Math Is Hard, IRS Addition

This time I couldn’t resist.

A client received an IRS CP2000 notice. This is an Automated Underreporting Unit (AUR) notice, designed to look for things such as matching errors. In this case, a client didn’t include his dividend income on his tax return. He was guilty as charged and was prepared to pay the tax due, but he ran the notice by me. The notice correctly noted that the ordinary dividend income from his brokerage hadn’t been included, but it said that the qualified dividends had been included.

Think about that for the moment if you’re a tax nerd. How can you have qualified dividends without having ordinary dividends?

For those of you who aren’t tax nerds or who haven’t figured this out, qualified dividends are a subset of ordinary dividends. The total of qualified dividends cannot exceed the total of ordinary dividends. If ordinary dividends are zero, qualified dividends must be zero, too.

So this IRS notice was wrong–I’m not sure if it’s a programming error (a systemic error) or not, but there were two other issues with this notice (both of which I expected). Somehow the notice ignored the one stock trade my client had. Could it be because my client lost money so that would decrease his tax? I’m sure my cynicism is misplaced, right? The client also paid foreign tax on his dividends; that, too, was left off the notice.

Does my client owe some additional tax? Absolutely. However, he owes about one-third less than what the IRS alleges, mostly because the IRS notice is plain wrong regarding qualified dividends.

To my clients and anyone else who receives an IRS notice: IRS statistics show that two-thirds of IRS notices are wrong in whole or in part. Do not blindly pay the notice without checking with your tax professional to see if the notice is accurate unless you like paying tax you don’t owe.


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