Category: Small Biz Stuff

Will an Offer in Compromise Relieve Me of this Horrible TFRP?

If the IRS has assessed a “Trust Fund Recovery Penalty” (TFRP) against you, you must take this very seriously.

As money withheld from employee paychecks, the IRS is very protective of this “Other People’s Money”. If this “other peoples money” is not properly deposited with the IRS, The TFRP will be assessed on those responsible for withholding and remitting payroll taxes to the government.

This penalty can be assessed on your own business, or, if you are an employee (not an owner of the business) and the withheld taxes have not turned over to the IRS, the could call you a “Responsible Person” and ask you to pay.

Wait!  That can’t be right, can it?  If you work for someone and part of your job duties were to prepare payroll, and your boss instructed you to NOT make the required payroll tax deposits, the IRS can hold you responsible???

Yep.  That’s what I’m saying.  Fair or not, the IRS calls this a “responsible person” penalty.  The IRS will always try and collect their money.

I. What’s a Trust Fund Recovery Penalty (TFRP) and Can an Offer in Compromise Help?

A. What’s a Trust Fund Recovery Penalty

Part of preparing payroll includes calculating the taxes to be withheld on each paycheck.  The company then adds their portion to this number and that would constitute that pay periods payroll tax deposit.

Most businesses will pay the payroll taxes withheld within a few days of payroll. If you owe less than $1,000 for a specific quarter, these taxes are paid when you file the quarterly payroll returns.

Payroll taxes are considered “Other People’s Money” (remember, you calculated the taxes to be withheld from your employee’s paychecks) so the IRS treats these payments a little differently than your income taxes.

That’s where the “Trust Fund Recovery Penalty” comes into play.  A responsible person can be the business owner(s) or the person tasked with preparing payroll and remitting taxes.

You CAN be a responsible person even if you don’t own any part of the business, or have signature authority on the bank accounts.

B. What’s an Offer in Compromise?

An Offer in Compromise is an IRS program designed to assist people with large tax debts (such as a trust fund recovery penalty) who won’t be able to pay without it horribly affecting their lives.

I don’t want to suggest that this is an easy way to get out of paying your taxes.  Ads claiming to get you out from under your big tax debt for “pennies on the dollar” are misleading.

The IRS is patient and will wait for you to pay. They have 10 years to collect. An Offer in Compromise may get you out of tax trouble, but you must qualify and the qualification bar is high.

There is also the cost of having someone prepare your application.  You can try yourself, but your chances of being approved are pretty low.  The OIC acceptance rate is usually around 33% overall (per the IRS in 2019).  You will see studies out there claiming anything from 5% to over 40%. 

C. Can an OIC help with my TFRP?

Short answer, yes.  But you have to qualify and the calculated amount must be less than the tax plus cost to prepare the application.

Let’s find out how to qualify.

II. Why The IRS Needs the Trust Fund Recovery Penalty (TFRP)?

A. Definition and Purpose of TFRP

The Trust Fund Recovery Penalty is put in place to ensure the government has enough money to operate.

Payroll tax deposits made by US businesses is the cash flow our government uses on everything it does.

When someone doesn’t remit the taxes withheld on peoples’ paychecks, there is less cash available to pay for things like our military, social security payments and money paid to states for things like education and Medicare.

How would your life be impacted if your employer stopped paying you, but still insisted that you kept working?  The TFRP allows the IRS to go after those who had responsibility to remit these withheld taxes.

B. How Does the IRS Know Who to Assess the Penalty Against?

The IRS can assess the TFRP against the business owner, an officer, a partner or an employee.  An owner, partner or officer can be held liable statutorily since they are already liable for other actions taken by the business.

The touchy one is when they go after an employee.  If you prepared the payroll and generally remit tax deposits, the IRS can hold you liable.

If you are/were an employee, the first thing we would do is collect evidence to support the fact that you DID NOT have any control or responsibility.  Easier said than done, but the first step.

III. Can An OIC Solve Your TFRP Problems?

A. The First Step Is to Do a Preliminary OIC Calculation

This is a seat-of-the-pants calculation to give you an idea what your offer will be.

