Comprehensive Review of Your Rights to a Collection Due Process Hearing Before the IRS

Under certain circumstances and upon the Internal Revenue Service issuing certain collection notices, you have the right to request a Collection Due Process Hearing. Requesting and holding a Collection Due Process Hearing before the IRS Appeals Office can be a very beneficial tool in resolving an outstanding tax liability. The article below provides detailed information relating to a Collection Due Process Hearing.

What is a Collection Due Process Hearing?

A Collection Due Process Hearing is a right afforded to a taxpayer when the IRS has proposed a levy or enforcement action to collect on a tax debt. The hearing allows the taxpayer to work with an impartial appeals officer towards a collection alternative to resolve the debt as opposed to the proposed levy action by the IRS.

When Can a Taxpayer Request a Collection Due Process Hearing?

The most common time a taxpayer has the right to request a Collection Due Process Hearing is upon the IRS issuing a Final Notice of Intent to Levy. A Final Notice of Intent to Levy is also known as Letter 11 (L 11) or Letter 1058 (L 1058). A taxpayer has 30 days from the date on the Final Notice of Intent to Levy to request the hearing.

How Does a Taxpayer Request a Collection Due Process Hearing?

The taxpayer makes the request by filing Form 12153 with the service center or revenue officer who issued the Final Notice of Intent to Levy. Form 12153 is completed with the taxpayer’s general information, the tax periods of which the Final Notice of Intent to Levy was issued upon or included on the notice, the reason the hearing is being requested, and the proposed collection alternative. The hearing request can be faxed and/or mailed to the appropriate party within the IRS.

What Are the Benefits or Potential Benefits of Requesting a Collection Due Process Hearing?

While there are many benefits to requesting a Collection Due Process Hearing, perhaps the biggest or most advantageous benefit is the stay or hold on enforcement action that is afforded the taxpayer when a timely hearing request is filed. When a taxpayer timely requests a collection due process hearing, there is an automatic hold on IRS collection actions such as bank levies, wage garnishments, and other asset seizures. Please note that the automatic stay on enforcement action may not apply when the taxpayer owes 941 employment taxes and the taxpayer is not in compliance with the current quarter. This stays on enforcement, which allows the taxpayer time free of levies and seizures to prepare for the hearing and make a proposal to resolve the outstanding tax liability based upon their current financial circumstances.

Once a Collection Due Process Hearing is Requested, What Can I Expect?

Generally, the taxpayer will receive a notice from the IRS Appeals Office within 30-60 days from requesting the hearing that their hearing request has been received, and an appeals officer will contact the taxpayer once assigned to the case. Thereafter, the taxpayer will receive a notice from the appeals officer assigned calling an initial hearing or conference date. The initial hearing or conference date can be adjusted by the taxpayer, but the taxpayer must contact the appeals officer to reschedule the hearing date. The notice from the appeals officer will generally request additional information the taxpayer wishes to present and produce during the hearing relating to the resolution proposal the taxpayer is proposing. This information could be financial statements and information relating to an installment agreement, an offer in compromise, or perhaps a request that the liabilities be placed in a currently non-collectible status.

What is the Procedure or Process of Working With the IRS Appeals Office?

