What To Do if You Receive an IRS Notice by Carolyn Flaherty

Accounting news has been reporting an increase in audits of high income taxpayers. In fact, I have personally seen an increase in the number of IRS notices that my clients have been receiving. If you receive an IRS Notice the most important thing to remember is DO NOT PANIC.

As was illustrated in last weeks’ blog, there are many reasons why you could be receiving a notice that do not include an actual deficiency. As the IRS becomes increasingly automated, the number of erroneous notices also increase. For example, last week a client received a notice claiming that retirement income of $3,349 was not included on their return. In fact, the $3,349 was a direct rollover that WAS reported on the return in a “rounded” amount of $3,350. Although a human being looking at the return would have matched the income up properly, the automated systems did not.

After you’ve slowed your heart rate and avoided the initial shock of receiving a notice, read the entire notice with particular attention to the stated deficiency and the due date of your response. Occasionally a taxpayer misplaces a tax form or receives it after their return is prepared and therefore there is indeed income missing from their tax return. Again, do not panic. In this case, you may owe additional taxes, but an honest mistake will not get you thrown into tax court or jail!

Also note that the IRS does not correspond via e-mail. Identity thefts frequently attempt to obtain personal information by posing as the IRS. Do not respond to e-mail that appear to be from the IRS.

Contact your tax advisor. I have a client that for years, upon receiving a notice would simply pay the amount shown; until the day he received a notice that claimed a $10,000 amount due. That day he came directly to my office, and in fact the notice was erroneous and there was no amount due. He was very glad he came to us. For years his feeling was that he didn’t want to “mess with the IRS.” However, you should not simply pay without understanding the notice. Therefore, contact your advisor so that they can review your return and properly advise you.

React promptly. As humans when we are intimidated by a situation or overwhelmed by it; we tend to put off action. Instead, take notice of the date your response is due and promptly contact an advisor.

Draft a letter of Response. Whether your tax position or the IRS position is correct; a letter of response should be drafted. Your advisor will typically draft the letter for you, but you will need to review and sign the letter. The letter should include a reference to the Notice number, an explanation of why you agree or disagree with the IRS findings, your conclusion, and a list of enclosed documents.

Be crystal clear. Include all documents that support your position even if the IRS should already have copies of the information. Using the example of the IRS asserting that retirement income was not reported: I would include a copy of the Form 1099R and a copy of Page 1 of the Form 1040. In the letter I would reference the specific line item on page 1 that the income is reported on. A sample letter is included at the end of this blog.

Consider requesting an abatement of penalties. If you find that the IRS position is correct, you will be required to pay the deficiency and interest due. However, if the deficiency is due to an honest error, you may explain the error and request abatement of the penalties. My experience has shown the IRS to be responsive to such requests. A sample request is included at the end of this blog.

Fill out the response form. The IRS provides a response form to fill out. If you have questions, your advisor can assist you. The form must be completed in full and signed by you.

Assemble your package. Before the due date of your response, gather (1) Your response letter (2) the IRS response form (3) the source documents that support your position. If you have determined that you owe a payment, the payment should also be included. The IRS provides addressed envelopes for your response. Mail the package certified mail, return receipt requested.

Unfortunately, IRS notices are becoming increasingly common. Therefore, take a deep breath and follow these above steps should it become necessary.

SAMPLE RESPONSE LETTER:

John Smith
Taxpayer Way
Boston, MA 00000
January 19, 2012


Department of Treasury
Internal Revenue Service
Ref. Notice # XX0000 dated January 3, 2012
Form 1040 Tax Year 2010

To whom it may concern:

Notice XX0000 dated January 3, 2012 identified $3,349 of retirement income from Local Bank Co. as not being included on the 2010 Form 1040. As shown in the copy of Page One of 2010 Form 1040 enclosed, Line 15a reflects a $3,350 IRA distribution which represents the Local Bank Co. income as appropriate. The IRA distribution was a direct rollover as reflected on the Form 1099-R as a Box 7 Code G “direct rollover,” (1099-R also enclosed). Therefore, there should be no adjustment to the 2010 tax return.

Also enclosed for your reference is the signed Response Form.

