Penalties for underpayment of taxes or the disallowance of business expenses can quickly tip your personal or business balance sheet into the red. When does it make sense to challenge the IRS?
Your odds may be better than you would guess. A report from the National Tax Advocate Nina Olson includes details on when taxpayers prevailed in IRS civil litigation last year. We'll explain when it might make sense to challenge an IRS decision or assessment.
Reliance on professional advice
One winner was billionaire Sumner Redstone who argued he had relied on the advice of a professional. He was able to avoid a penalty of $368,800 and millions in interest related to a gift tax return that had not been filed in 1972. Another was a business owning couple who was able to avoid a $12,000 penalty, because they had records that showed they relied on the advice of a tax preparer.
Depending on the sophistication of a taxpayer this type of defense does not always fly. Our July post discussed a case where the court did not believe the taxpayer argument that he didn't know a complex offshore trust scheme was unlawful.
Poor record-keeping practices: A common thread
One of the most common reasons that taxpayers get into trouble with business and personal deductions is record keeping. Vehicle expenses are one of these that can easily cause problems. The IRS disallowed a business deduction of $7,000 in car and truck expenses for one couple. The couple took the case to Tax Court and won. The judge believed their specific and detailed oral testimony even in the total absences of written records.
Of course, records do not help when deductions are not allowed in the first place.
A tax professional increases the chances of winning
The report noted that taxpayers represented by approved specialists, such as tax lawyers won 22 percent of the time. Taxpayers who represented themselves had a lower chance of success, but still were able to prevail 17 percent of the time.
What is not represented in that five percent differential is the number of contested cases tax attorneys are able to successfully negotiate, so trial is not necessary.
The report had one word of warning for those representing themselves. Frivolous arguments can lead to even stiffer penalties. One California taxpayer had a variety of arguments for why he did not owe taxes including his own definition of income that when pressed turned out to be "a cat with a pink bow." The judge in that case tacked on a $3,500 penalty on top of back taxes of $3,840.
Considering challenging the IRS? Talk with a tax attorney who can offer pragmatic advice. This could help you avoid a long battle that may not end in your favor.