Here’s part 1 of the calculation:

  1. How much is your monthly income?  If the amount is inconsistent, then come up with an average.
  2. What are your monthly expenses?  You’ll need to list these out.
  3. Regarding your monthly expenses, the IRS has limits on many expenses based on where you live.
  4. After paying your bills, you will know what your disposable income is.
  5. This amount is now multiplied by either 12 or 24 depending on how quickly you want to pay the IRS.

The next step is deciding how fast you can remit your offer amount to the IRS. If you use the 24 month amount, you have 24 months (or less) to pay off your liability.

If you use the 12 month amount, you must have your tax bill paid off within 5 months of IRS acceptance.

Part 2 of the calculation is as follows:

  1. Take the calculated amount from above.  We’ll pretend that number is $12,000.
  2. Make a list of all other assets and their purpose, i.e. business or personal.
  3. Exclude assets used for your business.  They must be business assets to exclude.  
  4. Figure out the equity in each asset.  That’s the amount you would get if you sold it. 
  5. As an example, this number is $25,000.  Add this amount to the first calculated amount.
  6. This is your offer to the IRS.  If you owed $250k, the $37k amount looks much better.  If you owed $25k, no bueno.

When attempting an OIC for a TFRP you must understand the “line” for the IRS is much higher. This is money that belongs to your employees, not you.

B. Who can apply?

This is actually pretty straight forward.  You can apply if:

  1. No unfiled or missing tax returns.
  2. Are not in bankruptcy.
  3. If you are the business owner, you must be current through the last 2 quarters with tax payments and employment tax return filing.
  4. If you are including the current year, you must be extended if you haven’t filed yet.

C. How To Apply

If you are an employee, you fill out form 656 and submit with the application fee, any tax deposit required and supporting documentation.   Supporting documentation can be anything from bank statements, bills and invoices you paid, and paystubs.

If you are the business owner, you will need to fill out form 433-OIC instead of form 656.  Depending on the amount owed, you may need to prepare forms 433-A and 433-B.

IV. Apply and Hurry Up and Wait

A. Submit your Offer in Compromise Application

Fill out the appropriate application and submit it with all supporting documentation.

If you make a claim on your application that you feel is important, make sure to include documentation to prove your point.

B. Now We Wait………

The IRS will now go over your application with a fine-tooth comb.  They will prepare their own calculations comparing them to your offer.  They can also corroborate your documentation.  The initial look-through will take around 6 months.

After the initial review, the IRS will most likely reach out to you asking for further corroboration.  They will be inquiring as to whether your financial situation has changed.  If your situation remains the same, they’ll look at the file again before making their decision.

C. Yes, No or We Need to Talk

Based on your application the IRS will either accept your offer or reject it.

Many times, however, they will come back to you with a different offer, or allow you to re-open negotiations.  Keep in mind that they WANT to resolve this case.

Once the IRS accepts your offer, you are required to keep up with your tax filigs, payments and estimate payments.  For the next 5 years, you cannot file or pay late.  You must pay your estimates if required.  You must be a model taxpayer.  Don’t give them an excuse to rescind the agreement, making the entire balance, plus penalty and interest fully due.

VI. What Alternatives Are Available?

A. Installment Agreements

This option allows you to pay the liability off over a period of time.  You have up to 72 months (6 years) to pay the debt.  There is also a possibility of a partial pay Installment Agreement.  If your finances won’t allow for full payment, then there is a possibility of making payments for 72 months and not fully paying the debt. Due to the size of most TFRP’s, a partial pay installment agreement might be the best course of action.

B. Currently Not Collectible (CNC)

This is a temporary fix.  Currently Not Collectible status is a pause in collection activity. This is for taxpayers who are in a temporary bind and only need time to sort things out.  If granted, the IRS will leave you alone, usually for 12 months.

This can be used to buy additional time to figure out your options.

