"Connecticut" by US Department of State is licensed under CC BY 2.0
*** UPDATE: CT DRS has announced an amnesty program running from November 01, 2021 through January 31, 2022. You can read more about the amnesty program here.***
In most instances, people who owe the IRS back taxes also owe delinquent state taxes. Given the disparate tax rates applicable to income at the federal and state level, federal income tax liabilities often greatly exceed those at the state level, leading many taxpayers and practitioners to prioritize the resolution of federal income tax liabilities over those owed to the state. However, understanding the options available for resolving a state tax liability and the implications that those options may have on your ability to resolve a federal tax liability can be critical in deciding how to balance efforts at resolving each.
Installment Agreements:
While the IRS has pretty clear guidance regarding the various types of installment agreements offered and the qualifying criteria for each, concrete guidance from the Department of Revenue Services is, even in the best light, sparse. The lack of definitive guidance leaves a great deal of uncertainty when approaching the DRS to request a payment plan, as the flexibility afforded by the DRS seems to vary depending on who you talk to and their mood on a given day.
According to the DRS website, taxpayers are eligible to establish installment agreements on personal income tax balances provided they meet the following criteria:
(1) The account is not in collection status with the DRS or with a collection agency working on behalf of the DRS;
(2) Your account is not under warrant, bankruptcy, suspense or criminal investigation by the DRS;
(3) All tax return filings are current;
(4) Current liabilities are $10,000 or less; and
(5) Payment plan terms must not exceed 12 months.
Taken at face value, this would exclude the vast majority of people looking to enter into an agreement with the DRS (as most taxpayers are unlikely to reach out and attempt to establish an installment agreement prior to the balance entering collection status). Though it’s not clear from the DRS website (again, the DRS falls well short of complete transparency regarding their collection policies and procedures), these requirements really only apply to taxpayers that want to set up a payment plan with the DRS online through the Taxpayer Service Center, with little to no involvement or review of the agreement by the DRS — sort of akin to a guaranteed or streamlined installment agreement with the IRS.
The DRS will still entertain installment agreements for those that don’t meet the criteria above (including for business taxpayers), but will generally require a call to the DRS to have a collection agent assigned to the account if one has not already been assigned. While the DRS typically maintains that they do not entertain installment agreements that exceed 12 months (I’ve been told this is a limitation on the system they use to code and track installment agreements), in practice, if you can demonstrate to the DRS that your financial circumstances warrant a longer agreement (though they currently provide no official form for doing so), they will often agree to enter into a monthly agreement for a monthly amount that will not fully satisfy the liability in 12 months. This is typically accomplished by entering in a payment plan that contemplates 11 monthly payments in a lower monthly amount with a balloon payment due in the 12th and final month to satisfy the remainder of the balance. However, DRS agents will often tell you that the balloon payment is merely a formality to get the agreement in the system, and will instruct you to call in and extend the agreement before the 12th monthly payment is due.
Because DRS installment agreements are seemingly less tied to one’s ability to pay than IRS installment agreements, it is generally worth attempting to enter into an installment agreement with the DRS in advance of entering into an installment agreement with the IRS. In determining one’s ability to pay, the IRS will provide as an allowable monthly expense an amount for the payment of delinquent state and local taxes. This is generally calculated by multiplying the percentage that the taxpayer’s delinquent state and local tax liability bears to their combined federal, state, and local tax liabilities. However, in instances were an installment agreement is negotiated with the state in advance of IRS assessments having been made, the IRS will generally honor the agreement negotiated with the state, regardless of the amount. For this reason, particularly in instances where there are unfiled state and federal returns that will generate a liability, it may be beneficial to file the state returns and negotiate for an installment agreement with the state in advance of filing the delinquent federal returns.
Offers of Compromise:
The Connecticut Department of Revenue Services does offer a formal process by which a taxpayer may settle their tax liability for less than the full amount owed by filing an Offer of Compromise. For business taxes, this is accomplished by filing a Form CT-656 and for personal tax liabilities, by filing Form CT-656a. The process for submitting and negotiating for an Offer of Compromise with the DRS largely tracks the process for submitting and negotiating for an Offer in Compromise with the IRS, with a few key differences that warrant highlighting.
