I Challenged The IRS And …..

Tax Taxes Government Refund Word Credit Re

Have you ever received a letter from the Internal Revenue Service (IRS) notifying you that you owe more in taxes than you paid? Have you ever been audited by the IRS challenging your tax return? If you have, it is possible the situation spelt doom for you. For the generality of people, a letter from the IRS evokes a panic attack. This is for good reason: the IRS has great powers and can chase you down anywhere you are and can even garnish your wages. Worse still, you can be prosecuted for tax fraud and put in jail if you conceal assets and income. Often the fear of the IRS is the beginning of tax wisdom in the US. Nobody wants to mess with the IRS. When confronted by the IRS, most people just give up and pay up. It’s that simple. Many don’t even want the hassle of challenging them, even if there is a possibility they can win.

One of the things I learned since being financially literate is to always report ALL my income. It’s not because I’m paranoid but because this is what the IRS expects you to do. The IRS explicitly states that “There is no minimum amount that a taxpayer may exclude from gross income.” Even though you’re not expected to get a 1099-MISC from a company if you make <$600, you are still required to report it when filing your taxes. I report incomes as low as $10 from surveys I do online. I feel that it pays to be rather safe than sorry. And your status in society does not matter with the IRS, they will come for you. Don’t believe me? Ask these celebrities convicted of tax evasion.

When I first came to this country, I was using a CPA to file my taxes. I knew next to nothing about taxes. Even the concept of filing my taxes every year was foreign to me. During tax time, I played a game of expectation to see how much refund my CPA would get me. It was as if the CPA was doing some magic to get back some money for me. And I would get some sizeable refunds. It felt good. But when I started educating myself in the world of personal finance, and discovered that I could actually file my own taxes myself, especially since I do not have a complicated tax situation, I wondered if I could get back as much money as my CPA used to get for me. However when I examined some of the old tax returns the CPA had prepared for me, I saw some errors and mistakes in them that I would not know how to explain if the IRS had audited me. By the way, even if you use a Tax Preparer or a CPA to file your taxes, you, the taxpayer is solely responsible for any errors or mistakes on your tax return, both accidental or deliberate. So I decided to start filing our joint tax return myself. My reasoning was if I get audited, I can defend myself well because I know and understand everything in the tax returns I filed myself. Well, it seemed as if I was clairvoyant because few months ago, I got a letter from the IRS.

Letter from IRS

So after a short trip in early June, 2018 we returned home and found waiting for us a letter from the IRS. In the letter, they were proposing changes to our 2016 Form 1040 tax return. In the summary of proposed changes, they stated that we owed $3,850 plus interest of $203 for a total of $4,053. This amount was said to be due by July 5, 2018.

Letter from IRS
IRS Notice

The letter was 9 pages long. My first reaction was that of panic. How did I get into IRS trouble like this despite all my effort to be accurate? I hated to have the IRS on my back. I felt maybe I should go get a tax lawyer? But then at what cost? Should I just save up money and pay them so I can be free? Different contrasting emotions rushed through my head as I went to bed that night and slept on this. I ruminated on it in my sleep. I have been filing our taxes for the previous 4 years and I was confident that we had paid all our taxes. When I woke up in the morning, I figured I should read the whole 9 pages of the IRS letter to see if I could get more clarity and figure out exactly where the discrepancy was. Sure enough, the IRS gave detailed explanation of the discrepancy, added some new math to our 2016 tax return and gave the proposed changes with the taxes due. The explanation of changes to our 2016 Form 1040 showed the IRS received some information from some third parties which does not match information reported on our tax return. Ok what could this information be? I read further. This appeared to be information from Vanguard Brokerage Services that reported our Backdoor Roth IRA contributions ($5,500 for each, or $11,000 total). Per IRS, they reported this information as taxable retirement income and as such we owed taxes on them. I went back to our safe (where I store all important documents) and looked at the 2016 tax return we filed. I believed everything was done correctly and all documentation was provided in our tax return. I filed the Form 8606 for me and my spouse for our Backdoor Roth contributions, as required by law. I felt this was an error on the part of the IRS. But then, how can I even begin to challenge the KGB IRS. Do I even have a recourse? Well, apparently I did. We all do, as taxpayers.

In that letter, the IRS had also provided me with a leaflet showing me the 10 Taxpayer Bill of Rights.

Taxpayer Bill of Rights

#4 of this Bill of Rights is The Right to Challenge the IRS’s position and Be Heard. It says that “Taxpayers have the right to raise objections and provide additional documentation in response to formal IRS actions or proposed actions, to expect that the IRS will consider their timely objections and documentation promptly and fairly, and to receive a response if the IRS does not agree with their position.”

My Response

Re-assured by the legality of the taxpayer bill of rights to challenge the IRS when you disagree with them, I set forth and crafted my response to them. Here is a part of that response:

Part of my hand-written response to IRS

“This statement is to notify you that I disagree with all the changes in that notice…” I went ahead and detailed the process of Backdoor Roth IRA contributions and how we did it and explained to them that this process did not trigger any taxes and as such was not a taxable event. I also explained that we correctly filed the supporting Form 8606 for each of us as is required when you do a Backdoor Roth contribution.

