When the IRS Makes a Refund Mistake

Experts suggest calling the local IRS office to explain the situation, then setting up a repayment schedule the agency considers reasonable

By Karen E. Klein

The IRS in February sent me a check for over $7,000. It was a mistake on their part as well as a mistake on my part for using the money for car repairs and other bills. I have no choice but to pay them back and will send them $600 or $700 this month. I'm self-employed and get Social Security. Can they take my business revenues or benefits each month if they do not like what I am paying them? —T.D., Valencia, Calif.

In certain cases, the Internal Revenue Service can levy a person's business revenue and Social Security benefits to collect past-due amounts, says David Donnelly, a CPA and tax manager at Marcum, an accounting and advisory firm in Melville, N.Y.

In fact, the IRS has been known to empty bank accounts—without prior notice—to satisfy debt in arrears, a practice particularly dangerous for a self-employed individual who may keep several thousand dollars in an account to cover cash-flow gaps, says Peter Iannone, a CPA and director of the Los Angeles office of CBIZ MHM, an accounting and consulting firm.

Fortunately, such practices typically take place only in extreme circumstances and after repeated attempts to collect the debt in a less intrusive manner are ignored or payment plans have been set up and then broken, Donnelly says. "If a person sets up an installment plan and complies with the terms of it, the service will not levy other sources of income."

Rather than just sending monthly checks, call your local IRS office and speak to an agent about this situation, suggests Robert Jensen, a CPA at King, King, Alleman, Jensen in Burbank, Calif. "Explain the error you both made and then ask if you can pay it back over time via an installment agreement. Since the mistake was first made by the IRS, the IRS may be willing to work with you," he says.

Payment Plan Request

Follow up the phone call by filing Form 9465, a request for payment plan. For amounts less than $25,000, the IRS will automatically grant a payment plan, Iannone says. If you can send a larger chunk of the money owed with the Form 9465 as your first payment, that will show your offer is "in earnest" and will make its terms more likely to be accepted, he says.

If the repayment formula you propose gets the total amount repaid within about 15 months, it's likely the IRS will consider that time frame reasonable.

And, if the original mistake was entirely theirs—and did not stem from a tax return error showing that you were entitled to a refund—then the IRS may waive the penalties it usually imposes, Iannone says.

It likely will not waive interest on the $7,000, however. "When the taxing agency discovers their mistake, they will charge interest on the amount from the date they sent the check to the date you pay back the money," says Jan Zobel, an enrolled agent based in Oakland, Calif., and author of Minding Her Own Business: The Self-Employed Woman's Guide to Taxes and Recordkeeping.

Your dilemma is a good reminder never to deposit or cash a check from the IRS or your state government if it is unexpected. "Hold on to the check until you confirm the validity with your tax professional or with the taxing agency," Zobel says. "If it was a mistake, write 'VOID' across it and return it to the address from which it came."

Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.