C. Challenge the Trust Fund Recovery Penalty Assessment

THis is the first thing to look at.  The IRS will cast as wide a net as possible to collect their money.  There are two things the IRS looks at:

  1. The duty to perform the collection, accounting for and payment of trust fund taxes (what payroll withholdings are considered).
  2. The power to direct these actions.

The Chief Financial Officer of the company would qualify as a responsible person.  A data entry clerk simply doing what the boss says would not be a responsible person.  Many times, this must be proven to the IRS.

IX. Conclusion to Using an OIC on your TFRP

Finding yourself in this situation can be paralyzing.  Typically, the dollar amount is big.  Huge sometimes.  If there are a lot of employees, the required deposit will be large.  2-3 full-time employees paid twice a month can conservatively amount to $10k per month.  One quarter will then be $30,000 PLUS PENALTY AND INTEREST!

This all becomes even worse if you were an employee and have no ownership stake.  It makes no logical sense that you, as an employee, can be held liable for your employer’s tax debt but in this case it’s possible.

To qualify to apply you must be current on all tax return filings and not currently going through bankruptcy proceedings.

The IRS looks at three things when deciding whether to review your file:

  • Doubt as to Collectability – You don’t/won’t have enough income/assets to full pay.
  • Doubt as to Liability – The IRS made a mistake in assessing the tax.
  • Effective Tax Administration – This is subjective.  Think ‘Do the right thing” as it relates to the IRS.  I use this for elderly clients who will never be able to pay.  Effective tax administration isn’t as readily accepted as the other two options.

For the IRS to accept your offer, you must demonstrate:

  • An inability to fully pay your debt.
  • The hardship you would experience if you paid the debt in full. 
  • The amount offered must be more than the “Reasonable Collection Potential” amount calculated by the IRS using the info you submitted.
  • You must show the ability to pay the offer amount within the repayment period.

The IRS deals with payroll tax debts differently than income tax debts.  Payroll tax deposits is the cash flow the US Government uses for daily operations.

If you find yourself in this situation you need to contact an expert in the field.  The IRS will do everything in their power to collect.  We need to be ready to defend your actions and responsibility to make this bad dream go away.

You Don’t Need To Be Making Big Time Money To Need An LLC

Four reasons why you need an LLC, and three reasons you don’t.

Do you need an LLC? The world is full of people with expectations.  These expectations are generally founded on nothing more than “Joe has one, I must need one too”.

As a business owner, you are constantly presented with choices that can affect your business and life. One such decision is whether to form a Limited Liability Company (LLC) as the legal structure for their business.

Do you need an LLC?  It depends on your situation.  Many tax guys like me suggest that your income level should determine whether you form an LLC or not.  I don’t think your income level is as important as some would lead you to believe. There’s more to this decision than saving on taxes.

I like to look at a clients financial life outside of their business to help determine their needs.  What needs protection?  Is there family or spousal wealth that needs to be considered?  Income level is an important consideration, but so many other things need to be considered.

Let’s be honest.  Saying “I have an LLC” or “I’m incorporated” feels good.  We sound legitimate.  We sound like a real business, like Microsoft or Google.

Let’s take a look at a few reasons why you should and a few reasons why you shouldn’t.  Not everyone needs to house their business within an entity, such as an LLC or Corporation.  Let’s figure out what’s best for you.

Four Big Reasons You Need an LLC

1. Liability Protection Just In Case!

An LLC will protect it’s members (shareholders). This means that your personal assets, are kept separate from the company’s liabilities.

The business will be held liable if you, or an employee or agent of the company does something that caused loss to someone.

In the event that the business faces financial or legal troubles, your personal wealth remains shielded. This protective barrier is a powerful safety net, offering peace of mind and security to entrepreneurs.

If you have employees that drive around on company business, affording yourself additional liability coverage has a lot of benefits.  My employees do drive around to pickup documents from various clients.  I incorporated around the time this was starting up.

2. You Pick How You Want To Be Taxed

This is something that I don’t see a lot of on various “Why You Need an LLC” articles. There are two types of LLC’s you can choose from.

A Single Member LLC (SMLLC) or a Multi Member LLC (MMLLC) are the two types of LLC’s you can pick from.

