The Top 10 Taxpayer Disputes with the IRS

October 9, 2024 3:49 PM

Tax season can be difficult enough for professional tax preparers to navigate, but for the average taxpayer, who lacks the practitioner's technical knowledge, it can be an absolute minefield — and it gets even worse when the Internal Revenue Service comes back with a question or a problem with a self-prepared return.

Discrepancies and disagreements with the IRS, while business as usual for CPAs, can be terrifying to the taxpayer. With that in mind, below are the Top 10 disputes that taxpayers run into with the IRS as selected by Miklos Ringbauer, secretary/treasurer of the California Society of CPAs. While they may be considered elementary for seasoned preparers, they may constitute a helpful reminder for taxpayers who face them once a year.

10. Tax return preparation errors

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Taxpayers who rely on tax preparation software to prepare their returns may encounter disputes related to errors or inaccuracies in their returns. Mistakes in reporting income, deductions or credits can lead to IRS audits and potential penalties for tax return preparation errors.

Preparers should encourage clients to carefully review their returns before filing to ensure accuracy and completeness. The IRS may conduct audits to identify and correct errors and and may assess penalties for negligent or intentional misrepresentation.

It's easy to sign up for an account that offers a cash bonus and then forget about it, noted Ringbauer. "It takes five minutes to open an account and get your bonus, but people very quickly forget about it," he said.

"And then there are the 'ghost preparers,'" he added. "Some of them should not be preparing returns at all, and others may be qualified but don't want the responsibility or the liability, so they prepare the return and don't sign it or they use someone else's credentials. This is especially prevalent in Southern California. The telltale sign is when the return is completed and the taxpayer is ready to sign, it shows that it was self-prepared. And if a preparer is not signing the return, they could care less about the accuracy of the return."

9. Retirement account contributions and distributions

Taxpayers that contribute to retirement accounts, such as IRAs or 401(k) plans, often encounter disputes related to contribution limits, eligible deductions and required minimum distributions. Discrepancies in reporting retirement account activity can lead to IRS audits and penalties for noncompliance.

"This is an area that is not fully understood by taxpayers," said Ringbauer. "We frequently see taxpayers that contribute to a 401(k) that they max out. And then they contribute to a Roth IRA or to a traditional IRA. And if you overcontribute, of course, there is an excise tax penalty assessed on the additional contributions that the taxpayer was not allowed to make. That's one of the areas where the taxpayers run into an issue and then the preparers have to untangle it. That takes a lot of time and effort, both for the IRS as well as for the preparer."

8. Tax withholding and payments

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Disputes may arise when employers fail to withhold the correct amount of taxes or neglect to remit withheld taxes to the IRS. Employees may also encounter disputes if they fail to make timely tax payments or underestimate their tax liability.

"The IRS may assess penalties for underpayment or late payment of taxes but may waive them in certain circumstances, such as due to reasonable cause or financial hardship," said Ringbauer.

7. Foreign income reporting

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Taxpayers who earn income from foreign sources, such as foreign investments or employment abroad, are required to report this income to the IRS. Disputes may arise when taxpayers fail to report foreign income or incorrectly report it, leading to audits and potential penalties. Preparers should educate clients with foreign income on the reporting requirements to ensure they accurately report all foreign income.

6. Worker classification

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Employers must correctly classify their workers as either employees or independent contractors for tax purposes. Disputes may arise when employers misclassify workers to avoid paying payroll taxes or providing employee benefits. Misclassification can result in IRS audits and penalties for both employers and workers. Employers should familiarize themselves with the classification factors of the IRS and of their state's tax agency.

5. Estimated tax payments

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Self-employed individuals and taxpayers with significant sources of income may be required to make estimated tax payments throughout the year. Disputes may arise when taxpayers underpay or fail to make timely estimated tax payments, leading to penalties and interest charges. The IRS may assess penalties for underpayment of estimated taxes but may waive them in certain cases, such as due to unforeseen circumstances or financial hardship.

4. Taxpayer ID theft

Taxpayer identity theft occurs when an individual's personal information, such as their Social Security number, is stolen and used to file fraudulent tax returns or claim refunds. Identity theft can lead to delays in processing legitimate tax returns and disputes with the IRS over fraudulent activity.

"This is a huge issue," said Ringbauer. "Breaches of personal information are becoming commonplace. The IRS, and we as tax professionals, recommend that our clients get an IP PIN identification number. It's a unique number every year for a taxpayer to file their return. It's very tedious to correct the stolen ID because you need a human person to process it. It can take months, or even years, to correct. The average time right now to correct it is 19 months. When it happens, the taxpayer runs into the problem where they file a legitimate return and they don't have enough funds, or they are expecting a refund and will not get it on time."

2. Deductions and credits

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Taxpayers often claim deductions and credits to reduce their taxable income and lower their tax liability. However, disputes may arise when taxpayers claim deductions or credits that the IRS deems ineligible or unsubstantiated. As society becomes more technologically oriented, deductions such as the one for electric vehicles have become more complex.

1. Accuracy of income reporting

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One of the most common disputes arises from discrepancies in income reporting. Taxpayers may receive income from various sources, including employment, investments and freelance work, and accurately reporting all sources of income is crucial.

Discrepancies in income reporting can lead to IRS audits and potential penalties if not addressed promptly, and since the service may review bank statements, pay stubs and other financial records to verify income sources, taxpayers should be prepared to provide documentation and evidence to support their reported income.