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."

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:

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.
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:

All current-year tax returns have been filed or are on extension.
Have paid all past year’s taxes or are on a payment plan.
Have filed the same type of tax return, if required, for the past 3 tax years before the year to be abated.
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:

Just call them up and get abated over the phone.
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.

Why you need to Act Now on your IRS Debt Problem

It’s a natural tendency to want to avoid dealing with an unpleasant task such as an IRS debt problem. After all, the IRS is not particularly speedy in most of the things they do, so ignoring them, in the beginning, is easy. But this is probably going to cost you. Waiting for that levy notice to come in the mail is going to reduce the time available for you to arrange your finances so that your payments to the government are minimized.

Why is this? Unless you qualify for a streamlined payment plan, the IRS is going to perform a financial analysis of your situation to determine how much money they should be able to collect. Basically, they are going to relate your income to what they consider to be the “reasonable” costs of living. If that cash flow projection is positive, they are going to want a deal that gives them that amount as a minimum.

Here is where the time problem comes in. Given enough time in advance of that levy notice, you can use the IRS financial analysis approach in advance to figure out what changes you can make to minimize the amount that the IRS might think of as collectible. For example, say you do not have life insurance. The IRS allowable expenses include term life insurance premiums. But, you need at least 3 months of payments to the insurance company before the IRS will include this money in their calculations. So, signing up for life insurance tomorrow is not going to work. Given enough time in advance of negotiating with the IRS could result in you having life insurance with zero difference to your cash flow.

Performing the financial analysis early allows you to develop a strategy to minimize the IRS’s impact on your life. Waiting for the levy notice is a mistake

How does the IRS define “Economic Hardship”?

Economic Hardship is a kind of get-out-of-jail-free card when it comes to dealing with IRS Collections Division. It can be used to get a levy released or an Offer-in-Compromise accepted if the financial analysis showed the result would place the taxpayer in an economic hardship

So, just what is an Economic Hardship? Economic hardship occurs when a taxpayer is unable to pay reasonable basic living expenses. The IRS considers the taxpayer’s equity in assets and expected cash flow to determine how much money should be available to pay their tax debts. This information is brought together with a formula that is called the Reasonable Collection Potential or RCP. Much of the “reasonableness” in the formula comes from various tables of allowed or allowable living costs.

Plug all the numbers into the RCP and if the result is positive, the IRS figures you can make payments. If the number comes out negative, then you are in an Economic Hardship situation.

This leads us to one of the major reasons for Offers-in-Compromise to fail. Nobody did the RCP analysis and instead made an offer that was unacceptable on the face of it.

Are Retired People Screwed when it comes to IRS Debt?

A retired couple decides to liquidate some of their stock investments because they are no longer able to handle the ups and downs of the market. This action puts them into a strong and safe cash position but also produces a large tax bill. Paying that bill significantly reduces the savings they have built and depend upon for their retirement years.

They decide to make an Offer-in-Compromise with the IRS instead. The offer is rejected by the IRS because the analysis of their financial position shows that they could full-pay the debt. Is it a lost cause for this couple?

Not necessarily. The IRS can accept the Offer under Special Circumstances where the collection of the debt in full would create an “Economic Hardship”. This would be the case for the retired couple depending upon their savings for the rest of their lives.

The big factor for taxpayers hoping to have an Offer with Special Circumstances accepted is a history of compliance. Investing in dubious tax shelter schemes, repeated non-filing penalties, or failure to pay on a regular basis are all factors that will work against the offer. Most of these offers are in fact initially rejected by the IRS, so you can expect that a trip to Appeals is going to be part of the process.

I will discuss the meaning of “Economic Hardship” in more detail in my next post.

Can the IRS have your Passport Revoked?

The IRS does have the power to have the State Department revoke your passport for owing back taxes is YES. Recently the Fifth Circuit upheld the constitutionality of the government restricting international travel for James Franklin due to back tax debts of $55,000. Mr. Franklin had claimed that revoking his passport had violated his 5^th Amendment rights to due process. Luckily, the US is a big country, so you can still have some places to go while all those IRS notices are building up in your mailbox.

Revoking your passport is not the only tool in the IRS toolkit that goes beyond liens and levies. In 2014 Congress passed the Consolidated and Further Continuing Appropriations Act that prohibited federal agencies from awarding contracts or grants to contractors with any amount of delinquency in federal taxes. This law does not get used consistently, but it is another good reason to avoid getting in the hole with the IRS.