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.
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.
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.
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.
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:
- 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.
- 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.
- 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.
- 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.
- 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.
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.
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 126.96.36.199.10 (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.
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:
- Call the company on the form and try to get them to amend it.
- 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.
- 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.
- 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.
- 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.
The IRS issues millions of liens on tax debtor property every year. Unlike other creditors, IRS liens are “self-releasing”. There is a highlighted box on each Notice of Federal Tax Lien that states that this notice will also operate as a lien release one day after the Last Date for Refiling. The problem is that most people, including financial professionals, do not read this and keep looking for a formal release that is not coming.
The easiest way I have found to handle the problem with bankers and closing agents expecting a formal withdrawal is to send them a copy of the lien notice and highlight in red the already highlighted box. You can also send them IRS Publication 1468 which explains the self-releasing nature on page 4.
The IRS will formally withdraw the lien notice if the debt is cleared prior to the Statute of Limitations. This is usually done automatically within 30 days after the debt has been paid off with money or an Offer-in-Compromise. There are also other reasons they will issue a withdrawal if the government can be convinced it is in their best interest.
Occasionally you really need to pay the IRS on a single day without fail. This can happen in cases with real estate closings in which the IRS is a lien holder. The safest way to make this happen is a bank-to-bank wire transfer.
The IRS Same-Day Wire Federal Tax Payments at https://www.irs.gov/payments/same-day-wire-federal-tax-payments has a downloadable worksheet that you can fill out and take to your bank. There are of course fees involved.
There is one big caveat to keep in mind in using wire transfers. If your wire comes in after 5:00 PM ET, it will be returned to the bank.
An Innocent Spouse Claim is worth considering in cases where the taxpayers jointly owe a lot of IRS debt. The downside is that the IRS does not generally approve these claims. Worse, most of the appeals to the courts have been IRS wins.
That said, it is still worth considering. Innocent spouse claims arise in cases where the tax understatement can be attributed to just one spouse. Additionally, the other spouse must have no knowledge or benefit from that understatement. The strategic advantage is that you might get a better result on the Reasonable Collection Potential formula by removing the one spouse from the liability.
An Offer-in-Compromise will only work if the taxpayers can show that they do not have the financial means that will enable them to pay the debt in full. The IRS does not accept offers for less than full pay merely because someone throws a number at them. Instead, they do a financial analysis. The results are plugged into the Reasonable Collection Potential formula. Removing one of the spouses from the liability could change the formula results and make the other spouse eligible for an offer.
If your tax debt is the result of an IRS Audit, do not overlook the possibility of getting the IRS to reverse the audit assessment. The Audit Reconsideration as explained in Pub 3598 is a process to get some relief from audit results you do agree with or an assessment made by the IRS because you did not file a return.
You may request audit reconsideration if you:
- Did not appear for your audit
- Moved and did not receive correspondence from the IRS
- Have additional information to present that you did not provide during your original audit
- Disagree with the assessment from the audit
The IRS recommends you use form 12661 to explain your dispute. New information is the key to getting this process to work. It is critical that you provide all the documentation with the request. Requests without documentation enclosed will be denied out of hand. You can use this process as long as the assessment is outstanding.
Your reconsideration request will be accepted if you:
- submit information that has not been considered previously.
- filed a return after the IRS completed a return for you.
- believe the IRS made a computational or processing error in assessing your tax.
- The liability is unpaid, or credits are denied.
This is a relatively cheap process to get rid of an IRS debt if you have the grounds to pursue it.