Over-Taxed???

Every Thursday we will look at a unique situation that has come across my desk during the week. This week we will look at a situation where a customer believed he was being over taxed. Now I realize this is not all together a surprising circumstance. There are lots of people who believe this to be the case in their own situations from time to time. This case however covers a specific circumstance.

This was a client who runs a business as a sole proprietor which is simply a small one man operation. His net income on the business is only about $20,000 on an average year. He received a notice from the IRS making him aware that he owed almost $18,000 in taxes for one tax year. He was a little confused at how he could owe so much tax on such a small income. There may be a lot of people who have experienced this and wondered the same thing. Well, here is how this occurred.

This particular customer operated his business for almost 6 years without filing a single tax return. The companies he did business for, however, filed 1099 forms with the IRS for work completed throughout the year. After several years of 1099's filed on my client without a single tax return filed, the IRS opted to complete a "Substitute for Return" on his behalf. The IRS can choose to file this type of return in lieu of an actual return being filed by the taxpayer. Typically, these are filed about three years after the due date of the unfiled return. The drawback to this type of return is that the IRS will file the income straight from the 1099 income (or W-2 income) filed with the IRS without any cosideration of tax write-offs for business expenses or other income credits such as child credits or mortgage interest which are allowed by law. This would leave the taxpayer paying taxes on total gross receipts rather than net income. For this particular client his gross receipts were over $60,000 even though he only would have claimed $20,000 in income after all of his deductions. Due to taxes, penalties and interest his total debt is $18,000 but this amount can be reduced by simply filing a return for the year in question thus enabling the taxpayer to file the appropriate deductions and only pay tax on the adjusted net income.

So make sure you file your taxes timely each year to avoid such a return being filed on your behalf. This will keep you in good graces with the IRS and eleviate the stress of being "over-taxed."