Florida Law
Florida Tax Law: Individual
Tax Law: Individual
State taxes in Florida are among the lowest in the nation. In fact, a recent survey shows that only residents in Alaska, Wyoming and Nevada pay less state taxes than Floridians. The reason for the low tax rate is simple: Florida has no state income tax. Instead, Florida depends upon sales and use taxes generated, in large part, by the state's enormous tourism industry. Because of Florida's low tax rate, most of the tax issues that Florida consumers face do not concern the state's Department of Revenue, but its larger, federal counterpart, the Internal Revenue Service (IRS). The purpose of this chapter is to provide an overview of federal income tax law and explain how consumers can manage disputes with the IRS.
The Federal Income Tax System
The federal tax on income was born in 1913, after ratification
of the Sixteenth Amendment to the Constitution, giving
Congress the power to tax incomes from whatever source
derived. The Internal Revenue Code, which is about
the size of Miami's telephone directory, is the principal
source of federal tax law and the IRS, a branch of
the Department of Treasury, is the agency responsible
for income tax collection.
Since tax law permeates virtually every financial transaction we make, it would be nice if the laws were simple, clear and easy to understand. Unfortunately, the present federal tax system has none of these characteristics. Many tax laws are unclear from the time they are written. Often, writing tax legislation involves so much compromise and redrafting that by the time a tax bill becomes law, even its author and sponsors do not fully understand what they have created. Other tax laws might be perfectly clear as written, but it may be difficult to know how to apply the laws to a particular taxpayer. And, different courts in different jurisdictions can apply the same law to similar fact situations and reach completely different interpretations, each interpretation valid in that particular jurisdiction.
All this complexity, and the fact that most people would rather not part with their money, may dissuade taxpayers from paying their fair share. This is not recommended. Tax evasion is severely punished under federal law. And why take the risk when there are many ways to legally to reduce the amount of income tax paid? There are legions of accountants and tax preparation services ready to assist consumers in legally limiting their tax liability. There is nothing wrong with taking advantage of loopholes in the tax code or investing in tax shelters.
IRS Audit
The IRS audits approximately one and one-half million
income tax returns annually. Receiving an audit letter
from the IRS is not an indication that a person necessarily
did something wrong. A person's return may simply be
unclear or contain an inadvertent error. If you are
audited, it is best to gather the requisite receipts
and other documents and be cooperative. IRS employees
know their task is not a popular one and they do not
try to aggravate taxpayers on purpose. They, too, struggle
with a huge bureaucracy and must make do with outdated
computers and a complex tax code with many gray areas
of law.
Who Is Audited
It used to be that the IRS had three methods for selecting
which returns to audit: the two mentioned below and
random selection. Since any tax return could potentially
be audited, the random selection method helped to ensure
voluntary compliance with the tax code. In 1995, however,
due to budget constraints and frequent complaints by
selected taxpayers, the IRS did away with the random
selection method. Today, audit selection is the result
of either of the two following methods.
The first method is a computerized process whereby the IRS separates returns that it believes may contain errors or be fraudulent. The computer program is fine-tuned each year based on the experience the IRS gains from applying the tax code. Most of the returns selected this way have some unusual characteristic that raises a red flag for auditors. For example, if the IRS determines that many taxpayers claiming exceptionally large deductions for entertainment expenses are trying to defraud the government, the computer can be programmed to separate out returns with unusually large entertainment deductions.
An important point to know about this method of selecting returns is that it is completely impersonalany return raising a particular red flag is tagged by the computer. Thus, if a taxpayer has an unusual circumstance that gives him or her an unusually large, yet legitimate, deduction, the computer will select the return for audit every year. IRS auditors try to avoid repeat examinations for the same issue. Thus, if the IRS examined a taxpayer's return for the same issue in either of the previous two years and found in favor of the taxpayer, the taxpayer should call this to the attention of the IRS. Often in these cases, the audit is terminated without further investigation.
The second method for selecting returns for audit compares information provided by the taxpayer with information from other sources. For example, if someone reports less income on his or her return than is reported on the W-2 form provided by the taxpayer's employer, the IRS can seek to clarify the discrepancy.
