**This article is part of a larger article series titled, The 941 Payroll Tax Resolution Process. There is a specific sequential order to this series, so we highly recommend that you start at the beginning.
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A tax debtors resolution options are almost entirely based on financial analysis. In short, it’s a way to provide a statement of your financial status, including information about your assets, the businesses monthly income and monthly expenses.
Because the financial analysis largely makes up what resolution options are available to you, we are going to explore this topic in detail.
After completion of a financial analysis of your business, the IRS will use the information to figure out your ability to pay your balance in full, the amount you’ll need to make as part of an installment agreement situation, or if you are eligible for an offer in compromise.
It is best to think of the entire tax resolution process, but specifically the financial analysis step of the process, as if you were applying for a major business loan. You will need to be extremely thorough with all the financial and operational components of your business. The similarities between applying for a major business loan and completing your tax resolution case are uncanny. You are basically applying for a government loan to help pay back the tax debt you have already accumulated.
By the end of the process, you will have provided as much information to the IRS as you would have to bank for a business loan. Don’t be alarmed by this. Embrace it and be prepared to provide lots of documentation.
A QUICK REFERENCE
For quick reference purposes, here are likely outcomes based on what the financial analysis shows that a business has:
- Assets (or access to equity) – then you’ll likely have to tap into these sources of cash to pay the debt in full.
- No Assets, but Disposable Income – then you’ll likely fall into an installment agreement where extra income outside of ordinary and reasonable expenses will go to the IRS on a payment plan.
- No Assets, No Disposable Income – Likely a currently non-collectible (CNC) situation.
- Offer in Compromise – Not many qualify, but if you do it’s all about the math.
THE IRS PLAYBOOK (Financial Analysis Secrets)
The Internal Revenue Manual is the IRS’ playbook on what their procedures are supposed to be. If you know the playbook, you can put up a better defense against whatever the IRS is going to throw your way and will lead to a better resolution outcome.
Unlike the 1040-individual tax resolution side of things, the financial analysis on the business side is much more intricate. When an individual has a tax liability, the financial analysis comes along with set collection standards (housing, food, clothing allowances and the like). Unfortunately, there are no set collection standards for businesses.
Instead, there is much more grey area.
Revenue Officers predominately are going to peel back your company onion to look for essential assets, property, and expenses that are “for the production of income”.
Form 433-B is what you will use to put all of the pieces together for the IRS. In order for you to put together this form confidently, you need to understand a few specific Internal Revenue Manual components.
1. Necessary and Ordinary
The first concept is likely the most important. The IRM dictates that business expenses must be “necessary for the operation of the business”. IRM 126.96.36.199(3) takes it a step further by saying, “allowable business expenses are the cost of carrying on a business or trade”.
What is considered a necessary and ordinary expense?
It is fairly grey, but at the end of the day, the IRS will examine more thoroughly (and may not allow expenses to be a part of your analysis) those expenses that do not directly impact business income. When you start down the resolution path, you need to be willing to make some business adjustments and that first starts with this concept.
In short, the IRS does not trust you. They justify a lack of trust because of how you got to this position in the first place.
You need to expect a high level of scrutiny in all matters with the IRS: reviewing of bank statements, tax returns, verification of assets, and other records with line items. When they ultimately verify assets, expect scrutiny. They will scrutinize all sources of revenue, all liquid assets, any equity in assets and available sources of credit.
In other words, get your crap in order, because the IRS will poke and prod their way to the truth whether you like it or not.
3. Adjust Immediate Expenses
The IRS will expect to receive any and all money in excess of ordinary and necessary business expenses.
To be short, the amount you have left over after reasonable expenses, the IRS will want to keep. But, there are likely reasonable expenses that you do not currently pay for that could:
1. Enhance your company, and
2. Keep money out of the IRS’ hands (which we are a big fan of).
The goal here is to adjust immediate expenses legally and ethically that are in the reasonable expense category. By absorbing reasonable expenses, you lower your long-term required payment amount or your one-time cash payment to the IRS.
A few specific reasonable and ordinary expenses to consider adding (or reasonably expanding) are:
- Legal, payroll, and accounting fees
- Adding or increasing reasonable compensation to Employee-Shareholders
- Safety compliance training for staff members (you are in construction after all!)
