Don't panic if IRS accuses you of having 'unreported income'

One of the fundamental precepts of our criminal laws is this: You are innocent until proven guilty.

Unfortunately, the opposite is true in tax law. The IRS is presumed to be correct and it is generally our responsibility to prove it wrong. So, if the IRS decides we have unreported income or nondeductible expenses, or penalties and interest are owed, we have to prove it wrong.

I know: It’s hard to believe, but that really is the way it is.

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A common example of the hardship this creates is the Forms 1099 that are sent out every year. Businesses have the responsibility of issuing a Form 1099 to the IRS and to each of us for any taxable income we receive.

The IRS computer will take its copy of that Form 1099 and compare it to your tax return. If they don’t match, then the IRS will send you a notice that you owe additional taxes for this “unreported income.”

Recently, I have had a number of new clients come in complaining that the IRS had set up additional tax liability against them for “unreported income” claimed on an erroneous Form 1099 they received. Invariably, these clients claim they did not receive that income or that amount of income and that this proposed assessment is unfair.

So, exactly how do you prove you did not receive that income? Proving the truth of something is hard enough, but proving a negative — that something didn’t actually happen — is really hard to do.

And worse, keep in mind that all of this is initially being handled by the IRS computer. IRS agents are notorious for not being sympathetic. Let me assure you that the IRS computer is even less sympathetic.

So, there are a couple of ways of handling this. Let’s start out with the fact that in unreported income cases the IRS is no longer presumed to be correct. Instead, the IRS today — because of a court case and a statute — has the burden of producing evidence that you actually received this unreported income.

You read that right. Today, the IRS has the burden of producing evidence that you received this income and that it was taxable.

Further, if the IRS insists upon assessing that tax against you administratively or in court beyond a reasonable period of time, it is quite possible to collect attorney and accounting fees for the time spent doing the job the IRS is supposed to do.

But be careful how you handle this. There is a lot of complexity here. There are statutes that govern the situation and there are a lot of tax court cases that do as well. So, there are a lot of things you don’t want to do that may shift the burden of production back onto you if mishandled.

Folks, the reality is the IRS has issued millions of proposed tax assessments to innocent taxpayers who did not receive the claimed income based solely upon a Form 1099. While the IRS may think this is necessary in order to administer the tax laws, it has generated hundreds of millions of dollars in taxes that were not due.

So, if you receive a notice from the IRS that you have unreported income, don’t panic. Also, don’t represent yourself. Find a good tax lawyer familiar with the federal tax laws on so called “unreported income” to get the right result.

Most of all, don’t be afraid. Fear is the greatest tool the IRS has, and it uses it aggressively.

David Leeper is a board certified federal tax attorney with 40 years of experience. He may be reached at 915-581-8748, davidp@leepertaxlaw.com and leepertaxlaw.com.