Author: Jim Payne

Jim Payne, a Florida Certified Public Accountant (CPA) since 1976, offers candid insights on getting square with the IRS — with the least pain, and at the lowest cost — with (or without) the help of a tax representative. Mr. Payne is a former IRS agent and expert in business profitability, IRS audits, IRS payroll tax, and IRS non-filer issues. As a Tax Representative, his goal is clear: " I will speak on your behalf to all IRS agents, so you never have to, and I'll guide you in executing a strategy to resolve your IRS problem so you can get back to enjoying life."

Avoiding the IRS Accuracy Penalty

The IRS accuracy penalty is a charge that the IRS imposes on taxpayers who file inaccurate tax returns. The penalty is equal to 20% of the amount of taxes that are owed as a result of the inaccuracies. This can be a hefty amount so it’s worth considering what you can do to minimize their potential.

What is the biggest cause of the IRS Accuracy Penalty?

The biggest cause of the accuracy penalty is underreported income. Computer software matches all the 1099s and W-2s reported by 3rd parties to the tax returns and automatically generates a CP2000 Notices proposing changes for anything not on the return.

How can you avoid the IRS Accuracy Penalty?

 The easiest and surest way to avoid matching problems is to file an extension and check your IRS transcripts when the income and wages are posted in early June.

If you need to file before June, it’s still a good practice to check the income and wage transcripts. Should you find a difference, immediately amend the original return with a 1040X. A timely correction makes it very hard for the IRS to claim you were negligent.

What about Information Return Errors?

The IRS process millions of information returns and a fair number of them are in error. In theory, it’s up to you to contact the 3rd party issuer and ask them to correct their filing.  Lots of luck with that approach. The fallback is to make sure that your return reflects the total income reported. Then deduct the error with a note on the return explaining the error.

Conclusion

The accuracy penalty can be big bucks. Avoiding the penalty is far easier than dealing with them after the IRS finds unreported income and automatically assesses the penalty.

Common mistakes that will earn you an IRS Audit

The IRS tries to keep its processes for selecting returns for audit a secret. However, we do know some of the general steps. The majority are selected by computer-generated scores that are based on how different an individual return is from an average return. The higher the score, the more likely the return will be sent to an audit group for audit consideration. Stacks of these returns are assigned to individual auditors. These auditors will look over the returns and decide which they find to be audit worthy.

Here are some common mistakes that will make it more likely to pique that auditor’s interest:

  1. Lots of rounded numbers. This is saying to the auditor that my bookkeeping is lacking and there are probably tax dollars to be found here.
  2. Non-cash charitable contributions. The IRS knows that most people fail to get receipts, overvalue the junk they donate, and will not spend the money on a professional valuation when required.
  3. Large amounts of business travel or auto expenses. This is almost an automatic adjustment in an audit. Most business owners will not keep the logs required to document the business purpose, dates, and amounts. Every new IRS auditor learns this within the first 10 audits they perform.
  4. Hobby losses. How earners with losses from a farm, horse ranch, race car, etc. are likely to get an IRS call to schedule the audit date. Auditors know that the burden of proof to prove there is a real business purpose for these losses has shifted from the IRS to the taxpayer.
  5. Unreported 1099s or W-2s. Not having enough compensation or gross receipts at least equal to the totals that 3rd parties have sent to the IRS is an almost guarantee that you will be spending some time with the audit division.

Most of these mistakes can be avoided. Simply don’t use rounded numbers or report a lot of non-cash charitable contributions without getting proper documentation. Keep the auto logs or be prepared to see at least 50% thrown out in an audit. If you are not sure what 1099s have been reported to the IRS, file an extension and check your IRS transcripts when the wage and income transcripts are usually updated in July of each year.

IRS Lien Basics

A lien is a legal claim or right against someone else’s property, usually for the payment of a debt. The IRS can place a lien on your property if you owe taxes and have failed to pay them. This can be a very stressful and difficult situation to deal with, but it is important to know your rights and options if you find yourself in this situation.

If your situation with the IRS has gotten to this stage, it’s time to contact a tax professional. They can help you to determine what your options are in dealing with the IRS to minimize their impact on your life.

When does the IRS File a Lien?

The IRS has the power to issue a lien when taxpayers fail to pay back taxes, which must be paid within 10 days of the IRS sending the taxpayer a final notice of intent to levy. If you fail to pay the taxes within 10 days, the lien will be automatically filed with the County Recorder’s office. The IRS may also issue a lien when a taxpayer fails to respond to an IRS request for information or fails to make an installment payment promised under a payment plan. A lien might also be issued if the taxpayer violates the terms of an offer in compromise or fails to provide information the IRS is requesting to verify a claim of innocent spouse relief.