First, the appeals officer will verify that the IRS has taken all required and legal steps towards a collection of the debt and that the taxpayer has received their proper due process. Further, the appeals officer verifies that they have had no prior involvement with the applicable case or taxpayer and are a true impartial party to the matter. Upon establishing the hearing or conference date, the taxpayer will need to compile the necessary information, documents, and statements to submit to the appeals officer along with their proposal to resolve the tax liability. If the taxpayer was an individual and owed individual income tax, they would draft an individual collection information statement, also known as Form 433A, and compile all of the necessary attachments such as W-2s, income statements for self-employment income, bank statements, current statements for stocks, bonds, 401(k)s, mortgage statements, etc., to verify the income, expenses, and assets stated on the financial statement. If the taxpayer was a business or the applicable individual owned a business, the taxpayer would also need to compile Form 433B, which is a collection information statement for businesses. The taxpayer would use the financial statements and documents to propose an installment agreement or request their liabilities be placed in a non-collectible status. A taxpayer can also request a settlement, known as an offer in compromise, through the hearing process. If a taxpayer requests an offer in compromise through the hearing process, the offer will be submitted by the appeals officer (usually) to the IRS Offer in Compromise Unit, and the appeals officer will maintain the file while the IRS Offer in Compromise Unit makes an initial determination on the offer. If the determination on the offer needs to be appealed to the appeals office and the taxpayer appeals the initial offer determination, the appeals officer will then have control or jurisdiction of the appeal. Inevitably, through the appeals hearing process, the appeals officer will make a determination relating to a resolution of the liabilities.

What Are the Potential Outcomes of Holding a Collection Due Process Hearing?

The outcome or determination issued by the appeals officer through the hearing process may be dictated by the resolution proposed by the taxpayer. If the taxpayer has proposed an installment agreement and the appeals officer and taxpayer agree on the terms and conditions of an installment agreement, the appeals officer will issue a determination that an installment agreement has been reached, and thus, the levy action proposed by the IRS is not sustained. In short, if the taxpayer and appeals officer come to a collection alternative, then the appeals officer will issue their determination stating the agreement that has been reached and that collection action is not sustained. However, if an agreement or resolution cannot be agreed upon with the appeals officer, the determination made by the appeals office will state that the proposed levy action by the IRS is sustained, and thus, the taxpayer is open to enforcement such as levies once the file or case is returned to IRS Collections or the IRS revenue officer.

What if I am Unable to Establish a Formal Agreement Through the Collection Due Process Hearing?

If you cannot come to an agreement with the appeals officer, it does not mean an agreement is not possible. You are still able to enter into an installment agreement or submit an offer in compromise through the IRS Offer Unit, but you would do so outside of the context of the appeals hearing or appeals office. The key would be to work on formalizing or proposing an agreement as quickly as possible after the appeals hearing concludes because, technically, once the matter is back before the IRS Collections Department or the revenue officer, you are subject to enforcement because there is no longer a stay or hold on enforcement.

Form 5471 is an information reporting form the must be filed with a taxpayer tax return when they meet certain ownership amounts of foreign corporations.

Broadly speaking, the form reports who owns the foreign corporation, the current year financial information of the foreign corporation, information related to subpart F and GILTI inclusions (discussed below), and the characterization of earnings impact of the corporation on the U.S. Shareholders.

Who has to file form 5471:

Generally speaking, U.S. Shareholders have to file form 5471. The annual filing requirements depend on how much of the foreign corporation is owned. There are instances where a person who owns no interest in a foreign corporation must file a form 5471, for that discussion, see Category 2 filer below.

Who is a U.S. Shareholder?

A U.S. Shareholder is a U.S. Person (individual, corporation, partnership, trust, estate) who owns 10% or more of the voting rights of a foreign corporation and/or who owns 10% or more of the value of a foreign corporation.

There is a separate rule when the foreign corporation is an insurance company. In that instance, a person will be a U.S. Shareholder if it owns ANY shares of the foreign corporation.

Do all U.S Shareholders have to file a form 5471?

The fast and terrible answer to this question is: it depends.

The form 5471 is required when a person (again individual, corporations, partnership, trust, estate) meets the requirements of one of several categories of filers for form 5471.

