Handling a Tax Dispute


Elements of a Tax Claim

There are three elements to any tax debt: the deficiency principal, interest, and penalties. The deficiency principal is the amount of actual tax owed to the governmental agency. Interest on state and federal deficiency balances accrue from the date the tax became due at the rate established for federal income tax deficiencies. This means that interest will begin accruing months or years before the final assessment is entered.  Currently, the federal rate is calculated based on the interest rate for federal short-term debt, plus 4.00%. Both the Internal Revenue Code and Alabama Code authorize the revenue authorities to assess numerous penalties against taxpayers, including: failure to file a return; failure to timely pay tax; underpayment due to negligence; and underpayments due to fraud. Agencies have discretion in the application of these penalties; the Internal Revenue Code and the Alabama Code allow the agencies to waive or reduce penalties if the taxpayer can show reasonable cause.  Reasonable cause in this context means that the taxpayer acted in good faith.

Audits, Assessments, and Appeals.

Either the federal or state taxing authorities may conduct an audit on a taxpayer. Audits typically occur within 3 years of the later of the date upon which the tax return was due or the date it was actually filed (this limitation on the years subject to an audit can be extended to 6+ years, depending on the circumstances).

After the results of an audit, the taxing agency will enter a final report that becomes the basis for their preliminary assessment. Taxpayers may appeal the preliminary assessment. If the preliminary assessment is not appealed or the taxpayer loses their appeal, the preliminary assessment becomes a final assessment. Final assessments of federal tax claims can be appealed to the U.S. Tax Court, the U.S. Court of Claims, or the applicable U.S. District Court. Final assessments of ADOR tax claims may be appealed to either the Alabama Tax Tribunal or the applicable Alabama Circuit Court. Final assessments that are either not appealed, the appeal is lost, or appeal rights have been exhausted have the same legal effect as final judgments entered by state or federal courts.

The Federal Tax Lien.

A federal tax lien arises when any taxpayer owes a tax debt to the IRS and fails to pay the amount after IRS makes demand for payment. The lien relates back and is effective from the date that IRS assesses the tax liabilities. Consequently, the lien will relate back to the assessment date, not the date that IRS made demand for payment. The lien attaches automatically to all property of the taxpayer, tangible or intangible, and includes future interests, executive contracts, after acquired-property, and any contingent property interests. The federal tax lien remains attached to all property until the liability for the assessment amount is paid in full or the statute of limitations on collection expires. In most cases, IRS (and ADOR) have 10 years from the date of assessment to collect the tax liability. However, in some cases, the statute of limitations may be suspended by the filing of a probate petition.

For the federal tax lien to have priority over other competing lien interests, the IRS must file a Notice of Federal Tax Lien (“NFTL”) in the appropriate Probate Court and/or with the UCC filing index with the Alabama Secretary of State. Even without filing an NFTL, the IRS has a perfected security interest in all property of the taxpayer

Lump Sum Payments.

From the government’s perspective, lump sum payments are always the preferred method of settling any tax debt; the agencies get paid in full up-front and do not have to administer a payment plan with the taxpayer, which can be both costly and time consuming for the revenue agencies. For many, however, a lump sum payment may not be possible. While a taxpayer may be able to borrow money from a financial institution, repaying a nondischargeable tax debt may render the institution’s loan also non-dischargeable under federal law. Thus, bank loans, when used to pay tax debts, can take on some of the characteristics of the tax debt.  Lump sum payments are the most effective means for settling a tax debt, if possible.

Payment Plans.

Taxpayers with outstanding tax issues (and regular income) may enter into payment plans with both the IRS and ADOR. The payment amount will be based on disposable income available to support the plan. IRS plans may last as long as the statute of limitations on collections. ADOR will only enter into payment plans lasting 12 months from the first payment date with the option for an additional 12-month extension if ADOR determines that an extension is in the agency’s best interest.