Score One For The Little Guy.

monopoly income tax dice
(Guest Post by fellow reader Grant)

Six months ago the tax man came looking for $7,000 and change and this week he left, empty-handed. What’s the story? It’s a good one, but one that gives a valuable lesson when dealing with state governments and requests for money from tax returns long ago.

In July I received a letter from the state of Alabama, a state in which I once lived, stating that through an audit they’d discovered I hadn’t paid income taxes for 2005 and 2006. My bill with penalties and interest? More than $7,000.

Shock, anger, sadness and dread washed over me. Where does one magically come up with $7,000 as a newlywed, fresh from a honeymoon and having already paid Uncle Sam $1,900 the year before?

A Little Background

A little background on this story. After graduating college in 2004, I took a job working as an independent contractor for a sports website. I was based in Mississippi. I am originally from Alabama, but over the course of school I established residency in Mississippi by signing leases, registering a car, getting a driver’s license etc. Legally I was no longer a resident of Alabama.

When I started the job as an independent contractor working for a subscription-based website out of Nashville, I became a subsidiary of my father’s small business based in Alabama. (See where this is going?) This allowed my revenue payments to flow through his company where expenses and taxes where handled for me and I was free to run my business. Every year my tax forms were prepared, I signed them and off they went to Uncle Sam and the state of Mississippi, where I lived, worked and earned income.

The Burden of Proof

Fast forward to July when that $7,000 request came through. I called my father and my accountant and asked what’s up. A few days worth of checking turned up that, yes, I did in fact pay taxes to Mississippi those two years. I replied to the initial letter stating as much and say that there must be some sort of mix up because the business was based in Alabama, but I earned income in Mississippi. We’re cool, right? No dice.

The reply came (citing law) that until I could prove that I was resident of Mississippi — supplying leases, car registrations, drivers licenses, tax forms etc. — I was on the hook for the $7,000, because in Alabama’s eyes I was still a resident of that state and no matter where the money was earned, Alabama wanted its cut.

Finding all that stuff would be an easy task had I not moved from Mississippi to Texas back to Alabama and then to Illinois in the four years since.

The Hunt Begins

So off I went tracking down old landlords, drivers records, car tags (found the physical one in a box!) and tax statements. This was no small task as pretty much everything you send to the state had to be notarized and sent certified mail. The state doesn’t take checks, it all has to be money orders for payment. So there’s waiting in line here and there, added payments for mailings, countless $1 bills for notary public stamps. All told I spent probably four hours on the phone and about $90 in money orders, notaries and certified return receipt mail. Finding one of my landlords involved searching of a tiny newspaper website for the original classified listing (using the term “smell the roses”) for the house I rented in Mississippi, and hence my landlord’s phone number.

Finally I got everything (save the tax forms, CRUCIAL not to have at the time, but I was on a deadline) packaged them all up with a detailed explanation of each and sent them back to the state of Alabama.

I heard nothing for quite some time and had, for the most part, forgotten about it. Until September when a “Notice of Final Assessment” came for the 2006 tax year. The state of Alabama says that assessment has been made and I owe $4,000. There is NO mention of 2005, so I can only assume that a clerical error caused all my proof to be applied to 2005, but not 2006.

So AGAIN I package everything up, including all previous correspondence, and ship it off the the Administrative Law Division with another detailed explanation of everything. And I wait. Some minor correspondence comes in letting me know that materials have been received and to sit back and wait.

Then the silver bullet comes through from Mississippi in the form of my 2005 and 2006 tax returns with payment amounts similar to what Alabama was looking for in those tax years. Bingo. I write a letter requesting that the documents be added to my file. I received a letter last week confirming the addition to my file, and that a request to delay judgement has been granted until my file can be reviewed.

Then today, VICTORY! The assessment is voided, the journey is over.

The Moral of The Story

The moral of the story is not to give up if you know you’re right. Once I got confirmation from my accountant that I was in the right, I set out to prove it. Simply put, the assessment of taxes was invalid. I didn’t have to find a loophole or get off on a technicality. I did, however, bear the burden of proof.

