Category: IRS Processes

What to Do If There Is a Substitute for Return: File It or Leave It?

You receive an IRS letter informing you they are proposing changes to your tax return. However, you never filed a tax return, so how can they correct it? The answer is that the IRS filed your return using Substitute for Return (SFR). An SFR is the IRS’s way of estimating your tax liability using the information they have on hand, such as W-2s, 1099s, and other income reports. While this might seem helpful, it most often results in a higher tax bill because the IRS doesn’t include deductions, credits, or exemptions you might be eligible for.

There are 3 possible outcomes from this process:
  1. The IRS is bang on right with its calculation of the tax.
  2. The IRS overstates the tax due.
  3. The IRS understates the tax due.
What should you do?

In the first case, they got it right.  You do not need to do anything other than pay the assessment.

Usually, though, they overstate the tax due. The answer here is simple: File your actual and correct return (not an amended return).

But what should you do if the IRS understates the balance due? My recommendation is usually to do nothing. After all, you did not file a false return, and it’s on the IRS to audit and correct the assessment.

The Statute of Limitations

The 10-year Statute of Limitations for collecting the tax due runs as of the assessment date, regardless of whether it is an SFR. There is a small downside. Since you never filed your return, the 3-year Statute of Limitations for auditing and assessing additional taxes never runs. Given the IRS audit rates, this would seem like a small risk.

Conclusion

It’s better to file your return timely and avoid the IRS using its Substitute for Return process. Dealing with the inevitable letters can be irritating, and you risk additional interest and penalties. However, correcting the IRS assessment can be easily done by simply filing the correct return.

What to Do If Your Offer-in-Compromise (OIC) Is Rejected

The IRS rejects 60-70% of Offers in Compromise (OIC) submitted by taxpayers. Receiving a rejection for your OIC can be disheartening, but it’s not the end of the road. Here’s what to do next:

Understand the Reason for Rejection: Carefully review the rejection letter. Common reasons include discrepancies in your financial information or the IRS determining you can pay the full amount through a payment plan.

Consider Appealing: If you believe the rejection was unjustified, you can appeal within 30 days. Use Form 13711, Request for Appeal of Offer in Compromise, to start the process. Be ready to provide additional documentation. The IRS does not publish official statistics on OIC appeal success rates, but many tax professionals report high acceptance rates for well-prepared appeals.

Evaluate Alternative Options: If an appeal isn’t viable, explore other avenues. You might qualify for an Installment Agreement to pay off your debt in monthly installments. If you’re experiencing financial hardship, you could request Currently Not Collectible (CNC) status. This temporarily pauses collection efforts.

Remember, a rejected OIC doesn’t mean you’re out of options. By understanding the reasons, exploring alternatives, and seeking expert advice, you can find a viable solution to manage your tax debt.

When Will the IRS Army of Auditors Hit the Warpath?

The IRS received a significant funding increase through the Inflation Reduction Act of 2022. This led to speculation about a sudden surge in audit activities. Many wondered, “When will the IRS army of auditors hit the warpath?” However, the actual plan for deploying these resources suggests a more measured approach by the IRS.

The Funding Context

The IRS’s additional $80 billion plans extend beyond just increasing enforcement. This funding is also earmarked for upgrading technology and improving taxpayer services. The aim is to make the IRS more efficient and responsive rather than merely more aggressive.

Recruitment and Training

Integrating new auditors into the IRS is a structured process. It begins with the challenge of recruitment. Finding the right candidates is not quick or easy. Once hired, these new auditors go through extensive training. They must master the complexities of tax law, ethical auditing practices, and the use of sophisticated technological tools.

Phased Deployment

Auditors are not deployed abruptly. Recruits start their careers by handling simpler cases under the supervision of seasoned auditors. This integration ensures they are fully prepared before they tackle more complex audits.

Projected Timeline for Deployment

  • Year 1-2 (2022-2023): The focus is on recruitment and training.
  • Year 3 (2024): New auditors start with simpler audit cases.
  • Year 4-5 (2025-2026): They begin to handle more complex audits as their experience increases.
  • Year 6 and beyond (2027 onwards): Auditors are fully integrated and handle various audits.

Implications for Taxpayers

The gradual deployment of new auditors means there will be no immediate spike in audit activities. The IRS aims to improve the accuracy and efficiency of audits. Taxpayers can probably find better things to worry about rather than an oppressive audit increase.

Conclusion

The immediate “army of auditors” concept does not accurately reflect the IRS’s strategy or ability.  Improving audit processes takes time.  Personally, I would be happy if the IRS would just answer their phones

Understanding the IRS Fresh Start Program: Evolution and Current Misconceptions

As a CPA who handles IRS collection issues, it’s ironic and revealing when marketing firms call me, offering to “rescue” me from tax debts through the IRS Fresh Start Program. These unsolicited calls miss the mark and show a deep misunderstanding of my professional role and the program they tout.

