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Overview of IRS Penalties – Individual Income Taxes

Posted on: February 19th, 2014 by sashworth No Comments


Written by Peter McFarland, Esq. on 10/9/2013

In 1955 there were only 14 penalties that the IRS could assess. Today, there are more than ten times that number! With this huge increase in the types of penalties the IRS can assess, clients are constantly asking what can be done to lessen the effect of these penalties.
In this article, I will focus on describing the most common penalties for individual income taxes only. If there is interest in this topic generally, I will write an overview of penalties applicable to businesses, including employment taxes. Also, keep an eye out for an upcoming article explaining penalty abatements.

Failure to File Penalty
Section 6651 of the Tax Code gives the IRS the authority to assess a penalty for any failure to file a tax return by the due date. Basically, if you owe tax and don’t file on time, the total failure to file penalty is usually five percent of the tax owed for each month that your return is late, up to five months. If your return is over 60 days late, the minimum penalty for late filing is the lesser of $135 or 100 percent of the tax owed.

Failure to Pay Penalty
Section 6651 of the Tax Code also gives the IRS the authority to assess a penalty for the failure to pay a tax obligation. If you file a return but fail to pay all amounts due on time, you’ll generally have to pay a penalty of one-half of one percent of the tax owed for each month that the tax remains unpaid until the tax is paid in full or the 25% maximum penalty is reached. The exact percentage can change based on certain specific circumstances, but this is the penalty calculation for the majority of taxpayers.

Estimated Tax Penalties
Section 6654 of the Tax Code further gives the IRS the authority to assess a penalty for the failure to pay estimated taxes. If you must pay estimated taxes but fail to pay enough through estimated tax payments, you may be charged a penalty. Further, if you do not pay enough by the due date of each payment period you may be charged a penalty even if you are due a refund when you file your tax return. Certain exceptions exist, and you may want to speak to a professional if you believe you will be assessed a penalty.

The calculation of the penalty depends on several variables, including the amount of the underpayment, the application of a statutory rate, and the length of time the estimated tax was unpaid. For assistance with this penalty, it’s best to speak to a professional to determine the extent of your tax liability.

Conclusion
There are a massive amount of penalties the IRS can and will use to attempt to gain compliance out of taxpayers. I have only explained three, and I’m sure the dry nature of the explanations made more than a few eyes glaze over. If you receive a notice that the IRS has assessed a penalty on your account I highly recommend you discuss your situation with a professional. At Estill & Long, LLC we have successfully abated penalties for clients for years and can help you get relief today!

Contact us today!

About Peter McFarland, Esq.
Peter earned his Juris Doctor (J.D.) degree at the University of Denver. After becoming licensed to practice law in the State of Colorado, he earned his Master of Laws (LL.M.) in Taxation at the University of Denver. In his current role, Peter represents taxpayers before the IRS and in the United States Tax Court. He gained valuable experience as an attorney with the University of Denver’s Low Income Tax Clinic during his graduate school studies and has been representing clients at Estill & Long, LLC since his arrival in early 2013.

Choosing a Business Entity for your Real Estate Activities

Posted on: January 14th, 2014 by sashworth No Comments

By: Scott Estill, Esq. and Stephanie Long, Esq.

There are many different business entities that a real estate investor should consider when starting their real estate company. However, there is no “one size fits all” entity for every investor. Each entity has its advantages and disadvantages, and it is only with careful planning that a decision should be made. We will describe the 3 basic entity types in this article and some things you should consider when forming one.

C-CORPORATION

A C-Corporation is simply a separate business entity (sometimes called an “artificial person”) that is organized under the laws of a state and is completely distinct from its owners.  A C corporation is basically any for-profit corporation that did not make an election to be treated as an S corporation.  It is called a “C” corporation because it is governed by Subchapter C of the Internal Revenue Code.  All C-Corporations are treated as separate entities for tax purposes and must file an income tax return (Form 1120) each year.