I then enclosed supporting documents to support my disagreement in their changes. These included:

  1. Form 1099-R from Vanguard (for both of us)
  2. Form 5498 from Vanguard (for both of us)
  3. Form 8606 filed in our 2016 tax return (for both of us)

I ended the letter by asking them not to hesitate to contact me if they needed further clarifications. I mailed this reply on June 11, 2018 by registered mail and tracked it to make sure it actually got to the IRS. It did. Within 3 days.

The Wait

In their initial letter, the IRS had warned me that while I have the right to disagree with them, and did not send the payment they requested, interests will accrue on the unpaid amount from the date the tax return was due (April 2017) until the tax is paid in full. The interest will be calculated at the rate of 5%. That would mean a couple more hundred dollars in addition to the current amount they claimed we owed. I was willing to take that risk.

It took another month before I got a response from the IRS. However it was not the response I was looking forward to. Their response, dated July 17, 2018, simply stated that they received my reply to their notice about proposed changes  to our tax return. They stated that before they can resolve this matter, they needed to process all of the information I provided and that they will send their complete response within 60 days.

Initial Response From IRS

They also included this caveat, “If you think you might owe additional tax, you should consider paying it now. The law requires us to charge interest on unpaid tax from the due date of the return to the date you pay the tax in full“. I was willing to take my chances. I simply waited. At 5% interest, I calculated that the total interest on the amount they stated that I owed will amount to close to $400 at the worst case scenario by the time they decided on my case. I expected a good outcome but prepared for the worst. I estimated I will have to shelve out $4,500 to send to the IRS if they denied my explanations. I started counting the days.

The Final Response from IRS

After what seemed an eternity, I got a letter from the IRS in the mail on September 18, 2018. My hands were shaking when I opened the mail. But my fears and trepidation vanished when I saw it was a single page short letter with a bold text at the top left stating: “Amount due: $0.00” Here is an except of their response:

Case Closed by the IRS

We’re pleased to tell you that the information you provided resolved the tax issue in question and that our inquiry is now closed.” I heaved a sigh of relief. It was all over. Thinking about it, this was a simple and straightforward issue and I shouldn’t have been worried that much from the get go. Besides, I filed our tax return and I understood all the details in it, so I could actually put up a challenge to the notice.

Closing Thoughts

This was a straight forward case. Sometimes it could be more complex than this. This was not an audit. An IRS audit is a review/examination of an organization’s or individual’s accounts and financial information to ensure information is reported correctly according to the tax laws and to verify the reported amount of tax is correct. An audit is usually more serious than a notice like this. However, an audit usually focuses on a particular area on your tax return. Even with an audit, you have the right to disagree with the IRS. Per this IRS publication, you have the right to representation by oneself, or an authorized representative and you also have a right to appeal disagreements, both within the IRS and before the tax courts. That publication also answers some basic questions about how you get selected to be audited, how you will be notified (the IRS will not contact you via email or telephone….beware of the IRS phone scams), how far back the IRS can go to audit your tax returns (typically returns filed in the last 3 years and usually they do not go back more than 6 years), how long an audit takes (variable depending on the type of audit and complexity of issues), your rights, what happens when you agree with the audit findings (if you owe money, then you pay up) and what happens when you disagree with the audit findings (you can request a conference with an IRS manager or you can file an appeal).

At the end of the day, the IRS is not the monster it’s made out to be. They are quite reasonable. And their process is transparent, at least by my own experience. There is no reason to be afraid of them, as long as you are diligent in reporting all your incomes and paying the taxes due. The reality is that even if a tax preparer had filed our taxes and I got this notice, I would still be responsible for the taxes due. If I was still naïve of the tax laws and did not have a basic understanding of taxes, I would have freaked out and hired a CPA or tax lawyer as a representative to deal with this IRS problem, thereby shelling out a few hundred dollars, if not thousands. Best case scenario? I would have been lily-livered and just ponied up the amount to send to the IRS so they would leave me alone.

Take home message? Get a basic understanding of personal finance and taxes. If possible, try and file your own taxes, if you don’t have a complicated tax situation (the vast majority of individuals do not!) When you file your taxes yourself, you will begin to understand how some deductions work on your final tax bill. It’s an educative process. And there are several tax filing online software. I personally use TurboTax. It’s one of the easiest tax software available and it will walk you through every single possible tax situation you may have. It’s so easy, a caveman can do it. If you’re so scared to do it yourself, you can prepare your taxes online using a tax software (but not actually file it), then print it out and take it to your tax preparer or CPA to scrutinize it for mistakes or lapses. If there isn’t much differences, you can subsequently file your taxes yourself.

So have you ever received a notice or been audited by the IRS? How did you handle it? Did you get representation to help you out? Comment below

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5 thoughts on “I Challenged The IRS And …..

  1. This is an important topic and we should all endeavor to file our taxes ourselves if we have an uncomplicated tax situation.

    I actually got a similar letter but it was due to undeclared gains from selling stocks and I paid. However you story is very encouraging that we can actually challenge the IRS when we are within the confines of the law and win.

    Thanks again for sharing

  2. what do you think about using the tax preparing applications like turbo tax, taxact etc?
    Although I have been preparing our taxes myself using this apps, I must confess that I just input figures.

    • You are doing ok. I use TurboTax myself. Filing your taxes is all about inputing figures. That’s basically what CPA or tax preparers do too. The software will ask you sundry questions that will help capture all your tax situations. If your tax situation is not too complex, you can comfortably do it with one of these softwares yourself

  3. Wow 😮 you actually challenged the KGB/IRS and won. Thats incredible and unheard of. Good job. Great article.

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