As a former IRS agent, I get called all the time from prospective clients that say that they received a "nasty gram" from the Internal Revenue Service.
Nasty grams come in those manila envelopes that say in the corner, “Department of the Treasury, Internal Revenue Service.” They come in all sizes but will ruin your day.
As you open this letter, a little bit of panic sets in, because you probably know you do not have a green federal check waiting inside the envelope.
What is the surprise inside, instead?
One particular nasty gram that the IRS sends out to millions of taxpayers is under the auspices of its “Matching Program.”
What is the IRS Matching Program?
When a taxpayer earns income, the issuing party will provide them with an IRS form. This may include a Form W2, Form 1099-MISC, Form 1099-DIV, Form 1099-INT, etc.
The key thing to remember is that not only does the taxpayer receive this form, but so does the IRS. Well, at some point in time, the IRS runs “checks” to make sure that the income reported on these forms “matches” what is reported on the tax return.
If there is a mismatch?
Well, let’s just say that the IRS will send you a “love letter” bringing the discrepancy to your attention.
With this program, the IRS scrutinizes income reporting before issuing a taxpayer’s refund. If the IRS finds a mismatch, the IRS freezes the refund and sends a notice to the taxpayer asking for more information to prove their income and withholding.
Unfortunately, taxpayers often forget to include W-2s, 1099s, W2Gs or other income source documents that should have been included with your tax return.
If you fail to make sure all your 1099s, W-2s, you may receive a bill from Internal Revenue Service, because they got notice of them, even if you did not turn it in.
The scary IRS letter is letting you know that they know you failed to report all your income with your federal income tax return. The penalties and interest can be harsh for that error.
The document matching program is a powerful IRS tool for detecting, on a mass scale, taxpayers who under-report or do not report their income. It also provides their auditors with a way of detecting unreported income.
The IRS collects about $5 billion a year through this matching program, and usually nails at least 1.5 million taxpayers through this match.
So what do you do if this happens to you?
Many people just have to take their medicine, and pay the penalties, along with the added interest. They then make sure they do not do that again. Lesson learned.
However, individuals who received 1099 income may also have options to deduct certain legitimate business expenses, which allow them to offset some of that income.
THE KEY TIP: Make sure you include all your income on your tax return, and consult a tax professional on a timely basis, because IRS medicine is no fun.
Michael Sullivan is a former IRS Agent & Teaching Instructor, once an ABC news correspondent in Washington, now affiliated with R3 Accounting, Mr. Sullivan has also contributed to the Bloomberg News and Wall Street Journal.