Every April, a certain shiver goes down my spine as I’m reminded of my own personal tax horror story. My problem started in 2006 when I was running my own business, which causes problems for a lot of people. Money comes in and you are responsible to report it and pay the correct tax, unlike a salaried job where the taxes are taken out before the money ever gets in your hands. There’s always the temptation (or the need) to spend all the income, without putting anything aside for taxes.
I got a recommendation from a friend for a tax preparer and the first danger sign, which I ignored, was that he wasn’t a CPA (certified public accountant) he was what’s known as a an “enrolled agent.” This is a lower level, less educated tax professional. Based on my experience, I will never use anything but a CPA again. I used this person to prepare two years of tax returns and I provided him with itemized totals of my income and expenses. I relied on his knowledge and experience to file the income correctly, using the correct forms and accounting for both personal and LLC (limited liability corporation) income and expenses. My tax liability was very low, but I didn’t think anything of it.
The problem
It was only when I got the audit notice from the IRS, that I really started to look at what this person did. This enrolled agent filed all the income, including LLC business income, as personal income for me, and then combined all the expenses to almost zero everything out. Almost immediately I could tell he did not do it correctly and I was in for a huge problem with the IRS. I was fortunate in that he (nor I) had not lied about levels or amounts of income, only filed things the wrong way. When I started to go over the numbers, I could see I was going to owe a lot of money.
How I fixed it
First, I educated myself on the correct forms and things to file. I found the IRS phone service people very helpful. It does take a very long time on hold, and you have to go through several people to get to an expert in the specific area you may need. I wanted information on how to file the returns for our LLC and how to properly account for the income, but also how to deduct business expenses I paid for personally. After several phone calls, I got to the right person and a woman from the IRS spent an hour on the phone with me, as we walked through all the different income and expenses and she told me exactly how to file everything, how to account for different types of income and expenses. After learning how everything should have been filed, I basically went through and re-did the tax returns for the years under audit, making sure to use all the forms and methods described to me by the IRS staff people.
Then to be safe, I paid an experienced accountant and tax attorney to review my figures. This saved me money as instead of paying them $2,000 to prepare the returns, I paid $350 for an hour and a half of his time, while he reviewed everything I had done and prepared to show for the audit.
The audit
When I went in for the audit, I was direct and honest. I explained to the auditor what happened and showed her the original returns and totals. I then presented her with the correct forms and returns, refiling the personal returns and filing the corporate income correctly. I showed her how the overall totals were the same, but that my tax preparer had filed things incorrectly. I showed her all my calculations and everything went very well. I wasn’t scared, I wasn’t hiding anything, we just went through both years and the auditor never even checked individual receipts, we just went over my reports showing the totals spent in each category.
The Result
The auditor accepted my re-filings and I was hit with a large tax bill of about $4,000, but this was the correct amount of taxes due, based on the income I had in those two years, less allowable deductions and the payments I had already made. Then I was hit with penalties and interest and fines of another $4,000. Had I just correctly filed and reported the income originally, I would have saved the $4,000 in fines and penalties and that’s my horror story, that I listened to this alleged expert and it ended up costing my $4,000 too much. After the audit, I communicated with the IRS and established a payment plan that I could afford and now make monthly payments.
Solutions for the future
I make sure to file everything on time, and many penalties are related to late filing. I set up a separate bank account for taxes. Whenever I receive income or compensation, I divert 30 percent to this tax account. At the end of the year, the balance should be enough to cover my tax liability. I also now make quarterly estimated tax payments so I’m not hit with a big bill at the end of the year.
Removal of Fines and Penalties
The IRS will review requests and may remove some fines and penalties. I was able to get some reductions in the fines and penalties as I had relied, in good faith, on the advice of the tax professional who signed my return. I was left with the fines and interest for not having paid the correct amount on time.
