What to Do If You Receive an IRS Notice

It’s a moment many taxpayers dread. A letter arrives from the IRS and it’s not a refund check. But don’t panic; many of these letters can be dealt with simply and painlessly.

Each year, the IRS sends millions of letters and notices to taxpayers to request payment of taxes, notify them of changes to their accounts, or request additional information. The notice you receive normally covers a very specific issue about your account or tax return. Each letter and notice offers specific instructions on what you are asked to do to satisfy the inquiry.

However, the letters also have to advise you of your rights and other information required by law. Thus, these letters can become overly lengthy and sometimes difficult to understand.

Here are dos and don’ts to follow if you receive correspondence from the IRS or state tax authority:

• Do immediately get a copy of the correspondence to this office so it can be reviewed and timely responded to.
• Don’t respond if the correspondence requests personal information. There has been substantial identification theft related to scam artists pretending to be the IRS or another authority, especially correspondence by e-mail. Let this office take a look before responding.
• Don’t procrastinate or throw the letter in a drawer, hoping the issue will go away. Most of these letters are computer-generated and, after a certain period of time, another letter will automatically be generated. And, as you might expect, each succeeding letter will become more aggressive and less easily dealt with.
• Don’t automatically pay an amount the correspondence is requesting unless you are positive you owe it. Quite often, you will not owe what is requested, and it will be difficult to get your payment back.

Most notices are computer-generated after comparing the income items reported on your return with those reported by the payers. For example, your employer sends you a W-2 every year and also sends a copy to the government so that your wages are on the IRS computer. Your bank sends the 1099-INT to the IRS showing how much interest you earned. Your brokerage firm reports your dividends with Form 1099-DIV and stock transactions with 1099-B forms. If you are self-employed, those who pay you $600 or more during the year are required to send you and the IRS a 1099-MISC, and if you have credit card transactions, the clearing house will issue a 1099-K. If you are retired and collecting a pension or drawing on your own IRA, a 1099-R will be sent to you. Lenders report how much interest you paid on your home loan during the year. If you are lucky enough to hit it big in Vegas, you will receive a 1099-G for your winnings. The list goes on and on, and if what you reported on your return doesn’t match what is on the IRS’s computer, you will receive a computer-generated notice.

One big problem that has developed over the years is the IRS’s willingness to allow payers to use substitute forms that are unrecognizable as income-reporting documents. Many of the brokerage firms are now providing their substitutes in letter-size documents printed front and back on multiple sheets that almost take a financial expert to understand. This results in frequent errors.

There are times when you may receive an income item and it appears to be taxable to the IRS, when in fact it is not. Here are some frequently encountered situations.

• Sold a security with no profit − Whenever you sell a security, the brokerage house will report the gross proceeds of sale to the IRS. In other words, the IRS has on their computer what you sold it for. For purchases made before 2011, they have no clue what you paid for it, which means you must report the sale on Form 8949 and Schedule D on your tax return. If you fail to report it, the IRS treats the entire sales price as a profit. Let’s say you sold 200 shares of stock, which originally cost you $5,050, for $5,000. You actually have a loss of $50. Unless you report the transaction and show that you paid $5,050 for the shares, the IRS is going to assume you had a $5,000 profit. This frequently occurs when taxpayers overlook a transaction or simply omit it because there was no profit. If this is what caused the notice, you will need to respond to the IRS to explain the mistake and provide verification of the stock’s original cost.
• Rollovers − Another frequent error is when you rollover an IRA, 401(k), etc. from one plan to another or one trustee to another. If you don’t show on the tax return that the distribution was rolled over, the IRS assumes the entire amount to be taxable. If these funds are transferred between trustees, a 1099-R is not supposed to be issued, but sometimes they still are. It is better to make sure. On the other hand, if you take possession of the funds and then redeposit them into another IRA, a 1099-R will be issued, and the rollover must be accounted for on the return. If this is what caused the notice, you will need to provide verification of the rollover to the IRS with your response.
• Shared accounts − Generally, banks and other financial institutions only have the capability of having one taxpayer ID as the primary owner on an account, even though it may be a joint account with others. These financial institutions will issue the 1099 or other reporting documents under the social security number (SSN) of the primary owner, and the total will be reported to the IRS under that SSN. This also will affect married or separated taxpayers who do not file jointly. The IRS expects to see the same amount that was reported on the 1099 on the return of the individual whose SSN was used on the 1099. When there’s a mismatch, the IRS will send out a notice of unreported income. When responding to the IRS notice, you will need to provide the names, addresses, and SSNs of the other owners and a statement to the fact that they each reported their appropriate share.

