Why IRS SFR Assessments Overstate Tax

Filing season may be over, but the IRS process is still moving.

For taxpayers who did not file, the IRS may already have income records from employers, banks, brokers, retirement plans, payment processors and other third parties. Those records can move through IRS matching systems even when the taxpayer has not sent in a return.

When the IRS creates a Substitute for Return, the tax often looks worse than it should.

That is because the IRS is usually working with income records, not the full taxpayer picture.

Now that filing season has passed, the next set of decisions begins. Before IRS processing or planning opportunities are missed, speak with Steve Perry, EA about your situation. Call 678-717-9818, email [email protected], or connect on LinkedIn at www.linkedin.com/in/steveperrybtm.

The IRS Starts With What It Has

A Substitute for Return is built from information available to the IRS.

That information often includes income.

It may include:

• Wages
• Interest income
• Dividend income
• Retirement distributions
• Contractor income
• Brokerage proceeds
• Payment processor reports
• Other third party reporting documents

Those records tell the IRS money came in.

The records that indicate a deduction or reduction in gain are not considered by the IRS in producing an SFR.They simply don’t care.

That is where the overstatement begins.

Income Is Easier to See Than Deductions

The IRS receives many income documents automatically.

The IRS does not receive the taxpayer’s complete expense file.

It does not know every business expense.

It does not know every deduction.

It does not know every credit.

It does not know every fact that belongs on a complete return.

A taxpayer prepared return is supposed to tell the whole story.

An SFR often tells only the income side of the story.

That imbalance can create a larger assessed balance than the correct tax.

What the IRS Usually Does Not Include

The IRS will not include items that reduce the tax because the IRS does not have them, does not verify them in the SFR process, and they simply don’t care.

Missing items include:

• Business expenses
• Cost of goods sold
• Vehicle expenses
• Home office expenses
• Basis in stock sales
• Basis in retirement distributions
• Rental property expenses
• Depreciation
• Correct filing status
• Dependents
• Education credits
• Child related credits
• Itemized deductions
• Self employment adjustments
• Net operating losses
• Other facts that reduce taxable income or tax

The result can be a balance that appears official but is not necessarily correct.

That matters.

A taxpayer should not assume the IRS number is the final answer without review.

Brokerage Sales Are a Common Problem

Stock and investment sales can make an SFR look much worse than it should.

The IRS receives a document showing gross proceeds from a sale.

Even if the basis is listed, the IRS will generally ignore it and it can be difficult to prove to them that the calculations are in error.

That can create a proposed balance far above the correct tax.

The taxpayer may have had little gain.

The taxpayer may have had no gain.

The taxpayer may have had a loss.

But the SFR does not reflect basis properly, and the account moves in the wrong direction.

If you are unsure what happens next after filing or whether your return could trigger IRS correspondence, speak with Steve Perry, EA to review your position. Call 678-717-9818, email [email protected], or connect on LinkedIn at www.linkedin.com/in/steveperrybtm.

Business Income Can Be Overstated Quickly

Self-employed taxpayers are especially exposed.

The IRS receives Forms 1099 showing gross income.

Gross income is not the same as taxable profit.

A business has:

• Supplies
• Subcontractor costs
• Insurance
• Advertising
• Software
• Professional fees
• Vehicle expenses
• Equipment
• Rent
• Utilities
• Payment processing fees
• Other ordinary and necessary business expenses

An SFR will not include those expenses.

That makes a business owner appear to owe tax on gross receipts instead of net income.

That is a major difference.

Filing Status and Dependents Can Change the Result

An SFR may not reflect the most favorable lawful filing status.

It will not include dependents.

It will not include credits connected to those dependents.

That affects the tax calculation.

It can also affect whether the taxpayer qualifies for certain credits or lower tax rates.

The IRS is not sitting with the taxpayer reviewing household facts, support, custody, income, eligibility, or documentation.

It is building an assessment from the information available that is in the best interest of the IRS.

The missing facts can matter.

Deductions Reported Elsewhere Will Still Be Missed

Some taxpayers assume that if a deduction appears on a third party document, the IRS will automatically use it.

That is wrong.

Mortgage interest, student loan interest, basis information, withholding and other reported items may exist somewhere in the IRS system. But the SFR process is not the same as preparing a complete taxpayer return.

The taxpayer still needs to review the account.

The taxpayer still needs to prepare the correct return.

The taxpayer still needs to support the numbers.