If you find yourself in a similar situation, I suggest you do the following things:

  1. Document EVERYTHING. Send certified/return receipt letters with every piece of correspondence.
  2. Respond immediately. Even if you aren’t sure where to go, respond in some form to open a dialogue. My first letter pretty much said (paraphrased) “No way Alabama! Not true!” That at least got the wheels going where I knew what I had to do to void the assessment.
  3. Hold on to important documents, even if in digital form. Not on purpose, but in recent years I’ve started scanning and saving all important documents to PDFs. These are backed up remotely and locally and kept in a fireproof safe. Five years ago I never would have thought I would have needed the lease to my first apartment out of college. Five years from now if someone tries to tell me I didn’t live in Illinois in 2010, I’ll have leases, car titles, registrations and drivers licenses to prove it.
  4. Never quit. There were at least two points where I thought “There is no way I will win this, I just need to set up a payment plan.” Now all that time in line at the post office, on the phone with the FINE PEOPLE of the State Government of Mississippi, and writing out meticulous letters explaining my position was 100% worth it! My assessment is voided, and I have the letter in my hand (and safe) to prove it.

Guest post by Grant – a fellow reader of Budgets Are Sexy who is revelling in all his glory!

(Photo by alancleaver_2000)

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  1. Grant January 27, 2011 at 8:34 AM

    “Score one for the little guy”

    Point of clarification. I’m 6-3! =)

    Thanks for letting me guest post J!

  2. Kevin @ January 27, 2011 at 9:36 AM

    This is terrifying, because I throw everything away. I don’t understand how the burden of proof is on the taxpayer: shouldn’t it be on the government. They can’t just tell me I owe them $7,000 and then take me to jail unless I prove them wrong, can they?

  3. slug January 27, 2011 at 10:18 AM

    I guess this is why “they” say to keep 7 years worth of document history. I would expect more of this kind of thing from the states as they face greater budget shortfalls. Yet another reason the FairTax is a better approach.

  4. Wade January 27, 2011 at 10:43 AM

    I for one have lived in the same state for my entire life. I’m not ruling out that I may move out of state, but I believe that if I do that I will be prepared for this situation. “Slug” mentioned the point of keeping documentation for seven years, and I have kept all of my tax information going back that far. I have not on kept my vehicle registrations for each year, but I would hope that type of information would be easy enough to track down.

    Anyway, good job on the successful hunt! It proves that hard work does pay off.

  5. Pete January 27, 2011 at 10:44 AM

    I had a similar situation a few year ago albeit for not quite as much money. We got an assessment of taxes in the mail for just under a thousand dollars for taxes owed. It turns out in our instance that we were wrong and the IRS was right because we had forgot to include some unemployment income my wife had made the previous year – thinking it was the year before. We paid up because we knew we were wrong, but I’m glad you figured it out and got out of paying again!

  6. Travis January 27, 2011 at 1:15 PM

    Great post, and glad for your happy ending! States are becoming more proactive in their audit proceedures to try to increase revenues to make up for their shortfalls. I see this time and again with my clients, who travel to different states frequently for business.

    The burden of proof is always on the taxpayer to determine residency. Like you said, documentation is key. I also caution those who do work in different states throughout the year. Most states now have a “statutory residency” test that you may meet; in other words, you could be a full-time resident of two different states. Usually this means spending over 183 days working in a particular state and maintaining a place of abode (renting an apartment while traveling). Fortunately, resident states usually give you a credit for taxes paid on income to another state.

  7. Donny Gamble January 27, 2011 at 1:49 PM

    The IRS has become stricter than ever with all of their new regulations and guidelines

  8. Marc January 27, 2011 at 2:02 PM

    Glad to hear that you came out on top. Whenever you get a letter from the IRS or a state saying you owe money it is in your best interest to do exactly what you did to show you are correct. I have a relative that works for the IRS doing audits and boy have I heard some stories!

    Three years ago my wife and I moved from CA to OR. We owned a home in CA and turned it into a rental since we couldn’t sale it due to the market tanking. Talk about having to do some crazy taxes the year and a half we owned the property after we moved. I had to split the interest paid the first year we moved into when we resided in the property and the remainder of the interest paid when we had it as a rental property. It was crazy as I did this all myself with lots of help from said relative. Going through this process taught me to keep everything to make it easy to access to prove you are right if and when the tax man comes knocking on your door.

  9. retirebyforty January 27, 2011 at 5:04 PM

    The Mrs. keeps everything. If it was up to me, most paper trails would be all gone…
    Nice going! Score one for the little guy indeed!

  10. The Money Watch January 27, 2011 at 7:24 PM

    Glad to hear that things worked out! It won’t be long and I’ll be needing to get my taxes done. . .in a weird way I’m kind of looking forward to it, lol. . .

  11. J. Money January 30, 2011 at 8:11 PM

    Thanks again for guest posting Grant! And I am ALL ABOUT saving all this $hit for 7 years too – you just really never know when things are needed randomly. It takes a few seconds to store something away now instead of HOURS and stress down the road. Well done again, my man!