Dear Rick:
I have an IRS problem that I need your help with. A few years ago a very dear friend of mine passed away. I was named beneficiary of her IRA. When it came time to do my tax return my tax preparer told me that I did not have to pay tax on the money. I remember at the time him telling me that since this was an inheritance I did not have to pay any taxes. A little over a year later I received a bill from the IRS claiming I owed taxes on the inheritance. At the time they also hit me with a penalty and interest. I took the letter to my preparer and he told me the IRS was wrong and that I should ignore it, which I did. Over the next year or so I received a number of letters from the IRS and I always turned them over to my preparer who assured me that I can ignore the letters. A few weeks ago I was notified by my bank that the IRS had taken money from my account. I contacted my tax preparer but he has ignored my calls. I did contact the IRS and in so many words they told me that the case is closed. They took from my bank account not only taxes but also interest and penalties. I am livid about the situation but I don’t know what I can do. My question to you is do you think I should hire an attorney to try to get the money back from the IRS?
Barb

Dear Barb:
I definitely think it makes sense to sit down with an attorney to discuss your situation. However, I don’t think the focus of the attorney should be on the IRS but rather, on your tax preparer. I believe you received incredibly bad advice from your tax preparer and it seems to me that he has some responsibility for your situation.

First, it is clear that your inheritance is taxable to you. Your tax preparer is generally correct in that inheritances are not subject to tax; however, the exception of the rule applies to things such as a 401(k) and IRA. When you inherit a traditional 401(k) or IRA, the entire amount you receive is subject to taxes at your ordinary income bracket. If the money you inherited was in a Roth 401(k) or Roth IRA, the amount you receive would not be subject to taxes. However, since this was a traditional IRA the money is taxed to you.

With regard to the IRS, they are correct when it comes to your tax liability. It is clear that the inheritance is subject to tax; however, there is an issue of penalties. The IRS has wide discretion as to the type of penalties assessed and if penalties are assessed at all. Therefore, it is possible that the IRS would waive the penalty in your situation. Unfortunately, you are fighting an uphill battle because the IRS has already taken your money. It is much more difficult to deal with the IRS when they have your money as opposed to you owing them. That being said, I believe at a minimum your tax preparer should refund to you the amount you paid in penalties. Without question, your preparer gave you bad advice and thus, should be responsible for the penalty that you incurred because of that bad advice.

The tax preparer gave bad advice when it came to how the inheritance is taxed. The tax issue at hand is not complex and thus, the preparer should have been more informed of the law. That being said, the advice to ignore the IRS was horrible advice. Even though over half the notices the IRS sends out are incorrect, you cannot ignore them. When the IRS sends you a letter, whether they’re right or not doesn’t matter; you must respond. If you don’t respond, trust me, the IRS will not go away, and resolving any tax difficulty you have will only be more difficult.

Good luck!

If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com.