A number of factors have contributed to day to day communications with the Internal Revenue Service becoming less than satisfactory.

Electronic Filing

Because of the early January 2013 changes to the 2012 tax law, the Internal Revenue Service (IRS) was unable to accept electronic filing until February 1, 2013. As the IRS requires all tax preparers who prepare more than 11 tax returns to efile, this caused many small tax preparation firms to have a backlog of returns waiting to be efiled.  In its wisdom, the IRS also reminded practitioners that they could incur a penalty for stockpiling returns and not promptly filing them. The IRS had no comment when asked if preparers then had to not prepare returns until the IRS was ready to accept them. As of today, the IRS will still not accept returns that contain certain forms and will not do so until early March.

Proof of Mailing

You cannot be careful enough to have proof that your return was timely filed. Last October we sent a 2011 tax return to the IRS via certified mail with return receipt attached. Inside the envelope was a letter requesting the IRS to time stamp a copy of the letter confirming receipt and to return in a stamped addressed envelope attached to the letter. A check for the tax due was stapled to the return. The signed return receipt came back in a week or so and the check was cashed the following week. But the letter was not returned until two months later bearing a December 22 post mark. In January 2013 the client received a letter from the IRS asking if they were going to file for a 2011 tax refund.

A reflex reaction followed and we received an email asking why we had messed up the return.  A review indicated that the return was correctly prepared. The client called the IRS (we cannot do so without Power of Attorney that can take 2 to 8 weeks for the IRS to process) and was told that their 2011 tax return had never been filed. The return was subsequently re-filed with the prior proof of mailing and the client then received a penalty notice for failure to timely file. This will all be worked out, but it will take hours to do so.

Who Has Your Tax File? Answer- No One

There is a misconception that once you receive a notice from the IRS that you can speak to a person who has your file on their desk, eager and ready to assist. Obviously a myth. When you call the 800 number you reach one of several service centers scattered around the U.S. and a computer sends your call to the first available agent. The person you speak to have a knowledge base limited to what is on the monitor in front of them. If some of your documents were not scanned, they do not know that. And why did you get a notice? There is likely a pre-programmed note on their monitor summarizing why. Can you speak to a person who actually looked at your return? No. The person to whom you’re speaking can likely identify the group and office that has your return, but either cannot or will not give you a name and number to call. So you are left with the task of writing the IRS a letter and they then have 60 days to then respond. It has been taking 6 to 12 months to rectify errors such as noted above.

Are You A Bermuda National With A U.S. Stock Broker and Foreign Stocks in Your Portfolio?

If yes, you are likely having too much income tax withheld. With respect to the payment of dividends a U.S. person will receive a Form 1099 and a foreign national a Form 1042-S. U.S. citizens are not subject to withholding on dividends if they have completed a Form W-9 and a foreign national is subject to a 30% withholding tax (or lower treaty rate) if they filed a Form W-8-BEN. What happens if a withholding error is made when the broker is producing Form 1099 or Form 1042-S? For example, suppose you are due a $1,000 dividend from a U.S. company. The U.S. broker is supposed to withhold $300 and send you $700. If they send you $1,000 in error, when the error is caught they still must send the IRS $300 and pay a penalty of 100% or $300 for failure to properly withhold. Because of the significant penalty, when in doubt, they appear to over withhold and leave it to the investor to file a U.S. tax return and get the money back.

Common Errors

The most common error we see is on Form 1042-S. If you have a portfolio that contains US stock and Foreign stocks you are only subject to withholding tax on dividends from a U.S. company. On review, we have found a tendency for there to be a 30% withholding tax on all your dividends. But as dividends are shown on Form 1042-S as one total it is incumbent upon the investor to request a detailed list of all dividends received and then to multiply the U.S. dividend by 30% and then compare this amount to the actual withholding. Will your broker return the erroneous withholding or pay for tax return preparation to get the over withholding back. Doubtful.

The other common error is for the broker to provide a foreign national with a Form 1099 with a 30% withholding. This is lethal if some or all the dividends are foreign source not subject to U.S. income tax. Foreign national U.S. tax identification numbers usually start with a 9 and sometimes with zero. US citizens and resident alien’s social security numbers start with 2 to 8 with some zeros. If the IRS receives a Form 1099 with a social security number beginning with 2 to 8 their computers seemingly label the person a U.S. citizen or resident and it will likely take multiple letters to obtain a refund of the tax over withheld.

IRS Knowledge of the Tax Law

We recently had as a client a Bermuda national who resided in the U.S. for a number of years, who had a Social Security number, an old U.S. friend as a broker and a portfolio of all foreign stocks. The broker issued our client a Form 1099 (in error) but also withheld $xx,xxx (in error). We filed a U.S. nonresident tax return for the client asking for a $xx,xxx refund. Months later the client received $xxx refund with a notice that additional tax was due.

One Power of Attorney, 3 letters to the IRS and 6 months later a letter was received indicating that additional tax was due “because there is no tax treaty between the United States and Bermuda.” Totally nonsensical. But the letter said to call an 866 number and anyone could answer a question. A 30 minute wait and a cheerful voiced asked how could they help. We asked them to explain to us why a Bermuda national who lives in Bermuda is subject to U.S. income tax on a dividend that the person received from a Bermuda company. They repeated what was on their monitor, “because there is no tax treaty between the United States and Bermuda.” When we stated that there was in fact a tax treaty between the 2 countries (though irrelevant to this situation) we were met with stunned silence. When we asked for an explanation we were told that they were not trained to answer questions and to write to the IRS. We asked for a return call from a supervisor.

A once in 10 year phenomena occurred and we were called back by the group supervisor. We indicated that whether or not a tax treaty existed between the United States and Bermuda was irrelevant and that Code Sections 872 and 871 were applicable. We again asked for an explanation as to why a Bermuda national who lives in Bermuda is subject to U.S. income tax on a dividend that the person received from a Bermuda company and now were told that it was because it was on Form 1099. We asked the person if they were familiar with Section 872 that states in part that a foreign person is only subject to U.S income tax on U.S. source income. The person then asked why we kept referring to Code Sections. As nicely as possible, we explained that the reference was to the Internal Revenue Code and requested that they open their copy so we could read it together. The person did not have one, was unsure if there was one in the office, had obviously not heard of it, yet alone used it as a reference guide. We were then requested to make a copy of the relevant Internal Code Sections and also pages from IRS publications (much simpler to read and understand) and fax them to the IRS.

The client will get the refund, but over 5 hours of time was spent in communicating with IRS personnel who clearly had no understanding of the tax law.

Pursuant to the requirements relating to practice before the Internal Revenue Service, any tax advice in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the United States Internal Revenue Code, or (ii) promoting, marketing or recommending to another person any tax related manner.