initiated, 3,268 sentenced to prison|
79.6% conviction rate
|3,853 investigations initiated, 3092 taxpayers sentenced to prison|
80.8% conviction rate, 3 years and 4 months average sentence
|Civil Penalties||$25.6 billion||$24.1 billion|
|Source: IRS Data Book 2014 and 2015 & IRS Criminal Investigation Management Information System.|
A tax lien is typically the first collection tool used by the IRS. As soon as the deadline for payment passes and the case goes into collection status, a statutory tax lien comes into effect. In 2015, the IRS filed 515,247 liens through its Automated Liens System.
What is a statutory tax lien?
- A lien is a legal claim against your property, with “property” being defined as anything and everything that you own or will own. This includes your home, car, business, bank accounts, retirement accounts, etc.
- The legal claim of a tax lien stops short of giving the IRS ownership and control of your assets. The IRS cannot use a tax lien to tow away your car or take possession of your house.
- However, a tax lien does give the IRS ownership of any proceeds that you might get from selling your assets. Sell any property and the money from that sale will go to the IRS; you will not receive any of the proceeds until your tax debt is fully covered.
- The tax lien is statutory because it is written into the legal code and occurs automatically when the payment deadline passes. There is no judge involved and no court hearing where you can challenge the lien. There is not even any paperwork to be filed and the taxpayer does not have to be notified that the lien is in effect. The statutory tax lien simply exists, by definition, when the IRS has past due taxes to collect.
What is a Notice of Federal Tax Lien (NFTL)?
A notice of federal tax lien occurs when the IRS makes the tax lien official by filing a notice with your local court or your state’s Secretary of State Office. Until then, the tax lien was a secret between you and the IRS. However, when that tax lien is a matter of public record, it’s official. All your creditors (as well as future creditors) will know the IRS has priority over all your assets. This could lower your credit score by up to 100 points and will make it much harder to get a loan or refinance an existing one.
Again, the IRS doesn’t need to go through much hassle to file a notice of federal tax lien. In fact, 21 percent of them are filed automatically by computers without any human involvement (Source). A federal lien notice can stay on your credit report for 7 years. However, you can request the IRS to post a certificate of release of federal tax lien and remove it from your credit report.
Related article: How To Remove A Federal Tax Lien Notice From Your Credit Report
With a tax lien, the IRS does not actually take ownership or possession of your property. It just calls dibs on all your assets. With a tax levy, on the other hand, the IRS actually takes ownership of your property. It can legally take almost anything you own, and sell your belongings to pay off the tax debt. In 2015, the IRS filed 1.46 million notices of levy on third parties to collect back taxes. (Source)
Though the term “levy” does apply to the actual taking of assets, the IRS “places a levy” by simply serving notice that it intends to take your assets at a future time. The Fifth Amendment of the U.S. Constitution states, “No person shall be … deprived of life, liberty or property without due process of law.” In the case of tax levies this “due process” requires the IRS to notify the taxpayer at least 30 days in advance. It must also give the option to request a hearing during that time frame to challenge the levy. If no hearing is requested or if the challenge fails, then the IRS has fulfilled its “due process” requirement and can seize the assets at the end of the 30 days.
Personal property that the IRS can seize and then sell to pay off your tax debt includes but is not limited to:
- Luxury items
- Vacation properties
- Other types of real estate
This is by no means an exhaustive list. In fact, there are only a few personal belongings that the IRS is not allowed to seize. The only personal property that taxpayers are guaranteed to keep regardless of the situation is:
- “Necessary” clothing
- “Necessary” school books
- Up to $6,250 worth of food, fuel, furniture, and personal effects
- Up to $3,125 worth of tools and books that are necessary for earning a living
- Undelivered mail
Because of the potential difficulties in seizing physical assets, the Internal Revenue Service prefers to seize financial assets. Besides being easier and safer to take they provide instant cash without the hassle of finding a buyer. The seizure of a financial asset is often referred to as a “bank levy.” However, bank levy’s are not limited to the money you keep in a traditional bank. There are many types of financial assets the IRS can seize including:
- Checking accounts
- Savings accounts
- Individual Retirement Accounts (IRAs)
- 401(k) accounts
- Stocks Bonds
- The cash value of life insurance policies
- Accounts receivable
The ability of the IRS to take your assets is not limited to what you currently own. The agency can also place a levy on your future assets via a wage garnishment.
