Susan was part of a multi-member limited liability company (LLC) that had purchased a building in an underprivileged area. They were renovating it and hoping to turn a profit in the future. In their founding year, the company made no money. Susan filed their tax return late and filled it with zeros, which accurately reflected the situation. Because she was late, the Internal Revenue Service (IRS) assessed her for a penalty of $10,000. Like many who receive adverse or incorrect IRS tax assessments and are told they owe the IRS more money, she was shocked and scared.
It turned out, however, that she owed nothing. Since the project had not yet had any transactions, Susan had not been obligated to file a tax return. Given that, there should be no penalty for her delay in filing. She fought the assessment, and the IRS withdrew the penalty.
Unfortunately, Susan is just one of many individuals and businesses who owe money to the IRS due to incorrect tax assessments and determinations made by the IRS.
What Is an Incorrect IRS Tax Assessment?
The IRS determines how much money you owe them. When they calculate that number erroneously, it’s an incorrect IRS assessment.
Faulty determinations of what a taxpayer owes sometimes occur when the IRS has information gaps and, therefore, is forced to make assumptions. Other times, they may have received incorrect information. Here are some examples of the source of errors:
- Not filing a return — In this situation, the IRS may receive W-2s and other statements that show your income, but they are unaware of deductions and credits that could lower your tax bill. Because they’re in the dark, they assess you for your full income without reducing it for potential tax breaks.
- Incomplete data — If the IRS does not receive all the information they need on your tax return, they may fill in the blanks. For instance, perhaps you sold some stock, but failed to account for how much it cost you. With zero cost noted, the IRS might assume that the sale was 100 percent profit, leading to an unrealistically high tax assessment. After all, most stocks cost money.
- Erroneous information — The IRS receives information from multiple sources, including your employer. If your employer accidentally forwards two W-2s to the IRS instead of one, the IRS may demand that you pay more taxes.
Unfortunately, there are also unforced errors, such as in Susan’s case. In this situation, the IRS should have been aware of their own filing rules.
Tax Audits Can Also Trigger Incorrect Tax Assessments
Some bad IRS tax assessments are the result of tax audits.
Let’s review a typical audit situation.
A taxpayer, George, receives a combo letter from the IRS stating they have audited his return and have detected errors. George might have done any of the following to trigger an audit:
- Entered data incorrectly
- Failed to include all the income he received
- Overstated deductions, such as charitable contributions
- Claimed self-employed status for his “business” that loses money year after year, leading the IRS to suspect it’s a hobby
- Erroneously claimed the earned income credit
- Changed his filing status after his divorce
Unfortunately, George receives a lot of junk mail, so he accidentally put the IRS letter in his circular file and moved on to other matters. Ninety days later, he received another notice, which he also ignored. Then, when George decided to refinance the mortgage on his house, he discovered the IRS had a lien on it. Not only did he have to settle his outstanding taxes before he could refinance, but the lien also remained on his credit report for seven years.
In 2018, the IRS conducted most (74.8 percent) of its audits via correspondence, issuing combo letters to taxpayers that provide their assessment and an opportunity to appeal it. While taxpayers have a chance to prove the IRS wrong and hold onto their hard-earned money, a mere 10 percent of them file an appeal. Sadly, according to IRS statistics, they may be leaving money on the table. On average, those who appeal IRS findings, reduce their taxes, penalties, and interest by 40 percent.
So what should you do if the IRS has audited you and based on incorrect or missing facts and data, decided you owe them money?
There are steps you can take to resolve the situation. To avoid ending up like George or Susan, be aware of the types of correspondence you might receive from the IRS, as well as your rights, and options when it comes to correcting a bad IRS assessment.
How To Know If You Are Being Assessed or Audited
If the IRS decides that you owe them money, you’ll receive a Notice and Demand for Payment from them.
The best way to protect yourself is to not ignore correspondence from the IRS. Open it. Read it. Make sure you understand it.
Review the IRS report and determine if there are incorrect items. If there are, pull together any documentation the IRS has not yet seen to support your claim. Your goal is to provide proof that the IRS’s determination is incorrect, whether the error is due to miscalculations or faulty reasoning.
The notice you receive will let you know how long you have to respond. You need to reply promptly with an appeal or a payment.
Do not pay outstanding taxes if you plan to appeal the assessment. Call the IRS and request they put a hold on collections while you appeal the case. The IRS may delay collections.
The Appeal Process
Appealing an incorrect federal tax assessment starts with the completion of one or more forms. It’s best to work with a tax professional on this. He or she will ensure your claim is correct and prepare the most airtight appeal. Remember, as a taxpayer, you have the right to pay no more than you owe. If you fail to respond, however, you can expect additional bills and eventually to be part of a formal collection procedure. You also waive your right to an appeal.
If the IRS sends you a Notice of Federal Tax Lien or a Notice of Intent to Levy, for example, you must respond in writing in 30 days. You can use the Collection Due Process (Form 12153) to request a hearing in which you can challenge the amount of money the IRS claims you owe. By doing so, you stop the collection activity and protect your right to sue in tax court where you can make a settlement offer. At the hearing, a settlement officer will speak with you or your representative to review your case. Based on the discussion and backup information, they will adjust the balance due to a fair amount or eliminate it. To make payment of the amount due more manageable, you may be able to set up an installment agreement.
Other forms you can use to challenge the IRS include:
- FORM 12661: Disputed Issue Verification is not required; however, it can help you to outline the part of the audit that you’re disputing and offer new information that backs your claim. While useful, this form does not stand alone. Along with it, you should send a letter that summarizes your issue as well as supporting documentation. The more details you can include, the better. Before sending documents, make copies of everything. Also, make the process as easy as possible for the IRS staff by adding a copy of your disputed tax return and phone numbers where they can reach you.
- You can use FORM 6562 “Offer in Compromise” (OIC) for several situations — if you are unable to pay the amount due given your assets and income; if payment would create hardship; and if you dispute the amount of taxes due. Let’s focus on a dispute, a.k.a. “Doubt as to Liability.” Use the form to outline why you don’t think you owe the tax amount the IRS has assessed. Then make a reasonable offer of the payment you believe would settle the debt. The IRS will decide whether to accept your offer. Form 6562 is not a magic bullet. The IRS turns down many OICs. Primary reasons they might deny your offer are that you fail to provide sufficient financial documentation or your offer is too low.
It is intimidating to receive a letter from the IRS stating you owe a lot of money or that the IRS plans to seize your property or rights to your property. Taking control of the situation allows you to sleep at night. Philadelphia CPA Dale S. Goldberg has been in business for almost half a century and has successfully defended thousands of people who’ve received these notices and reversed the audit findings and assessments.