Thank you,
John Smith

SAMPLE WITH REQUEST TO ABATE PENALTIES:

John Smith
Taxpayer Way
Boston, MA 00000
January 19, 2012


Department of Treasury
Internal Revenue Service
Ref. Notice # XX0000 dated January 3, 2012
Form 1040 Tax Year 2010

To whom it may concern:

We agree with the changes made in Notice XXX0000 dated January 3, 2012. Although we are not in possession of the 1099 in question we did receive interest income from Local Bank Co. during the tax year. Therefore we concede that the additional tax is properly due. We feel that it is likely a result of the relocation of our primary residence during the 2010 tax year that the 1099 was misplaced or never received and therefore not provided to our tax preparer. As such, we respectfully request that the penalty of $100 be abated.

Enclosed is payment of $1000 which represents payment in full of the additional tax levied and the associated interest. We have also enclosed the signed Response Form.

Thank you.
John Smith

THE IRS IS NOT ADEQUATELY FUNDED TO SERVE TAXPAYERS AND COLLECT TAXES posted by Carolyn Flaherty

As a subscriber to the IRS newswire, I receive bulletins and updates regularly. I thought this one was worth sharing with our followers because as members of the industry we have seen signs of all of these trends. That Congress is being made aware of these issues hopefully indicates that progress is forthcoming. Below are excerpts from Issue Number: IR-2012-6.

Workload Overload. The sharp increase in the IRS’s workload is due to several factors, including the increasing complexity of the tax code and the code’s frequent changes, the need to provide service to an increasingly diverse taxpayer population, the IRS’s increasing responsibility for administering economic and social policies, a surge in refund fraud and tax-related identity theft, and the implementation of new third-party information reporting requirements.

There were approximately 4,430 changes to the tax code from 2001 through 2010, an average of more than one a day, including an estimated 579 changes in 2010 alone. The IRS must explain each new provision to taxpayers, write computer code so it can process returns affected by the provision, and train its auditors to identify improper claims.

In addition, the report says, an expansion of refundable credits in recent years – including the First-Time Homebuyer Credit, the Making Work Pay credit, the American Opportunity tax credit, the health care premium tax credit, the adoption tax credit, and the Additional Child Tax Credit – has helped spawn an increase in illegal activity.... In 2011, the IRS’s Electronic Fraud Detection System (EFDS) flagged 1,054,704 returns on suspicion of fraud, an increase of 72 percent over 2010. Meanwhile, the IRS’s centralized Identity Protection Specialized Unit (IPSU) received more than 226,000 identity theft-related cases, an increase of 20 percent over 2010.

Shortcut Taxpayer Rights: “Non-Audits,” IRS Math Errors, Lack of Notice, and Delays. To keep up with its rising workload, the IRS is increasingly relying on automated data-matching procedures to identify potentially inaccurate claims and adjust tax liabilities. However, automated processes are inherently imperfect, so the taxpayer’s return position often turns out to be correct.

In addition 78% percent of IRS Audits were completed by correspondence in a highly automated campus setting where no single IRS employee was responsible for the audit, making it more difficult for the taxpayer to communicate with the IRS about his or her case.


Substantial Delays to Receive Large Refunds. Among taxpayers who sought assistance from TAS after their refunds were withheld on a suspicion of fraud, 75 percent received relief. These taxpayers had to wait an average of nearly six months overall to receive their refunds. The average refund amount was $5,600, a significant sum for most households. Thus, these delays can create significant financial hardships.

Taxpayer Service Concerns: Delays and Non-Responses to Taxpayer Inquiries. Two key indicators of taxpayer service are the IRS’s ability to answer taxpayer telephone calls and the IRS’s ability to respond to taxpayer correspondence. From FY 2004 to FY 2011, the percentage of calls that the IRS answered from taxpayers seeking to speak with a telephone assistor dropped from 87 percent to 70 percent.

Over the same period, the IRS’s ability to timely process taxpayer correspondence also declined. Comparing the final week of FY 2004 with the final week of FY 2011, the backlog of correspondence in the tax adjustments inventory jumped by 158 percent (from 357,151 to 920,768), and the percentage of correspondence in this inventory classified as “over-age” (i.e., 45 days or older, with issues that have not been resolved) increased by 309 percent (from 11.5 percent to 47.0 percent of correspondence).