A wage garnishment is when the IRS takes money out of your paycheck to pay off the tax debt over a period of time. With this collection tool you never even receive the money; your employer is required to pay the IRS each pay period and deduct the amount from your take-home pay. The garnishment continues until the entire debt is paid.
The amount that the government takes out of each paycheck can be significant.
- The IRS will leave you enough income to pay for basic living expenses. However, your definition of “basic living expenses” will most likely differ from the IRS’s.
- In the most extreme cases, those tables allow the IRS to leave the taxpayer with little more than $180 per week.
- The agency does not take into account what your living expenses actually amount to and may leave you without enough income to pay the bills.
- At best, a wage garnishment will leave you living a very frugal existence effectively working to support the federal government rather than pursuing your own goals.
Unlike other levies the garnishment of wages is not a one-time event. Though they only have to provide “due process” once, the IRS can then seize money from dozens or even hundreds of your paychecks. The wage garnishment continues for as long as is necessary until the IRS is satisfied that you have paid in full. Often that requires the wage garnishment to continue for years.
Even though the liens, levies, and garnishments used by the IRS to collect back taxes may seem harsh, they are not in and of themselves considered penalties. They are merely the methods used to collect what is owed.
However, there are penalties for failing to pay taxes. The penalties are mostly financial in nature and require you to pay more to the IRS than what you actually owe in taxes. In 2015, the IRS imposed $24.1 billion in civil penalties. Increasing the amount owed makes it more difficult to pay the tax bill, increasing the odds that the IRS will have to seize assets or garnish wages. There are also instances where the tax penalties go beyond simple interest and fines and can result in criminal prosecution and jail time.
There are several actions (or inactions) that the IRS will penalize you for, including:
- Failing to file a tax return.
- Failing to pay taxes or paying less than what is owed
- Filing inaccurate tax returns
- Negligence or a lack of effort in complying with tax rules
- Tax fraud or intentionally underpaying taxes
The IRS reserves criminal prosecution to the most serious tax fraud cases. Inmates don’t pay taxes, so the IRS prefers to punish minor charges and cases of negligence with “civil” penalties. Unless you fail to file tax returns or you blatantly defraud the IRS, it’s unlikely the IRS will start a criminal investigation. That being said, the IRS initiated more than 3,800 investigations in 2015 and 3,092 were sentenced to prison. The average sentence was three years and four months.
How To Avoid Being a Target of an IRS Audit
If you don’t want to become a target to the IRS, keep in mind a few of the factors that can trigger an IRS audit and start the IRS collections process:
- Filing a late tax return.
- The taxpayer cannot afford to pay the entire tax bill.
- Not paying IRS tax penalties.
- Not reporting all sources of income.
- Claiming deductions for which you have no proof or receipts.
- Having a spouse that owes taxes or underreports his or her income.
- There is an unresolved issue from a previous tax year.
- The taxpayer receives a notice from the IRS and does not respond. Failing to respond correctly can lead to the collection process regardless of the reason for the lack of response. For instance, sometimes a taxpayer will receive an IRS notice that they believe to be a mistake and will ignore it. Even if it truly is an error by the IRS the taxpayer must respond in order to correct the error.
- The IRS sends a notice but the taxpayer doesn’t receive it. This is often due to a change of address but there are many reasons why a taxpayer might not be aware of the problem before it is too late.
What Should You Do Next?
If you have received a call or letter from one of the IRS Collections departments, take it seriously. The IRS can literally take everything you own and destroy your credit. Even if you can’t afford to pay your taxes, continue filing your tax returns and maintain good communication with the IRS. The IRS Fresh Start Program has opened multiple tax relief programs you may qualify for. These programs include installment agreements, offers in compromise, currently not collectible status, penalty abatement, and bankruptcy.The good news is that no matter how bad you think your situation is, there is probably a tax relief program you that can help you.
If you owe $10,000 or more in back taxes or you’re facing a tax audit, you need a tax attorney. Even if you decide to deal with the IRS by yourself, it’s a good idea to consult with a tax attorney before you do anything.