Friday, May 29, 2009

IRS Penalties – A Financial Nightmare

IRS penalties can be a nightmare! Most people probably do not understand just how devastating penalties imposed by the IRS can be. For individuals the IRS applies two types of penalties. One is the failure to file penalty and the other is the failure to pay penalty. The failure to file penalty is 5% of the balance due as of April 15th and continues for 4½ months. The failure to pay penalty is approximately ½ of 1% per month and is applied to any unpaid balance until the total interest charge reached 25%. The failure to pay penalty can not exceed 25%. Now let’s see how this works out.

Suppose a taxpayer did not file a tax return for 2002, 2003 and 2004. Let’s further assume that the taxpayer owed approximately $5,000 for each of those years. The IRS will apply 5% per month for approximately 4½ months to each balance. So now each balance is approximately $6,125. Next they will apply approximately ½ of 1% per month to each balance. Seeing as how the returns are fairly old the total interest rate applied will be 25%. So now each balance would be $7,375. So this taxpayer would owe $22,125 instead of $15,000 that was originally owed. This taxpayer needs help and needs help quickly! This does not take into consideration the fact that interest is continuing to accumulate. A tax professional can offer good advice on how to handle this.

IRS – Removal of Penalties

The law permits the IRS to remove or reduce the penalties applied to a taxpayer's account if the taxpayer can submit a written explanation with an acceptable reason as to why the IRS should remove or reduce the penalties. Once submitted the IRS will review the documentation and will contact the taxpayer to notify them of their decision. It is important to note that the law does not permit the IRS to remove or reduce penalties. There may be instances where the IRS will require the taxpayer to pay the tax in full before removing or reducing the penalties.

IRS notice 746 contains a wealth of information regarding your notice, penalties and interest. The reduction or removal of penalties can be a difficult task to get the IRS to agree to due to the way the IRS rules are written. First the taxpayer has to submit to an IRS interview called the Penalty Abatement Reasonable Cause interview. The questions are detailed and they are tough, but if enough documentation can be provided to convince the IRS drop the penalties then it is well worth it. A great place to start would be with Notice 746 which gives an excellent explanation of things. This can help a taxpayer decide whether or not they need to involve the services of a tax professional to help with penalties (but not interest).

Friday, May 22, 2009

Underreporting Income

I wonder how many people know what happens when they under report their income to the IRS. When this happens it can cause a rather serious situation to arise. When a taxpayer sends a tax return to the IRS the first thing the IRS does is perform a computerized “tax match.” This is an automated system that matches the income reported on a tax return to the report the IRS maintains on each and every taxpayer of what has been reported that the taxpayer has earned.

If the income does not match the system will flag the return for further review. If the taxpayer has overstated their income then the IRS will issue a refund. If the income has been under reported then the taxpayer will receive a notice called a CP 2000. This requires the taxpayer to respond accordingly. There are many things that can cause a taxpayer to under report their income mistakenly, usually a simple oversight.
Then again there are other times that the under reporting is not due to an oversight but just blatant negligence. The IRS takes under reporting serious. If you have received a CP 2000 you have got some explaining to do. You may need the assistance of a tax professional to keep you out of trouble.

IRS Tax Problems

IRS tax problems can happen at any time throughout the year. The problems can stem from many different issues such as under withholding, under reporting of income or sometimes more serious violations such as unfiled returns. Any time you have a problem with the IRS it is a serious and most always requires attention.
The best advise to give when dealing with the IRS over a tax related problem would be to communicate with them! A lack of communication with the IRS is almost always guaranteed to get them a little hot under the collar and could jeopardize the final outcome of things. Some people are comfortable with speaking with the IRS and others are not. If you fall into the latter category and you have a tax problem I would encourage you to see professional tax advice. Don’t let silence be your downfall!

Friday, May 15, 2009

IRS Certified Mail – Your Last Chance

In my previous blog I compared certified mail from the IRS to a rattlesnake getting ready to bite. The IRS is getting ready to “bite” you when they send you a CP 504 letter. If you receive another piece of certified mail with “L1058” written on it then you know this is your last chance. If you do not respond to this letter you will get bit! Lions, snakes, dogs or anything with fangs are usually considered dangerous because of the damage a bite can do. The IRS is no different.

Their “bite” will not draw blood nor force you to seek immediate medical attention, but it will cause you equivalent pain financially. If this L1058 letter is not addressed immediately and effectively the financial effects can be dramatic. The IRS can attack all of the taxpayer’s sources of income, bank accounts as well as file a notice of federal tax lien against the taxpayer’s social security number thus laying claim to all property the taxpayer owns currently and any property the taxpayer may own in the future, not to mention the devastating effect the tax lien will have on the taxpayer’s credit score and subsequent ability to borrow money.

After income has been reduced and the ability borrow cut off this usually produces excruciating financial pain and can very difficult to correct. The best bet is to address the situation quickly before it becomes a problem. Lions, snakes, dogs or anything with fangs are best kept at a safe distance and preferably in a cage or somewhere else that would prevent a bite. Responding quickly to an L1058 letter from the IRS is the best way to avoid getting bitten by the razor sharp fangs of the IRS. Certified mail of this nature is best handled by a tax professional. Protect yourself! If you have received a letter like this call someone now and do not delay!

