To begin with, let me be very clear that this article is not intended to be tax advice, so please don't use it as such. I am not only saying that to avoid liabilities but also because I am not anywhere near qualified to give tax advice. Instead, the purpose of this dump is to share the understanding I gained regarding the purpose of CP2000 as used by IRS in my particular case. An auxiliary purpose is also to encourage you to not worry if you do get a CP2000 and instead just keep breathing and preferably go to an appropriate tax professional. Remember CP2000 notices say right at the top that it is not a final bill, rather a proposal that one can respond to before arriving at a final resolution with the IRS.
In late May 2021, my wife and I received a CP2000 from the IRS. If you don't know what a CP2000 is please read this document from IRS titled: Understanding your CP2000 Notice. In our case, the CP2000 was sent to us for the tax year 2019. In other words, the IRS believed that we had made a mistake in our tax filings for the year noted and they had sent a notice proposing certain changes.
In our case, the CP2000 claimed that the filing change would require us to pay an additional $8000 (approx.) in taxes. As you can imagine this was a huge blow for us. It was like someone just sent us an invoice for eight thousand dollars. At my first reading, I had conveniently ignored the reminder that is printed right on the first page of the notice: Reminder: This is not a bill. We haven't charged the proposed amount due. So for people who get a CP2000, my first non-tax-related advice is to please stay calm. Don't hyperventilate. This is not a bill. Please sit down and carefully read the entirety of the notice. And if you are anything like me, please don't scare your spouse into worrying either. Once again, CP2000 is not a bill, it is a proposed change in your tax payments. The proposal could be correct, but please read the whole notice first.
Once I read the notice carefully!
So...once I sat down and read the whole notice, I recognized the following:
- In 2019 I had sold some RSU stocks I had through E*TRADE.
- When I filed my 2019 taxes in early 2020, I uploaded the tax documents from E*TRADE to TurboTax in order for the details to be included in my Tax Return.
- These documents don't properly report the cost basis for RSU stocks. In fact, it reported the cost basis for all the RSU stocks I had sold in the year at $0.
- This meant that profit on these stock sales was reported to IRS at sale price since the cost basis was $0.
- This meant that I owed taxes on the total value of the sale, instead of the amount my investment had grown over the cost-basis.
- This is why the IRS had proposed a tax bill of approximately $ 8000.
Why did the IRS believe this about my cost basis?
So the first question is why did the IRS believe that my cost basis for these sales was $0. This was fundamentally wrong because when I had originally received the stocks from my employer I had already paid tax on the cost basis. And by calculating my cost basis at $0, I was being double taxed.
But the IRS believed it to be true because of a weird way RSU sales are reported by the broker, in this case, E*TRADE, at the end of the financial year. For example, in my case, when the broker reported the sale transactions they reported the cost-basis at $0 in Form 1099-B. So this meant as far as IRS was concerned I got these stocks for $0 and sold them at a much higher price, and didn't pay any taxes on them. I am not sure why brokers report it this way on Form 1099-B. FWIW, there is also this note on Form 1099-B, which I had conveniently ignored:
The information provided below is in accordance with Federal tax regulations and the IRS instructions that govern our reporting requirements. You should review this information carefully when completing your Form 8949 and Schedule D. There may be instances where our reporting requirements will not be consistent with your particular tax accounting position or elections. For these reasons, the IRS requires us to provide you with this reminder: Taxpayers are ultimately responsible for the accuracy of their tax returns.
So I think the takeaway here is that when I was filing my taxes I should have carefully read my Form 1099-B and realized that it doesn't report my cost basis correctly and taken steps to report them correctly in Form 8949 and Schedule D. It is this discrepancy between the actual cost-basis and the one reported by Form 1099-B for RSU stocks compounded by me not reporting the correct cost-basis that led the IRS to believe that I owed additional taxes.
How to fix this misunderstanding regarding cost-basis?
As we panicked through understanding the issue and resolving it, I first approached a tax professional service. But my experience with them was kind of horrible as they took my money and my case and didn't bother to take any steps to reach out to me or tell me what the next steps were. And by now I was fairly confident what the issue was and decided to deal with it myself. I don't advise it to everyone since everyone might have different circumstances under which they receive CP2000 and your understanding about them may not be as thorough as you think.