- Business, Errors & Omissions Insurance and premiums for health insurance for employees
- Marketing and advertising to get additional business
- Mileage and auto expenses getting employees to and from the job site
- Federal Tax Deposits (yes, start paying your deposits right away)
As you can see, many of these are traditional business expenses that you may not be capitalizing on currently. If you pick apart each of these, you can likely make a reasonable claim that they ultimately lead to an increase in revenue. Try to lower your profit (reasonably, ethically, legally) and you will pay less.
4. Bookkeeping & Documentation
Bookkeeping, accounting, and documentation are incredibly important while putting your financial analysis situation in place. The 433-B dictates that 6 months of income and expenses be provided. Even in cases that are less than $25,000 and are in IBTF-E (meaning that the 6-month rule is technically not required), the Revenue Officer may still ask for things that you need to have.
You would be wise to hire a bookkeeper to get past months of accounting completed and brought up-to-speed regardless.
5. Verification of Financial information
The IRS is going to verify a lot of information, both from a business operation perspective as well as a financial one. Expect them to verify business and company information, ask about your customers, how you operate and so forth.
A site visit is also required if your tax liability is over $25,000. Revenue Officers will typically request this early in the process. Just do it ASAP and get it over with. Don’t be surprised if they sketch out a floor plan of the building, count the number of employees, and take notes on business assets.
Once it comes time to verify financial information, expect them to review accounts receivables, bank statements, contracts, etc. They will be incredibly thorough.
6. Commingling of Business and Personal Expenses
A word of caution when it comes to co-mingling. This is a big no-no with the IRS, and quite frankly its justified. If you are currently co-mingling between business and personal expenses, then shame on you. It is not a healthy practice, and the IRS is going to have a field day with you. At the very least, you will be a prime candidate for a Trust Fund Recovery Penalty assessment, but they likely will just make your life hell.
If you do have commingling, call the IRS or Revenue Officer assigned to your case and ask for a Stay of Enforcement in order to give you time to get everything cleaned up.
7. They Will Go deep!
The IRS will go extremely deep to verify the information that you provide them. Hint, hint… be honest and transparent. They will use every agency, vendor, institution, online sources, etc. that is legally available to them to verify that you are telling the truth.
If you are not being truthful, and they find out, you’ll have a much worse resolution outcome at the end of the process. Revenue Officers are trained on what to look at and how to “sniff out” sources of revenue and assets that are being hidden, so just don’t leave anything to “sniff out”.
8. Financial Statements & Business Cash Flow
You can submit business financial statements, including a statement of cash flow, in lieu of the income/expense section of Form 433-B. The IRS may go so far as to request pro-forma cash flow projections to review your collection potential anyways. If it looks like you have a seasonable business (say an HVAC professional in Phoenix, Arizona) then you might have different payments throughout the year.
Regardless if they ask for it, take advantage to provide a full financial statement package to the IRS.
This is allowed by the IRS and creates a sense of organization with the Revenue Officer. It will look like you have (or are putting) your crap together and will lead to a better resolution outcome.
9. Making the Collection Decision
Understanding how the Revenue Officer is going to evaluate different expenses and assets is incredibly important. When considering how to make the collection decision, the Revenue Office is going to look at several things, like:
- Compliance history
- Reasons for non-compliance (are they justified)
- How many returns are filed or not filed?
- Are they current and compliant?
- Would it be better for the company to be shut down and liquidated?
- Will the CSED expire before liabilities can be paid?
- Will there be any impact on third parties if the IRS takes certain collection actions?
- Are there any fraud issues here?
- Who is a potential Trust Fund Recovery Penalty candidate?
All of this is good to know because if you know how they are thinking (aka the playbook) then you can combat their thinking through prudent financial analysis.
Once they have gone through this entire analysis exercise, they are going to review your case and determine what resolution option will be allowed: paying all of it now, paying over a specific amount based on specific assets, filing a tax lien, installment agreements, offer in compromise, etc.
NEXT ARTICLE: Tax Resolution Options to Consider