The IRS requires that a business has filed all overdue tax returns in order to gain compliance status.  For corporations, that means filing all overdue or absent 1120 tax returns.  For partnerships, that means 1065s and for businesses with employees, 940s and 941s.

The 940s and 941s are usually considered the most difficult of these to stay up-to-date on.  For each quarter that a business had its first employee to the quarter in which they have their last, they are required to file one 941, and if there are periods during that time period when the business has no employees, it is still required to file a payroll return.  941s allow for a business to communicate to the IRS that the business will no longer have employees, after which point, 941s become unnecessary.  Tax return 940 operates under the same rules; however, they are only filed once per year.

The final stipulation for compliance is that any business remain up-to-date with its current payroll deposit requirement.  In fact, before a business can pursue IRS tax resolution, it usually must stay in compliance two or more quarters.  As a business facing a potential IRS collections action, it is important to either be in compliance status or know how to gain compliance status.

Failure to file a tax return and then Filing it:

Before negotiating an IRS tax resolution with a taxpayer, the IRS requires the taxpayer seek compliance with the IRS, meaning that all requisite tax returns be filed.  The taxpayer then, has two options.  He/she may either: file the missing tax returns, thereby being in compliance with the IRS, or not file them.  In most cases, this choice boils down to either: the easy way, or the hard way.  This essay provides information regarding the ’easy way’.

To file the requisite tax returns, the individual will need to provide the IRS with all pertinent information, including number of dependents, income, adjustments, deductions, etc.  The disadvantages of this option include: 1) The information ceded to the IRS can possibly lead to additional liabilities; 2) the late-filing penalty may be applied; and 3) In the event that a tax liability has continued from previous years, any refunds the taxpayer could receive for the tax year could be forfeit.

On the other hand, filing missed returns makes the taxpayer achieve compliance status, allowing the individual to proceed with IRS tax resolution, for example, by pursuing an Offer in Compromise, seeking an Installation Agreement, or seeking a status change to Currently not Collectible (CNC).  Additionally, compliance allows the individual to address any forthcoming collection methods, such as IRS bank or property levies.

Housing and General Housing Expenses

Mortgage, rent, homeowner’s insurance, renter’s insurance, phone, sewer, garbage, water, gas, electricity, and other miscellaneous costs fall under this category.  It is important to note that many households go beyond the standard funds allotted to these allowable expenses, and the IRS is quite strict about not exceeding the standard limit for these subtractions from the Reasonable Collection Potential.

Vehicle Operating Expenses

All additional costs for maintaining a vehicle fall under this heading, such as fuel, insurance, repairs, registration, and maintenance (check-ups, oil and lubes, alignments, tire rotation, etc.).  However, those submitting an Offer in Compromise may be able to claim additional fees.  In addition, vehicles with over 75,000 miles on the odometer and over 6 years old qualify for an additional $200/month that will not be available to pay off tax debt.

The Necessary Expense Test

The expenses that meet the necessary expense test requirements are charges deemed the right of United States citizens, such as health insurance, term life insurance, mandatory retirement, union dues, and dependent care.  The individual must submit accompanying documentation for each of these costs in order to subtract them from the Reasonable Collection Potential.

Conditional Expenses

These are the expenses that fail the Necessary Expense Test, but in the event that the individual may still pay off the total tax debt within a 5-year time limit, they may be allowed.  Tuition, charities, credit card payments, and other expenses are some of the most common conditional expenses.

Some of the preceding expenses may be prorated if there are other, non-liable parties living in the household who generate income, which means housing and vehicle operating fees, for example, may be determined to be shared between the individual with tax debt and non-liable parties, dropping the allowable expenses.

The general rule is that debt forgiveness is taxable.  Some exceptions to this rule include bankruptcy (Title 11), qualified farm indebtedness, insolvency and certain qualified real property business indebtedness.  But now under the Mortgage Forgiveness Debt Relief Act of 2007 (enacted on 12/20/07), taxpayers may be able to exclude qualified principal residence indebtedness if the balance of their mortgage was less than $2 million (or $1 million for a married person who files a separate tax return).

There are some exceptions to debt foregiveness under the Act.  Debt foregiven through a short sale, a principal balance reduction or restructuring, as well as mortgage debt forgiven in connection with a foreclosure may qualify for this relief.  Debt forgiven on a rental home, auto loan, second home, business property, or credit cards will not qualify under the new provision. In certain situations other relief may be available.

If only a part of a loan is qualified principal residence indebtedness, the exclusion applies only to the extent the amount discharged exceeds the amount of the loan (immediately before the discharge) that is not qualified principal residence indebtedness. For example, assume your principal residence is secured by a debt of $300,000, of which $225,000 is qualified principal residence indebtedness. If your residence is sold for $200,000 and $100,000 of debt is discharged, only $25,000 of the debt discharged may be excluded (the $100,000 that was discharged minus the $75,000 of nonqualified debt). The remaining $75,000 of nonqualified debt may qualify in whole or in part for one of the other exclusions, such as the insolvency exclusion.