I cannot stress enough how important it is to make sure that all different types of income that you received in a year are reported on your 1040 tax filing.
Most entities that received income throughout the year will provide you with the correct income form, typically a W-2 or some form of a 1099. When these are sent to a taxpayer, they are also sent to the IRS. The IRS uses an automated computer program that matches this information to your tax return to ensure the income reported on these statements is also reported on your tax return. Unfortunately, if you do not report the income, the IRS will discover it 2 or 3 years later and then access the tax debt plus penalties and backdate the interest, possibly costing you thousands of dollars in addition to the tax debt that is owed.
This is why consulting a good tax professional is so important. A big part of their job is to go through your financial situation to determine all the income that should be reported so you don’t have to worry about being in that situation.
How Some People Get Into Tax Debt
We take on a lot of these types of cases where people fail, for many different reasons, to accurately report their income. The taxpayer may be a disorganized self-employed contractor receiving multiple 1099’s from different entities that he performed services for. Sometimes it’s a person who worked multiple W-2 jobs throughout the year.
Another situation that we see often is when somebody goes through a foreclosure or a short sale on their property. This is a horrible situation to go through and the last thing a person thinks about is the tax ramifications.
If a property is sold through foreclosure or a short sale and the proceeds do not completely satisfy the debt amount, then the financial institution has the right to report the cancellation of that portion of the debt to the IRS. The forgiven debt amount now becomes income for the taxpayer and must be reported on their tax return.
If the taxpayer omits this or other forms of income off of their tax return, they will surely receive an IRS Notice CP-2000 at some point where the IRS has reassessed their filing with that income added. This letter can appear to be a bill and many times even has a due date on it. However, in smaller print, it does state that it is not a bill but is still a proposed debt. If you do not agree with the debt, you do have the right to dispute the IRS assessment.
However, there are many different deductions and exclusions to income that may be able to be used to amend what the IRS is saying that you owe. If you are not sure what your rights are in this type of situation, it would be wise to contact either an Enrolled Agent or a CPA to advise you.
I have seen many of these types of cases over the years but one, in particular, comes to mind. For the client’s privacy, we will call him Mr. J.
A Decade of Tax Struggles
When this taxpayer initially contacted us, he had been having issues with the IRS for almost a decade. Over the years he had tried many different avenues to resolve his tax debt. He had hired a few different companies but they failed to help him achieve any sort of resolution. He had tried payment arrangements directly with the IRS but could never keep up with the high payments they required. At one point he had even begun the bankruptcy process but was unable to complete that as well.
He had used many different tax preparers to file his taxes throughout the years but the problems kept coming. On one occasion he received a letter from the IRS stating that he owed another $60,000 which essentially doubled what he had currently owed them. He didn’t understand how that was even possible.
We talked about a few different possibilities of where the debt could have come from and possible programs that may be a solution for him. I explained to him how we work, our process, and how we always start by gathering the facts.
After dealing with so many different tax relief companies with their sales pitches and false promises over the years, he loved our approach and appreciated our honesty. He hired us immediately to begin his tax investigation. A Tax Investigation is where our Enrolled Agents contact the IRS on a client’s behalf and they provide us with their tax records. Once we have that, we know everything that is going on. This part of the process only takes about 10 days to complete.
When and only when we have all of the facts is when we can lay out a strategy for a client. We were able to provide Mr. J with a good strategy to help him obtain an end date to his tax situation and into a program that he could afford with the IRS.
Results of the Tax Investigation
When we received his information from the IRS, his transcripts confirmed the story that he told us but more importantly filled in the blanks on the information that he did not know but was so very vital.
We found out that the recent notice that he received was a CP-2000 notice. This was for unreported income a few years back. The income that he had left off of his tax filing was a 1099-C from his bank after a foreclosure he had gone through.
It also appeared that this wasn’t the first time that he had received this type of notice. He owed the IRS for 4 other years as well, going back as far as 2008. Two of these years resulted in small tax debts due to a lack of withholdings and then there were two other years with fairly large tax debts. These particular years were from underreporting income just like the tax year he had just received the notice for.
Altogether, at this point he owed the IRS $120,000.
We took our time and educated him on what had been happening over the years and were able to show him everything with IRS documentation. By educating clients about their mistakes and by doing some future tax planning, we can set our clients up for success and prevent them from becoming repeat offenders as Mr. J had been for many years.
Mr. J was blown away just by this part of the process. He said that of all the different companies and attorneys he had hired over the years, nobody had ever done this for him. He felt that if he had this conversation with us 10 years ago, he could have avoided 10 years of IRS problems and tax debts.
His $120,000 Tax Debt Gets Cut in Half
As important as educating Mr. J was, the next step in the process was fixing the mess that had compounded over the years. The first thing that had to be done was deal with the recently discovered unreported income. This is where knowing tax law is very important.
When the IRS reassess a tax year due to unreported income, they do not give any deductions, credits, or exclusions that the taxpayer may qualify for. In this case, the income came from foreclosure on Mr. J’s primary residence. The Mortgage Forgiveness Debt Relief Act of 2007 provided an allowable exclusion to income which has been extended through many other acts and was available for the year in question. The provision allows taxpayers to exclude income from the discharge of debt on their principal residence. Up to $2 million of forgiven debt is eligible for exclusion for debt reduced through mortgage restructuring as well as the mortgage debt that is forgiven in connection with a foreclosure. So, in his case, by going back and amending this tax year and using this allowable exclusion, the $60,000 tax debt from this year was eliminated.
From Owing the IRS $60,000 to Only $3,000
The next part of the process would be to deal with the remaining older tax debt. Unfortunately, even if these types of exclusions or deductions are available on the older debts, you can only amend a tax return up to three years of the original filing date. In this situation, that wasn’t a big concern because the IRS programs that Mr. J qualified for were much more beneficial.
At this point, Mr. J was living off of retirement income and had almost no savings. His wife also had a very small social security distribution every month. They were truly living paycheck to paycheck. As I have mentioned many times in previous articles, a taxpayer does have the right to pay his or her allowable expenses before paying on a tax debt. By enforcing this right, we were able to get Mr. J into a program where he would only pay back approximately $3000 on the remaining $60,000 tax debt.
The last thing and most important thing that had to be done for Mr. J was future tax planning. Education is a huge part of our process. To keep the benefits we obtained for him and in order to remain in his payment program, he cannot accrue another tax debt and must file his taxes on time every year.
We instructed him how to change his withholdings so that he will no longer owe taxes every year. He decided that he would have us file his taxes correctly every year going forward. He knew from his experience with us that we will definitely scrutinize his financial situation every year to make sure that no further income is underreported.
As long as he does all of these things moving forward, Mr. J will end up saving close to $117,000.
If you have been struggling with a tax debt or other tax issues and have no idea what to do, contact us for a free, no-obligation tax consultation.