This common confusion highlights a bigger problem: widespread misinformation about tax relief programs. Anyone with tax debts needs to understand the true nature and evolution of the Fresh Start Program.

The IRS Fresh Start Program: A Brief Overview

Introduced in 2011, the Fresh Start Program aimed to help taxpayers struggling financially by simplifying the process of paying back taxes and avoiding liens. Despite being advertised as ongoing, the program’s special initiatives have become standard IRS procedures. Here are the key changes:

  • Lien Thresholds: The program raised the liens automatically filed on tax debts from $5,000 to $10,000.
  • Installment Agreements: These agreements allowed more taxpayers to set up installment plans for debts up to $50,000 without detailed financial disclosure.
  • Offers in Compromise: The program introduced more flexible terms, enabling some taxpayers to settle their debts for less than the full amount owed.

Evolution of the Program

The Fresh Start Program started as a pilot project introducing more forgiving methods for managing tax debt. Its success resulted in these methods being permanently adopted into the IRS’s regular procedures. This transition from a temporary measure to standard practice often leads to misunderstandings due to the program’s initial marketing.

Misleading Advertisements

Today’s advertisements can mislead taxpayers by portraying the Fresh Start Program as either still running or as a special relief effort. In reality, the beneficial changes introduced are now just routine IRS procedures.

Understanding these details about the Fresh Start Program can help taxpayers manage their responsibilities more effectively and avoid confusion and scams.

Are you Out-of-Luck when the IRS cannot be convinced that its Assessment is Incorrect?

It happens. The IRS audits you and makes an assessment that you know is wrong. Maybe you missed the audit appointment, and the auditor disallowed all your deductions. Or maybe the IRS has a 1099 or W-2 showing that you have unreported income and you have never heard of the issuer. If you just can’t get the IRS to listen to reason, one of your options is an Offer-in-Compromise based on Doubt-as-to-Liability.

What is an Offer-in-Compromise?

An Offer-in-Compromise is an agreement with the IRS to pay less than the full amount of the assessment. Usually, the basis for this offer is based on the inability to pay the amount before the Statute of Limitations runs. The IRS accepts these offers after doing a financial analysis and concluding that it’s their best option to collect.

The Offer-in-Compromise due to a doubt-as-to-liability is the less well-known sibling to the offer based on lack of potential to pay. Rather than submit financial information, you submit your evidence one last time as to why the assessment is in error. It gives the IRS the option of settling the issue without going through the expense of going to court and possibly losing.

What’s Different about DATL Offers?

There are two major differences. First, the offer can be very low. Second, you are not submitting information about your personal or business financial condition which is full of potential problems if there is an error on the form.

How Much Should You Offer?

This all comes down to how strong is your case. The more likely the IRS is to lose in court, the smaller your offer should be. The minimum I would suggest is $150 so that they can feel like the offer at least covers their processing costs. If it’s a 50-50 likely win for both parties, I would be inclined to make an initial offer between 30 and 50 percent. There will be an opportunity to negotiate the final amount.

Conclusion

All is not lost when it comes to assessments that you believe are in error. Try to use the regular appeals processes first. But if that does not work, then an Offer based on doubt-as-to-liability is well worth trying.

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.

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.

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.

How do you prove a negative to the IRS?

One of the hardest and most irritating problems to work with the IRS is when someone has issued a W-2 or 1099 with an incorrect social security number on it. Generally, what happens is that you receive an IRS notice of proposed changes to your tax return for unreported income. The notice includes a list of 3rd party 1099s and W-2s issued to your social security number. One of those 1099’s, for say $20,000, is from some company that is not even in your part of the country.

Calling up the IRS and complaining about this does nothing. The IRS’s position is that it is up to you to prove that the 1099 is in error.  Several people I have known over the years have given up at this point and just paid the additional taxes.

However, there are better options:

    1. Call the company on the form and try to get them to amend it.
    2. Fill out IRS Form 2624 giving the IRS permission to contact the payor. The IRS will race at a snail’s pace to contact them, but this is usually enough of a prompt to get it fixed.
    3. If this does not work, it’s possible that you are a victim of identity theft. You should call the IRS and request an IP PIN.
    4. The next step is to file a Form 911 with the Taxpayer Advocate Service. One of their primary purposes is to get the bureaucracy to correct errors when its processes fail.
    5. Finally, if it’s enough money, consider an Offer-in-Compromise due to Doubt as to Liability. Make an offer of $150 to cover the processing costs and hopefully, the IRS will let it go at that.

What is so irritating about this issue is its unfairness and the IRS response that this is your problem, not theirs. Luckily, most of the millions of 1099s and W-2s are issued with correct id numbers.