The IRS Does It Again

Those of you who are regular readers of this column know that my wife and I were the subject of an audit by the Internal Revenue Service in regard to a business, one we owned for several years but closed in 2013.

Our bizarre tale with the IRS was summarized here, but I'll give you the upshot before getting into this column.  An IRS auditor sent us a bill for over $29,000 in back taxes two years after the business closed, claiming that we had failed to report revenue of the business for tax year 2013.  One year later, about $10,000 in accountant's fees out-of-pocket, and after lots of free lessons to the auditor about how to read tax law, the entire audit was dropped without our owing one cent.

For tax nerds, the bottom line was that the revenue they thought we hadn't reported for 2013 had actually been reported for tax year 2012, because of the way our business consistently reported revenue.  Once the auditor's supervisor recognized that (A) the auditor had no idea of the proper application of the law, and (B) we had indeed legally reported all the revenue we were supposed to, and that it was actually in a way that paid IRS sooner, he shut it down and dropped their claim.

Of course, it is a sad statement on the way the IRS does business -- well, the first of two such statements I'll give you -- is that their "final" letter to us does not state explicitly that their previous claim had been dropped; it does not state that we owe no further taxes; it does not even mention the fact that all $29,000 was no longer due.  The fact that their letter was free of content is plot material.

The second sad statement will not astonish you, I'm sure.  We were residents of the Commonwealth of Virginia at the time of the audit, and for two years thereafter.  Virginia also has an income tax.  So the IRS, in their infinite wisdom, sent a notice to Virginia at the same time they sent the original $29,000 bill, telling them that ooh, ooh, the Suttons owe you state income taxes, too!

Now, IRS audits are routinely challenged, and routinely the original figure owed is reduced or, as in our case, eliminated.  So you would think that IRS would wait until a final disposition of the audit before sending a notice to the state of the victim's residence.  OK, no, you wouldn't think that; after all, it is the IRS.

But sure enough, on Tuesday we got a note from our accountants that the Commonwealth of Virginia, acting on an old audit statement sent them by IRS, was asking for a healthy check, including interest and penalties, for unpaid back state taxes.  They quoted the $29,000 figure sent them by the IRS in their letter, meaning that even though the final disposition of the audit, with us owing nothing, was over a year ago, no one from IRS had sent an update to Virginia to tell them that!

I do not yet know how Virginia will act.  I called the Virginia tax department first thing yesterday to tell them what had happened, wanting to explain that I had in my hot little hand the final letter from IRS, which said exactly nothing and therefore could not be used in defense of our contention that we didn't owe anything.

And by the way, our CPA who defended us in the audit passed away in November.  In coelo quies est.

The nice lady from Virginia who sent me the original bill answered her phone the first time.  I described the situation, and mentioned that the IRS letter was useless.  She said, bless her, that she herself would call IRS and verify the disposition, and then write me back.  So I'm hopeful that it will take one simple phone call to drop Virginia's claim.

But in the meantime, I am sitting here wondering why, in the three years since the audit started, did IRS never once think to undo their damage by notifying Virginia that they had dropped their claim?  Would it have been that hard?

Tax reform ... a necessary step.  I'll keep you posted.

Copyright 2017 by Robert Sutton
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