I represent taxpayers every day in California. Sitting in my office in Redlands, I review financials with taxpayers who have just filed multiple years of federal tax returns and want to compromise their tax debt. When I ask about the state income tax returns they always state that their accountant just got the IRS filed and that we can work on the state later.
Unfortunately, this was terrible advice from the accountant/tax preparer, and just made resolving the tax debts that much harder. Why?
First thing most taxpayers do not realize, and accountants do not explain, is that the state departments of revenue are every bit as aggressive as the IRS, and often more so. In addition, most states do not have the programs and taxpayer protections that the IRS has in place. The way this plays out in practice is as follows:
- The federal tax returns were filed first, so the IRS (correctly) takes the position that its debt comes ahead of the state tax debt;
- Most state (California amongst them) do not care if the IRS is ahead of them and will demand payment. Hence the taxpayer will be stuck dealing with and paying the state regardless of the fact that they also have to pay the IRS.
Had the taxpayer field the state tax returns first, then the state would be ahead of the IRS in priority. The state would collect its taxes they way it would anyway, but here the IRS would allow the state payment first and factor that in as an allowable expense when calculating what the taxpayer could pay it. By filing the state tax returns first the taxpayer would be in a more manageable payment situation.
The other reason to file the state tax returns first is when it comes to an IRS Offer-in-Compromise. The IRS will allow the state payment as an allowable expense and factor it into the analysis when calculating what the taxpayers Reasonable Collection Potential (RCP) for the amount of the Offer-in-Compromise. If the federal tax debt was created first so the IRS is ahead of the state then the IRS will only allow a percentage of the payment based upon the amount of the state tax debt divided by the total tax debt. For instance, if the taxpayer is paying the state $1,000 a month, and the taxpayer owes the state $20,000 and the IRS $80,000, then the state debt is 20% of the total tax debt ($20,000 state debt divided by $100,000 state and federal tax debt total). The IRS would allow 20% of the $1,000 state payment, or $200.
Had the taxpayer filed the state returns first then the full $1,000 payment would be allowed as an expense. This can be critical, because the IRS will not accept an Offer-in-Compromise if the taxpayer shows the ability to pay the debt back over the life of the collection statute. Having the full $1,000 payment allowed will help reduce the amount available to the IRS, making it less likely that the taxpayer can full-pay the debt, and reducing the amount available for the RCP calculation.
Taxpayers who are filing multiple years returns should file the state tax returns first. Once the notices are received from the state then file the federal returns.
If you have any questions regarding your IRS issue in Redlands, CA or any other area of California do not hesitate to contact me at (909)570-1103 or by email at Carlos@HealthcareTaxAdvisor.com
Carlos Samaniego, EA
Healthcaretaxadvisor.com
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Carlos Samaniego, EA
Enrolled Agent
Licensed by The Department of Treasury to represent taxpayers
1255 W Colton Ave, #535
Redlands, CA 92374
Ph. (909)570-1103
Fax (909)586-9190
