Correct Your Tax Errors Penalty-Free
There is an old saying: an ounce of prevention is worth a pound of cure.
You notice an error on a client’s previously filed tax return. Circular 230 §10.31 says you
…must advise the client promptly of the fact of such noncompliance, error, or omission. The practitioner must advise the client of the consequences as provided under the Code and regulations of such noncompliance, error, or omission.
The client (not you) must decide whether or not to correct the error. If the client decides to fix it, he or she can submit a qualified amended return and avoid §6662 accuracy-related penalties on the additional tax owed provided that the amount is not related to a fraudulent position on the original return.
Under Treas. Reg. §1.6664-2(c)(3), a qualified amended return is an amended return filed after the due date of the return (including extensions) and before the earliest of
The date the taxpayer is first contacted by the IRS concerning any examination (including a criminal investigation) with respect to the return,
The date any taxpayer is first contacted by the IRS concerning an examination of that taxpayer for claiming an abusive tax shelter benefit,
The date a pass-through entity is first contacted by the IRS in connection with an examination of the return to which the pass-through item relates,
The date on which the IRS serves a summons described a §7609(f) John Doe summons relating to the tax liability of a person, group, or class that includes the taxpayer with respect to an activity for which the taxpayer claimed any tax benefit on the return, and
The date on which the IRS announces guidance published in the Internal Revenue Bulletin a settlement initiative to compromise or waive penalties, in whole or in part, with respect to a listed transaction if the taxpayer who participated in the listed transaction and for the taxable year(s) in which the taxpayer claimed any direct or indirect tax benefits from the listed transaction.
In most circumstances, a qualified amended return is one filed prior to the date that the IRS contacts a taxpayer regarding an examination of that tax year.
A return filed on or before the due date of the return (unextended or extended) is not a qualified amended return but instead is a superseding return. I wrote about superseding returns in a prior newsletter edition.
Example. A client’s 2019 tax return has an erroneous $25,000 Schedule C deduction creating a $22,000 loss. It is not a trade or business activity, so the $3,000 of income should be reported as other income on Form 1040 and no deductions are allowed. Let’s assume the taxpayer is in the 24% tax bracket.
If the taxpayer uses a qualified amended return to proactively fix the tax return issue, and the taxpayer files and pays the balance due on May 1, 2021, then the correction costs the client $6,216:
$6,000 in additional tax,
$216 in interest on the additional tax, and
No §6662 accuracy-related penalties.
Here’s the alternate situation: the IRS finds the error in a correspondence examination. If the examiner issues the audit report on February 1, 2022, then the proposed examination changes will cost the client $7,559:
$6,000 in additional tax,
$359 in interest on the additional tax, and
$1,200 in §6662(b)(2) accuracy-related penalties.
Interest will continue to accrue on the tax balance until the taxpayer pays the additional tax or posts a §6603 deposit.
Articles I Recommend
Monte Jackel’s article Who Will Complain About Pro-Taxpayer Ultra Vires Guidance? asks an important question: if the IRS issues pro-taxpayer guidance that is contrary to the law, who will contest it?
This article is especially timely since the IRS released a website FAQ indicating married taxpayers in community property states can get additional §85(c) exclusion amounts based on their community property status when compared to similarly situated married couples in non-community property states. As I discussed in a prior newsletter edition, there is authority suggesting this is improper; however, if the IRS permits it, and in fact auto-adjusts returns in this manner, then there is no one to challenge it.
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Oregon Society of Tax Consultants - May 21, 2021 - Newport, OR
American Rescue Plan Act of 2021 (3 CE)
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National Association of Enrolled Agents (NAEA) National Tax Practice Institute- June/July 2021 - Virtual
Level 1: Statutes of Limitations (2 CE); Ethics (2 CE)
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Update on IRC §199A (2 CE)