Thursday, 12 June 2008

• The IRS Says I Owe Over $100K in Back Taxes

  A few weeks ago I received a letter from the IRS. I was wondering what could it be....I still hadn't turned in my tax return for this year so it wasn't a refund. Could it be a surprise stimulus check perhaps?
  
  Once opened, I realized that my 2006 return was under "examination" and they had a question or two about my return that needed answering. The letter stated that they received a 1099 form from my brokerage that they couldn't find on my return......dun dun DUN!
  
  1) One item was interest received from shorting stocks which was around $400.
  
  2) The other item was the net proceeds of all my stock sale transactions that was well over $300K
  
  So in other words, the IRS is "suggesting" I may owe taxes on additional income of over $300K, plus extra for interest and penalties.
  
  Well let me tell you- that might as well have been a stimulus check because when I read that, my heart skipped a beat.
  
  I say to myself "surely this must be a mistake" since I'm nothing if not thorough with processing my tax returns.....
  
  The letter gives me three options to respond:
  
  1) Agree with their assessments and they will kindly recalculate my taxes and undoubtedly send me a $100K+ tax bill.
  
  2) Contest some of of their assessments.
  
  3) Contest all of their assessments.
  
  OK, so I start looking over the first assessment....the ~$400 interest not being reported. I look at my tax return for that year....and I don't see it. I log onto my brokers website and check tax forms. Then I find it...a 1099 statement showing I did get that interest. This wonderful broker doesn't send out their 1099's, which is how I missed it.....doh! This broker also pays decent interest on the extra money in your account due to shorting stocks...my other brokers paid diddly interest. Those two combined for this nice surprise. Extra stimulation...
  
  Now I'm knocked out of my comfort zone. I didn't report that income.....but I don't make mistakes like that on my tax return....but I did. Now the door is open in my mind wondering if I made other mistakes. Did I not send in the Schedule D showing my stock transactions? Am I gonna be in a world of hurt with tax penalties? I can feel my body temp rising with each negative thought....
  
  OK, calm down I say to myself. First of all I know I certainly didn't make $300K+ in stock sales income, otherwise this xanga would be titled "I'm a Free Man" or "Bye Bye Corporate Job".  The way it works with the IRS is that brokerage's only report the stock sale transaction and not the price you purchased it for. So for example, let's say you purchased 100 shares of stock for $2500.00, then sold it later for $3000.00. You made $500, but the brokerage reports to the IRS that you sold the stock for $3000.00. This would be less hassle if they just reported the net profit...but I guess that would make things too easy. That's where the Schedule D form comes in so you can more accurate report both the buy and sell side to show the "profit" that's taxable rather than the whole sales amount. So the real question is did I not send in the Schedule D for this form?.....
  
  I check my records and....I DID include it on my tax return...whew! However, the values I reported are different than what my brokerage sent in though....hmmmmm. Did I make an adding mistake? If I did it's a big one as the difference is over $30K. I notice my broker has an online schedule D for that year so I look at it and compare it with mine.......
  
  Then I notice it....the brokerage included my open short sale positions in their report to the IRS. This is just plain stupid and here's why- any stock position has an opening and a closing end. If you buy a stock to open, you sell stock to close. If you borrow stock from the broker to short, you pay it back to close. Once you have a closing transaction, that should be reported to the IRS. Here's what the brokerage did- they reported the open short positions as straight up sales even though they were still open and not closed. I didn't close those positions until the next year so the IRS should not have been sent that information until the following year. That extra amount is where the $30K difference was coming from, which led to the IRS not being able to match up my schedule D with the amount reported by the brokerage, making them think it was all unreported income.
  
  OK, so that one is easy to explain why the IRS is in error...problem solved! But I still have the case of not reporting my interest income that they are right about.....
  
  Then in looking over my online statement of that years activities, I see that I paid out dividends on my short position. When you own stock that pays out dividends, you get paid a certain amount during the year from the company. When you short dividend paying stocks, you become responsible for paying the dividend and it is deducted from your account. I realized I didn't include this on my tax form either.....doh!  Since it is an investment expense, it's tax deductible, meaning I paid more taxes than I should have.
  
  So I made two mistakes of leaving out information.....one in the IRS's favor and one in mine. I had to create a 1040X and include the changes to determine what the new results would be.......
  
  Crunching the numbers revealed my fate...........
  
  The IRS owes ME about a $10.00 additional refund!
  
  
  Now maybe they'll think twice before examining my return in the future.
  
  
  
  
  

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