To read this issue in it's entirety visit www.irs.gov.
Related Items:
•Executive Summary: 2011 Annual Report to Congress
•Complete Report: 2011 Annual Report to Congress

What to do if your business systems have been hacked - Adapted by Carolyn Flaherty

The December 2011 edition of The PPC Accounting and Auditing Update published a list of guidelines to follow if your business is hacked. The following list is based on that publication:

Don’t turn off the Internet connection or detach the affected computer from your network as doing so can erase evidence that will help investigators to determine what information was stolen and where the information was sent.

Contact both local law enforcement and a forensic investigations company. Experts should be employed to find the software used to hack your system and determine what type of information the program was trying to steal from your systems.

Let professionals assess the extent of the breach. Do not assume that because the infected computer has been cleaned up or removed that the attack is over. Assess all computers and systems to ensure that the breach has not spread.

Document your reaction to the breach and record every time someone has access to a compromised computer or server. Proper response to a security breach is essential for your legal protection.

Forty-six states have passed laws regarding reporting requirements when there is a potential that records have been exposed to a possible data breach. In addition, the federal Department of Health and Human Services has their own such reporting requirements. Therefore, you must determine whether or not your breach warrants disclosure to your customers and employees and if so, what information you are required to disclose.

Bonus Depreciation and Section 179 Depreciation 
by John Ratcliffe

If you are considering investing in business property in the next few months you may want to consider making the investment before the end of 2011. Depending upon whether the asset is new or used you could benefit from either the bonus depreciation rules or Section 179. If you are buying a new asset you should look to see if bonus depreciation is more beneficial than section 179 depreciation. If the asset you are purchasing is used then you can only benefit from the section 179 rule as bonus depreciation does not apply to used business property purchases. Regardless of the depreciation method you use the asset must be “placed in service” before you can depreciate it. This means that if the asset requires any installation or construction you cannot depreciate the asset until it is functional for use.

There is a 100% write-off in the placed-in-service year for the cost of property eligible for bonus depreciation under Code Sec. 168(k). This applies for property acquired and placed in service after Sept. 8, 2010, and before Jan. 1, 2012. There is a 50% bonus first-year depreciation allowance under Code Sec. 169(k) for property placed in service after Dec. 31, 2011, and before Jan. 1, 2013.

The Small Business Jobs Act of 2010 and Section 179 Deduction
A qualifying taxpayer can choose to treat the cost of certain property as an expense and deduct it in the year the property is placed in service instead of depreciating it over several years. This property is frequently referred to as section 179 property.

The Small Business Jobs Act increases the IRC section 179 limitations on expensing of depreciable business assets and expands the definition of qualified property to include certain real property for the 2010 and 2011 tax years.

Under Small Business Jobs Act, qualifying businesses can now expense up to $500,000 of section 179 property for tax years beginning in 2010 and 2011. Without the Small Business Jobs Act, the expensing limit for section 179 property would have been $250,000 for 2010 and $25,000 for 2011.

The $500,000 amount provided under the new law is reduced, but not below zero, if the cost of all section 179 property placed in service by the taxpayer during the tax year exceeds $2,000,000.

The definition of qualified section 179 property will include qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property for tax years beginning in 2010 and 2011.

Depreciation limits on business vehicles:
The total depreciation deduction (including the section 179 expense deduction) you can take for a passenger automobile (that is not a truck or a van) that you use in your business and first placed in service in 2010 is increased to $3,060. The maximum deduction you can take for a truck or van you use in your business and first placed in service in 2010 is increased to $3,160. (Note: with bonus depreciation for a new vehicle, the dollar cap becomes $11,060 for autos and $11,160 for trucks or vans). A word of caution: These limits are reduced if the business use of the vehicle is less than 100%.

In conclusion if you are considering a purchase of business property please seek advice from your tax advisor on how you could benefit by accelerating your depreciation deduction.

Tax Planning with Like Kind Exchanges by Karla Hopkins

A like-kind exchange provides a tax advantaged alternative to selling property. The sale of property may cause you to recognize a gain, which in turn may require the payment of taxes. A like-kind exchange, on the other hand, allows you to avoid gain recognition through the exchange of like-kind properties. The gain on the exchange of like-kind property is effectively deferred until you dispose of the property you receive. The IRS allows this tax-deferred transaction because it recognizes that just because you have exchanged one property for another, you should not have to incur taxable gains. Moreover, the deferral encourages re-investment and acknowledges that if you have re-invested your proceeds you may lack actual funds to pay tax on the sale of the original property. You will, however, have to recognize gain on any money or unlike property that you receive in the exchange.