 

A C-corporation must file its own tax return (Form 1120) every year and it is taxed on its net profit (after business expenses have been deducted).  Depending upon the net income of the business, it may be advantageous for the business to be taxed at the corporate level, as the tax rate may be lower than it would be at the individual shareholder’s tax rate level. C-Corporations can also have a medical reimbursement plan for its employee/owners, which can provide a very nice tax benefit for those who have high medical expenses.

 

One of the other big advantages of a C-Corporation is that it provides personal liability protection for all of its shareholders. The disadvantages are potential double taxation to the corporation and its shareholders, potential accumulated earnings taxes and reasonable compensation issues.  We generally look to a C-Corporation for our real estate investor clients who are real estate dealers (i.e. those who are in the business of fix and flips), management companies, and real estate brokers.

 

S CORPORATION

An S corporation is identical to a C corporation except that it makes an election with the IRS on Form 2553 to be treated as an S corporation. The main difference between a C and S corporation is the way the corporation is taxed.  An S corporation is required to file a tax return (Form 1120S) but it does not pay any income tax on its net business income.  Instead, the shareholders pay tax on the corporate income based upon their percentage of ownership in the corporation (i.e. an S-Corporation is a “flow-through” entity).

Some of the advantages of an S-Corporation are that the S-Corporation provides personal liability protection for its shareholders, it avoids the double taxation problems of a C corporation, and there are no accumulated earnings tax issues with S corporations. An S-Corporation is also a viable entity for saving employment tax dollars for employee/owners of the company required to take out a reasonable salary. The disadvantages include being limited to 100 shareholders in the corporation, only having the ability to issue one class of stock, the lack of the ability to have a medical reimbursement plan like a C-Corporation, passive activity loss restrictions, and reasonable compensation issues. We recommend using an S-Corporation for real estate dealers, real estate brokers and management companies.

 

LIMITED LIABILITY COMPANY (LLC)

A limited liability company, or LLC, is a mix between a corporation and a partnership.  It is similar to a corporation because it limits the personal liability of its members but is taxed like a partnership. An LLC is very flexible in that the company can elect taxation depending on the needs of the owners. An LLC can be taxed as a C-Corporation, and S-Corporation, a Partnership or a Disregarded Entity. An LLC is also a “flow through” (with the exception of an LLC taxed as a C-Corporation) business entity, meaning the LLC itself does not pay any tax on its profits, the individual owners do.

The advantages of an LLC include personal liability protection for its members, no double taxation issue if the LLC is taxed as a partnership, no accumulated earnings tax problems, and no reasonable compensation issues. The disadvantages include having to pay self-employment taxes on earned income generated through the LLC, lack of the ability to have a medical reimbursement plan like a C-Corporation, and certain passive loss restrictions on passive investment losses passed down to the owners of the company. We usually recommend using a LLC for real estate rental businesses, long term investment property (i.e. property held a year or more), and as holding companies for investors with multiple rental properties or significant assets.

As you can see, the three main entity types have their advantages and disadvantages. It is important that you work with your legal professional to help you decide which entity is right for you, as the formation of such an entity is dependent on the owner’s individual facts and circumstances. The formation of these entities can be costly in both formation costs and ongoing maintenance. For example, most of these entity types will require a separate tax return be prepared each year. Additionally, different Secretary of State offices charge different fees to have an entity formed. There also may be additional fees such as for bookkeeping for the entity and transfer taxes. Although such costs can be looked at as part of doing business (and in most cases tax deductible), each owner should understand the pros and cons of adding such a structure to their current real estate business.

 

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Understanding Your IRS Collection Notice

Posted on: December 6th, 2013 by sashworth No Comments

 

IRS collection notices can be a source of stress and sometimes even embarrassment.  Taxpayers fall behind, it happens. The problem is that when a taxpayer owes the IRS money, a flood of notices come to the mailbox and often it’s hard to tell how serious any threats found within the letters are.  Some correspondence appears threatening on its face but lacks any real serious bite.  Other notices appear innocent, yet can result in serious legal ramifications if left alone.

As a practitioner, I receive sometimes dozens of letters in a single day meant for my clients and I have learned to quickly identify what notices require immediate action.  This article, while not exhaustive by any means, is intended to give you a quick primer on the different notices the IRS sends out when the IRS believes it is owed money.

