A debt to the IRS can create enormous problems. If the IRS files a Notice of Federal Tax Lien, your credit scores will tumble. And you’ll likely find out that the IRS has a wider variety of collection tools at its disposal than most other creditors. So what happens if you come into some money, but don’t want to have to turn it over to the IRS? Do you have options? A reader writes:
Q: I need some help on my tax problem. The IRS has a filed a tax lien for $9,356.00. I estimate that I owe the IRS just over $10,000 now with interest & penalties. I am currently on “Non-collectible” status.
In about 2 months, I am scheduled to receive an inheritance from my father’s estate. The estimated value of my portion of the estate is around $35,000. My question is, will the IRS seize my inheritance? If so, is there anything that I can do to prevent this? Perhaps an installment agreement? Offer in compromise?
I am 63 years old and my only income is $689 per month in Social Security, and my husband’s income is $25,000 adjusted gross income per year. I do not want to lose what my dad left for me. Please help!
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A: I turned to some tax pros to help answer these questions. And here’s what they said:
Howard Chang, CPA, says:
Based on what she described, I assume that she was put on the “Currently Non-Collectible” (CNC) status because of financial hardship, given her and her husband’s income position. This is known as “Status 53.” Sometimes taxpayers’ financial situations worsen to the point that they cannot pay their back taxes, and cannot even afford to make monthly payments.
In cases like this, the IRS can mark a taxpayer’s account as CNC and any collection activities, like tax levies, are stopped. If the IRS places the taxpayer into the CNC status, it means that they are not going to require any payments from the taxpayer and they are going to leave the taxpayer alone until the taxpayer’s financial situation improves. However, penalties and interest will continue to accrue, so it is not necessarily the best position to be in.
Once in “non-collectible” status, the IRS would have suspended any collections activities. The IRS will monitor and review her income tax return each year, to determine whether the taxpayers have the capability to be placed on an installment payment arrangement. When she gets the inheritance, she would have to report the income for that tax year. Once the tax return is filed, the IRS will notice that her income has increased, and they will remove her from the “non-collectible” status and ask her to complete a new financial statement to assess if she can afford either to make monthly installment payments or to pay off the full balance. It is possible that when the IRS notices any increase in income that it will place levies on the taxpayer’s accounts and assets.
By law, the taxpayer is guaranteed to remain in this status for at least one year. In practice, if the taxpayer never has any significant changes in income, it is possible for the taxpayer to remain in this status until the statute of limitations expires and the debt is forgiven.
One option is to work with a tax professional, to see if she can do an “Offer in Compromise.” Generally, when a taxpayer is in the CNC status, it is more likely for the IRS to agree to an offer in comprise. However, given that she will be receiving an inheritance greater than the amount owed, the IRS might not agree to the offer.
Another alternative is to work with a tax professional as soon as she receives the inheritance, and work with the IRS to pay off the full balance.
Similarly, Bob Brinkman E.A., and president of Privateer Services Inc. warns:
Yes, the IRS will move to seize part of the inheritance to satisfy the tax lien. If their father has already passed away, it is too late to use techniques such as structuring the inheritance to go into an irrevocable trust as opposed to directly to the taxpayer. An Offer In Compromise is a good way to go, though it should have been attempted before now as it will most likely take more than two months for that process to complete and, once that money is received, the OIC is pretty much dead in the water. An installment agreement is probably a BAD way to go here as it will cost more in the long run (with interest and the like continuing to accrue) than merely paying it upfront.
Really, the best plan, if possible, is to attack the foundation of the existing tax liability. While there are a few other long-shot options, if the liability cannot be attacked directly, at this point in the game, this person is pretty much stuck because of the timing of this matter.
Scott Estill, an attorney with Estill and Long, LLC and a former senior trial attorney for the IRS, raises one more possibility:
She may consider an estate disclaimer, which means she gives up the money and it goes to her heirs. But if this is not acceptable because she needs the money, she could consider filing an Offer in Compromise based upon Effective Tax Administration, or “ETA.” These offers state that she owes the money and can pay it (due to the inheritance) but it would be inequitable to require her to pay. Usually these work only if you are choosing between paying taxes and paying for something that is a necessity, such as food or medicine. If she cannot make a good ETA Offer argument, she is stuck with paying the IRS in full, either in a lump sum or over time with a payment plan.
While none of this sounds like good news for the taxpayer who is likely to see a third of her inheritance go straight to the tax man, there is a bit of a silver lining here. Once the tax debt has been satisfied, she can ask the IRS to remove the tax lien from her credit reports. And that debt will no longer be hanging over her head.
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Image: Sarah G, via Flickr