The current form 5471 category filers are broken out into the following categories:

• Category 1a, 1b, 1c
  • Dealing with persons who are U.S. Shareholders of foreign corporations who were a Section 965 specified foreign corporation during the tax year including instances of constructive ownership.
• Category 2
  • Dealing with U.S. individuals who are officers or directors of a foreign corporation in a year when a U.S. Person acquires 10% of the foreign corporation or acquires enough shares to exceed the 10% ownership threshold to become a U.S. Shareholder (as defined above).
  • Notably, the director or officer does not have to own any interest in the foreign corporation for the filing obligations to exist and mee the requirements of a Category 2 filer.
• Category 3
  • Dealing with U.S. persons when they acquire or dispose of shares in a foreign corporation such that that person becomes a U.S. Shareholder, stops being a U.S. Shareholder or adds 10% to their current holdings. It also covers when someone owing 10% or more becomes a U.S. person.
• Category 4
  • Dealing with U.S. persons who are in control of a foreign corporation. That means they own, directly, indirectly or constructively 50% or more of the foreign corporation.
• Category 5a, 5b, 5c
  • Dealing with U.S. persons who are U.S. Shareholder of a controlled foreign corporation. This includes certain constructive owners of controlled foreign corporations.

A U.S. person can fall into multiple categories per year.

There is a larger discussion of the category filers in this article (Link to other 5471 article) that also discusses constructive ownership rules.

There are several exceptions to the form filing obligations, so ensure you are taking those into account when making filing determinations.

If you meet one or more category filers, do you have to file every year you own the interest in the foreign corporation?

Not all U.S. Shareholders will need to file a form 5471 every year they are U.S. Shareholders. In any year that you meet the requirements of any of the Category filers, you will likely have a filing obligation if you don’t meet any of the exceptions.

As an example, in year 1 you (a U.S. individual) bought 15% of a foreign corporation. You are the only U.S. person who owns shares in the company. You are not related to any other shareholders. Since you now own more than 10% of the foreign corporation you are a U.S. Shareholder. In year 1 you have a form 5471 filing obligation as a Category 3 filer.

In year 2, you have not bought any more shares, and all the shareholders are the same. In year 2 you do not meet any of the category filer requirements and do not have a form 5471 filing obligation.

In continuation of the above example, if in year 3 you purchase an additional 15% of the foreign corporation (brining your total ownership to 30%) AND two other U.S. persons each bought 15% of the foreign corporation (30% total), you become a Category 1a, 3 and Category 5a filer. Thus, you will have a form 5471 filing obligation in year 3.

If in year 4 none of the facts change and the foreign corporation has three U.S. shareholders owning a collective 60%, the entity is considered a controlled foreign corporation and the form 5471 is required to be filed by U.S. Shareholders.

The important point to remember when owning shares in a foreign corporation is that you must review your holdings and the holdings of other shareholders annually to determine if you have a form 5471 filing requirement.

Why do you have to file form 5471?

The form 5471 is required to be filed as outlined in the U.S. tax code. The information provided allows the IRS to make determinations on a U.S. persons offshore investments and if any income should be included in the taxpayer U.S. tax base.

Broadly speaking, the form 5471 and the requirement to file the 5471 has no direct impact on a U.S. taxpayers taxable income. That being said, the form does require the taxpayer to report their proportionate share of Subpart F income and tested income.

What is Subpart F income and what is the point of computing tested income?

A detailed discussion of Subpart F income and tested income are beyond the scope of the article, but each play a key role with respect to form 5471.

Subpart F income is income earned by the controlled foreign corporation (Category 5a, b, c filing for U.S. Shareholders) that is not able to be deferred from U.S. income inclusions by U.S. shareholders. Very loosely, it is passive types of income and income earned in a company whereby that company hasn’t done any of the work to earn that income. Net earnings and profits of that type is required to be treated as if it were earned by the U.S. shareholders directly and is included in the U.S. shareholder taxable income.  When a controlled foreign corporation has this type of income, it needs to be reported on the form 5471 and allocated appropriately to the U.S. Shareholders. Subpart F income is reported on Schedule I, J, P, and Q of the form 5471.

