Another Bewildering Encounter with the I.R.S.

I got another letter from the IRS while I was away. This one is particularly baffling.

To catch you up on the story so far: In early 2006 I decided to stop paying the self-employment tax (I was already resisting the federal income tax by staying below the tax line). So when I filed my 2006 return, I didn’t include a check for the remainder of my 2005 self-employment tax. I also didn’t pay any self-employment tax last year, and won’t be paying any when I file my return this year. The IRS has sent me a number of letters complaining about this, and recently started seizing money from any bank accounts of mine they’ve been able to locate. In January they managed to find more than $4,000 which they sucked into their maw.

But get a load of their latest letter to me. Does this make any sense at all?

Overpaid Tax Applied to Other Taxes You Owe

We applied $3,286.79 of the overpaid tax on your 2005 tax return to the unpaid balance of other federal taxes which our records show you owe.

You may still be due a refund if we applied only part of your overpayment to other taxes. You also may be due a refund if you recently made a payment against the other taxes that we had not credited when we applied your overpayment. In either case, you will receive a check for any refund due you as long as the amount is greater than one dollar. You must request a refund of less than one dollar. If you have any questions, please call us at the number listed above.

The figures below show our calculation

How We Applied Your Overpayment

Amount of Overpaid Tax on Your Return	$3,286.79
Amount of Interest You Earned on Overpayment	$.00
Total Amount Due You	$3,286.79
Total Amount Applied	$3,286.79
Amount You Will Receive as a Refund (any interest due you will be added)	$.00

Where We Applied Your Overpayment

Form(s)	Tax Period(s)	Amount(s) Applied
1040	December 31, 2006	$3286.79

The following information may pertain to you if you are currently married or were previously married… [omitted]

My best guess as to what this means goes something like this: I owed unpaid taxes for tax years 2005 & 2006. When they seized that $4,000+ in January, they took more than I owed for 2005, but less than I owed for both years combined. They applied what they seized to my debt for 2005 — their software apparently isn’t sophisticated enough to split the amount between the two tax years, so the best they could do is to overpay the 2005 amount, issue me a refund for that overpaid amount, then immediately seize that refund and apply it to the 2006 amount. Then their unsophisticated software issued me an automatic letter awkwardly telling me some misleading version of this story.

(For completeness’s sake, I’ll note that the IRS also sent me a copy of Notice 1212 concerning their automated telephone service and a copy of Publication 1 — “Your Rights as a Taxpayer” — with the letter.)

In 1935, the U.S. Supreme Court noted:

The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.

In other words, if the law provides a route by which you can reduce or eliminate your taxes, and you follow that route according to the letter and spirit of the law — there’s nothing legally wrong with that, even if your only motive for taking that route is to avoid taxes.

Since then, other legal critics have advocated replacing this doctrine with one that would require people to structure their lives and businesses as though they were ignorant of the tax consequences of their decisions, and to accept whatever such consequences follow — in other words, to forbid people from changing their default behavior if the only reason for doing so were to avoid or reduce some tax. However, in a tax case the U.S. Supreme Court decided earlier this month, they seemed to show no interest in changing their mind about this.