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ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – CAN YOU PROTECT AND KEEP YOUR STATE INCOME TAX REFUND WHEN YOU OWE THE IRS?

By Robert S. Schriebman
2020

Introduction

The IRS has an agreement with the State of California concerning entitlement to your state income tax refund. If you owe the IRS, they can levy on your state tax refund and take all or a part of it, depending upon how much you owe the IRS. Most people feel they have no control over the power of the IRS when it comes to the realization that their long awaited FTB or EDD refund may never be received.

There is a process that may allow you to take control over your state tax refund and prevent the IRS from getting its hands on it. This article will discuss the recent U.S. Tax Court Etoty decision. Paulette Etoty convinced the Tax Court judge that her future state tax refunds are not subject to levy and seizure by the IRS. Let’s look at the Etoty case and learn from it. (Etoty v. Commissioner, TC Memo. 2020-49, April 20, 2020)

Etoty Case Background

Paulette Etoty owed the IRS but could not pay in full. She contacted the IRS automated collection system (ACS) and convinced an IRS employee to grant her hardship status. The technical term is “currently not collectible” (CNC). When a taxpayer’s case is in CNC status, the IRS follows a policy of not engaging in enforced collection action. In Ms. Etoty’s case, the IRS levied on her state tax refund and applied it to her federal deficiency. She was also given an opportunity for a Collection Due Process (CDP) and timely filed her petition. During the CDP hearing she was offered an opportunity to seek an Offer in Compromise (OIC) but she refused to do so. She petitioned to the US Tax Court to prevent the IRS from taking her future state income tax refunds. She wanted a ruling from the judge that future state tax refunds could not be taken from the IRS so long as her account remained in CNC status.

The US Tax Court Ruling

Paulette Etoty’s primary reason for requesting a hearing before the US Tax Court, was to obtain a ruling that the IRS be prevented from taking any future state refunds because she had very limited income. The judge confirmed the IRS policy that no collection action, including levies on state income tax refunds, are allowed – it’s hands off! Ms. Etoty’s future state income tax refunds will be safe from the IRS so long as her account remains in CNC status. Having said this, no one is entitled to CNC status forever. The IRS has the right to contact the taxpayer every couple of years to request updated financial information in order to determine if the CNC status should be lifted and the taxpayer put on an installment payment arrangement. In order to avoid this from happening, and to ensure that the IRS will permanently leave you alone, consider an OIC. If the OIC is accepted, the account is deemed paid in full forever, and all tax liens are removed. A taxpayer in CNC status requires the IRS to file a notice of federal tax lien (NFTL) if the amount owed meets the lien filing criteria.

IRS Is Allowed to Take Your Federal Income Tax Refund

Although the IRS is prohibited from taking a state tax refund, it is allowed to take your federal tax refund. CNC status prohibits the IRS from levying in order to collect back taxes, but the federal tax refund is not levied – it is offset against the tax liability and this gets around the prohibition from issuing any levies. While Ms. Etoty’s future state tax refunds are protected, her future federal tax refunds are in jeopardy.

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Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD and he is not employed by the EDD or any other agency of the State of California.

Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.

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