No one likes surprises from the IRS, but they do occasionally happen. Here are some examples of unpleasant tax situations you could find yourself in and what to do about them.
An expected refund turns into a tax payment. Nothing may be more deflating than expecting to get a nice tax refund and instead being met with the reality that you actually owe the IRS more money.
What you can do: Run an estimated tax return and see if you may be in for a surprise. If so, adjust how much federal income tax is withheld from your paycheck for the balance of the year. Consult with your company’s human resources department to figure out how to make the necessary adjustments for the future. If you’re self-employed, examine if you need to increase your estimated tax payments due in January, April, June and September.
Getting a letter from the IRS. Official tax forms such as W-2s and 1099s are mailed to both you and the IRS. If the figures on your income tax return do not match those in the hands of the IRS, you will get a letter from the IRS saying that you’re being audited. These audits are now done by mail and are commonly known as correspondence audits. The IRS assumes their figures are correct and will demand payment for the taxes you owe on the amount of income you omitted on your tax return.
What you can do: Assuming you already know you received all your 1099s and W-2s and confirmed their accuracy, verify the information in the IRS letter with your records. Believe it or not, the IRS sometimes makes mistakes! It is always best to ask for help in how to correspond and make your payments in a timely fashion, if they are justified.
Getting a tax bill for an emergency retirement distribution. Due to the pandemic, you can withdraw money from retirement accounts in 2020 without getting a 10% early withdrawal penalty, but you’ll still have to pay income taxes on the amount withdrawn. If you don’t plan for this extra tax you will be surprised with an additional tax bill. And you may still get an underpayment penalty bill from the IRS because you did not withhold enough during the year. You may also still receive an early withdrawal penalty in error because the IRS is still scrambling to update their systems with all of this year’s tax relief changes.
What you can do: Set aside a percentage of your distribution for taxes. Your account administrator may withhold funds automatically for you when you request the withdrawal, so check your statements. Your review should be for both federal and any state tax obligations. If the withholding is not sufficient, consider sending in an estimated tax payment. And if you are charged a withdrawal penalty, ask for help to correspond with the IRS to get this charge reversed.
No one likes surprises when filing their taxes. With a little planning now, you can reduce the chance of having a surprise hit your tax return later.
Coronavirus uncertainty abounds. Thankfully, by monitoring tax changes on your behalf, we can work together to navigate the right path for you and your family. Here is a round-up of tax-related laws and information to help with tax planning for 2020.
Early distribution penalty waived The 10% early distribution penalty on up to $100,000 of retirement withdrawals for coronavirus-related reasons is waived during 2020. New tax rules allow tax liabilities on these distributions to be paid over a three-year period. So if you need the funds, you won’t see your tax bill skyrocket in one year. Even better, you can return these distributions back into your retirement account over a three-year period and not be subject to the annual contribution limits. Action: This could be a great way to handle emergency payments until you receive a stimulus check, unemployment payments, or a pending small business loan.
Required minimum distributions (RMDs) waived for 2020 Required minimum distributions (RMDs) in the year 2020 for various retirement plans is suspended. The corresponding 50% penalty associated with not taking an RMD is also suspended in 2020.Action: Taking out distributions when the market takes a tumble can hurt retirement income for many years. This change allows you to wait to let the value in your retirement account rebound before you withdraw funds.
IRS installment agreement suspension The IRS is suspending payments of all amounts due from April 1 through July 15, 2020. If you do not pay your IRS installment payment during this time your installment agreement will not be in default. Interest will continue to accrue on these installment agreements. Action: Being on the bad side of the IRS is never fun. If you currently have an IRS installment agreement, look to take advantage of this delay.
Offers-in-compromise The IRS will allow you until July 15, 2020 to provide additional requested information for any pending offers-in-compromise (OIC) and will not close out the OIC during this time without your consent. The IRS is also suspending any payments due under an OIC until July 15, 2020.
Enforcement activities suspended? Not so fast…The filing and enforcement of liens and levies will generally be suspended. However, IRS Revenue Officers will continue to pursue high income non-filers and initiate other actions when warranted.