Tested income is used in computing the U.S. Shareholder amounts of Global Intangible Low Tax Income (GILTI). GITLI is another anti-deferral mechanism that prevents the earnings of a controlled foreign corporation from not being included in U.S. Shareholder taxable income. GILTI broadly treats all income of a controlled foreign corporation as if it were earned by the U.S. Shareholders directly and thus includable in their taxable income. Tested income is computed on Schedule I-1 of the form 5471.

Subpart F and GILTI are complicated topics that deserve their own discussions. There are numerous rules that impact the calculation and requirements of each. Suffice to say, if the entity you own an interest in is a controlled foreign corporation and you are U.S. Shareholder, careful attention must be paid to Subpart F income and GILTI income.

Do you have to file form 5471 if the entity you own is inactive or loses money?

Yes, mere ownership of the entity creates the filing obligation.

How do you file form 5471?

If you meet one of the categories of filers for the form 5471, you will need to complete the sections that are required of that specific category filer and attach it to your timely filed tax return. The form will be considered timely filed if it attached to your tax return which was timely filed including extensions. The form 5471 will need to be substantially complete to be considered timely.

If you fall into multiple category filer status, you need to file just one form 5471 per entity reporting all the information for each category you meet.

What happens if you don’t/didn’t file form 5471 or you file it late?

Failure to file form 5471 is subject to penalty. There is a monetary penalty of $10,000 for failure to file the form 5471. With this form, late filing is considered failure to file and subject to penalty. There is an additional $10,000 penalty for failure to file form 5471 Schedule O as well.

If you have not filed form 5471 and are required to do so you should contact our firm to discuss your options and the application of any penalties. We work with clients on their delinquent filings to assist with preventing or abating the penalty on late filings of form 5471.

Other considerations?

If you have a form 5471 filing obligation you may have other information reporting forms to file as well. Additional filings that may apply could be:

• Foreign Bank Account Reporting (FBAR)
• Form 8938 foreign financial asset reporting
• Form 8865 foreign partnership reporting
• Form 926 contributions to foreign corporations
• Form 8858 foreign branch and disregarded entity reporting
• Form 8992 GILTI reporting
• Form 8621 Passive Foreign Investment Company (PFIC) reporting

Updates on Form 5471

In recent years, there have been some updates to Form 5471 that are worth noting. The IRS has made revisions to the form and its instructions to ensure that they remain current and accurate. These changes are designed to make the form easier to understand and fill out, and to ensure that it accurately reflects the current tax laws and regulations.

One of the key updates is the revision of Form 5471 and its separate Schedules E, G-1, H, I-1, and M in December 2021. The separate Schedules J, P, Q, and R were revised in December 2020, and the separate Schedule O was revised in December 2012. These revisions are part of the IRS’s ongoing efforts to keep the form and its schedules up to date with the latest tax laws and regulations.

Another important update is the requirement to report all information in functional currency in accordance with U.S. generally accepted accounting principles (GAAP). Each amount must also be reported in U.S. dollars translated from functional currency using GAAP translation rules. This change is designed to ensure that all financial information reported on Form 5471 is accurate and consistent.

The IRS has also updated the instructions for Form 5471. These instructions provide detailed guidance on how to fill out the form and its schedules. They include information on who needs to file Form 5471, what information needs to be reported, and how to report it. The instructions also provide examples to help taxpayers understand how to fill out the form correctly.

It’s important to note that these updates are part of the IRS’s ongoing efforts to improve the tax filing process and ensure that all taxpayers are reporting their foreign investments accurately. If you’re a U.S. person with ownership in a foreign corporation, it’s crucial to stay up to date with these changes to ensure that you’re meeting your tax reporting obligations.

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Corporate Formation: a corporation can only be formed by satisfying and complying with certain state statutes.  The statutes will require the filing of a document with the appropriate state agency, generally the secretary of state, which is the case in Colorado, appointing the registered agent and paying a filing fee.  Additionally, to maintain the corporate form, annual reports will need to be filed, again usually with the secretary of state.

