What to Do When the IRS Makes a Mistake

Question:

I paid the balance due in full of a 2011 business tax debt in May 2013, but the Internal Revenue Service mislabeled the money and used it to offset another debt my company had incurred. The IRS says I still owe, but I don’t understand how or why I’m responsible for repaying them money they lost, due to mistakes within their own system. What to do?

Answer:

Your question is a timely one, given that the IRS announced last week that it is issuing a Taxpayer Bill of Rights, which it will post in its offices and mail out with tax notices. In your situation, a lot depends on whether you designated the payment you sent in to be applied to your 2011 business tax debt. If you specified that the money was for payment of that debt, the IRS was required to apply it according to your instructions, says Scott F. Berger, certified public accountant and principal at Kaufman Rossin in Boca Raton, Fla. “If you didn’t designate it, they will put it where it serves their best interest. And they tend to apply it to things like penalties and interest first,” he says, “so you’re out of luck.”

However, if you did designate it and they misapplied it, there are some avenues you—and additional business owners who want to challenge the tax man—can take.

Give them a call. Maybe all it will take is a friendly chat to get your problem resolved. The toll-free business help line operates from 7 a.m. to 7 p.m. on your local time (Alaska and Hawaii use Pacific time) at 800-829-4933.

Pay them a visit. Chat doesn’t go so well? Drop into a taxpayer assistance center near you. “The wait could be five minutes or several hours,” Berger says. Then he mentions that he uses the practitioner priority line, which won’t be open to you. Maybe this is the time to get a pro involved in your case?

Use the advocate. The Taxpayer Advocate Service is an independent organization, as much as one can be when it actually operates within the IRS. It calls itself “your voice at the IRS” and reminds you—somewhat ominously—that “the worst thing you can do is nothing at all.” There’s no charge for using the service to help resolve your situation. And it turns out that Nina E. Olson, the National Taxpayer Advocate, has been lobbying for the Taxpayer Bill of Rights since 2007.

File an appeal. The Office of Appeals is another independent branch within the IRS. Appeals can be heard face-to-face or over the phone. Berger says he’s had middling success with client appeals: “It depends on what you need them for and what your case is.” A recent small business client, who was audited and assessed tens of thousands of dollars in additional taxes, won his appeal after a process that took several months, he says. The tax agency doesn’t reimburse winners for the cost of the appeal, but they do “sometimes” pay interest on funds they’re ordered to return, Berger notes.

Take it to court. The end of the line is U.S. Tax Court, a place Berger says he “would prefer never to have to go.” It is more formal than the appeals office and, while taxpayers can represent themselves, they are advised to hire attorneys specially licensed to practice there. “It’s used when you’ve exhausted everything else,” Berger says.

You may consider investigating those companies that run commercials promising to resolve your dispute with the IRS, but don’t bother. The Federal Trade Commission calls them fraudsters. They charge upfront fees—a major red flag—and hawk programs that don’t work for most taxpayers,