The IRS Collection Process: A Review of the Basics

Editor: Valrie Chambers, Ph.D., CPA

Procedure & Administration

The IRS is the largest collection agency in the country and by far the strongest, empowered by Congress to take actions necessary to collect taxes owed to the federal government. Such a wide-ranging power can easily create some fear among those who do not know the procedures the IRS follows in its collections process.

The IRS has a straightforward automated collection process. If a client owes taxes, the first letter he or she receives is a CP14 notice, which informs the recipient an income tax amount, along with any penalties and interest, is due and explains the steps to resolve it. (More information is available on the IRS’s “Understanding Your CP14 Notice” page).

The next notice is a CP501, which reminds the taxpayer that he or she has a balance due with the IRS. If the taxes remain unpaid or the taxpayer does not respond to the CP501, the taxpayer will then receive another reminder, CP503. If the previous notices are ignored, the taxpayer will receive CP504, “Notice of Intent to Levy,” stating that if the amount due is not paid immediately, the IRS will seize (levy) the taxpayer’s state income tax refund or other funds or property and apply it toward the amount owed. This notice must not be ignored if the taxpayer wants to avoid levies or liens. Then, the client may receive Letter 1058, “Final Notice of Intent to Levy and Notice of Your Right to a Hearing.”

When notified that a client has received an IRS notice, a CPA should discuss with the client his or her ability to pay the taxes due in full. If the client cannot pay in full, the next step is to have the client sign a Form 2848, Power of Attorney and Declaration of Representative, which must be filed before the IRS can disclose the taxpayer’s account information to the CPA. (Note that Form 2848 changed in late 2011. Married clients who file joint returns must each sign a separate Form 2848; a joint Form 2848 is no longer acceptable.) After filing the Form 2848, the CPA should contact the IRS immediately to try to avoid other actions, such as the filing of a notice of federal tax lien, a levy on assets or wages, or offsetting of a state tax refund. However, some taxpayers cannot immediately pay what they owe. If so, they have several options for paying the balance due over time.

Alternative Payment Options

The first option is to apply for an extension of up to 120 days to pay if the taxpayer can pay that amount in full within that time. The IRS does not charge a fee for the extension, but late payment penalties and interest accrue until the full amount due is paid.

A second option for qualifying taxpayers is a “streamlined installment agreement.” This plan is available for taxpayers that owe up to $50,000. The taxpayer is not required to submit a financial statement to the IRS, and the repayment period for the debt can be up to six years. Persons who owe $25,000 or less who want a streamlined installment agreement should file Form 9465, Installment Agreement Request, and those who owe between $25,000 and $50,000 should file Form 9465-FS. (Form 9465-FS is fairly new and part of the IRS’s “fresh start” initiative.) The form is attached to the front of the tax return or submitted separately if the return has already been filed. If it is filed separately, the taxpayer should send the form to the address indicated in the form instructions. The IRS will normally respond within 30 days with an acceptance or rejection. The taxpayer must submit a $105 processing fee ($52 if monthly payments will be made through electronic transfers) with the form.

The instructions to the forms suggest that taxpayers make monthly payments as large as possible to avoid additional interest and penalties. However, some practitioners multiply the balance due by 1.13 (use a 13% simple interest rate), divide by 60 months, and round up. While not exact, this formula results in frequent acceptances. Clients can pay more than required under the agreement as funds are available.

As an alternative to completing the appropriate form on paper and submitting it to the IRS, a taxpayer also can complete and submit the forms online at irs.gov or may call the IRS to arrange an installment agreement. These options are much quicker, and the taxpayer receives immediate notification of approval. (See IRS, “How the Installment Agreement Works,” in the Form Form 9465-FS instructions).

Taxpayers with amounts due of more than $50,000 can apply for a traditional installment agreement that, like a streamlined agreement, allows the taxpayer to pay the bill in monthly increments; this is usually done by direct deposit or payroll deductions to ensure timely payments. However, the IRS requires the taxpayer to provide financial information so that it can determine the amount the taxpayer is able to pay. Individual taxpayers must complete Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, and, if the taxpayer owns a business with employees, Form 433-B, Collection Information Statement for Businesses.

A fourth option is to apply for a delay of collection if the taxpayer is unable to pay. If the client qualifies, the IRS places the taxpayer’s account into a “currently not collectible” status that the IRS will review from time to time to determine if the taxpayer’s financial conditions have improved. The IRS generally determines the taxpayer’s ability to pay based on the information provided on Form 433-A and, if necessary, Form 433-B.

A fifth option is to submit an offer in compromise, which allows some taxpayers to settle their bill for less than the amount they owe. “However,” the IRS warns, “the criteria for accepting an offer are strict and relatively few offers are accepted each year” (IRS, “The Collection Process”). The taxpayer must submit Form 656, Offer in Compromise, Form 433-A, and, if necessary, Form 433-B.

Liens vs. Levies and Seizures

A tax lien publicly notifies all creditors that the IRS has a lien against all of the taxpayer’s property, including property that the taxpayer may acquire after the IRS has filed the notice of federal tax lien. “The lien is required by law to establish priority as a creditor in competition with other creditors in certain situations. . . . Once a lien is filed, it may appear on a taxpayer’s credit report and it may harm a taxpayer’s credit rating” (IRS, “The Collection Process”).

The IRS actually collects delinquent taxes through levy on any property or rights to property of the taxpayer on which there is a lien. The term “levy” includes the power of seizure by any means (Sec. 6331(b)). The IRS may levy on any property the taxpayer owns or on payments, subject to exemptions provided in Sec. 6334. Levied assets or payments may include wages, Social Security benefits, and retirement income. The IRS also can offset tax refunds, by applying to the tax balance owed all future federal and state tax refunds otherwise payable to the taxpayer.

A taxpayer may feel powerless when confronted with a tax lien and the possibility of an IRS levy. However, the IRS may release liens, such as when:

1. The IRS determines that the notice was premature or not filed according to administrative procedures;
2. In certain cases, the taxpayer enters into an installment agreement;
3. The lien withdrawal will allow taxes to be paid more easily or quickly, perhaps by keeping a credit rating higher and therefore interest expenses lower; or
4. The withdrawal is in the best interest of both the taxpayer and the government, as determined by the National Taxpayer Advocate and the government. 

In addition, the IRS must withdraw a lien if it was filed during the automatic stay period in a bankruptcy proceeding.

Filing an Appeal

The taxpayer also can appeal the collection action. The taxpayer receives Publication 1660, Collection Appeal Rights, explaining how to request a hearing with the Office of Appeals. Publication 1660 notes that “[t]he Office of Appeals is separate from and independent of the IRS Collection office that initiated the collection action.” Publication 1660 fully explains the rights and procedures for challenging collection actions.

Tax practitioners should counsel their clients to contact them as soon as they receive any sort of collection letter from the IRS, so that the practitioner can help them create an effective plan of action. Practitioners should also encourage clients to keep good records and documentation of their finances and to be as organized as possible, so that they can deal more easily with any tax problems. Although taxpayers may fear the IRS and its power, the ultimate way to stand up to it is to be educated about its procedures and abilities.