Top 5 Tax Problems and How to Fix Them
Most folks feel their hearts skip a beat when they get a letter from the IRS in the mail.
It’s understandable – the IRS truly is the most powerful creditor in the country. And most of the time, they’re not writing to tell you about the huge unclaimed refund that you left behind in the US Treasury.
That said, if you get one of these dreaded IRS letters, there are several reasons why you should take a deep breath before you start googling which countries don’t have extradition treaties with the US.
Here is a list of the five most common tax problems according to the IRS – and the simple steps you can take to mitigate or solve these problems.
1. Why did the IRS charge me a penalty? Am I in trouble?
There are many reasons why the IRS may charge you penalties and interest. Paying tax after it’s due, and filing a return that reports a balance due after the deadline, are the two most common reasons for an assessment.
While interest charges, by law, can never be abated, there are certain situations when the IRS will agree to abate a penalty.
If you have not been penalized by the IRS in the three years prior to receiving your penalty assessment, you will likely qualify for the First Time Abatement – a one-time Get Out Of Jail Free card.
You don’t need a good excuse – the IRS will completely remove the penalty if you qualify, no questions asked. You simply need to call them and ask for the First Time Abatement or authorize your accountant to call them on your behalf.
Even if you don’t qualify for a First Time Abatement, you may still be entitled to penalty relief if you can demonstrate “Reasonable Cause” for the event which triggered the penalty. Some common examples of reasonable cause include:
You suffered a fire, flood or other natural disaster;
You or someone in your immediate family was seriously ill or deceased;
You were unable to obtain all of your tax records due to circumstances beyond your control.
Unlike the First Time Abatement, which is usually a slam dunk, getting an abatement under reasonable cause requires you to make a persuasive argument, bolstered with evidence.
For example, if someone in your family had a serious health issue, you will need to include a signed statement from a doctor, or provide some comparable medical record to the IRS.
Furthermore, timing is everything. You cannot cite a personal trial that occurred in 2019 or 2020 to explain why you were late filing your 2021 tax return.
If you don’t qualify for any penalty relief and find yourself stuck with a hefty bill from the IRS, there are still options to defer most of that cost, which brings us to Tax Problem #2…
2. I can’t afford to pay my taxes! What can I do?
Sometimes you get hit with a tax bill that you’re just not ready to pay. Maybe you…
Started your first year of self-employment and you didn’t make any quarterly estimated tax payments.
Sold some stocks, crypto, or rental property for a significant gain.
Were forced to take an early withdrawal from your retirement plan due to financial hardship.
Whatever the reason, the IRS will usually agree to an installment agreement, to give you more time to pay the balance due.
Of course, penalties and interest will accrue as long as you carry a balance, but these financing costs are relatively low compared to the credit cards you’ve got in your wallet.
For the typical individual payment plan, the penalty is one-half of one percent per month that you carry a balance (not to exceed 25% total), plus another 3% for interest.
Assuming you don’t have a pre-existing plan with the IRS, the IRS will automatically approve any installment agreement for up to $25,000 of tax owed, spread out as far as 6 years. You can request the payment plan by attaching Form 9465 to your tax return, or if you already filed your return, you can call the IRS or go to their website.
If you owe more than $25,000 or need more than 6 years to pay your balance, the IRS may still agree to your requested payment terms, but you (or your accountant) will need to talk directly to an IRS agent, rather than getting automatic approval.
The IRS will require you to submit detailed personal financial statements, showing your assets, debts, monthly income and living expenses, to prove that you cannot afford to make larger monthly payments to the IRS.
In rare situations, a taxpayer may even qualify for an Offer-In-Compromise (OIC), in which the IRS outright forgives some or all of the tax due.
You’ve likely seen commercials of starry-eyed couples sitting in their living rooms, rejoicing that their hundred-thousand dollar tax liabilities were magically reduced to mere pennies.
And while this theoretically could happen in real life, it is sadly not the result of a savvy accountant weaving arguments like Clarence Darrow around the spinning head of an IRS agent.
