Don't Mess With Taxes

Remember the kinder, gentler IRS? That tax collector persona appeared following the agency's 1998 reorganization that was mandated by Congress following public outrage over collection tactics.

As the deficit has grown, and Congress can seem to make itself pay for projects, the IRS has been given more leeway to get tough again. Capitol Hill  has instructed the agency to find ways to close the tax gap, the billions of dollars the IRS says it is owed but that hasn't been paid.

To this end, private debt collectors have been hired. The IRS also has ramped up audits.

But it looks like the agency thinks there's still a place for less aggressive ways to get money it is owed.

"Soft notice" pilot program: This month, the IRS is testing a pilot program that will alert taxpayers that they may be underreporting income on their returns and give them a chance to make good on the owed tax by filing amended 1040s. The IRS believes there are around 15 million cases of underreported income each year.

The so-called "soft notice," officially known as CP 2057, will start going out mid-October to about 31,000 taxpayers.

This notice doesn't propose changes to taxpayer returns. It will simply "encourage" notice recipients to "double check" the tax filing information in question and, if they find errors, "self-correct" by filing Form 1040X.

"We believe this approach will allow taxpayers to correct underreporting issues without having to extensively correspond with the IRS, thus benefiting both taxpayer and the Service," according to IRS spokesman Bruce Friedland in a statement about the program.

Computer checking: The CP 2057 notices are automatically generated by the IRS' computerized document matching system. The technology compares information on a taxpayer's tax return with third-party tax documents, such W-2s and investment statements.

If you get a CP 2057, you don't have to respond to the agency. Rather, the notice instructs you to contact the third party who issued the tax data in question if you believe there's been a reporting mistake.

If, however, you realize you did indeed forget to include that part-time job's income or the interest from that savings account, you'll need to file an amended return to straighten out your tax liability.

You always can ignore the notice. The IRS says it won't take any action. I'm not sure I believe this.

But if reporting discrepancies are found on your next tax return, you can be sure that the subsequent questionable return will be bumped to the top of the tougher CP 2000 notice list.

CP 2000's tougher line: With the CP 2000, the IRS actually proposes changes to your return based on the third-party data. This includes the amount of unpaid tax calculated by the IRS, along with penalty and interest charges.

With a CP 2000, the agency assumes that its changes to your Form 1040 entries are correct. You do, however, have 30 days from receipt of the proposed changes to tell the IRS why your original numbers were correct.

Low-hanging tax fruit: The IRS says the new CP 2057 notice was developed to deal with at least some of the more than 10 million cases each year that the agency doesn't follow up on because the amount due might not be worth the cost to pursue under the current notice and collection process.

These returns are part of what the IRS has referred to as "low-hanging" fruit that it handed off to private debt collectors. However, since that program seems in jeopardy because of continued Congressional opposition, the CP 2057 could help bring in that missing tax money.

The IRS says the CP 2057 pilot program will require only "a very small portion" of staff to administer. But if these CP 2057 mailings prove successful in bringing the U.S. Treasury some extra cash, expect the IRS to expand the notice's use.

The IRS informed tax preparers about the CP 2057 via this presentation delivered at the agency's Nationwide Tax Forums this summer. The acronym "AUR" in the slide show stands for automated underreporting."

Avoiding IRS attention: The IRS also gives good advice in that presentation's last slide that should be followed every filing season:

• Keep good records of all your income.
• Report all your income and pay attention to your tax form as to exactly where to list it.
• Review your return before filing it to make sure it includes all your income.
• Make sure that payers (employers, investment companies, etc.) have your most current address so you get the same statements that are sent to the IRS.

You also might want to check out the "Living too large alerts the auditor" section of this post for tips on dealing with an audit.

Other ways to keep you from becoming an audit target can be found at:

• Tempting the tax auditor, an article I wrote for Bankrate.com,
• The Entrepreneur's Guide to Avoiding a Tax Audit, a blog entry from The Digerati Life, and
• Audit Avoidance 101, tips courtesy AccountingWeb.com.

And here's hoping you never meet an auditor and never get a CP 2057 or CP 2000 notice!