Audit Process
The audit process begins as soon as the taxpayer receives
a letter from the IRS stating that his or her return
has been selected for further examination. The audit
may be done entirely by mail if the IRS has only a
few questions, or the audit may be held at an IRS office
or at the taxpayer's home or business if the IRS has
more substantial questions. The taxpayer can request
that the audit interview be transferred to another
IRS district if a different location is more convenient
for the taxpayer.
Time Limits
Under normal circumstances, the IRS cannot audit tax
returns filed more than three years ago. For example,
the deadline for the IRS to audit a 1995 tax return,
filed at the latest on April 15, 1996, is April 15,
1999. Under certain circumstances, the three-year limit
is extended. The IRS can demand records as far back
as six years if an audit reveals that the amount of
income the taxpayer failed to report on his or her
latest return is in excess of 25 percent of actual
income. Also, the IRS is under no time limitation regarding
a taxpayer who fails to file a return or deliberately
files a false or fraudulent return.
Records
IRS auditors almost always want to see financial records
that relate to the return they are examining. This
raises a commonly asked question: How long does a taxpayer
need to keep records relating to income tax filings?
The answer is generally three-and-a-half years because
after that time, the IRS typically cannot audit the
taxpayer. A taxpayer should keep financial documents
longer than three-and-a-half years if they might affect
any future returns. Thus, a person should keep records
of any stocks purchased until they are sold, because
only then can profit or loss be determined and reported
on the next income tax return.
Taxpayer Rights in an IRS Audit
Some taxpayers claim they are made to feel like criminals
in IRS audits. Unfortunately, this is understandable.
Criminals actually receive more procedural safeguards
in the court system than taxpayers do in the audit
process. Unlike a criminal trial where a defendant
is presumed innocent until proven guilty, in an IRS
audit the taxpayer must prove to the IRS's satisfaction
that the information on a return is correct and legal.
For example, if the IRS questions a deduction for business-related
travel expenses, the IRS does not have to show that
the travel was entirely for pleasure or that the taxpayer
never traveled during the year of the return. The burden
is on the taxpayer to show that he or she really did
incur the amount of travel expenses claimed. If he
or she cannot document the expenses, the IRS can disallow
the deduction without offering any evidence at all.
Fortunately, a person has the right to ask the IRS to cancel a penalty if he or she can show his or her actions were the result of bad advice from the IRS. Thus, if someone pays less tax than owed, and the IRS discovers and penalizes the taxpayer for it, the taxpayer might have the fine canceled if he or she reasonably followed IRS advice in calculating taxes. The first step in proving that erroneous advice from the IRS caused a mistake is to document what an IRS employee said in person, over the telephone, or by letter. It is important to write down any tax advice received over the telephone or in person. Remember to note the time, the date and the name of the IRS employee giving the advice.
Next, the taxpayer must show that it was reasonable for him or her to rely on the advice provided by the IRS. Someone merely saying what the taxpayer wants to hear is not sufficient reason for the taxpayer to rely on that information; reliance must be reasonable. Determining reasonableness is tricky, but the taxpayer should be aware that if a piece of advice seems too good to be true, it may not be true. If a reasonable person would seek a second opinion, then the taxpayer should also seek another opinion. Although the IRS may cancel a penalty for relying on bad advice, it is not obligated to cancel the interest accumulated on any additional tax the taxpayer may owe.
During the audit, the taxpayer only has to answer those questions the auditor asks. The taxpayer should not commit perjury, but he or she does not have to make the auditor's job easier by volunteering damaging information. If the taxpayer is instructed by the IRS to make documents available during an audit, it is best to have all these documents available for inspection in an organized and logical manner. During an audit conducted at home or at a place of business, called a field audit by the IRS, the taxpayer does not have to give the auditor access to a copying machine or allow the auditor to take original documents back to IRS offices. The taxpayer should, however, make copies of the documents that the auditor specifically requests and make a note of which documents the auditor receives copies of. If an audit is by mail, the taxpayer should send to the IRS only copies of those items specifically requested. Documentation should always be sent to the IRS via certified mail with a return receipt requested.
Many taxpayers are concerned about the privacy of information they provide on a tax return or in an audit. The government is obligated to respect the confidentiality of information a taxpayer provides in the tax collection process, and anyone who prepares a return or represents the taxpayer is also obligated to respect the client's privacy. In limited circumstances, the IRS is allowed to share some taxpayer information with state tax agencies, the Department of Justice or other federal agencies. During an audit or at any time the IRS asks for information, the taxpayer has the right to know why the agency wants the information, how the information will be used and what may happen if the taxpayer chooses not to provide the information.