No new audits The IRS will not initiate new audits during this time, but will act to protect the statute of limitations.
A letter in the mailbox with the IRS as the return address is sure to raise your blood pressure. Here are some tips for handling the situation if this happens to you:
Stay calm. Try not to overreact to the correspondence. They are often in error. This is easier said than done, but remember the IRS sends out millions of notices each year. The vast majority of them correct simple oversights or common filing errors.
Open the envelope. You would be surprised at how often people are so stressed by receiving a letter from the IRS that they cannot bear to open the envelope. If you fall into this category, try to remember that the first step in making the problem go away is to simply open the correspondence.
Carefully review the letter. Understand exactly what the IRS thinks needs to be changed and determine whether or not you agree with its findings. Unfortunately, the IRS rarely sends correspondence to correct an oversight in your favor, but its assessment of your situation is often wrong.
Respond timely. The correspondence should be very clear about what action the IRS believes you should take and within what timeframe. Delays in responses could generate penalties and additional interest payments.
Get help. You are not alone. Getting assistance from someone who deals with this all the time makes going through the process much smoother.
Correct the IRS error. Once the problem is understood, a clearly written response with copies of documentation will cure most of these IRS correspondence errors. Often the error is due to the inability of the IRS computers to conduct a simple reporting match. Pointing the information out on your tax return might be all it takes to solve the problem.
Use certified mail. Any responses to the IRS should be sent via certified mail. This will provide proof of your timely correspondence. Lost mail can lead to delays, penalties and additional interest on your tax bill.
Don’t assume it will go away. Until a definitive confirmation that the problem has been resolved is received, you need to assume the IRS still thinks you owe the money. If no correspondence confirming the correction is received, a written follow-up will be required.
It’s easy to push tax planning to the sidelines when tax laws are ever-changing and hard to understand. Here are some common (but often unfounded) reasons for avoiding tax situations, plus tips to help get past them and start paying less tax this year:
It doesn’t make a difference. This point of view is especially problematic in years with unique situations. Even in uneventful years, external forces like new tax laws can be managed if planned for in advance.
Selling a house? You can avoid taxes if primary residence requirements are met.
Starting a business? Choosing the correct entity can save you a bunch of taxes.
Getting ready to retire? Properly balancing the different revenue streams (part-time wages, Social Security benefits, IRA distributions and more) has a huge impact on your tax liability.
It’s out of your control. Timing is important when it comes to minimizing taxes, and the timing is often in your control. Bundling multiple years of donations into one to get a deduction, holding investments over one year to get a lower tax rate, and making efficient retirement withdrawals are just some examples of prudent tax strategies that you control.
There’s not enough money. There are tax strategies to be implemented at all income levels, not just those at the top of the tax bracket. Tax deductions are available for student loan interest, IRA contributions and others even if you claim the standard deduction. Certain tax credits (called refundable credits) will increase your refund even if you don’t owe taxes. Missing any of these tax breaks can unnecessarily increase your taxes.
I only need help at tax time. When the standard deduction doubled in 2018, many people assumed they could kick their feet up and wait for a big refund. That assumption proved to be false for a large number of taxpayers when their refunds came in lower than expected or turned into a tax bill. Don’t let this happen to you! Every year has it’s own set of changes and challenges that you should plan for well before tax time rolls around.
It’s too overwhelming. Tax planning is often as simple as looking for ways to reduce taxable income, delay a tax bill, increase tax deductions, and take advantage of all available tax credits. The best place to start is to bolster your level of tax knowledge by picking up the phone and asking for assistance.
Thankfully, it’s not too late to get on track for 2019. If you haven’t scheduled a tax-planning meeting, now is a great time to do so.
The IRS recently released its 2018 Data Book, including information on its audit activities for the last fiscal year. This details what you need to know regarding your audit risk, how to prepare for and what to expect in an IRS audit.
Know the facts
An IRS audit is a review to ensure your tax filings are reported correctly according to tax laws.
Both individual and business tax returns can be audited.
The IRS won’t initiate an audit by telephone.
