Anybody can make a mistake, and that includes the IRS. Taxpayers may receive notices with an incorrect tax liability, so you must know how to file the appropriate dispute.
In this article:
- Understand What Is Tax Liability
- Know How to Calculate Tax Liability
- Become Familiar About the IRS Dispute System
Incorrect Tax Liability: How It Happens and What a Taxpayer Can Do About It
Understand What Is Tax Liability
Simply put, an individual’s tax liability is what they owe to the IRS as taxes. However, the process can be more complex as many regulations and schedules affect tax reporting and calculation.
Complexities in the tax processes and calculations affect not just taxpayers, but also the IRS. For the tax year 2014 as reported in 2015, the IRS actually sent 1.6 million notices that there were computation errors on the part of the IRS, from 155 million tax returns filed.
While that 1% margin of error for IRS calculations may seem small, the unreported or unacknowledged errors cause taxpayers more worry and expenses. This added mental burden arises from many avoidable causes like:
- The IRS having outdated information, like having the same salary, old civil status, lack of tax-deductible dependents and other important information.
- Notice sent incorrectly. This situation became more common since some taxpayers have older mailing addresses and have since changed residences.
- Taxpayers having the same name, both first and last names. For example, a son who inherited the state, as well as taxes, of his deceased father and residing in the family home may be surprised to find a massive tax liability since both taxes are added together.
However, the most common reason why a taxpayer receives an incorrect tax liability in his tax return comes from the late filing of tax returns.
Filing and paying taxes late not only leads to late penalties and fees, but also to IRS letters and notices, which can have a much higher tax liability. This higher tax liability is not a malicious action by the IRS, but an automatic reminder of the unpaid taxes, using the previous tax return and with incorrect tax deductibles since the IRS does not have all the information it needs to fill out the tax deductions.
Know How to Calculate Tax Liability
It is highly recommended for taxpayers to get assistance from an accountant or a tax specialist since tax calculations can be quite complex. In fact, some taxpayers also use online tools to budget their finances, taxes included.
Quite a lot of taxpayers simply rely on what the IRS sends them. In spite of this trust, taxpayers may still want to review tax returns, especially if there are discrepancies in both the information present in the returns as well as the total payable tax amounts.
However, taxpayers can try their hand at calculating their tax liabilities. Here are a few steps on how a taxpayer can check if the IRS properly calculated their tax liability.
1. Understand and List down Income Amounts and Sources
The IRS classify income as taxable and non-taxable. Taxable income includes:
- Capital gains from selling stocks
- Income from a business
- Hobby income
- Receipt of alimony payments
- Tax refunds from state and local tax return
On the other hand, non-taxable incomes include:
- Interest from bonds that are tax-exempt
- Tax refunds from the federal government
- Child support
- Most life insurance payouts
- Welfare payments
- Workers compensation
Of course, this list is not exhaustive. However, the taxable and non-taxable income sources for most taxpayers generally fall under these items.
The taxable income leads to the federal gross income for tax purposes.
2. List down Valid Expenses
After listing down the income amounts and sources, taxpayers must calculate their AGI or adjusted gross income.
AGI = gross income (taxable income) minus allowable adjustments.
Allowable adjustments include:
- Payment of alimony,
- Medical insurance premiums (self-employed),
- Tuition and related fees,
- Employer part of Social Security and Medicare contributions (FICA),
- Expenses for moving to a new workplace at least 50 miles from old residence,
- Student loan interests.
After the adjustments, deduct from the AGI standard or itemized tax deductions. Some deductions include donations or gifts to registered charities, personal property taxes, medical and dental expenses if they reach 7.5% of the AGI or higher as well as the home mortgage.
The taxpayer can now add any exemptions available. For example, having a dependent and a spouse entitles a taxpayer to some tax advantages that can lower the total tax liability.
3. Calculate Tax Liability and Tax Credits
After getting your gross tax liability, you can now apply the appropriate tax rate. Application of your tax rate to the gross tax liability will lead to the correct tax payable to the IRS.
However, some taxpayers have credits and tax refunds available.
For tax refunds, the IRS usually prefers to apply any refunds to tax payables first. Of course, the taxpayer can opt to have the refund sent to their accounts, but these transactions can take time.
Some common tax credits include:
- Earned income credit, for those in the lower income bracket,
- Dependent Care Credit, for taxpayers with dependents who are disabled,
- Child Credit, for taxpayers with children who are 17 or younger.
Current tax rates for 2018 to 2019 are pretty straightforward.
Taxpayers can simply add their taxable income, deduct allowed expenses, deductions, exemptions, refunds, and credits, and arrive at the tax liability for the year.
Most of the time, the IRS sends an incorrect tax liability and taxpayers unknowingly pay the higher amount. By calculating the tax liability themselves, the taxpayer can avoid this situation.
However, tax calculations can be more time-consuming and complicated than expected. Using an online tax calculator can point a taxpayer in the right direction, but relying on just the tool may not be a great idea.
Become Familiar About the IRS Dispute System
Once the taxpayer has certainty that the IRS made a mistake in the tax liability, he or she can dispute it through the appeals process.
All IRS appeals and disputes go to the Office of Appeals in the IRS, with the tax court as the last resort. Take note, this is not a judicial entity, which means that an appeal is not a legal proceeding but an administrative one, and lawyers are not needed for an appeal.
The appeals process is typically done via mail correspondence, which makes proper annotation of the recipient critical. Simply mentioning the IRS will lead to a literal communications block: the IRS has many departments and taxpayers will not want their mail to get lost in the IRS.
Another crucial piece of information that taxpayers should know regards the two categories of tax disputes.
The taxpayer should use the formal written request if the tax debt amounts to $25,001 or more. For $25,000 or less, the taxpayer can use the (usually faster) small case request.
However, an employee plan (investment) exempt organizations, S corporations, and partnerships cannot use the small case request.
The taxpayer should use Form 12203 (Request for Appeals Review) to start the appeals process for the incorrect tax liability levied by the IRS. Interested taxpayers may also want to call 1-800-829-3676 (1-800-TAX-FORM) to get any necessary forms other than Form 12203.
Generally, the taxpayer has 30 days to reply to the notice sent by the IRS. For taxpayers who received the Income Underreporting Letter (CP2000), they should reply within 30 days or the incorrect tax liability becomes the legal and enforceable amount.
Taxpayers getting an incorrect tax liability can rest secure that the IRS will look at the matter very seriously. As long as the taxpayer sends to the IRS the proper protocols, calculations, and information, the IRS will process the correction of the errors in a timely manner.
How will you report an incorrect tax liability? Do you have any questions about how the IRS proceeds with an appeal or dispute for taxes? Share your insights below!
If you owe back taxes, visit taxreliefcenter.org for more information on tax relief options.