The taxpayer has the right to take someone along to an IRS audit interview. This could be an attorney, a certified public accountant, the person who filled out the tax forms or an enrolled agent. Another person may represent the taxpayer in his or her absence during an audit interview, as long as the taxpayer files with the IRS a power of attorney form or a similar document.
The taxpayer has the right to tape record the audit interview. To do so, the taxpayer must inform the IRS in writing at least 10 days in advance of the interview and must supply the tape recorder. If the IRS decides to tape record an interview, it must inform the taxpayer at least 10 days in advance. The taxpayer has a right to a copy of the IRS tape, but must pay for the copying expenses.
If, at any point in the appeals process, the taxpayer feels that the proceeding is not going well, he or she always has three options. First, the taxpayer can agree with the IRS, pay additional taxes and vow to be more careful when filing future tax returns. Second, the taxpayer can ask the IRS for a notice of deficiency and take the case to a federal tax court. Third, the taxpayer can pay the disputed amount, file a claim for a refund and then take the case to the federal district court, the federal tax court or the federal claims court.
Result of an Audit
A minority of taxpayers who are audited receive from
the IRS a no-change report, a letter stating that the
IRS accepts an audited return without changes. Only
about 30 percent of the people audited get a no-change
letter. In even rarer situations, the IRS owes the
taxpayer money after an audit. However, in most cases,
the IRS determines that the taxpayer owes more money.
If the taxpayer owes more money, the IRS sends the taxpayer a 30-day letter and a copy of the audit report outlining the additional taxes owed. If the taxpayer agrees to the changes detailed in the audit report, he or she can sign the enclosed form and return it within 30 days to the IRS with a check. If the taxpayer sends a signed form back without a check, the IRS sends the taxpayer a bill, which must be paid within 10 days. Either way, the taxpayer pays interest on the extra tax, calculated from the due date of the audited return to the billing date.
Another option outlined in the 30-day letter is the IRS's internal appeals process which can be initiated by submitting a written protest within 30 days to the IRS requesting a conference with an appeals officer. If the amount of the additional tax is less than $2,500, the protest does not need to be in written form.
If the taxpayer ignores the 30-day letter, the IRS sends a notice of deficiency, sometimes called a 90-day letter, because it notifies the taxpayer that he or she has 90 days to either settle the matter with the IRS or to file suit in one of three federal courts.
Appealing an Audit
If a taxpayer disputes the results of an audit, he or
she can appeal the auditor's decision to a regional
IRS appeals office or directly to a federal court.
The IRS internal process is relatively straightforward
and generally less expensive and time-consuming than
going to court. If taxpayers go to federal court and
win there, they can sometimes recover from the IRS
some or all of their administrative and litigation
costs, but only if they first use the IRS appeals process.
Appealing Within the IRS A taxpayer can start the IRS appeals process by requesting a conference through the IRS's local district director. The district director then arranges a meeting with one of the IRS's appeals officers, located in most major cities. The request for an appeals conference should state the exact elements in the auditor's report with which the taxpayer disagrees, the elements of tax law that support the taxpayer's case, and any facts that support the taxpayer's position.
As in any dealings with the IRS, the taxpayer can be represented or advised by an attorney during the appeals conference and can bring along witnesses to support statements of facts. These conferences are informal, and they represent a last chance to resolve a dispute before going to court. There is no guarantee of what will happen, but quite often the IRS officers make some concessions at this point in order to avoid going to court.
Going to Court
If a taxpayer decides that the IRS's decision is unfair,
unjust or unreasonable, he or she can take the dispute
to one of three federal courts, all of which operate
independently of the IRS. Deciding whether to file
suit in tax court, claims court or district court depends
on a number of legal and personal factors. Each court
is guided by the previous cases that it has decided.
As a result, a taxpayer's odds of success may be better
in one court than in another. Most cases, no matter
which court first hears them, can ultimately be appealed
to the U.S. Supreme Court.