Entity: A corporation is an entity that is separate and apart from the persons who have formed the corporation.

Liability: The corporation is liable for its contracts and actions, but the managers and shareholders of the corporation are not liable.  The limited liability of a corporation is an advantage of the corporate structure.

Ownership:  The corporation is owned by the shareholders.  A share of stock can be considered a unit of ownership in the corporation.  Corporate shares are issued by the corporation.  The shareholders who own the corporation have different rights such as voting rights to elect the directors who will manage the corporation.  Thus, shareholders do not necessarily manage the corporation, but they vote on and elect the individual that will manage the corporation.  In many respects, share ownership in a corporation measure power.  For example, if John owns 400 shares in Corporation ABC and Jeff owns 40 shares, John has ten times the votes as does Jeff and for every dollar Jeff receives in a corporate dividend distributions, John will receive ten.  This applies of course unless another corporate document reads otherwise.

Management: A corporation is managed by the board of directors.  It is possible that a shareholder and a director are the same person, but this also allows for a separation in ownership and management.

Transferability:  A shareholder can transfer stock relatively freely.  With a publicly held corporation just get online and sell your stock.  Stock held within a closely held corporation may not be as easily transferred, but can still be sold, exchanged or transferred.

Taxation: A C corporation will pay tax on corporate income whereas an S corporation will pass income through to the shareholders.  The shareholders of a C corporation will also have to pay individual income tax on the dividends they receive.

Raising Capital & Capital Needs:  All businesses, including corporations need money. A corporation can raise capital by obtaining loans and/or through selling ownership interests in the corporation.  There are advantages and disadvantages to both obtaining lending and allowing other third parties to obtain an ownership interest in the corporation.

If you have questions related to the formation, structure or taxation of a corporation please contact The McGuire Law Firm to speak with a Denver business attorney.  Whether you are long time business owner or just starting a small business, a business attorney can help you make important legal decisions that your business can benefit from as it operates and grows.

To form an LLC in Colorado, you can go to the Colorado Secretary of State website to complete and file your articles of organization.  First, you will check on the name for your LLC to see if it is available.  Once availability has been checked, you can complete the articles of organization.  The articles of organization will state: the name of the LLC; the address of the LLC; the registered agent of the LLC; the members of the LLC and their addresses; who is filing the articles; whether the LLC is member managed or manager managed and other information.  Once you have completed the articles, you pay a filing fee, which is currently $50 and the articles are filed with the secretary of state.  Typically, you will also pay a yearly renewal fee to the secretary of state.

After completing the articles, you may wish to obtain an EIN depending upon your circumstances.  You can obtain an EIN on the IRS’ website.  Most banks will now allow you to open a business bank account with your articles of incorporation and EIN.

In most circumstances, if you have a multi-member LLC, it is recommend that you have an operating agreement, which is a partnership agreement and controls certain actions and issues within the LLC and between the LLC members and potentially the LLC manager.

For tax purposes, a multi-member LLC will file a 1065 U.S. Partnership Income Tax Return and the pass through items will be reported to the members on a K-1.  A single member LLC is considered a disregarded entity for tax purposes and thus is treated like a sole proprietorship and the individual will file a Schedule C with their 1040 Individual Income Tax Return.  It is recommended that you speak with a tax attorney or tax professional regarding the individual tax implications of an LLC, as well as to the tax issues surrounding the formation of the LLC.  The formation of an LLC by itself may not create any taxable event, but the contribution of property and/or money to an LLC is likely to have tax consequences in the future that should be understood from the beginning if possible.  If you have questions regarding the formation of an LLC, you can contact The McGuire Law Firm to discuss such issues with a business attorney or tax attorney.

Contact The McGuire Law Firm to schedule your free consultation with a business attorney or discuss your individual or business tax questions with a tax attorney.  The McGuire Law Firm has law offices in Denver and Golden Colorado.