The foregoing are just a few of the more common examples of computer mismatches that can cause computer-generated notices. Even though the IRS feels the notices are readily understandable, experience has shown that taxpayers can become confused and that the experienced eye of a tax professional is usually required to decipher the notices. That is why we highly recommend that this office review any notice you receive prior to your taking any action or responding.

A Word of Caution − The IRS routinely provides state tax agencies with the results of the correspondence audits. Generally, if the IRS’s notice proves to be correct, the results of the correspondence audit will need to be dealt with on the state level through an amended state return, or you can wait to receive the state notice. However, if you wait for the state notice, additional interest and penalties may possibly accrue for the state return.

Please give our office a call if you have questions related to a correspondence you received from the IRS or state authority.

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Social Security Administration Launches New Online Tool

If you go back a few years, you may remember that every year, about three months before your birthday, you received an earnings and benefits statement from the Social Security Administration providing you with a history of your earnings and projected benefits. Then, along came a recession and the accompanying budget cuts and the mailing out of the statements stopped, except for workers age 60 and over.

The earnings and benefits statements provided a valuable annual reminder of what you can expect to receive and how benefits are calculated. It also prompts us all to make Social Security part of our long-range retirement plans.

New Retirement Tool Now Available - On May 1st, Michael J. Astrue, Commissioner of Social Security, announced that an online version of the Social Security Statement is now available at the Social Security Website. The new online statement provides eligible workers with secure and convenient access to their Social Security earnings and benefits information. The online statement also provides estimates for disability and survivors benefits, making the statement an important financial planning tool. People should get in the habit of checking their online statement each year, around their birthday.

In addition to helping with financial planning, the online statement also provides workers a convenient way to determine whether their earnings are accurately posted to their Social Security records. This feature is important because Social Security benefits are based on average earnings over a person’s lifetime. If the earnings information is not accurate, the person may not receive all the benefits to which he or she is entitled. The online statement also provides the opportunity to save or print the personalized statement for financial planning discussions with family or a financial planner.

To get a personalized online statement, people age 18 and older must be able to provide information about themselves that matches information already on file with Social Security. In addition, Social Security uses Experian, an external authentication service provider, for additional verification. People must provide their identifying information and answer security questions in order to pass this verification. Social Security will not share a person’s Social Security number with Experian, but the identity check is an important part of this new, robust verification process.

Once verified, people will create a “My Social Security” account with a unique user name and password to access their online statement. In addition, the portal also includes links to information about other online services, such as applications for retirement, disability, and Medicare.

It is important to note, however, that Social Security anticipates some members of the public will not be able to be verified through this process. Some people may not correctly answer the security questions based on information on file with Experian, and others may supply identifying information that does not match their Social Security records. In instances where this occurs, people will have the option to request that a hard copy of their Social Security Statement be mailed to them. People who cannot verify online initially also may visit their local Social Security office and present an identity document in order to create an account and gain access to the online version of the statement.

In February 2012, Social Security resumed mailing paper statements to workers age 60 and older if they are not already receiving Social Security benefits. Later this year, the agency plans to mail paper statements to workers in the year they reach age 25. For more information about the new online statement, please go to www.socialsecurity.gov/mystatement.com.

If you need more information related to Social Security credits and taxation of Social Security benefits please give our office a call.

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IRS Liberalizes Position on Local Lodging

In the past, a business deduction was allowed only for lodging when a taxpayer traveled away from his or her “tax home.” A taxpayer’s tax home is generally the location (such as city or metropolitan area) of a taxpayer’s main place of business (not necessarily the place where he/she lives).

This has long created problems for individuals attending conferences and training sessions within their tax homes that include extended-hour events that preclude traveling back home between days of the events. In 2007, the IRS announced that it would amend the regulations to allow certain temporary local lodging expenses to be treated as business expenses; now, five years later, the proposed regulation changes have recently been announced.