As with payment plans that extend beyond 6 years, an OIC requires the taxpayer to provide detailed financial information to the IRS, to determine how much they can realistically afford to pay over a given period of time.
After an exhaustive review of the taxpayer’s records, if the IRS believes that some or all of the tax is basically uncollectible, they will forgive that uncollectible portion from the taxpayer’s account – with the condition that the taxpayer files their returns and pays their tax in a timely manner going forward.
3. I haven’t filed since the Reagan administration…should I keep whistling past the graveyard?
My wife was watching a YouTube video the other day about the lawsuit between Cardi B and Tasha K. When the commentator mentioned that Tasha K has not filed tax returns in three years, my wife looked at me wide-eyed and said, “You can DO that?”
That’s a typical reaction from people who are accustomed to filing on time each year. The idea that you could go years without filing seems preposterous.
But it’s actually a pretty common problem – the IRS contacts over 10 million people per year on average, about their un-filed tax returns.
While it’s possible for a non-filer to fly under the radar for a few years, eventually the IRS does catch up with you. Unless your compensation is paid entirely in cash, most of your income has already been reported to the IRS by third parties, before you hand a single document to your accountant or make a single data entry in TurboTax.
It might take a couple years for IRS computers to identify which people had income reported to their system, without filing a tax return – but eventually they will find you.
And once the IRS finds you, your state tax agency won’t be far behind, as the Federal and state tax departments share data.
When the IRS contacts you about an unfiled tax return, it will often come in the form of a simple reminder, without any corresponding tax assessment. This means you don’t need to panic, but you do need to start taking steps to get caught up. The IRS can be held at bay for a little while, but eventually their patience does run out.
If there’s a chance you would be due refunds for any un-filed tax returns, it would be to your benefit to get caught up sooner than later. Your claim for a refund expires three years after the original due date for the un-filed tax return (including the extension, if one was filed).
If you’re scratching your chin right now, wondering if there’s a similar statute of limitations on collecting tax for an un-filed return, I’m sorry to say that you didn’t just invent the perfect tax evasion scheme. The IRS has TEN YEARS to collect tax, starting on the date that tax was assessed.
That ten-year timer doesn’t start ticking until you either file the tax return, or until the IRS assesses tax based on the income data available to them, in the absence of a tax return. Either way, avoiding filing accomplishes nothing.
Once you begin the process of getting caught up, the biggest challenge is often compiling tax data that in some cases is several years old.
In this situation, the best first step is to request your Wage and Income Transcript from the IRS. All that income data which was reported to the IRS by third parties is also available for your own review.
Ironically, the tool which put you on the IRS radar in the first place can also be the most helpful tool in resolving your tax issue.
The IRS Wage and Income Transcript does not include any information about state tax withholding, so you may still need to contact your employers and financial institutions individually, to request duplicate copies of W-2’s and 1099’s. But the IRS transcript at least gives you a comprehensive picture of what pieces need to be tracked down.
4. The IRS said my tax return is wrong. They must be right…right?
With the ever-increasing digitization of information, it’s hard to slip through the cracks these days. If you file a tax return that omits one of your W-2’s or 1099’s, you’ll probably get a letter from the IRS shortly after filing.
And while math errors have become less common with the proliferation of high-quality tax software, all it takes is checking the wrong box or typing an override in the wrong field, for a faulty computation to occur.
When IRS computers detect unreported income or math errors on your return, they will send you an automated letter proposing an adjustment, and offering you the chance to either agree or disagree.
Sometimes the IRS adjustment is correct, and you have no choice but to pay the additional tax or accept the reduced refund amount.
But many times the IRS adjustment is wrong. For example, if you omit a 1099-NEC from your tax return, the IRS will propose a balance due which assumes the income on that 1099 is fully taxable – when in reality, you probably incurred business expenses which would reduce your taxable income.