Before assuming your tax situation is complete for the year, consider having Steve Perry, EA evaluate your next steps and planning opportunities. Call 678-717-9818, email [email protected], or connect on LinkedIn at www.linkedin.com/in/steveperrybtm.

An Overstated SFR Can Become a Collection Problem

The problem with an overstated SFR is not only the tax number.

Once the IRS assesses the tax, the account can move into billing and collection.

That may involve:

• Balance due notices
• Penalties
• Interest
• Collection notices
• Federal tax lien risk
• Levy risk
• Pressure to enter a payment arrangement based on the wrong balance

If the taxpayer does not respond, the IRS number can become the number the system collects on.

That is why timing matters.

The taxpayer needs to know whether the IRS proposed or assessed amount is correct before making long term resolution decisions.

The Correct Return Is the Answer

The proper response to an overstated SFR is not guessing.

It is preparing the correct return.

That means gathering the records, reviewing transcripts and building a complete taxpayer filing for the year at issue.

The corrected return should address:

• All income
• Filing status
• Dependents
• Deductions
• Credits
• Business expenses
• Basis
• Withholding
• Estimated payments
• Carryovers
• Any other facts needed to calculate the correct tax

The goal is not to make the balance disappear.

The goal is to determine the correct balance.

Once the correct balance is known, the taxpayer can address penalties, interest and collection options.

Post Filing Season Is the Time to Catch the Problem

After filing season, many taxpayers stop paying attention.

For nonfilers, this is when exposure may be developing.

The IRS may be processing income records. Matching systems may identify a missing return. Notices may be generated. A proposed SFR assessment may be issued. A prior SFR assessment may move toward collection.

Waiting until next filing season does not improve the taxpayer’s position.

It allows the IRS system to keep moving.

Post filing season is the time to ask:

• Are all required returns filed?
• Has the IRS issued a nonfiler notice?
• Is there an SFR assessment on the account?
• Did the IRS use gross income instead of net income?
• Was basis included?
• Were dependents and credits included?
• Would the correct return reduce the balance?
• Is current year compliance being handled?
• Is a collection response needed?

Those questions create direction.

They also help prevent a wrong number from becoming the basis for collection.

Common Mistakes With Overstated SFR Balances

Taxpayers often make the same mistakes.

They include:

• Assuming the IRS calculation is complete
• Assuming the IRS included expenses
• Ignoring stock basis
• Forgetting business deductions
• Missing dependent related credits
• Waiting until collection begins
• Making payments without checking the balance
• Requesting a payment plan on an overstated amount
• Failing to file the correct return
• Creating another balance while fixing the old one

These mistakes reduce control.

They also make the account harder to resolve.

The Better Approach

The better approach is direct.

First, identify the year involved.

Second, pull transcripts and income records.

Third, gather taxpayer records.

Fourth, prepare the correct return.

Fifth, compare the correct tax to the SFR amount.

Sixth, address penalties, interest and collection.

Seventh, correct current year compliance so the same issue does not repeat.

That is how the taxpayer moves from IRS calculation to taxpayer supported correction.

Final Thought

SFR assessments almost always overstate tax because the IRS usually sees income more easily than it sees deductions, credits, basis, expenses and household facts.

An SFR may look official.

It may lead to billing.

It may lead to collection.

But it is not a complete taxpayer prepared return.

Filing season may be over, but IRS processing, matching, billing and enforcement sequencing continue after submission. Many IRS issues arise not from the missing return alone, but from what taxpayers fail to do after the IRS creates a number from limited information.

After filing season ends, many taxpayers miss critical planning windows that affect next year’s outcome. If you want to stay ahead of the process, speak with Steve Perry, EA now. Call 678-717-9818, email [email protected], or connect on LinkedIn at www.linkedin.com/in/steveperrybtm.

FAQ

Why do SFR assessments often overstate tax?

They often overstate tax because the IRS has income records and doesn’t consider legitimate deductions even when they have the right information.

Does the IRS include business expenses in an SFR?

No.The IRS only considers reports of income.

Can stock sales cause an SFR to be wrong?

Yes, the IRS doesn’t look at the basis, just the sales price.

Can I correct an overstated SFR balance?

Yes.A correct and accurate tax return can and generally should be filed to replace the SFR.

Should I set up a payment plan before reviewing the SFR?

No.The assessment from the IRS is virtually always wrong.Determine the correct liability before arranging for a payment arrangement.