A quick note: If you owe the IRS money and are receiving these notices, please don’t hesitate at all.  Waiting only makes dealing with the IRS more stressful and difficult.  If you wait, you will receive more threatening letters and eventually face enforced collections.  You should call the IRS to explore your options or hire a professional to represent you.

 

Notices

Now that that’s out of the way, let’s get to our first notice:

The CP14 Notice

Often the first notice that taxpayers will receive is a CP14 notice.  The CP stands for computer paragraph, and it is an automated notice created by a centralized computer system at the IRS.

Here’s an example of the first page of a CP14 notice:

If you find yourself with a CP14 notice in hand, the good news is that this is the least serious of the notices.  That being said, you should be proactive and either call the IRS to discuss your options or hire a professional to negotiate with the IRS on your behalf.  If left alone, other notices will be sent soon with more serious ramifications.

The CP504 Notice:

The next notice you may receive is the CP504 notice.  This is a more serious notice than the CP14, as it proposes to levy your property if you do not pay the liability in full.  A levy, to be clear, is not the same as a garnishment or lien.  A levy will attach to your bank accounts and your banking institution will be required to pay any amount that you have deposited in your bank account to the IRS.  Essentially, the IRS wipes out your bank account to pay your liability in part or in full.

Here’s an example of a CP504 notice: CP504 or CP504B Notice

With the CP504 letter, the IRS means business.  The IRS is ready to begin enforced collection activity and it is giving you notice that it intends to seize your property.  If you find yourself with a CP504 in hand, call the IRS to discuss your options or call our office immediately to speak to one of our experienced attorneys.

Under some circumstances, this CP504 notice is the last notice you receive before the IRS begins levying.  If you have had an opportunity previously to request a Collection Due Process Hearing, it will likely be the last notice you receive.  If you have not had the opportunity to request a Collection Due Process Hearing, then there will be one more notice you will receive.

The CP90/297 notice:

The CP90/297 notice, under some circumstances, is the final notice given to a taxpayer before the IRS employs levies to collect an outstanding liability.  It is the “triggering event” to be able to request a Collection Due Process Hearing, which is a very powerful tool in a taxpayer’s arsenal.

If you receive a CP90/297 notice, time is of the essence.  You have 30 days to request a Collection Due Process Hearing, otherwise the IRS will employ levies to collect the liability.  Special forms are required to request the Hearing, so it may be best to consult with one of our experienced attorneys.

Here is an example of a CP90/297 notice: CP90/297 Notice

 

What if a Taxpayer Can’t Pay the Full Liability Shown on the Notice?

The IRS realizes that paying the liability in full is not possible for many taxpayers, or even if paying in full is possible on paper it would actually create a hardship.  The IRS has several programs in place to address this reality, including monthly installment agreements, offers in compromise, and a currently not collectible status.

If you cannot pay your liability in full, speak to a licensed tax professional immediately and bring any notices you have received to the initial consultation.  Estill & Long, LLC’s tax attorneys are well-versed in negotiating with the IRS and can help you set up a plan to avoid enforced collections by the IRS.

 

Conclusion

The IRS sends many other notices, and the format of any particular IRS notice is subject to change in the future.  This article is only meant as a short primer to get you familiar with what IRS notices look like and may give some insight into a notice that you have already received.

In any event, collection action by the IRS can be aggressive and for some taxpayers catastrophic.  If you have received an IRS notice listed above (or any other notice not discussed in this article) I implore you to reach out to Estill & Long, LLC to assist you.

 

About Peter McFarland, Esq.

Peter earned his Juris Doctor (J.D.) degree at the University of Denver. After becoming licensed to practice law in the State of Colorado, he earned his Master of Laws (LL.M.) in Taxation at the University of Denver. In his current role, Peter represents taxpayers before the IRS and in the United States Tax Court. He gained valuable experience as an attorney with the University of Denver’s Low Income Tax Clinic during his graduate school studies and has been representing clients at Estill & Long, LLC since his arrival in early 2013.