When the IRS Says You Owe More

So you filed your annual return some time ago, but you receive a letter from the IRS stating you owe additional taxes. Not a happy thought! The IRS can adjust your federal return for a variety of reasons and assess additional taxes. Perhaps your employer made a mistake on your W-2 statement and issued a new one with different numbers. Maybe there was investment income you forgot to report. You may have computed your tax liability incorrectly when you prepared and filed your tax return. Or you faced a dreaded federal tax audit and the Internal Revenue Service deemed some of your itemized deductions as non-deductible or you did not have adequate proof (most likely the receipts) to show you spent the money for the deductions you claimed.

The IRS catches up with you sooner or later, adjusts your income and demands additional tax payments, interest and penalties. When you receive an IRS notice demanding additional tax, do not pay until you are sure your liability was computed correctly. The IRS may not be seeing the “whole picture.” Additional details provided by you or your tax professional may result in lower federal taxes owed. Once you have determined the correct amount of additional taxes owed, the IRS agrees with you, and you’ve paid the additional tax or worked out a payment plan for it, your work is not finished.

Uncle Sam’s counterpart at the state level will need to know about the changes to your federal return if it has an effect on your state tax liability, anywhere from 30 days to one year (depending on the state) after your federal return adjustments have been finalized. If the federal changes have no effect on your state tax return, you do not need to report the changes to the state. But if your total income or a deduction permitted at both the state and federal levels were changed by a federal audit or determination, you will need to prepare and file an amended state return to reflect these changes. Many people forget to do this and as a result, end up receiving a notice from the state automatically assessing additional taxes, interest and penalties. The interest accrues from the original filing deadline of the return, and can accrue over a period as long as five years. Even though most states cannot assess additional tax more than three years after a return has been filed, most states can assess additional taxes two years after the taxable income on your federal return has been changed and finalized by the IRS.

Of course, don’t forget that if you (or, on a rare occasion, the IRS), found an error on your federal return that overstated your federal tax liability and chose to file an amended return to get a refund, you can also file an amended state return to reflect the federal changes and get a state tax refund as well. The state tax refund will typically be considerably less than the federal refund and may not be worth the effort and/or tax professional’s fees. So decide if the additional refund from state taxes is worth the added costs of filing. The state, of course, will not have a problem keeping the extra money and you will not be obligated to file an amended return in that circumstance.

While simple changes do not always require a tax professional’s services, amended state tax returns can be tricky, cannot be filed electronically and will likely require copies of certain federal forms to properly complete the filings. Depending on how complicated the changes to your taxable income are, you may wish to have a tax professional prepare your amended state return filing.