A Single Member LLC is reported on Schedule C when you file your taxes.  This designation is chosen if there is only one principal to the business. This is the default selection for a one person business.

A MMLLC is a partnership and reported on form 1065.  This is a separate return from your personal return.  Form 1065 will produce K1’s for each partner.  The info on the K1’s is used to prepare each partners individual return.  A K1 is kind of like a W2 for partners.

So far, you can report your LLC’s tax activity as a Sole Proprietor or a Partnership.  You can also elect to be taxed as a corporation by filing form 8832 – Entity Classification Election.

Once you elect corporate status, you then need to decide if you want to be an S Corp or a C Corp.

How you file will depend on your personal (and your partners if any) tax and financial situation.

I’ll write an article on how to choose your entity later.

3. Easy Management Structure

Compared to a corporation, an LLC has much less required annual maintenance.  Other than a tax return, the only other thing you need to do to maintain your LLC status is generally file an information return with your state Secretary of State every other year.  This is also required for corporations, but not for unregistered businesses.  Most business not an LLC or Corp are considered unregistered.

A corporation is required to maintain minutes of shareholder meetings.  Most states require at a minimum, one annual shareholders meeting.  LLC’s have none of these requirements.

4. You’re a REAL BOY Business now!

This reason is the primary reason people form LLC’s, and it’s not a bad reason.  Housing your business in an LLC or corporation tells the world that you are serious about your business.

The cost to form an LLC on MyCorporation.com (it’s who I use) is around $500, l if you do it yourself.  It’ll cost upwards of $2,500 to have an attorney do this for you.  You could probably find a better use of your money this early into your venture.

But.  Perceptions are real.  An LLC appears more like a real business than someone selling oranges out of his trunk.  It’s a perception.  It may not even be real.  The guy selling oranges might have 1,000 other people selling his oranges out of their trunks.  That’s a real business.  But the perception is less than.

Getting financing or other funding is also easier if you are a registered entity, such as an LLC.

Three Important Reasons Why You Don’t Need an LLC

1. Additional Cost and Other Troubles

Setting up an LLC costs money.  Depending on your needs it can cost upwards of $2,500.

In California (and in other states as well) there is an LLC Gross Receipts fee.  They also charge a minimum tax of $800 each year, regardless of whether you have taxable income or not.

You can also count on a higher tax preparation fee.  A Single Member LLC is reported on form Schedule C on your federal return, but there may be additional returns needed at the state level.  These state level returns add at least an additional $250 to your return prep costs.

If you elected to be treated as a Multi Member LLC or as a Corporation (S or C) you can count on an even higher fee to prepare the LLC’s own return.  An properly prepared LLC or corporate return will usually start at around $800.

2. Ever See an LLC as an IPO?

I love LLC’s.  I think they are the perfect entity to hold your business.  You have the liability protection of a corporation, without a lot of the compulsory rules that make having a corporation too much for a small business.

But what if your dream is to build a business, sell it, then build another?  You want the life of a serial entrepreneur.  In this case, an LLC may not be the best choice.

You can absolutely sell your business if it’s not in an LLC or Corporation.  But you won’t receive proper value.  And generally the tax code has more ways to save on taxes if you  sell from a corporation.  Under some circumstances, you could even sell your corporation and reinvest the funds into another small business stock, without paying tax on any possible gains.

Compliance, compliance, compliance.  The biggest headache when having an LLC is the amount of compliance and record keeping that is required.

Let’s talk about record keeping.  Keeping books.  You are required to keep a full general ledger set of books.  A balance sheet, profit and loss, and maybe a cash flow statement are what you should aim for.

Maintaining a good, solid, accurate set of books is essential to running a business.  No one can tell how their business is doing just from “touch”.  Running your business from the seat of your pants is a slow walk to insolvency.  How can you make educated decisions without accurate information?

Compliance is actually the easy part.  Your state Secretary of State will require your LLC to file an information return every (or every other) year.  This is needed so the state has a record of your officers or managers on file.