Contact The McGuire Law Firm to schedule your free consultation with a Denver business lawyer!

You can schedule a free consultation with a business attorney by contacting The McGuire Law Firm!

Contact The McGuire Law Firm to schedule your free consultation with a Denver business attorney!  720-833-7705

Schedule your free consultation with a business attorney by contacting The McGuire Law Firm!

Offices in Denver and Golden Colorado.  Schedule your free consultation today!

A corporation that meets the requirements of Internal Revenue Code section 1361 may make the election to be taxed as an S corporation.  The requirements are: the corporation must have no more than 100 shareholders; all shareholders must be individuals (other than nonresident aliens), estates, qualified trusts, electing small business trusts or certain tax exempt organizations; the corporation may only have one class of stock; the corporation may not be a financial institution, insurance company, possessions corporation or DISC.

An S corporation may also own 80% or more of the stock in a C corporation, and the liquidation of a C corporation  into an S corporation is governed by the rules of Subchapter C, specifically Internal Revenue Code Sections, 332 and 337.

An S corporation that has a wholly owned subsidiary can make an election to treat the subsidiary as a qualified subchapter S subsidiary.  Under such circumstances the subsidiaries assets, liabilities and items of income, deduction and credit are treated as those of the parent S corporation.  Thus, the separate existence and status of the subsidiary is ignored for tax purposes.  When such election is made, the subsidiary is deemed to have liquidated in a tax free liquidation under Internal Revenue Code sections 332 and 337 immediately before the election was effective.  The built in gains rule under Internal Revenue Code 1374 will apply

Certain types of trusts can also own stock in an S corporation.  To qualify, the trust is treated as owned by an individual who is a citizen of the United States; the trust is a trust with respect to stock transferred pursuant to a will; the trust was created primarily to exercise the voting power of stock transferred to it; or an electing small business trust.  An electing small business trust is a trust that has no beneficiary other than an individual, an estate,  or certain charitable organizations.

The make the S corporation election, the corporation will likely file Form 2553.  All shareholders must consent to the S election and the election is filed with the Internal Revenue Service on or before the 15^th day of the third month of the Corporation’s taxable year.  Taxpayer’s may be allowed relief for certain late filings of the election under certain revenue procedures.

A new corporation that makes the S election is not subject to tax at the entity level.  An S corporation is a pass through entity where by the profits, losses, credits and deductions are passed through to the individual shareholders and claimed on their 1040 Individual Income Tax Returns.  The amounts passed through to shareholders are passed through pro rata per the shareholders ownership interest.  Because an S corporation can only have one class of stock, an S corporation does not have the flexibility of an LLC or partnership in allocating income or losses.  Losses from an S corporation may be deducted only to the extent of the shareholder’s basis in their stock and any indebtedness of the corporation to the shareholder.

A shareholder’s basis in their stock will reflect their capital contributions to the corporation and will be increased by their pro rata share of corporate income and decreased by their pro rata share of losses and distributions to the shareholder.  The basis cannot decrease below zero.  Losses or deductions that exceed a shareholder’s basis can be applied to reduce the basis in indebtedness of the S corporation to the shareholder under Internal Revenue Code section 1367(b)(2).  A shareholder’s basis is not increased by corporate level obligations to third parties.  When the distributions are made to a shareholder that do not exceed the shareholder’s basis in the stock, are not taxed to the shareholder under Internal Revenue Code Section 1368(b).

It is important to know that certain states do not recognize S corporations and thus will tax the entity as a C corporation.  You can speak with a Denver business attorney at The McGuire Law Firm to discuss your business law questions and issues.  A Denver business attorney can assist you with forming and structuring your business, the tax implications of your business, business operations and the eventual sale, transfer or disposition of business assets or interests.

Schedule your free consultation with a Denver business attorney at The McGuire Law Firm!  Offices in Denver and Golden Colorado.