Tax and Financial News for November 2011

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Some Unexpected ‘Gifts’ Come With a High Price

“Never look a gift horse in the mouth” is one of those old adages that many of us grew up with. Sometimes, though, even the wisest among us might want to stop and think before accepting a gift with blind trust.

One such example is an unexpected check from a taxing authority. Before computers made it easier for the IRS and other tax agencies to keep track of your account, that scenario was unlikely; however, with the government on the lookout for needed revenue, what you don’t know might cost you.

A not-for-profit executive recently received numerous checks in the mail from a state tax department. The description on the checks indicated they were for overpaid taxes from past tax periods. The revenue clerk asked if he should deposit the checks and without hesitating, the executive said, “Yes.”

In this instance, the refunds were truly due to the organization, but the simple act of depositing the checks could have opened the nonprofit entity up to penalties and interest even though the tax agency itself had sent them the funds. It might seem unreasonable, but this is how the IRS and other taxing authorities view this kind of transaction.

For example, you filed your 2008 income tax return and paid the $10,000 balance due on April 15, 2009. The IRS sends you a refund check on Oct. 31, 2010, in the amount of $5,000 for the 2008 tax year. You have no idea why they sent the check they sent the check, but you are happy to deposit it. Three months later, the IRS sends you a notice that claims you underpaid your 2008 tax bill by $5,000 and you now owe them $5,000 in taxes plus penalty and interest.

Do you owe the full amount of that bill? You do owe the $5,000, but will you owe the penalties and interest you’re being charged (starting from April 15, 2009) as well? The answer, according to the IRS, is yes. When you deposited the $5,000 check from them, it was as if you had never made the initial payment – even though you did. The IRS, or any other taxing agency, will assert you owe the full amount – and they can probably make that stick.

This scenario has played out with many clients over the years and, from a common sense standpoint, charging penalty and interest from the original due date of the payment doesn’t seem fair. But the IRS has been successful in collecting that amount. While a small sum for penalty and interest might be reasonable, charging for the entire period is not equitable – then again, nobody ever said taxes were fair.

The IRS has started notifying taxpayers that a refund is being sent and to contact them if the taxpayer believes the refund is in error. This notification, however, often gets less than your full attention.

What is the best course to follow if you receive an unexpected payment from the IRS? Well, first find out why you are receiving the refund. That could entail simply comparing the information the IRS sends against the data reported on your return. If you believe the IRS is correct, go ahead and deposit the check. If you believe the IRS is incorrect, do not deposit the check. Instead, call your tax preparer and explain your concerns. If you still believe you are not due the refund, send the check back to the IRS with a letter of explanation. Depending on the check amount, you might want to return it by certified mail. Make sure you keep copies of the check and all correspondence.

While keeping an unexpected gift sounds good, whoever came up with the “gift horse” saying probably never had a run-in with the IRS. If you receive an unexpected windfall from the government, make certain you understand and agree with the reason for the surprise payment. Otherwise, your only gift might be an unwanted headache. Let us know if we can help – we will be glad to assist you in minimizing any hassles with the IRS.

Happy Thanksgiving!


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