IRS Audit Statistics
Tax returns filed in prior calendar year
Percentage of returns audited
Less than 1%
What are your chances of being audited?
It depends. But for most taxpayers, LOW.
Approximately 1 in 198 tax returns were audited in 2018.
The IRS audited 0.6% of all individual income tax returns filed in 2018, and 0.91% of corporation tax returns (excluding S corporations)
There are two types of audits:
Field audit: An in-person interview and review of records. It often happens at taxpayer’s home, business or accountant’s office.
Correspondence audit: A written request for more info about a specific tax return item or issue handled via mail.
Did you know? Approximately 2/3 of audits are handled through the mail.
Reasons you may be audited
Although the IRS uses random selection as one method to choose tax returns to audit, it may also flag returns because:
You’re in a higher income tax bracket.
You have math errors on your tax return.
You report no income or not all of your income.
Your tax return involves issues with other taxpayers whose returns are being audited.
Other reasons: reporting too many losses, deducting too many work expenses and claiming too many charitable contributions may also trigger an audit.
Always be prepared
Use your past tax return as a checklist of items to keep on hand:
A copy of your signed tax return and all supporting documents
Worksheets that support your return
Forms 1099 (all versions)
Business Forms K-1
Canceled checks of deducted items
Receipts supporting deducted items
Itemized deduction support
Child care receipts and reporting documents
Credit card statements
Major purchases or sales
Receipts for any charitable donations
Proof of fair market value for any inherited items
Mileage logs for business, charitable and medical transportation
Business meals and cellphone use documentation
FYI: Always use copies of records during an audit. Keep your original documents.
More ways to prepare: Check IRS.gov to review its Audit Techniques Guides (ATGs). They are used by IRS examiners and can identify areas for potential audits, as well as help you understand what the IRS may question.
What to do if you’re audited
Your tax return may never be audited. But if it happens, here are a few tips to make the process go more smoothly:
Respond to the IRS in a timely manner. If you don’t, an in-person meeting may happen.
Ask for help. NEVER tackle the IRS alone!
Know what is being asked. Get a clear understanding of the core questions.
Understand how the auditor has been trained. IRS auditors are trained in certain areas. These are published in the ATGs.
The bright side: If you are audited, you may end up with a refund. In FY 2018, approximately 30,000 audits resulted in refunds, totaling $6 million.
Sleuthing your way through a tax audit by yourself is not the same as fixing a leaky faucet or changing your oil. Here are reasons you should seek professional help as soon as you receive a letter from the IRS:
IRS auditors do this for a living — you don’t. Seasoned IRS agents have seen your situation many times and know the rules better than you. Even worse, they are under no obligation to teach you the rules. Just like a defendant needs the help of a lawyer in court, you need someone in your corner that knows your rights and understands the correct tax code to apply in correspondence with the IRS.
Insufficient records will cost you. When selected for an audit, the IRS will typically make a written request for specific documents they want to see. The list may include receipts, bills, legal documents, loan agreements and other records. If you are missing something from the list, things get dicey. It may be possible to reconstruct some of your records, but you might have to rely on a good explanation to avoid additional taxes plus a possible 20 percent negligence penalty.
Too much information can add audit risk. While most audits are limited in scope, the IRS agent has the authority to increase that scope based on what they find in their original analysis. That means that if they find a document or hear something you say that sounds suspicious, they can extend the audit to additional areas. Being prepared with the proper support and concise, smart answers to their questions is the best approach to limiting further audit risk.
Missing an audit deadline can lead to trouble. When you receive the original audit request, it will include a response deadline (typically 30 days). If you miss the deadline, the IRS will change your tax return using their interpretation of findings, not yours. This typically means assessing new taxes, interest and penalties. If you wish your point of view to be heard — get help right away to prepare a plan and manage the IRS deadlines.
Relying on an expert gives you peace of mind. Tax audits are never fun, but they don’t have to be pull-your-hair-out stressful. Together, we can map out a plan and take it step-by-step to ensure the best possible outcome. You’ll rest easy knowing your audit situation is being handled by someone with the proper expertise that also has your best interests in mind.