Apr

9

Got an Audit from the IRS

April 9, 2007 |

And I must say, it is not as painful as it sounds. They did sent a letter requesting more than $28,000 in taxes, interests, and penalties, calculated in a very liberal way. It almost killed my wife out of a heart attack. I took it calmer, even when I didn’t have the letter in front of me while she was reading it via telephone. I knew that any error that I might have made must have been for less than the $28,000 IRS claim. To miss such amount of taxes would have meant that I forgot of at least $100,000 of income: something easy to miss for Bill Gates, but not for me. I also knew I had very detailed records to prepare a good defense. The letter sounded more like a “shoot first, ask questions later” strategy, but did allowed for rejecting the IRS claim and stating my own side of the story, which I did.It is interesting that the IRS almost always receives partial information. And when they calculate taxes to be paid to them, they choose the situation that favors them most. This is especially true with Capital Gains (what results from the sale of an asset). I had sold some assets during 2005, three items to be exact. Two of them resulted in zero capital gain. They where sold for the same amount as the cost basis, but they assumed that I have had the full proceeds of sale as capital gains. Had I just assumed them to be right, I would have been $26,000 poorer.

One of the three items they where right on the fact I had accidentally omitted it, but wrong on the calculated tax. It was a sale of an asset where there where some gains, but less than the full sale price. My real tax liability was around $2,000.

My response included providing plenty of documentation/proof for the asset sale and cost basis calculations, together with a very brief letter stating the facts. (Extremely brief, you can never trust a hungry tax officer with your words). I attached a check with what I believe is my tax liability. I will now sit and wait for a reply (assuming I get one) with any corrections they may want to do (they may want to ask for a few more dollars for Alternative Minimum Tax, and if they are in the mood for, penalties and interests). I also have to amend my state tax return.

I think I should now get used to tax audits. My income is above certain threshold that makes tax officers blood thirsty. Given my current situation, I may as well start getting used to the idea I am also a lawsuit target — and that is the reason I have umbrella insurance.

Lessons Learned:

  • Even if I assume that there is no tax liability for an asset sale, explicitly write on the Schedule D the cost basis, proceeds, and $0 as the gain. It also helps avoid accidentally missing a taxable item: like it happened to me. It also reduces the interest from tax officers in auditing the return.
  • Keeping very good records is crucial. Don’t trust brokerage accounts to keep records for you. They may go bankrupt or simply age out old records. Best place is scanned, saved, and many backups in multiple places (for example: one at home and one at safe deposit box or mother’s home).
  • File electronically: in the likely event that there is an audit, they may revise it sooner and I may save some interests.

Comments

4 Comments so far

  1. Flexo on April 10, 2007 1:14 am

    Sounds like you kept a cool head through the ordeal. That is something I hope I don’t have to go through.

  2. Jason on April 24, 2007 9:02 am

    I just got a letter yesterday and it was much the same scenario. Letter said I owed over $20,000 in tax, penalty, and interest. Looks like I’ll really owe more like $1,600. ‘05 was the first year I had any capital gains to worry about and I totally muffed my tax return. On top of that, E-trade apparently sent the IRS a 1099-B for a same-day stock option exercise and sale, which was included in my W-2. So the IRS had me down for $35,000 in income (zero cost basis) just from that. I about had a heart attack at first.

  3. ge on June 26, 2007 9:17 pm

    I just got the same thing and my heart nearly stopped. I do not owe anything else though. I am debating whether to use an account to clear this mess up on the first try or not. Did you hear back from the IRS and did your letter with documentation suffice?

  4. johnny lee buggs on July 25, 2007 9:43 am

    In 2004 i reported my refund cheak lost or stolen.The irs sent me a new check wich i reseaved.Now there holding me acoutable for the check becouse it was cashed.I was not the person who cash that check and should have not had to pay that back.I sent in the forms they sent me to prove my that it was not me,and in 2006 they toke my tax refund.i feel that they toke away my rights as a citazin.I think that this should be thought over again.12,00 dollers is a lot of money for someone just to take it from you.I feel like i was robed twise. from johnny lee buggs

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