First, and most critically, the 10 year limitations on collection imposed on the IRS gives a certain amount of leverage to taxpayers in negotiating for an Offer in Compromise’s acceptance. In fact, a demonstration that the IRS is unlikely to collect the liability in full over the time remaining to do so is a threshold matter that must be demonstrated in order for the IRS to agree to entertain an Offer in Compromise based on doubt as to collectibility. Unfortunately, the CT DRS has no such time limitation in which it can collect a delinquent tax liability, and therefore is under considerably less pressure to settle a tax debt.
Per guidance from the DRS, “An offer of compromise will generally be accepted when it is unlikely that the DRS would be able to collect the full amount owed, and the amount offered reasonably reflects collection potential.” In the context of an IRS OIC, this is a fairly rote practice — after subtracting availability equity from a tax balance, multiplying a taxpayer’s monthly ability to pay based on IRS standard allowances by the months remaining to collect will demonstrate that the IRS should not be able to collect the full amount owed. In the context of the DRS however, there’s no real way to definitively demonstrate that the DRS will not be able to collect the tax in full, because there is no explicit time period for them to do so.
Take for example a recent case I’ve been working with the DRS: the DRS has maintained the collectibility of liabilities that are nearly 20 years old and were all discharged via Chapter 7 bankruptcy. Despite the underlying taxes having been discharged, because the liens that arose from those liabilities survived the bankruptcy, they are still encumbering real property owned by the taxpayer. Despite the fact that the DRS is unlikely to ever foreclose on the liens and hasn’t collected any meaningful amount towards those liabilities in decades, they seem perfectly willing to wait as long as necessary (either the taxpayer’s death or a voluntary sale of the property) to collect on the balance owed and have thus far been fairly reticent about settling the tax debt, even when offered a considerable percentage of the outstanding liability to be paid within 30 days.
Furthermore, unlike federal OICs, which generally require you to make a initial 20% payment with the OIC application and the balance of the offered amount due within 5 months of acceptance (the IRS also offers periodic-payment offers that require the full offer amount be paid in 24 monthly installments beginning with offer submission and continuing while the OIC is pending review), the DRS does not require an initial downpayment with Offer submission and requires the full amount of the Offer of Compromise to be paid within 30 days of acceptance of the offer. While this affords a lower initial barrier to submitting an OOC with the DRS, it can present a challenge in coming up with the funds necessary to satisfy the terms of the offer subsequent to offer acceptance, particularly in instances where pulling equity out of property is necessary to satisfy the offer. For this reason, arrangements should be made prior to offer submission to secure the funds necessary to satisfy the offer in the short time period provided by the DRS.
It bears mentioning that the DRS is likely to review and make a determination on an Offer of Compromise much more quickly than the IRS will review and make a determination on a federal OIC submitted concurrently. Therefore, careful consideration should be given to (a) the amount of funds that are likely to be necessary to satisfy an accepted DRS OOC and (b) the impact that the state accepting the OOC first would have on a taxpayer’s monthly ability to pay as it pertains to the OIC. Theoretically, if the DRS accepts and OOC while a federal OIC is pending, the funds used to satisfy the DRS offer would no longer be considered available equity in determining a taxpayer’s reasonable collection potential, but at the same time, if a monthly expense allowance has been made for the payment of delinquent state and local taxes, that may no longer be allowed by the IRS when the Offer comes up for review because the delinquent state liability has been satisfied through the OOC. When submitting both federal and state offers concurrently, it is important therefore, to consider the viability of each offer (though particularly the federal offer) in the context of the other offer being accepted and satisfied first.
A note on “settlements:” For a number of years, the DRS would often entertain informal “settlements” or “closing agreements” on delinquent taxes, particularly for older liabilities for which the DRS was not actively pursuing collections or had not been able to collect against for some time. Some senior DRS officials would allow representatives to informally offer (e.g. in a single phone call) a percentage of the outstanding tax liabilities and interest (typically the tax owing plus between 20-30% of the interest assessed on the account) in exchange for a waiver of the remaining interest and penalties. This was a powerful tool for practitioners, as it allowed us to efficiently provide considerable tax savings for clients without the complexity and work involved in submitting and negotiating a formal Offer of Compromise. From my perspective, it was a good program for the state as well — they collected considerable sums of outstanding tax revenue without the administrative costs of enforced collection or reviewing formal offers. However, within the last couple of years, the DRS appears to have moved away from such practices and will now generally require a full financial disclosure and submission of OOC forms before considering a settlement. However, it may still be worth calling in and asking if the DRS would consider an informal settlement agreement prior to moving forward with preparing a formal OOC.
