How the new, small-business-friendly tax-reform laws can help you in an IRS audit.
New business owners would disagree that tangling with the IRS can be an emotionally and financially draining experience. Horror stories of overzealous IRS agents closing down small businesses fan the flames of fear, as many small-business owners believe that they simply cannot afford to fight the government--even if the IRS is dead wrong. What can you do when it seems the IRS isn't playing fair?
The passage of the Taxpayer Bill of Rights 2 in July 1996 has added some powerful new weapons to the small-business owner's arsenal with which to fight the IRS. Knowing these rights before the IRS comes knocking may be the only way to prevent them from destroying your otherwise healthy business.
"This new law finally levels the playing field for small-business owners by making sure that, if money or property was wrongfully obtained by the IRS, a business owner can get it back quicker from the government," says Congressman Jon Fox (R-Pa.), a strong advocate of the Taxpayer Bill of Rights 2. "Frankly, I'm working on a new Taxpayer Bill of Rights which would shift the burden of proof to where it belongs, on the IRS."
Even the most sophisticated business owner would generally acknowledge that, when it comes to what the IRS can and cannot do under the law, they are in the dark. For example, many business owners have no idea that, under current law, the IRS can shut down a business and seize its assets with virtually no prior notice to the owner. This may sound drastic, but the IRS has this option at its disposal.
When IRS agents in Colorado Springs, Colorado, started a routine audit of a small chain of children's clothing stores owned by members of Carol Ward's family, the family had no idea of how ruthless the IRS could be. After Ward insulted an IRS agent by questioning her competence and honesty, she found herself and her family embroiled in an IRS nightmare.
On April 19, 1993, about one month after the encounter with the IRS agent, gun-toting federal agents raided each of the three family-owned stores and seized all of Ward's business assets. Worse, the IRS emptied her personal and business bank accounts and even filed a lien on her mother's home. IRS agents posted notices in each of the stores notifying the public that the IRS had assessed that the Wards owed $325,000 in back taxes, penalties and interest. The agents seized everything that the Wards owned by using a little-known provision of the tax code called a "jeopardy assessment." Although this heavy-handed assessment is designed to be reserved for use in assessing taxes owed by international criminals who are clear flight risks, the IRS used this extreme measure against the Wards anyway. (Citing taxpayer-confidentialty laws, the IRS refused to comment on the Ward case.)
Two months after the raid, the IRS recalculated Ward's taxes, based on an audit of her tax returns for the previous six years. The new assessment (including penalties and interest): $3,485. Although it was clear that the IRS had made a horrendous "mistake," the IRS didn't even offer so much as a private apology. Amazingly, they even refused to accept the owed taxes unless Ward agreed not to sue the IRS for their misconduct. When Ward began to search for an attorney to represent her in a suit against the IRS, she encountered a lot of sympathy, but could find no one who was willing to take on the IRS without a commitment to cover legal fees, which she was told could reach $100,000 in a battle with the government. Moreover, under the then-existing law, it would be difficult to recover any attorney's fees, which made the task of finding representation even more daunting.
Finally, with the help of the media, Congressman James A. Traficant Jr. (D-Ohio), Representative Pat Schroeder (D-Colo.), and Colorado Senator Hank Brown, Ward recovered her seized property. She also found an attorney who was outraged enough to risk taking on the case against the government, and her case is now pending in the federal courts.
"It was amazing. My own government had burst into my store, terrorized my family and customers, and destroyed our lives to retaliate for my unkind words about an IRS agent. Now, instead of an apology, they have mounted a campaign to discredit me, and tried to intimidate me into not filing a lawsuit against a rogue IRS agent," says Ward. "The most annoying part is that the American taxpayers are footing the legal bill to defend the IRS' illegal actions against me! What I didn't understand three years ago was that, even though the IRS knew they were wrong, they simply didn't care."
Despite the fact that her suit against the IRS has not yet been settled, Ward felt vindicated in May of 1996, when Congressman Traficant delivered an address on the floor of the House of Representatives, congratulating Ward on her determination, courage and conviction in her noble fight against the IRS. The address was met by a standing ovation on the House floor. Congress went one step further than simply recognizing the Ward case: They authorized a bipartisan task force to study the question of IRS reform, known as The National Commission on Restructuring the Internal Revenue Service.
Sean P. Melvin is an attorney in the Malvern, Pennsylvania, law firm of Lentz, Cantor, Kilgore & Massey Ltd., counseling entrepreneurs and business owners. His book, The Entrepreneur's Handbook of Business Law(Macmillan/Simon & Schuster, $15.95, 800-428-5331), will be released in July, 1997.
