Tips for Handling IRS Notices & Exams
here for our IRS exam services.)
Recently the IRS has been making life more difficult for traders. In
2009, it announced major new tax-exam programs on the upper income. “Upper
income” is defined as those making more than $250,000 per year.
Those making more than $1 million per year face even more scrutiny.
The IRS has indicated more audits are coming. It’s facing more pressure
than in prior decades to “close the tax gap” and improve taxpayer
compliance. Plus, advanced new IRS computer systems seem trigger-happy
these days, sending out tax notices left and right, especially on Schedule
C (used by sole proprietors). These mini tax exams are stressful, costly
Many traders pushed the envelope on qualifying for trader tax status and
using tax treatment elections they were not entitled to, like Section
475 MTM ordinary loss treatment. The IRS busted these taxpayers, and the
traders wouldn’t accept huge tax bills so they proceeded recklessly
into tax court. As expected, they lost their weak cases and set a bad
precedent for other traders. (One such case that comes to mind this past
year is Richard Kay, Jr. v. Commissioner, TC Memo 2011-159.)
We hope more traders assess trader tax status properly. Don’t play
the audit lottery by trying to cheat the IRS and your state on tax treatment.
This gives the trading industry a bad name and makes our job more difficult.
If you have trouble with the IRS or your state, please consult with us,
and if you can’t afford us, maybe TradersAdvocacy.org can help.
One of our competitors has caused our industry a lot of damage. They told
traders who don’t qualify for trader tax status they could deduct
large amounts spent on education. In one case recently, we heard they
told a trader to deduct $30,000 and the trader only had five trades during
the year, even though a business trader needs closer to 500 round-turn
trades per year! Education expense is clearly disallowed as an investment
expense under Section 274(h)(7) and a dual-entity scheme cannot fix this
problem either. Be very wary of trader tax advisers that are not CPA firms
(the firm I mentioned is not a CPA firm). If you work with a bad-apple
firm, watch out because the IRS may bust them and ask for their client
The IRS also announced closer examination of pass-through entities, C-Corps,
global businesses (on transfer pricing) and foreign offshore accounts.
In 2013, the IRS announced several high-profile prosecutions of U.S. residents
and offshore banks who allegedly conspired to evade U.S. taxes.
IRS COST-BASIS REPORTING
The big news for 2011 and 2012 is new IRS rules for cost-basis reporting
from securities brokers. Congress and the IRS felt compliance was very
lacking on taxpayers and brokers reporting trading gains and losses for
securities, and they wanted brokers to report cost-basis and holding period
information, designating short-term vs. long-term capital gains and losses.
Taxpayers are forced to deal with a challenging new tax form 8949, which
captures the beefed-up Form 1099-B cost-basis and holding period information.
We expect many taxpayers and brokers will make errors on Form 8949 and
1099-Bs and key reconciliations — the purpose of Form 8949 —
will be off. That will invite IRS tax notices and perhaps tax exams. Random
tax notices will likely occur to measure compliance with the new rules.
See “The cost-basis saga continues” for more about problems
on Form 8949.
TAX NOTICES AND EXAMS
If the IRS or your state’s department of revenue contacts you with
questions or a notice of tax due, or to schedule an exam, don’t
panic or reply on your own. Consult a trader tax professional and proceed
under this person’s advice, either representing yourself (the inexpensive
approach) or by engaging the expert as your tax representative, with power
of attorney. Your direction should depend upon your financial resources
and the complexity of your case.
EXAMS, APPEALS, AND TAX COURT
If you have a difficult agent and supervisor in the exam process who refuse
to understand the nuances of trader tax, it’s often wise to “agree
to disagree” at the exam level and take your case to the next level
— the appeals process.
The last resort is tax court — often an expensive and more grueling
process than a tax exam. If you go to tax court, you must show you acted
in one manner or another contemporaneously and that you didn’t change
your position in hindsight, which costs the IRS a lot of money.
This is an excerpt from chapter 10 in Green’s
2013 Trader Tax Guide
• Copyright © 2013