After the IRS files a lien, what happens?

When the IRS files a lien, it will make a public record of the lien and its amount. This will be included on your credit report, which means that your credit score will be affected. The IRS will send you a letter, called a Notice of Federal Tax Lien, detailing how much is owed, when it is due, information about payment options, and how the lien affects your rights. The IRS may take other collection actions such as wage garnishment and seizing funds from your bank accounts.

While the IRS has the right to seize and sell your property, they only take that action in extreme cases. They do not want to have the cost of the seizure, securing, and finding a buyer for your stuff. Instead, they would rather wait and seize any proceeds should you sell your property.

How can I get rid of an IRS Lien?

The most effective way to get rid of an IRS lien is to pay the debt in full. Once the debt is paid, the IRS will remove the lien from the public record. You can also request a withdrawal of the lien in certain cases. This is when the lien is withdrawn, but the debt remains. Generally, your debt must be less than $25,000 or you have a good reason why it is in the government’s best interest to make the withdrawal.

How long does an IRS Lien stay in place?

IRS liens stay in place until the tax debt is paid in full or the statute of limitations expires. The statute of limitations is a time frame of 10 years from the date the taxes were assessed. This date will be extended if collection activities are suspended due to actions such as filing bankruptcy or requesting an Offer-in-Compromise.

To wrap things up

The initial impact from a federal tax lien is a hit on your credit report. Usually, nothing else happens until such time that you want to refinance or sell your home. The IRS will negotiate with you about subrogating their lien so that a refinance can happen provided you give them some or all of the cash proceeds. The IRS in almost all cases will grab your share of the proceeds from the sale of your home or another real estate.

IRS Levies and Social Security Benefits

The IRS can levy social security benefits. Even worse, that levy can continue even though the statute of limitations has expired. The question is how often does the IRS levy social security payments? And what can you do if it does?

The IRS annual statistics report does not drill down anywhere close to the level needed to answer the first question. But it does seem to be exceedingly rare and only applied to tax protestors. This is in alignment with IRM 5.11.6.2(1) “Use discretion in determining if retirement income should be levied“. And more specifically, IRM 5.11.6.2.1(4) “Use discretion in determining whether a levy on Social Security benefits is appropriate under the circumstances.”

However rare, what can you do about it? If the levy was correctly applied before the statute of limitations runs, then the levy will continue after the expiration. The authority for this is Treas. Reg. § 301.6343-1(b)(1)(B)(ii) which provides that “a levy reaches all property rights at the time the levy is made, including the right to receive payments at some point in the future, and will not be released under this condition unless the liability is satisfied.” This regulation leaves you with only one option, you must make a deal. Specifically, an Offer-In-Compromise proving that the seizure of your retirement income places you in the category of “Economic Hardship”.

Economic hardship cases are usually hard to get through at the collections level. Expect a trip to Appeals.

What Should You Do When the IRS Corrects Your Returns?

The CP11 letter arrives in the mail. You open it up and see the words “We made changes to your return because we believe there is a miscalculation. You owe money on your taxes as a result of these changes.” Yep, this is going to be a great day.

Usually, these notices are vague. They typically list various reasons which might be the cause of the change. Perhaps it’s an invalid social security number, or maybe it was a limit based on AGI. You get to take your best guess as to which of these reasons applies to you. This can lead some people to put off responding and that is a very big mistake.

CP11 notices are considered to be a “Math Error” procedure by the IRS and not an audit. This is an important distinction. In an audit, you have the opportunity to contest a tax assessment. A Math Error, on the other hand, will get you an immediate assessment if you do not contest it within the 60-day time period. This means IRS Collections will begin immediately.

You can contest the change by calling the IRS. Lots of luck with that approach given that you will be on hold for hours. The better way is to write up your response as to why the original return is correct and mail it certified to the IRS. Do not expect a quick response from the IRS. You will have plenty of time to gather documents to support your position.

For more information, here is a link to a Taxpayer Advocate Service blog

Burden of Proof

January is the month to receive IRS information forms such as W-2s and 1099s. Inevitably, some of these forms are going to wrong. Who has the burden of proof to correct these errors? The answer is that it’s you, the taxpayer. IRC 7491 does shift the burden to the IRS, but only if you are in court and have introduced “credible evidence” with respect to the issue. Bottom line, you can save yourself a lot of time and headaches by fixing the problem yourself before the IRS computer systems issue a letter.

This is a two-step process:

  1. Contact the issuer and ask them to correct or amend the form. If the issuer will not fix their error or cannot be contacted, move on to step 2.
  2. Gross up the income on your return to cover the error and take a deduction to offset it. Here is the critical part of this step – include a statement explaining the problem and deduction. Failure to explain and document this error could get you off on a very bad footing in an audit.