IRS Certified Mail - It's Serious!

Certified mail from the Internal Revenue Service is serious and should be treated the same way you would treat a rattlesnake that’s about ready to strike. The IRS is issuing the taxpayer a warning that they are going to strike. Coming from the IRS the threat is real and it must be addressed quickly. Usually the first certified letter a taxpayer will receive from the IRS will be a CP 504. This is an initial notice the IRS will send out notifying a taxpayer they are intending to take action to collect on an outstanding tax account.

In many instances when a taxpayer owes a tax debt and it has progressed to the point where the IRS is sending this type of notification the taxpayer usually does not have the funds necessary to pay the tax debt in full. It is for this very reason that the taxpayer must take immediate action on the letter and get help because the IRS is getting ready to strike. The first place the IRS strikes is the taxpayer’s rear end, specifically their wallet. The IRS will issue a wage levy against the taxpayer’s paycheck taking up to 85% of the taxpayer’s salary!

Most taxpayers, not all, financial affairs are much like dominos delicately arranged on a table. If one domino falls it could cause some of the others to fall. When the IRS issues a wage levy it is just like knocking over the very first domino in a string of dominos causing all the others to fall, one right after the other. When a taxpayer’s income is drastically reduced it usually causes other financial problems to occur immediately. If you have received a CP 504 take action! Get help immediately! A tax professional can be an invaluable resource when dealing with this type of situation.

Friday, May 8, 2009

Mortgage Debt Forgiveness

Under the current tax law a taxpayer can exclude from gross income any discharge of qualified principal residence indebtedness (see page 104 of IRS Publication 17). The exclusion applies to discharges after 2006 and before 2013. One stipulation is that the basis of the principal residence (the main home) must be reduced (but not below zero) by the amount excluded from gross income.

This represents a significant degree of help for someone who has lost their home due to the recent and ongoing economic turmoil in our country. Prior to the introduction of this law a lender who discharged a mortgage debt would send the homeowner a 1099-C, Cancellation of Debt form, in the amount of debt charged off. The taxpayer would then have to claim this as income and would have to pay taxes on it!

The law is very tricky however. There are many instances where a discharged mortgage debt can be charged to the homeowner as income, such as a second home, investment property, etc. Therefore if confronted with a 1099-C, Cancellation of Debt notice it would be wise to have this reviewed by a tax professional.

Reporting Income

When preparing income tax returns, reporting income is very important. One reason is that the IRS will perform a “tax match” once they receive your return. The IRS will “match” the income listed on the return to the income they have on file that has been reported that you have earned.

Reporting income falls under the category of Accounting Methods and can be read in detail in IRS Publication 17. There are two methods of accounting, cash and accrual. Constructive receipt, garnisheed wages, debts paid for you, payment to a third party payment to an agent and checks received or available to you are cash methods of accounting. Income paid in advance would fall under the accrual method.

Knowing and understanding what constitutes “income” for reporting purposes is very important. Mistakes in this areas can be costly. If, when the IRS performs their tax match, they determine a taxpayer has underreported their income this triggers an investigation and the IRS will send the taxpayer a CP 2000, underreporting of income letter. If a taxpayer is sent this letter it would be wise to get a tax professional involved. The tax return must be amended and re-submitted to the IRS and then managed thru the process to avoid having the return rejected.

Friday, May 1, 2009

Why Do I Owe Taxes To The IRS?

At times I have had to be the bearer of bad news. I have had situations where a spouse will call and tell me they have received notification from the IRS stating they owe a large sum of money and they ask the question, “Why do I owe taxes to the IRS?” The question this because they are being charged with a tax liability for years they didn’t even work.

Often times this is a situation where one spouse has worked for several years and has not filed income tax returns for several of those years. The other spouse, the one calling me, has not worked at all and has somehow been kept in the dark about their tax filings. What happens usually happens is that something prompts them to file their returns. Once the returns are filed, and here’s the important part, Married Filing Jointly, the total liability is automatically assigned to each spouse equally.

Unfortunately this tax filing sleight of hand occurs just before the unscrupulous files for divorce leaving the other spouse equally liable. Once the returns are filed and the liability is assessed the trap door slams shut and the collection process begins. This is one way a taxpayer may wind up owing taxes and not fully understand why they owe. Taxpayers in this situation can benefit from professional tax resolution.

Self Employment Taxes

Seldom a week goes by where I don’t speak with someone who is self employed, is great at doing what they do, but have a tax problem that is putting the business in serious jeopardy. As the conversation unfolds it becomes clear that the lack of knowledge of how to pay taxes as a self employed person as well as a proper record keeping system lies at the root of the problem.

In its most simplified for the self employed person is the only person working for the business. In the more complicated situations the self employed person has or did have employees who were paid in cash and were not issued 1099s. Sometimes the tax liability comes about as a matter of improper withholding. Other situations are due to simply not filing the tax returns.

In either event as time rolls on the IRS eventually catches up with them and the day of reckoning arrives like a very unwelcome guest that is here to stay and is not going away. Once this happens the self employed person is forced to deal with the issue head on. Sometimes things can be worked out with the IRS and the business can continue operations. There are also times when this is not possible and the business is forced to close. Every case is unique. My strong recommendation to anyone facing such a situation would be to get a professional involved. This can and usually does make a world of difference for the better.