A cautionary tale about tax scams and erroneous claims for refund

September 24, 2015 by Diane Potter
Crime scene tape and magnifying glass over 1040 tax forms

There are a number of tax scams out there that can get you into big trouble. But tax nightmares aren’t just for scammers. They can happen to people who make seemingly innocent mistakes, and even to those who believe they are doing the right thing. This is a story about a taxpayer – let’s call him Abe –  who filed an amended return to claim a tax credit and ended up with an IRS penalty of $21,708.60.

It all began when Abe found himself subject to the Alternative Minimum Tax (AMT) to the tune of $3,181. A year or so later he heard something about the AMT Credit (Form 8801, Credit for Prior Year Minimum Tax) and remembered that he had paid the AMT tax in a previous year. The AMT Credit is quite complicated, but Abe did not seek any advice from anyone about how the credit worked or if he qualified for it before he amended his tax return in an attempt to claim it.  And when he filled out the form for the amended return, he transferred the wrong information to Form 8801, which resulted in a refund of over $108,000 − more money than he makes in a year!

Most people would wonder about a refund of that amount, but Abe mistakenly believed he was entitled to it. And since the IRS did not issue the refund to him in a timely manner, Abe contacted the Taxpayer Advocate’s office seeking their assistance. But instead of helping him get his refund faster, the call resulted in Abe’s amended tax return getting audited.

IRS Revenue Agents tend to be tough, but when he learned what the problem was the examiner who reviewed Abe’s case said he was willing to close the audit with no refund for Abe and no amount due from him either. But before he could do that he said he had to run it by his manager.  That’s when the erroneous refund claim penalty (IRC 6676) reared its ugly head.

The Internal Revenue Code states that the erroneous refund penalty may be imposed unless the taxpayer can show “reasonable basis” for the refund claim. “Reasonable basis” means that you have “substantial authority,” which generally means that you have a solid legal basis for your tax position. This is what the Revenue Agent’s manager was looking for when he requested that Abe provide a good reason why the penalty should not be imposed.

Even though Abe was the one who had entered the information on the amended tax return form, he blamed his tax software for the error. He was unable to produce any other explanation as to why he had filed this amended return that could convince the examiner’s manager to abate the penalty. The final outcome was that the IRS imposed the IRC 6676 penalty of more than 21K.

The moral of the story is this:  if you are unsure about something on your tax return – especially if something seems too good to be true – investigate further or seek out professional advice. It could save you from a terrible tax outcome and many nights of nightmares.


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