Requesting a Waiver of Penalties:
A request for the abatement of penalties imposed by the DRS can be initiated by the filing of Form DRS-PW. The grounds upon which a taxpayer can request a waiver of penalties imposed by the DRS largely tracks the same analysis employed by the IRS in reviewing a request for abatement based on reasonable cause. However, several key differences exist.
First, while penalty relief can be requested from, and granted by, the IRS at any time while the penalty balance remains on the account (or if paid, there are funds on account for that tax year that are still eligible for refund), a request for penalty waiver submitted to the DRS generally must be submitted no later than one year from the date that the DRS first notified you of the penalty assessment, or, if the penalty was reported on a return, no later than one year from the date the return was filed. So, if you believe grounds exist to request an abatement of penalties, it’s best to make that request as soon as is practical.
Second, while the IRS has no similar requirement, the DRS will only consider an abatement of penalties if the taxpayer filed all required returns and has paid (or is in an installment agreement to pay) any outstanding tax liabilities. Again, given the short period of time the DRS provides to request the abatement of penalties, consideration should be given to the timing of filing delinquent returns that are likely to generate penalty balances. In instances where a number of years of returns have not been filed and there is a potential for penalty abatement. It may make sense to prepare all delinquent returns and submit them at once rather than filing them piecemeal, as filing a return that generates a penalty balance will start the running of the one year clock, but the DRS will not consider an abatement request until all outstanding returns have been filed.
An interesting aspect of the DRS’s penalty abatement provisions is that the DRS will presume that reasonable cause exists if the IRS has waived a penalty imposed on you for the same tax type and period. In most instances where a waivable penalty (such as failure to timely file a return or pay a tax due) has been assessed by the DRS, there’s likely to be a similar penalty assessed by the IRS. In these instances, it may be worth filing an abatement claim with the IRS as soon as possible and then waiting until as late as possible within the 1 year time frame provided by the DRS to submit a waiver request. Doing so will allow the greatest amount of time possible for the IRS to grant a reasonable cause abatement, which would result in the DRS automatically agreeing to abate the penalties as well. In practice, however, it often takes a considerable amount of time for the IRS to make a determination on a penalty abatement request, so it’s always best to have a separate request ready to be sent to the DRS in the event that a determination is not made by the IRS within the one year time period for submitting a waiver claim to the DRS.
Finally, the DRS will presume that reasonable cause exists if it is the first time that you have been subject to a penalty. This program largely tracks the IRS’s First Time Abatement Waiver. This waiver can be useful in two scenarios. First, where you’ve only been assessed penalties for one year and do not have a penalty history with the DRS, a penalty waiver can be achieved quickly without having to go through the effort of demonstrating reasonable cause based on the circumstances giving rise to the penalty. Second, in a situation where you’re dealing with a number of years of penalties, if the DRS denies abatement on reasonable cause grounds, you should, at a minimum, be able to have the first year of penalties waived under this provision.
Conclusion:
To conclude, when compared to the IRS, the relative lack of transparency by the DRS regarding their policies and procedures surrounding the collection alternatives available for delinquent tax liabilities leaves many taxpayers “in the dark,” so to speak, when attempting to resolve their state tax debts. Because of the lack of official guidance, taxpayers often receive conflicting information from state collection representatives, and without something concrete like the Internal Revenue Manual that taxpayers can point to, many are left to rely on the incorrect or mercurial advice they’re given. In the absence of a more formal set of procedures, an understanding of what can and cannot be accomplished within the bounds of the DRS collection division can only come from having years of experience working with the DRS to resolve all manners of liabilities. Therefore, if you’re dealing with a delinquent tax liability with the state of Connecticut, it makes sense to speak with a tax professional experienced in resolving cases with the CT DRS, especially if you expect to be resolving DRS liabilities concurrently with IRS liabilities.