Only qualifying property may receive like-kind treatment. To qualify, both the property you give up and the property you receive must be held by you for investment or for use in your trade or business. Buildings, rental houses, land, trucks, and machinery are examples of property that may qualify.

Like-kind exchanges provide a valuable tax planning opportunity if:

• You wish to avoid recognizing taxable gain on the sale of property that you will replace with like-kind property;
• You wish to diversify your real estate portfolio without tax consequence by acquiring different types of properties;
• You wish to participate in a very useful estate planning technique, or
• You would generate an alternative minimum tax liability upon recognition of a large capital gain in a situation where the gain would not otherwise be taxed.

The like-kind exchanges rules are very specific and very complex in terms of timing for identifying the property, completing the transaction and the handling of the proceeds for the transaction. Using a professional that is familiar with the like-kind exchange rules is important to ensure that the transaction is not disqualified and you are surprised by a tax consequence that you were not anticipating.

Education Tax Credits Available in 2011 by Karla Hopkins

The Federal form 1098-T is used to provide college students and their parents with information for claiming education benefits on their tax return. The form may include the amount of payments received OR the amount billed to the student. Remember though, the education credits are only for the amounts PAID during the year not the amount that was billed to you and remains unpaid at the end of the year. Your financial records such as canceled checks or credit card receipts are the official supporting documentation for calculating your education credit.

There are currently two education credits. The first is called the American Opportunity Tax Credit. The value of the credit is the first $2,000 plus 25% of the next $2,000 (maximum value $2,500) paid for each student for qualified expenses. To claim this credit the student must be in the first four years of post secondary eligible institution. They must be at least a half time student, and be enrolled in a program that leads to a degree or certificate. Qualified expenses include tuition, course materials, supplies and equipment. Qualified expenses DO NOT include room and board or athletic fees.

The second credit is called the Lifetime Learning Credit. The maximum lifetime learning credit is $2,000. Unlike the American Opportunity Tax Credit, this credit is available to students enrolled in one or more courses leading to an undergraduate, graduate or certification credential or if the course is to acquire or improve job skills.

In both cases, tuition and education expenses paid for with education or other types of loans are eligible for the tax credit.

One area of the educating tax credit laws that often reduces or eliminates the benefit of the education credit is when a divorced or separated couple shares the dependency deduction of the student on a year by year basis. One of the requirements for the credit is that it is allowed for a taxpayer, spouse or a DEPENDENT claimed on a tax return. Many times, a divorce decree controls the dependency deduction between couples without considering the implications to the benefit of education credits. Generally, the tax credit is most beneficial to the individual in the highest income tax rate. When a couple is electing to file a "married filing separate" return, NO credit is available on either return. Given the high costs of education today, it is important to consider the education tax credits in your tax planning and tax filing elections.

Documenting Loans from Corporations to their Shareholders by Karla Hopkins

In a recent tax court decision, the courts again ruled that a loan made to a shareholder by a corporation was a taxable distribution to the shareholder and not a loan. We are thus reminded that it is always important for proper documentation to support all transactions between corporations and their shareholders.

In this case, the shareholder was an employee and the sole shareholder. He was also the president and director. While there was a loan agreement, it was not signed until six months after its creation. Moreover, even though the note provided for a market rate of interest, interest was not actually charged at the market rate. In addition, the taxpayer did not make any principle payments on the note.

The Court considered the following factors in reviewing the validity of the loan transaction:

• Is the promise to repay evidenced in the note?
• Is interest charged?
• Is a fixed repayment schedule established?
• Is there any collateral?
• Were repayments made?
• Does the borrower have a reasonable prospect of repaying the loan?
• Did both parties conduct themselves as if the transaction was a loan?

This case points out the importance of the details in a loan transaction especially when it involves related parties. In the case of a loan between a corporation and a shareholder, failure to follow the terms and provisions of the loan will likely result in the loan being treated as a taxable distribution. This is even more likely to be true when there is no written agreement or evidence of a transaction at all. It may not be enough to just have a loan document, following the provisions of the document are key to the transactions too.