There are new tax scams where people receive fraudulent IRS notices that try to strong arm them into paying money the scammers are not entitled to. A big telephone scam was recently shut down in India, and another will certainly rise from the ashes. So, it is safe to say that taxpayers will always have to worry about fraudulent notices scaring them into having to pay something they don’t.
Unfortunately, one could argue that they have to worry about fraudulent notices from the IRS as well.
Fraud is one of those words that gets thrown around a lot. People don’t understand that fraud requires two parts. There is the act, and also an intent to defraud. That is, there is an intent to deceive someone intentionally. Suppose you make a mistake and send someone an incorrect bill because your software has a bug in it. That in and by itself isn’t fraudulent. Maybe negligence, but unless there was some intent to trick people into paying something they weren’t supposed to, there is no fraud.
Now, once you become aware that your software is spitting out incorrect notices, and you take no action to remedy the known mistake (by either fixing the program or no longer sending bills until the issue is corrected), someone could argue that is fraud. An omission can count as an act. When under the duty to do something and you don’t do it, the law can treat that — the failure to fix something — just as bad an act to do something.
We see a very specific set of circumstances in which one could argue that the IRS is fraudulently sending out a notices it knows to be incorrect because its software has a fairly obnoxious bug.
To understand this mess, there are two things we need to get familiar with: The Alternative Minimum Tax, and the IRS Automated Under Reporting (AUR) Unit.
What is the Alternative Minimum Tax?
The AMT, as amended in 1982, imposes a parallel system of income taxes where the overall rates are lower, but many deductions are eliminated or phased out. The point is that Congress wanted more, so you pay whichever bill is higher. Your regular tax, or your bill under the AMT regime.
Your AMT is calculated on IRS Form 6251. Tax software will generate a Form 6251 even when you don’t even owe the AMT. Why? Because the AMT needs to be calculated as if it is higher than your “regular” tax from your 1040, so you would have to pay the AMT.
Your initial AMT is on Line 31 of Form 6251. After any foreign tax credits, Line 33 lists your tentative AMT. But you might not have to pay it, right? Because first, you have to compare it with your regular tax to see which is more. On Line 34 you list your regular tax, and subtract it from your tentative AMT of Line 33. So if your regular tax is greater, your AMT zeros out. You have no AMT to pay. You have your regular tax to pay.
So remember these Lines:
- 31 = Initial AMT
- 32 = Foreign Tax Credits to reduce Initial AMT
- 33 = Tentative AMT
- 34 = “Regular” income tax
- 35 = Actual AMT to pay
This will become important shortly but first we must talk about the IRS Automatic Under-Reporting Unit.
The IRS Automatic Underreporting Unit (AUR)
A W-2 or 1099 are both types of third-party reporting. Whether you receive wages (and in certain instances when you receive money) the person paying the money is obligated to send a report to the IRS. The IRS collects this information to match it with the taxpayers return.
If the taxpayer doesn’t file a return, the AUR’s software can spit out a Substitute Filed Return (SFR) based on the third-party information it received. The SFR doesn’t do any “favors” for the taxpayer and usually results in a tax bill that is higher than if the taxpayer filed a return on their own. Part of the reason this is done is it encourages the taxpayer to file a return to correct the inflated SFR amount (firms like ours do this all the time).
So what happens if you file a return but leave off, for example, a 1099 for $500 of interest income. The AUR’s software will rerun your entire return through their software, now including this additional income item. Your entire return gets processed, as one change can affect many different schedules and ultimately, how much you owe.
When the AUR detects an increase in a tax bill, it sends a CP2000 notice. The IRS claims the CP2000 is not a bill (although the IRS can give you an invoice to pay if you agree with the proposed increase). The IRS does give you an opportunity to contest proposed changes. You can call or mail in your response.
The Fraudulent CP2000 Notice Overcharge
As I said, the AUR runs your entire return through their software when they detect you are missing an item of income. In our example, $500 of interest income is run through, and a small amount of regular tax will be added. Everything goes fine, until the software gets to the AMT Form 6251. There, the software stops inputting data at line 33 and treats that as that final number. This is significant as recall these lines:
- 31 = Initial AMT
- 32 = Foreign Tax Credits to reduce Initial AMT
- 33 = Tentative AMT
- 34 = “Regular” income tax
- 35 = Actual AMT to pay
So line 33 is a really bad spot to input data because it lists the tentative AMT, not the actual AMT. It doesn’t reduce any foreign tax credits, and more consequentially, doesn’t compare the Tentative AMT with the Regular tax.
This is how people who may owe something additional to the IRS due to a missing income item, could be paying well over the actual AMT they owe. The AUR is sending out notices that could be $10,000, $25,000 or even higher than the actual Tentative AMT. This is because the Initial AMT is being treated as the actual AMT to pay.
If this is something you or your client run into, hopefully you will be able to clear this up.
Conclusion
While I believe the personal income tax to be morally wrong and evil, the irony is that there are many good people who work at the IRS. They have helped me, our firm and our clients out for years, and continue to do so.
In support of this opinion, let me offer this as evidence: It was the CP2000 Unit at the IRS who admitted and completely explained this error to us. It sounds as if they are embarrassed, not to mention demoralized, as they have to deal with irate and frustrated taxpayers for something that they know is not correct, yet are powerless to stop.
Perhaps they may have told us because we tend to have big mouths.
This article will be emailed to the Treasury Inspector General (TIGTA). They tend to do good work.
If you have a tax issue you need assistance with, contact us. Call 888-727-8796 or email info@irsmedic.com.