Proposed Changes - The IRS has issued proposed reliance regulations permitting certain non-away-from-home lodging expenses to be treated as deductible business expenses by employers and tax-free working condition fringe benefits or accountable-plan reimbursements to employees. The proposed regulations provide a safe harbor; local lodging expenses are treated as ordinary and necessary business expenses if all of these conditions are met:

1. The lodging is necessary for the individual to participate fully in or be available for a bona fide business meeting, conference, training activity, or other business function.
2. The lodging is for a period that does not exceed five calendar days and does not recur more frequently than once per calendar quarter.
3. If the individual is an employee, his or her employer requires him or her to remain at the activity or function overnight.
4. The lodging is not lavish or extravagant under the circumstances and does not provide any significant element of personal pleasure, recreation, or benefit.

Example: A business conducts business-related sales training sessions at a hotel and conference center near its main office. The employer requires both its field and in-house sales force to attend the training and stay at the hotel overnight for the bona fide purpose of facilitating the training. If the company pays the lodging costs directly to the hotel, the stay is a working condition fringe benefit to all attendees (even to employees who live in the area who are not on travel status) and the company may deduct the cost as an ordinary and necessary business expense. If the employees pay for the lodging costs and are reimbursed by the company, the reimbursement is of the accountable plan variety and is tax-free to the employees and deductible by the company as an ordinary and necessary business expense.

Example: If a locally-based self-employed consultant were required by a company to attend the sessions and stay at the hotel, he or she could deduct the expense if he or she paid for it himself or herself or exclude the expense if he or she were reimbursed by the company after accounting for it in full for his or her costs.

The new rules apply to expenses paid in prior years in cases in which the statute of limitations for claiming refunds is still open (generally, after 2008). Thus, returns can be amended for refund where a lodging deduction would have been allowed.

If you have questions related to how this change affects prior filed returns or how it will affect your business deductions going forward, please give our office a call.

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Do You Have a Financial Interest in or Signature Authority over a Foreign Financial Account? Better Read This! June 30 Is a Critical Date

Every U.S. person who has a financial interest in or signature or other authority over any foreign financial accounts (including bank, securities and other types of financial accounts in a foreign country), if the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year, must report those relationships to the U.S. government each calendar year.

The government uses this reporting mechanism as a means to uncover hidden foreign accounts and ensure that investment income earned in foreign countries by U.S. taxpayers is included on their U.S. tax returns. The Treasury Department has placed a new emphasis on foreign accounts, and taxpayers with a financial connection to a foreign country should determine whether they have a reporting requirement.

Reporting is accomplished by filing a Report of Foreign Bank and Financial Accounts form—more commonly referred to as the FBAR—which must be received by the IRS at its Detroit office on or before June 30 of the succeeding year. Thus, the FBAR filing for the 2011 year must be received by the IRS no later than June 30, 2012. This report is filed separately from the taxpayer’s income tax return, and no extensions of time are available for filing this form. In addition, taxpayers generally are required to answer “yes” or “no” to questions related to foreign bank and financial accounts on their tax returns.

Penalties for failing to comply can be draconian. For non-willful violations, civil penalties of up to $10,000 may be imposed; the penalty for willful violations is the greater of $100,000 or 50% of the account’s balance at the time of the violation. A reasonable cause exception to the penalty is available for non-willful violations but not for willful violations.

Overlooked Accounts — Many taxpayers overlook the fact that they have a reporting requirement in situations such as the following:

• Family Accounts — Recent immigrants to the U.S. may still have parents or other family members residing in the “old” country, and those relatives may have included them on an account in the foreign country. This is common practice for some ethnic groups. The taxpayer does not really consider the account his or hers, but it falls under the reporting requirement if he or she has signature or other authority over the account and the value exceeds $10,000.
• Inherited Accounts — Inherited accounts in a foreign country fall under the FBAR reporting requirement even if the funds are subsequently transferred to the U.S. The FBAR rules state that reporting is required if at any time during the year the foreign account exceeds $10,000.
• Business Accounts — An officer or board member may have signature authority over a business account held in a foreign country and overlook the need to meet the FBAR reporting requirements.

In addition to including any reportable foreign income on his or her tax return, the taxpayer must ensure that the foreign account questions are completed correctly on the tax return and that the FBAR is filed when required.

If you have questions regarding this reporting requirement, please contact our office.