Conclusion

Do you need an LLC?  Why?  Are you planning on growing, then selling your business?  Have you given any thought to your long term plans?  Do you have a need to protect assets not in use or owned by your business?

The decision to form an LLC to hold your business and its assets is usually the right choice.  The only fault I can find in forming an LLC and using it to hold your business, is the timing.

Here’s what I look for when determining whether an LLC is a proper choice.

  • What is the basis for your business (service or selling product)?
  • What personal assets needs protecting (home, real estate, savings)?
  • Along the same lines, how much income from other sources will you have?
  • What are your long term plans (grow, sell,…)?
  • Will you have employees out in the field?
  • What other kind of liability exposure are you concerned with?

When I mentioned timing above, I mean “When did you form the LLC?” and “Why did you choose that time to form the LLC?”

If you are in business as your livelihood (not some part time gig type endevor) and growth, and possibly passing the business on to heirs are some of your biggest concerns, you will be forming an LLC (or a corporation) eventually.  But there’s no hurry.

I’m not a fan of wasting money on unnecessary expenses.  If you’re serious about starting and growing a business, you will be forming an entity at some point.  Don’t do it before you need it.

Expert Advice On How to Pick Retirement Plans for Independent Contractors

Retirement plans for independent contractors are plentiful.

As an independent contractor, it is you and only you who are responsible for your retirement planning.  And there’s no wrong choice.  Take a look.  I’m sure there’s something to best suit your needs.

As the ultimate boss of your life, you must take tangible steps to ensure retirement is something to look forward to, not freak out over.  Let’s go through the plans I’ve recommended to many clients in the past.

I. The Usual Charlie:  Traditional Retirement Saving Plans:

   A. Individual Retirement Account (IRA) The backbone of retirement plans for independent contractors:

  • Traditional IRA: This is the one you usually think about when you hear “IRA”.  In general (everything IRS has exceptions, so I’ll just discuss the plans in general) you can contribute money ($6,500 in 2023, $7,500 if you’re over 50) and deduct the contribution on your taxes.  You don’t pay taxes on the growth until you take distributions after you retire.  The entire distribution is taxed if you took the contribution as a deduction on your taxes.
  •  Roth IRA: This one allows the same annual contribution (and amount) but it’s not deductible on your taxes.  But…you don’t pay tax on any distributions you take after you retire.  I advise younger people to start with this one.  I started my son’s when he was 11.  He’s 27 now.  Time is your friend with ROTH’s.  You aren’t taxed on any of the growth.  The longer you leave it alone, the more growth..

   B. Simplified Employee Pension (SEP) IRA: The big brother to the above IRA’s.  This one is great when you outgrow regular IRA’s and their contribution limits.  A SEP will allow you to contribute as much as $66,000 in 2023.  $66k for 30 years is almost $4.7 million, at 5% annual growth.  The kicker is to contribute the max you’d need net self employment income of $330,000.  You can contribute 20% of your net self employment income.

   C. Savings Incentive Match Plan for Employees (SIMPLE) IRA: A little brother retirement plan to a 401(k). I included this one since having an S or C Corp requires you to pay yourself through payroll.  If you choose this way to save, you have to offer it to your employees (max 100).  You can contribute $15,500 in 2023 with an additional $3,500 if you’re over 50.  The business must make a matching contribution (which is also deductible) on behalf of each participating employee.  And it’s something good to offer the employees.

II. Solo 401(k) Plan:

   A. This one is my favorite for spousal teams.  It allows each one to conceivably contribute $66,000 to their retirement, reducing their taxable income by that same $66,000.  This one is a mix of a traditional 401(k) plan with a SEP IRA (discussed earlier).  To contribute the max, you need  to make $210,000 in wages.  Much less than the regular SEP.

   B. This one is for a true sole proprietor with no employees other than themselves and their spouse.  Other than that, you’re out of luck.

   C. They’re as easy to set up as any other IRA.  Not all brokerage houses do these, but the big ones will.  This will give you a wide variety of investments with a cost a lot less than a typical 401(k) plan, with none of the reporting requirements (that you need to worry about).

