You can fight the government—if you know the ropes.
Herewith, four true stories about tax enforcement, mostly anonymized. They are object lessons in contesting unfair tax assessments.
In 2012, taxpayer A cashed in $56,739 from a 529 account to cover college bills. She overdid it; a small portion of the withdrawal was for nonqualified expenses like activity fees, so she declared the gain on that portion and paid tax on it.
She didn’t hear a peep from the IRS until November 2014, when a Notice of Deficiency landed with a thud in her mailbox. It declared, nonsensically, that the entire withdrawal was used for impermissible purposes. She was supposed to confess and send in a check for $4,476.
A deficiency notice is heavy artillery, normally used only after the taxpayer has been given plenty of opportunity to explain and has been found wanting. It appears that either the IRS or the Postal Service dropped the ball. If the IRS ever sent a polite request for back-up detail before resorting to its ultimatum, A never got it.
Tax lawyers call these notices 90-day letters because the victim has a nonnegotiable, no-excuses deadline of 90 days to file a court appeal. Miss the deadline and you are out the money, no matter how absurd the government’s position.
A was no lawyer but didn’t want to spend money on one. She downloaded some forms and filed a pro se case against the IRS in U.S. Tax Court. The case was assigned to an IRS attorney in San Francisco, who did not relish the idea of defending the government’s clerical error before a judge. He got in touch with the IRS auditors on the East Coast who were responsible for the mess.
The auditors wanted to know why this trivial matter was in court when a phone call might have resolved it. Because, A answered, I didn’t want to take the chance that further IRS fumbling would put me past the 90-day limit and leave me with no defense. The IRS backed down before trial, accepting A’s return as originally filed.
Moral: When you get a 90-day letter, sue first and ask questions later.
B was working in Silicon Valley in 1999 when he got the inspiration that Internet stocks were in a bubble. He bought long-dated put options on AOL, on margin.
Bad timing. The stock kept going up, the puts went down and the broker sold them when B didn’t meet a margin call. B didn’t even put the transaction on his tax return. Big mistake.
The California Franchise Tax Board picked up the sale transaction from an electronic report by the broker. Lacking an entry for the purchase price, it assumed, as it was entitled to do, that the entire proceeds represented profit. It sent a notice to B demanding more tax. But, since he lost money on his trade, he didn’t owe more tax. He ignored the notice.
He kept getting notices from California. But by then he had left the state. The notices went in the trash.
Fifteen years after B had settled in Brooklyn, he got a call from his bank saying that his account was overdrawn. But I should have $9,000, he said. No you don’t, said the banker. Yesterday the State of California took your money.
A tax expert informed B that he had missed too many deadlines to put up a defense. As B now ruefully explains it, “If you don’t show up for the soccer match you forfeit the game.”
Moral: Never assume that you are outside the reach of a state tax collector.
Taxpayer C is a retired economics professor who does his own tax returns. A few years ago he got a letter from the IRS declaring that his tax calculation was wrong and he owed a few hundred dollars more.
He thought that was odd. Tax software doesn’t make calculation errors. So he called an IRS office and asked for an explanation. Precisely which entry in any of the calculation worksheets was wrong? The person at the other end of the line couldn’t answer the question. Can I speak to your supervisor? C asked.
After a delay, a higher authority came on the line and the prof repeated his question. That expert was as stumped as the first, but insisted that the IRS was right and he should just pay the money. But the taxpayer wanted to know: Am I not entitled to know exactly what I did wrong?
Eventually, the IRS brought in a still more experienced agent. That person was also unable to figure out the discrepancy. At this point the government folded its hand and accepted the return as filed.
Moral: Be polite but firm.
This last tale is a first-person account. Many years ago I filed an income tax return with New Jersey, including a $23,335 capital gain. This amount went into the state’s computer system as $33,335. The state demanded more tax. I wrote back, noting the keypunching error. The response I got was a computer-generated proposal that I take advantage of New Jersey’s amnesty program. If I paid in full, nothing bad would happen to me.
How do you argue with a computer? Trolling through a state government manual, I stumbled on the fact that the guy running the tax department was one John R. Baldwin. He was no kin, but I saw an opening.
I wrote a letter addressed to him personally, including my last name in the return address. I figured a mail clerk would pull the envelope out of the department’s in-box on the assumption it was about some family matter.
John Baldwin did not respond, but somehow, soon after, the state’s computers came to their senses.
Moral: When dealing with a bureaucracy, find a sympathetic ear.
Originally published at Forbes