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Are You an Employee or an Independent Contractor?

The distinction has significant implications for both the employer and the employee. Employers like to treat individuals as independent contractors because they avoid having to match the employees’ payroll tax, pay benefits, pay unemployment insurance, etc. This results in a significant savings for employers.

When you are an employee, the employer pays you a net amount after making all the required tax withholdings and provides you with a W-2 for tax reporting that shows your taxable wages and details all of the withholding amounts. If you are an independent contractor, the employer will pay you a gross amount without any withholding and will issue you a 1099-MISC. 

Independent contractors must pay self-employment (SE) tax instead of having FICA (Social Security and Medicare program contributions) deducted from their wages. The SE tax rate is generally twice the amount of the FICA rate. Independent contractors are generally treated the same as self-employed individuals, so the SE tax and income tax are based on their net earnings after deducting any allowable expenses incurred to earn the income.

The problem here is that employees generally do not have tax-deductible expenses related to their jobs, so employees who are incorrectly classified as independent contractors find themselves essentially paying both the employer’s and their own share of the Social Security and Medicare taxes. To make matters worse, as an independent contractor, no federal or state income tax was withheld, leaving the independent contractor with a sometimes unexpected tax liability.

Classifying a worker as an employee or independent contractor is not discretionary for the employer. The employer must follow federal guidelines when making the determination. Basically, it boils down to whether the employer has direction and control over the individual, which includes, among other guidelines, specifying working hours, how to perform the work tasks, the right to fire, etc. If the employer does have direction and control, the individual is probably an employee.

If you have been treated as an independent contractor and think that you are really an employee, you do have recourse. You can file Form 8919. If the IRS agrees with you, you only have to pay the employee share of FICA/Medicare not the self-employment tax. You still have to pay the income tax. The filing will make life miserable for your presumably former “employer,” so it might turn into a bridge-burning exercise. 

If you have questions, wish to explore alternatives, or need assistance filing Form 8919, please give our office a call.

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Forgot Something on Your Tax Return? It’s Not Too Late to Amend the Return

If you discover that you forgot something on your tax return, you can amend that return after it has been filed. The need to amend can include a number of issues:

• Receiving an unexpected or amended K-1 from a trust, estate, partnership, or S-corporation.
• Overlooking an item of income or receiving a corrected 1099.
• Forgetting about a deducible expense.
• Forgetting about an expense that would qualify for a tax credit.

These are among the many reasons individuals need to amend their returns, whether it is for the just-filed 2011 return or prior year returns.

Here are some key points when considering whether to file an amended federal (Form 1040X) or state income tax return.

1. If you are amending for a refund, you should be aware that refunds generally won’t be paid for returns if the three-year statute of limitations from the filing due date has expired. Thus, with the exception of amending a return to carry back a business net operating loss (NOL), the IRS will pay refunds only on returns from 2009 through 2011. Some states have a longer statute.
2. Generally, you do not need to file an amended return to correct math errors. The IRS or state agency will automatically make those corrections. Also, do not file an amended return because you forgot to attach tax forms such as W-2s or schedules. The IRS or state agency will send a request asking for the missing forms.
3. If you are filing to claim an additional refund, wait until you have received your original refund before filing Form 1040X. You may cash that check while waiting for any additional refund.
4. If you owe additional 2011 tax, file Form 1040X and pay the tax before the due date to limit interest and penalty charges that could accrue on your account. Interest is charged on any tax not paid by the due date of the original return, without regard to extensions.
5. When amending multiple returns, send them in separate envelopes. Sometimes when filed together, they are mistaken for a single return, and the additional returns filed in the same envelope are not processed.
6. If the changes involve another schedule or form, it must be completed and included with the amended return. In addition, it may be appropriate to include documentation to avoid subsequent correspondence from the IRS or state agency.
7. A detailed explanation of the changes must also be attached. This is required to explain to the processing staff the reason for the amendment. In insufficient explanation can lead to additional correspondence and delays.
8. Depending on why you file an amended federal return, you may be required to amend your state return. However, if the federal amendment is filed to claim or correct a tax credit that the state does not have, no state amended return will likely need to be filed. In most other circumstances, you will need to amend the state return as well as the federal.

An amended return can be more complicated than the original, so please contact our office for assistance in preparing your amended returns.

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