You could, of course, call the IRS and ask for their assistance with this problem.  Lots of luck even getting them on the phone.

First Time Penalty Abatement – Easy to Get?

The IRS does abate penalties provided you can prove reasonable cause. Establishing reasonable cause is very much a hit-or-miss proposition. However, there is a more effortless penalty abatement procedure if you can qualify.

First Time Abate or FTA will automatically remove the Failure to File, Failure to Deposit, and Failure to Pay penalties for those who have a good record of compliance. A good record of compliance has the following requirements:

  1. All current-year tax returns have been filed or are on extension.
  2. Have paid all past year’s taxes or are on a payment plan.
  3. Have filed the same type of tax return, if required, for the past 3 tax years before the year to be abated.
  4. Did not receive any penalties for the past 3 tax years before the year to be abated.

Now comes the hard part, how to apply:

  1. Just call them up and get abated over the phone.
  2. Mail a Form 843 Claim for Refund and Request for Abatement.

I have found that most IRS people will wipe out the penalties without an argument over the phone. The problem is that it takes hours to get one of them on the phone. It’s far easier to file Form 843, which takes less than 10 minutes than to deal with the IRS phone system. The downside to the mailing is that they are also very inefficient in processing paper returns. So, expect six months minimum of waiting for an answer.

Is the IRS coming for You?

The Inflation Reduction Act (which apparently has nothing to do with inflation) included $79.6 billion more dollars for the IRS over the next 10 years. This has created a lot of commotion along the lines that IRS auditors are going to be everywhere.

Let me point out a few things that should reduce anybody’s anxiety over this concern:

  • The spending increase is over the next 10 years during which the baby boomers in the IRS are retiring in record numbers.
  • Currently, the IRS has some 8,000 revenue agents. The headcount 10 years ago was 13,000 and in the mid-1990s it was over 15,000. The expected new hirers will bring the levels of revenue agents up to about 17,000 at the end of the 10 years.
  • Training new agents will take close to one year and will require the IRS to remove some of their better agents from the field. This means everyday people are not going to see any expansion of IRS audits for the next several years.
  • The federal government has rarely demonstrated the ability to be effective at anything it does. The IRS is no exception and can’t even answer their own phones.

The idea that IRS auditors are going to be banging on everybody’s door is very much overblown.

Have you ever heard of a Superseded Tax Return?

Here is the scenario. You filed your 1040 on February 1 in the hopes of getting your refund fast. Three weeks later you receive a 1099 in the mail that was not included on your return. Worse, it was for a sizable amount of money that you had assumed was non-taxable since the 1099 was not received in January. Without a doubt, the IRS is going to hit you with a balance due. What’s more, the 20% accuracy penalty is going to be assessed on top of that. Are you up the creek without a paddle?

Not necessarily. The Internal Revenue Manual 21.6.7.4.10 (03-18-2022) refers to “Superseding Returns” and defines these as either an amended return (1040-X) or a corrected (duplicate) return filed after the first return but before the April 15th due date. This IRM requires IRS employees to adjust their databases to reflect the corrected return information. (Hint: It would be a great idea to write “Superseding Return” at the top of the new tax return). The fact that you have correctly filed your return by the due date removes the potential for any penalties other than failure to pay and estimated tax penalties.

This procedure does have an important limitation. While you can correct income and deductions, you cannot modify any irrevocable elections that were made on the first return. Elections such as filing jointly are irrevocable and cannot be reversed with a superseding return.

Will the IRS one day be able to answer their phone?

Rumors are leaking out in the tax representation community that the IRS is finally going to do something about answering their phone. They have a pilot program running with the Practitioner Priority Service phone number that requires the caller to repeat a phrase before being placed on hold. The idea here is to ensure that it is an actual person calling rather than some auto-dialer.

I am not holding my breath on this, but this is the first action step they have taken that I have heard.  It is certainly a significant economic waste to have thousands of people on hold for hours at a time.

In other news, the IRS has issued the Inflation Adjusted Numbers for 2023 in Rev.Proc. 2022-38.  Running a few of the numbers on Excel shows a change of 6.9% from 2022.

Finally, there is a potentially big issue coming down the highway. PPP Loans that were improperly forgiven cannot be excluded from income according to the IRS Chief Counsel. How this will work in practice is a question. If the debt is no longer forgiven and must be paid back, it would still not be income.  Presumably, the SBA would make that repayment demand as part of their determination process. The only way this would produce taxable income is that they left the loan forgiven in spite of their determination that the forgiveness was improper. That seems unlikely. Perhaps the plan is to have IRS agents make the determination of improperness as part of their audit process and not bother with foregiveness.