So in my case, since the issue was that Form 1099 B didn't report my cost basis correctly I went and found a document called Stock Plan Transactions Supplement from the broker which correctly reports the cost basis for my sales. I wish IRS got this document from my brokerage in addition to Form 1099 B, but for whatever reason, they don't do this.
The notice CP2000 itself mentioned a couple of things that really helped with my next steps to fix this discrepancy:
- First, they informed in the notice that if the cost basis is incorrectly listed in their records send the corrected cost basis using Schedule D, Capital Gains and Losses along with Form 8949, Sales and Other Dispositions of Capital Assets.
- Second, they also informed in the notice that if I don't agree with the proposed changes (which I didn't for the reasons listed above) I don't need to file an amended return and that when I respond to them with the required documents they will make any applicable corrections.
So that is exactly what I did, I responded to CP2000 in order to correct my cost basis. My response consisted of the following components:
- Cover Letter: In this, I briefly summarized why I believe the cost basis was wrong and then I listed all the other documents I had attached to the response. Be kind and gentle in this cover letter, the person reading it on the other end is a human being like you and me and would appreciate a kind response.
- Form Schedule D, Capital Gains and Losses: I submitted this form for the year 2019 and corrected the cost basis for each transaction that IRS had listed in CP2000.
- Form 8949: Once again, I submitted this form for the year 2019 and corrected the cost-basis for each individual stock transaction.
- Stock Plan Transactions Supplement: This document from E*TRADE notes the adjusted cost basis for the RSU stocks that I had sold in the financial year 2019. This was the fundamental evidence that reported my correct cost-basis for the transaction in question.
- Original Form 1099 B: I am not sure if this form was required, since it is the basis of which the CP2000 was sent to me, but I added it to the response anyway so it is easier for the IRS officers looking into this case to understand what is going on.
A word of caution about sending this response to the IRS. The postal worker at USPS had informed me that for a mail like this I should use a certified mail receipt with tracking. This will make sure that I have a certified record from USPS about whether or not the mail was received by IRS. I did this, it only cost $5.20 for me and I got a notification saying that IRS had received the response by July 2nd, 2021.
What happened next?
Waiting for an issue like this to resolve could be unnerving. So I hope the following timeline gives you some peace about how an issue like this unravels:
- Last week of May: Received the CP2000
- May 27, 2021: Sent the response to IRS by certified mail receipt.
- July 6, 2021: Receive the first response from IRS saying that they have received my response on June 2, 2021, and that they are looking into it. This letter also noted that a further response from them could take up to 90 days.
- September 2, 2021: Received the final response from IRS. This response is in the same format as CP2000, almost a new CP2000. But this notice basically took account of the adjusted cost basis and on the basis of that corrected information proposed a refund of $115.
The final resolution!
What a relief it was to receive that final CP2000 with the corrected information on September 2, 2021. Because not only was my cost-basis not the same as the total sale price of the stocks, but instead I had made a net loss on my sales. My actual adjusted cost-basis for the transactions was in the RED. Which meant we were due a little bit of refund. The final CP2000 acknowledged this and proposed a small refund. My wife and I were asked to sign this new CP2000 and return it in the mail. We are expecting a refund as a result.
So at the end of this interaction with IRS, which was very unique for me, these are some final thoughts and takeaways:
- If you received a CP2000, don't panic. First and foremost it is not a bill. You can still work it out. And it is possible that the IRS made a mistake or that you made a mistake in your filing that lead to this.
- Read your CP2000 carefully. Since now you have the opportunity to respond to the notice it is very important that you read every page of the notice carefully.
- Take advice from a tax professional. This blog is not tax advice. It is just a recounting of my very particular and unique experience. In your case, it might be necessary to go to a good tax professional in order to resolve this issue.
- Do your taxes carefully. I think I still do my taxes the same way I used to do it when I was in college. But back then I made almost nothing in income and my financial situation wasn't as complex as it is now. I am not saying you cannot do it on your own, tools like TurboTax definitely make it easy. But do it very carefully. Read all the tax forms and documents you receive from your banks, brokerage, etc. very carefully. And if you don't feel up to it splurge on a good tax preparer. I may do it starting in the financial year 2021.
- Finally, God is sovereign over every situation in your life, so don't panic and continue trusting in God. I am preaching to myself here.