Mortgage income deductions, pass-through income, basis calculations of tanked investments. The IRS can goof in these areas and more with wealthy clients’ taxes, advisors say.
“Because of budget issues or lack of knowledge of the area of tax law, IRS staff and agents can sometimes make mistakes,” said Brian Stoner, a CPA in Burbank, Calif. “A lot of errors tend to happen in more complicated investment strategies and a huge volume of financial transactions [and] large, multiple, like-kind exchanges.”
Common IRS errors include those involving filing, failing to document a requested extension of time to file, confusing a taxpayer with a taxpayer’s relative or the agency losing a physical return and refund. An IRS agent also reportedly showed up at a Florida office recently because of only a clerical error.
Sometimes the IRS fails to adhere to its own recent changes, as in the case recently spotlighted by the National Taxpayer Advocate when the IRS sent collection notices to taxpayers in one region before the extended filing deadline that the agency had previously set.
Lawrence Pon, a CPA in Redwood City, Calif., has seen the IRS makes mistakes when taxpayer try to take advantage of a qualified charitable distribution. A QCD, a direct distribution from a traditional IRA of up to $100,000 to charity if a taxpayer is older than 70 years and six months, is not a taxable distribution and fulfills the obligation for required minimum distributions from a retirement account.
Pon said that the format of the 1040 tax return can be inadequate to account for QCDs. He added that one IRS document prone to error is the CP2000, generated when the IRS receives information from Form 1099s that the tax agency doesn’t see reported on the Form 1040 tax return.
“Many clients don’t want to confront the IRS and just pay the bill,” he said. “Many times, these notices are incorrect.”
Faced with what appears to be an IRS mistake, don’t always pay immediately and don’t panic, advisors say. Assemble details and documentation and contact the IRS office that sent the correspondence. they said, adding that people whould beware of notices that don’t come by snail mail.
“Many people get that CP2000 saying that the IRS has unreported income for them and that they owe $2,000 in taxes. The IRS lists that health savings account distribution a taxpayer failed to mention and the sale of a security that netted $5,000,” said Morris Armstrong, enrolled agent and RIA at Armstrong Financial Strategies in Cheshire, Conn.
The agency will not necessarily follow up to get all important details, he said. “The IRS would never ask what the HSA money was spent on ... in all likelihood a medically related … zero distribution. The IRS may not be aware that the $5,000 is all that’s left from the taxpayer’s purchase of a BlackBerry that cost $20,000.
“Taxpayers may be naive if they simply rely on an IRS notice as correct,” he added.
Use respect when questioning an IRS position, said Gail Rosen, a CPA in Martinsville, N.J., who once handled a federal audit letter about a client’s mortgage interest deduction, which her firm had calculated correctly with the client’s return. “The IRS did acknowledge that we calculated the allowed interest correctly—once we answered the notice,” Rosen said.
“Talk to the IRS agent involved and walk them through the entire set of transactions,” Stoner said. “If it’s a complex issue, [often] an agent will be glad for the help ... which can a lot of times resolve the issue.”
“The ‘IRS’ are people, and the best way to deal with them is the same way that you’d like to be treated,” Armstrong said.
He added that the agency also has overseers like the U.S. Treasury Inspector General for Tax Administration and various legal enforcement and appeals levels, some of them above the IRS.
“Move up the ladder,” Armstrong said, advising taxpayers to make sure any verbal response from the agency is followed up with written confirmation.
“The IRS makes errors,” he said. “Otherwise, why would we have a federal Tax Court?”