New Taxpayer Tools
Indeed, if the Taxpayer Bill of Rights 2 had been in place, Ward may never have had to suffer at the hands of the IRS. She would have had a much easier time recovering her property, and her options for suing the IRS for their outrageous conduct would be more plentiful.
The new law provides important tools for helping small-business owners to successfully fight the IRS, including:
Taxpayer Advocate. The law establishes a new high-level position of Taxpayer Advocate within the IRS. The Taxpayer Advocate is appointed by and reports directly to the IRS Commissioner. The Advocate's primary function is to assist taxpayers in resolving problems with the IRS. The law also gives the Taxpayer Advocate broad authority to act on behalf of taxpayers who would otherwise suffer significant hardship due to IRS enforcement. The Advocate may issue a Taxpayer Assistance Order, which requires the IRS to cease any action, or refrain from taking any action, if, in the determination of the Advocate, the taxpayer has been the victim of inappropriate or illegal enforcement activity.
Small-business start-up relief. Often, new businesses fail to use the correct procedure for depositing employment taxes (the most common mistake is sending the taxes directly to the IRS rather than depositing them into a government depository), and the IRS would assess a severe financial penalty, even though the mistake was inadvertent and the employment tax return was filed. Until the passage of the Taxpayer Bill of Rights 2, the tax code didn't allow the IRS to waive the penalty for such mistakes. The new law now allows the IRS to waive these penalties for an inadvertent failure to deposit employment taxes into a government depository.
IRS liens and levies. Before the Taxpayer Bill of Rights 2 was passed, the IRS would withdraw a federal tax lien or a levy (IRS terms for authorizing the government to take your assets without a hearing to satisfy your tax bill) against your business assets only if the lien or levy was filed "in error." The new law provides that the IRS can withdraw the lien if: 1) the lien was not in accordance with the tax code or regulations; 2) you agree to pay your back taxes in installments; and 3) if the Taxpayer Advocate orders the lien released. Also, the IRS must now give a copy of the notice of withdrawal to you and make reasonable efforts to notify creditors and financial institutions of the withdrawal.
Outrageous IRS conduct. If your business has been the victim of outrageous IRS conduct in connection with collecting alleged back taxes, the Taxpayer Bill of Rights 2 allows you to recover up to $1 million in damages. This amount is 10 times the previous $100,000 cap on such suits. In addition to costing the government damage awards, incidents of IRS officers or employees who intentionally or recklessly disregard the tax code or regulations governing collections must be documented in an annual report made to Congress.
Legal fees. The new law makes it easier for taxpayers who win lawsuits against the IRS to obtain reimbursement of legal fees, and raises the cap on reimbursements from $75 to $110 per hour.
Employment taxes. As an employer, you should be aware that, if the amounts deducted from employee paychecks for federal taxes are not deposited, the IRS can assess the employment tax amount against you personally and recover the money and penalties from your personal assets through collection. This is true even if you were not the person responsible for depositing the taxes. When a business which owes employment taxes is unable to pay the tax assessed, IRS agents routinely look for the "deepest pockets" among the principals of the business and then simply (and lawfully) assess that individual the full amount owed. The Taxpayer Bill of Rights 2 now requires the IRS to notify a "responsible party" at least 60 days before demanding the employment tax due. Additionally, the IRS must now disclose the name of any other person it has determined to be a responsible party, and must also report on their attempt to collect from other responsible parties. The new law also gives a taxpayer who is assessed a responsible party employment tax the right to sue other principals in the business for "contribution" to the taxes owed.
If The IRS Contacts You
Virtually all IRS contact with small-business owners is first made by mail. Failing to respond to these letters from the IRS will usually result in notices with a more threatening tone, and eventually in a phone call from the appropriate IRS official.
"Ignoring IRS notices is never the solution to tax problems," advises Betsy J. Joyce, a CPA with Joyce & Associates P.C. in Wayne, Pennsylvania, and a member of the American Institute of Certified Public Accountants. Joyce recommends contacting your CPA as soon as possible after receipt of an IRS notice to discuss the situation. "In many cases, your CPA can offer you a reasonable plan for working out the problem before the IRS initiates drastic measures, such as shutting down your business."
If the IRS has informed you that you are under criminal investigation, you should contact a tax attorney as soon as possible before answering any IRS correspondence or agreeing to interviews. If you do not know an attorney who handles tax matters, ask your CPA for a reference.
Although dealing with the IRS is never a pleasant experience, the Taxpayer Bill of Rights 2 has provided small-business owners with new ways to fight back against overreaching IRS agents and bureaucratic nightmares. When involved in a tax dispute, your knowledge and business sense may be your best resources for battling the unlimited resources of the IRS.
Carol Ward, (719) 548-8807.
Joyce & Associates P.C., 950 W. Valley Rd., #2903, Wayne, PA 19087, (610) 687-8200.