III. Saving for Medical Issues:

   A. Health Savings Account (HSA): While not a retirement plan, an HSA is great way to bank money for future medical needs, while writing off your contributions and paying no tax when you use it.  More free money. While this isn’t a retirement plan for independent contractors per se, it can be a big part of your retirement savings.

      1. To be eligible to start an HSA, you must have a high deductible health plan (HDHP.  Your health insurance plan) with a minimum deductible of $1,500 for a single filer or $3,000 for a family. The plan must also have a max out of pocket of $7,500 for a single filer and $15,000 for a family.

      2. Your maximum contribution for 2023 is $3,850 for single filers and $7,750 for family plans.

      3. I think of these like medical miracle plans.  I think EVERYONE should start one.

Do this:

Contribute the max if possible.  If young, pick a plan which allows you to pick what the money is invested in.  Don’t do one of those money market plans.

You’ll get a debit card to use on qualified medical expenses.

Hopefully you won’t need to use the card often.  What you’re doing is building a nest egg for later when you might really need it.

You deduct the contributions on your taxes – TAX SAVINGS!

Your investment grows without paying tax on dividends or capital gain transactions (remember, no money market plans) – MORE TAX SAVINGS!

You know that cliche about the only two “for sures” in life?  Death and taxes? You’re gonna die, but you won’t pay taxes on these plans.  ONLY SAVE 

IV. Be consistent.  Make your Retirement Plan Set and forget.

   A. Saving is a skill.  You have to learn it.  I can’t stress this enough.  You don’t want to creep up on 60 and suddenly realize that you’ll be working until you’re 75 (life expectancy in the USA is down to  76.4 years).  I’m pretty chill about most things.  But this is an important skill to develop. You’re going to need a retirement plan.

   B. Set and forget will be hard the first year or so.  When I decided to buy my own home, i started saving $700/mo (that was a lot for me then and it was in the 1980’s).  It killed me for about 6 months.  I still remember when I realized I hadn’t thought of the transfer to savings for a few months.  It was freeing..

   C. The goal is to save.  Sometimes, life throws a hurricane at us and money is an issue.  Adjust.  If you were putting away $1,000 or $100, adjust it to $500 or $50.  Or whatever you can.  But don’t stop.  Maintain and be consistent.

V. Do your research:

   A. From a tax perspective.  Limits and requirements change most years.  Rules are always being discussed for change in Congress as well.  Watch for changes in age requirements in the future.

   B. From an investor perspective.  You can either find an advisor (they cost) or self direct (you manage).  I think the smartest way to invest is via both open and closed end mutual funds.  Index funds (think Vanguard) have the lowest management fees and generally do just as good, or better than managed accounts over the long term.

   C. Start by doing a risk analysis on yourself.  This tells you how risk averse you are and guides you with your investment selections.  There are tons of great tools online to help you along.

Conclusion:

The number of retirement plans for independent contractors available makes it easy to create a retirement savings plan, even if it’s just to put away $100 a month. This might be the most important skill you develop.  Especially if you are smart or fortunate enough to start young.

Do this:

Open an account somewhere.  TD Ameritrade, ETrade, Schwab, …it doesn’t matter at this point.

Set an auto investment of $10, $50, $100.  Something.  Anything.  Do it now.  Set it for a monthly contribution.

Forget about it for about 30 years.

With a modest return of 5%, you’ll end up with almost $84,000 with a $100 monthly investment.  You contribute $36,000 and it turns into $84,000

That’s the power of compounding.  Put money away every month (your financial advisor might refer to this as Dollar Cost Averaging) and watch it grow.

Using one of the above tax deferred plans will let you grow without having to liquidate to pay taxes every year.

If you’re at least twenty years from retirement, start a ROTH IRA and contribute the max if you can.  Every year.  Contribute $7,000 a year for the above thirty years and you’ll have almost $500,000!  And pay no tax on distributions!  That’s as close to free money as Uncle Sam (the bastard) will allow!

Or contribute $66,000 to a SEP for the next 30 years and walk away with $4.7 million!

Think big people.