Our tax expert reveals the mysterious relationship between your money and the tax system
…and what it means for you!
Dear Marilyn,
I do my own books every year and have never had a problem. (Actually, I usually get money back as earned income credit!)
But this year I made a significantly better profit…which was awesome, until I got a notice from the IRS saying I owed them over $3000 more.
They included a second sheet to show the discrepancies between my records and theirs, but it didn’t really explain–just a “he said, she said” kind of thing. (I went over all my math on my tax forms and nothing was off.) The notice went on to say that I could contest their claim by sending in proof, but that if my proof didn't convince them, they’d do an audit.
Am I better off paying the $3000 in order to avoid an audit, or is it worth trying to contest their claim?
Marilyn Parham, C.P.A.: You're not alone here. This is a sad but not uncommon correspondence from the IRS.
Sometimes it is legitimate and a taxpayer has forgotten to include something on his/her tax return or made a simple math error.
But just as often, the IRS just doesn’t have all the information it requires and assumes you owe more tax. That is their default mindset. So it's up to the taxpayer to document and substantiate why their records are correct.
[Tweet “It's up to you as the taxpayer to document and substantiate why your tax records are correct. #TheBottomLine “]If the taxpayer can show that their records are correct, the IRS will almost always be okay with the explanation and consider the matter closed.
If the taxpayer can’t substantiate their position, the IRS has no recourse but to assume they owe the tax. An “audit” isn’t even necessary because it will typically go their way.
So What Can I Do?
Now, if you just don’t know what the IRS is talking about and don’t know how to provide them proof, an audit is an option.
However, a better way of dealing with this uncertainty is to call them and get an explanation of the notice. (It may take you a while to get a hold of them; however, this is helpful once you do.)
Most of the time, the notice should indicate the source of the reason the additional tax is being assessed. Many times I have seen this. Most of these instances involve a 1099 not being included in the tax return income…or so they think. IF you did include the income on your tax return, a simple letter and calculation will be sufficient to satisfying them that you did.
A Tale of Two 1099's
Let me give you a common example:
You record a schedule C business on your tax return with gross revenue of $53,231. Included in this amount is 2 different 1099s totaling $25,000 that you report as 1099-MISC income. You didn’t receive a 3rd 1099 but still reported ALL your income.
The IRS sends you a notice that they believe you didn’t report this 3rd 1099 (totaling $10,000) from XYZ company and therefore are assessing you additional income tax.
But since you did include the income in the $53,231 amount, you don’t owe the additional tax! You just need to send them a letter letting them know that you did not receive the form but that the income from XYZ company is included in your income.
You can even detail your income out to show them what all is included in your income:
XYZ company $10,000 income in question – no 1099MISC received by me
ABC company 5,000 1099MISC received
DEF company 15,000 1099MISC received
Other companies 23,231
Total $53,231
This sort of explanation should be sufficient for the IRS to consider the matter resolved and reverse the additional tax assessment.
The Most Important Thing NOT to Do
The most important thing is NOT to procrastinate with your response. The IRS usually only gives you 10-20 days to respond before they start getting a little nasty with their correspondence.
Without correspondence, they just believe you owe the tax and simply don’t want to pay it.
[Tweet “If you're in danger of getting audited, the most important thing to do is NOT procrastinate! #TheBottomLine”]During the call you make to the IRS, see if there is a fax number you can send the correspondence to. Snail mail is very slow and it could take weeks for them to process your request.
In addition, ask the agent that you speak to to put the account “on hold” while the correspondence is being processed. This will ensure you aren’t harassed while they are “processing.”
Make sure you jot down the IRS name and representative ID number so that you can have it if there is a problem later with them “not receiving correspondence.” (Remember, we're dealing with a government agency here.)
And do me a favor? PLEASE keep a copy of everything that you send to the IRS. You might need it.
Finally, follow back up with a phone call in 2-3 weeks to make sure they have the information that you sent and hopefully they will tell you that the matter is resolved. If it is not, call them back in another week. (T's actually kind of fun to turn the tables and start bugging them, for a change.)
The Bottom Line
The big takeaway on this is
- Don’t just assume the IRS is correct. Investigate.
- Call them. This may take a while and be a bit frustrating but it your money so find out what is going on and “why” they are sending you the notice.
- If you believe you do NOT owe it, sit down and send a letter and documentation.
- Do NOT procrastinate. Do it now as there is a short timeframe to respond
- Followup and make sure they process the information that you sent
An IRS audit is never fun, but if you have nothing to hide, you have nothing to fear. Besides a little inconvenience, that is.
[Tweet “An audit is never fun…but if you have nothing to hide, you have nothing to fear. #TheBottomLine”]Documentation is the key to making that inconvenience as light as possible, so remember to be organized and detailed in your tax return files so in case you do get audited (even 3 years from now), you have everything you need to come out clean.