A taxpayer may go to any one of the three courts without first going through the IRS appeals process, but quite often a tax court judge will not hear a case unless it has been considered for settlement by a regional IRS appeals office. If a taxpayer goes to tax court without first going through the IRS appeals process and loses his or her court case, the tax court judge may fine the taxpayer up to $5,000 if the judge determines that the lawsuit was a tactic to delay paying the IRS or that the suit was otherwise frivolous. In all three courts, the taxpayer has the burden of proving that the IRS is wrong. In other words, the court assumes that the IRS has correctly interpreted the tax laws as they apply to a case, and the taxpayer does not win unless he or she convinces the court otherwise.
U.S. Tax Court
Tax court hears only tax cases. To go to tax court,
a taxpayer need not pay the disputed tax amount first,
unlike the other two courts which require a taxpayer
to pay the disputed amount before filing suit. In tax
court, the taxpayer does not have a right to a trial
by jury; cases are heard by a judge who is experienced
in tax law, rather than by a group of peers who might
be swayed by emotion. If a taxpayer wants to take a
case to tax court, he or she must file suit within
90 days of the IRS having mailed a notice of deficiency
to the taxpayer's last known address. In general, tax
court rules are less strict than those used in the
claims or district courts.
If a dispute with the IRS is for an amount under $10,000, the taxpayer can go through the tax court's small tax case procedure, which is generally quicker and even less formal than the court's standard procedure. However, the decision of a judge who hears cases under the small tax case procedure is final, so if a taxpayer chooses this procedure, he or she loses the right to appeal the court's decision. Because the taxpayer does not need to be represented by an attorney in this procedure, it may be a good option in a dispute regarding smaller dollar amounts in which any money won would most likely only cover attorneys' fees.
Finally, a taxpayer should be aware of what is often called the tax court trap, which describes the ability of the IRS to impose even more fines based on any new information that it discovers about the taxpayer during a tax court proceeding.
Tax court is largely the most popular route for taxpayers because it does not require that the disputed tax be paid first. But tax court can also be an unsuccessful route. IRS statistics show that only about five percent of the taxpayers who bring their cases in tax court win. The taxpayer success rate in the other two courts, however, is only marginally better at about 11 percent.
U.S. District Court
Of the three courts that hear taxpayer disputes with
the IRS, only in federal district court is there a
right to a trial by jury. To bring suit in district
court, the taxpayer must first pay the disputed tax
to the IRS and then claim a refund for that amount
by filing the proper form with the IRS. If the IRS
denies the refund request, the taxpayer can sue the
IRS in district court. The taxpayer can sue for any
amount of refund in district court, no matter how small.
However, because the taxpayer is usually represented
by an attorney in district court, going to district
court may make sense only for larger monetary disputes.
If the IRS does not make a decision on a refund claim within six months, the taxpayer can file suit in district court. The taxpayer has up to two years after the IRS rejects a refund claim in which to file suit in district court.
U.S. Claims Court
The federal claims court follows the same rules as the
district court regarding filing lawsuits for refunds
from the IRS. A taxpayer must first pay the disputed
amount and then file a lawsuit in claims court for
a refund of that amount. There is no minimum limit
to the amount of a refund claim that can be litigated
in claims court. However, the taxpayer cannot file
suit in claims court if the claim is for a refund of
a penalty relating to tax shelter abuse. Also, a taxpayer
cannot file suit in claims court to recover a penalty
assessed by the IRS for fraudulently preparing someone
else's tax return.
Resources
The IRS's toll-free help line for general information
about IRS procedures and services is (800) 829-1040.
To check on the status of the current year's refund
or to listen to recorded tax information on approximately
140 topics, call (800) 829-4477.
Your Rights as a Taxpayer (Publication 1). One of many free publications from the IRS that can be obtained by calling (800) TAX-FORM or (800) 829-3676; see also Examination of Returns, Appeal Rights and Claims for Refund (Publication 556) and Your Federal Income Tax (For Individuals) (Publication 17).
For state tax questions, the Florida Department of Revenue can be reached at (904) 488-6800.
How to Cope with the IRS, Randy Bruce Blaustein, Esq., Retirement Living Publishing Co., New York, NY, 1991.
Keys to Surviving a Tax Audit, D. Lawrence Crumbley and Jack P. Friedman, Barron's, New York, NY, 1991.
Tax Procedure and Tax Fraud in a Nutshell, Patricia T. Morgan, West Publishing Co., St. Paul, MN, 1990.