So the first step when receiving an IRS letter about adjusting your tax return, is to confirm whether the IRS adjustment is correct. If the IRS is proposing a balance due, you need to move quickly. Ignoring the letter will cause the IRS to eventually pursue collection actions, such as levying your wages or bank account.
These collection actions can be avoided if you stay in communication with the IRS throughout the process. If you need more time beyond the deadline in the IRS letter, call the number on the letter and ask for an extension, before you pass that deadline.
If you determine that the IRS adjustment is in fact wrong, the next step is to fax or mail a statement to the IRS, explaining your position, and including any documents which corroborate your claims. If mailing your response, send it Certified Mail, Return Receipt Requested, to ensure delivery – or to prove that you responded on time if your package gets lost.
Once you’ve sent your response to the IRS, prepare to wait many months to hear back from them. These delays have become even worse since the Covid shutdown of 2020 – the IRS fell behind processing tax documents, and they have not caught up to this day.
But eventually, if you correctly interpret the tax law and include the necessary back-up documents, the IRS will accept your position and close your case.
5. I’m being audited! Am I going to jail?
While less common than the previous four tax problems, audits strike the most fear in taxpayer hearts. Some people will go so far as to forfeit legitimate tax deductions, because they’re afraid to arouse the suspicion of the IRS.
And while there are certain red flags which tend to trigger an audit – such as claiming huge business losses, or omitting substantial amounts of income – there is no perfect formula for avoiding an audit.
You might be randomly selected for an audit purely as a training exercise for a new agent who needs field experience. Or perhaps you conducted business with someone who was pushing the envelope with their own taxes – the IRS audited that person first, and it started a domino effect of examining other people with financial ties to the audit subject.
Since you cannot control when the IRS comes knocking on your door, my advice would always be to file accurately, which includes taking every legitimate tax deduction to which you’re entitled.
If you have all your ducks in a row, there is nothing to fear from an audit other than your accountant’s invoice. Audits can be very time-consuming, but you can mitigate that cost by keeping your records as organized as possible.
“Can I defend myself in an audit?”
Of course, you’re not required to hire representation, but it’s advisable for a few reasons.
First, the accountant can meet with the IRS agent without the taxpayer being present. Audits can be stressful, and people can become agitated in that situation. Lashing out at the IRS agent is obviously counter-productive to getting a positive result, so keeping the taxpayer away from the IRS helps maintain a civil relationship.
This separation also gives the accountant and the taxpayer an opportunity to reflect on questions from the auditor, and formulate the best possible responses.
An accountant can also advise on strategies to reconstruct records that are not readily available. Most IRS agents are reasonable people who will consider alternative forms of documentation, as long as they have substance and are presented in an organized manner.
For example, a frequently audited deduction is business mileage. If the taxpayer neglected to keep a mileage log, you can prepare one after the fact by reviewing other records like a work calendar and expense receipts, which show where you traveled and when.
Lastly, not all tax laws are black-and-white. Many tax laws are complex and ambiguous and could be interpreted in your favor, or to your disadvantage.
If your audit touches on any of these tax law complexities, an accountant will be able to cite prior court cases and IRS rulings, to make sure any gray area is resolved to your benefit.
The IRS will typically focus its audit on a few specific items from your tax return. If you successfully defend those areas of interest, the agent will probably push to close the audit sooner than later, so that they can move on to potentially more fruitful examinations.
On the other hand, if you cannot defend those initial inquiries, the agent will start digging into other areas of your tax return, and they might even open other tax years for examination.
So the best defense for an audit remains, filing a complete and accurate return to begin with.
Whatever tax problems you might be facing, they are likely scarier in your mind than they are in reality. Despite their reputation, the IRS is not the mob. Their agents have to follow strict protocols and treat you fairly.
As with any relationship, the key is communication. Don’t ignore their letters, and don’t be afraid to talk to them on the phone. If the situation is more than you can handle, find a licensed tax professional to step in and take the burden off your shoulders. You’ll probably find the solution to be far less painful than you imagined.
