Back in August, in the midst of finding daycare, getting ready to teach, paying two mortgages, and reeling from my mother's illness, I got a most unwelcome piece of mail from the IRS. Actually, I think the timing of getting that letter is bad no matter when it occurs.
The IRS had selected me for an audit and declared that I owed them $1X00 in back taxes because I had failed to pay self-employment taxes on my graduate fellowship income. I had paid income taxes on the stipend, but not self-employment taxes.
Upon reading that, I did what any normal human being would do. I freaked out. When I calmed down, I read through all the tax guidelines. What I read was (purposely?) confusing, and as best I could make out, I was maybe in the wrong and the auditor was maybe in the right. And I'd been doing my taxes that way for all 4 years of the fellowship. If I paid the government those $1500, would they next come after me for the other 3 years? It was a sobering through.
But then I did what any blogger would do, I blogged about my situation. And wonderful, amazing, incredible blog readers saved my hide. (Note: what follows should not be construed as tax advice, simply a recounting of what worked in my situation.)
I got a number of really helpful comments, but several of them pointed out that as a fellowship recipient I was not an independent contractor and it was a "non-compensation type of grant" (as the IRS seemed to be claiming), so the stipend was not self employment. This distinction between a compensation grant and a non-compensation grant seemed to be key in the reading that I did. So I contacted my university and got them to send me a letter on official letterhead that explained that for the year in question I was on a fellowship, and X amount is what I was paid as a stipend.
(My tax situation was made somewhat more confusing because that year I did do some consulting work and so had paid self-employment taxes on a small amount of income.)
I attached the university's letter to the "request for appeals review form" along with this statement
"$X,000 income was derived from a XXX fellowship, a non-compensation type of grant, which does not constitute income from a trade or business, and hence is not subject to self-employment tax. The $X income was derived from completely a completely separate activity: conducting a science education workshop for teachers." I mailed off my appeal.
And then I waited. And waited. And then I got a certified letter saying that because I hadn't paid or appealed within the 30-day window, I was now due in tax court. And then I got really peeved, because of course I had replied.
So I called the IRS. And let me tell you, this was the most pleasant part of the whole experience. There was no wait time, and the lady I talked to was very nice and looked over my case, saw that I had replied, let me explain my situation. Then she made a note on my file saying that it was her judgment that I had been correct originally and no additional tax was owed.
Two weeks later, I got a letter from the IRS saying that the case had been closed and no tax was owed.
Thank goodness.
Based on the number of commenters I heard from (and the emails that still come to me asking about it), it seems that the IRS habitually audits graduate students on fellowships trying to get them to pay self-employment tax. Either they themselves are confused by the tax code (a real possibility based on the vagueness of their publications) or they are being predatory towards grad students. (But since almost everyone earns more than grad students, this seems like a strange way of trying to ease the federal deficit.)
In any case, this is what worked for me. But don't consider this advice, and all the usual disclaimers.
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I actually read a study a while back about how wealthy people were less likely to be audited, even though one could theoretically get more out of them, essentially because they could afford lawyers. The net result is the IRS audits a lot of people who earn less than $50,000/year. Governmental efficiency at work.
Having been through my own version of IRS hell (they couldn't accept that one of my kids was real despite birth certificate, immunization records and letters from the neighbors saying yeah we heard him screaming regularly) I found out that they do indeed target lower income, in part because we're less likely to hire lawyers, in part because the tax laws are confusing and vague, and in part because the tax laws really do favor the rich.
I also learned that rulings made by the IRS are not binding to the IRS....so what one agent told me another said no that's not the case.
Glad you got out of it successfully.
I was one of the other post-docs you mentioned who had gotten the same notification. Fortunately, since it was with DOE, ORISE had pre-emptively given me a letter from the Memphis IRS office stating that the post-doc money was not subject to taxes.
I sent them a very nice note and enclosed a copy of the ORISE letter. Never heard from them again. But even though it is now some 15 years later, I still have that letter filed away.
Not that I don't trust the IRS or anything...
hmm ... that's really interesting. i had friends in grad school who wouldn't even pay income tax on their fellowships, citing the likelihood of an audit to be extremely low. i've never heard that the IRS would ever claim graduate fellowships to be self-employment income. wow.
I'm glad there was a positive ending to that frightening situation. I would like to hear more about this science education workshop for teachers, though - could you point me to a past post or perhaps post about it in the future? (You might already be able to tell I'm a grad student thinking about going into education...)
Seine: Not paying any income taxes at all on a fellowship and betting on not getting audited seems like a tremendously bad idea. In the very least, by paying the taxes upfront (like you are supposed to, like it's the law) means that you don't get used to the money. What happens if you do get audited and suddenly have to fork over several thousand dollars after it's all been spent.
Astrophyschyk: You can read about some of my teacher workshop experiences in my June 2005 archive on the old site. If you want more details, send me an email.
Ah, so that's what happened. I got a similar letter, I think I had spent time in 4 states & two countries at that point though so I didn't even try to argue...it was too confusing.
What a relief that it worked out in your favor.
The EXACT same thing happened to me. I got a letter from the IRS trying to get me to pay self-employment tax of 1 or 2 K on my grad school fellowship, a couple of years after. I was pretty darn sure I didn't have to pay it - the level was way too high for my level of income and I wasn't self-employed. Nevertheless, resolving it with the IRS, through their standard mail process was VERY stressful.
Woohoo!! I myself was audited by the IRS for claiming out-of-the-US income from a year spent in the antarctic. Although technically a grey area, winterovers had been claiming that since, well, I guess since the IGY in 1957 with no problem. Two years after I wintered the IRS suddenly changed its mind and audited every winterover from the previous 3 years. I knew I'd been taking a technical gamble, so I wasn't overly bitter, but it did seem like a pretty absurd way to balance the books--nickle and diming folks. And I always suspected perhaps the IRS agent was a onetime winterover hopeful who'd been rejected. They didn't count on all of us banding together and suing them, though! Ha! We lost, in the end, but at least we tried. It was frustrating to learn how contradictory the government can be--that Antarctica counts as a separate country when deciding if OSHA and labor laws apply (they don't) but IS part of the US when deciding if it counts for regular taxes (they do). Now that I am legitimately claiming out-of-US income, I'm terrified I'll be in their crosshairs for a long time....
So I called the IRS. And let me tell you, this was the most pleasant part of the whole experience. There was no wait time, and the lady I talked to was very nice and looked over my case, saw that I had replied, let me explain my situation. Then she made a note on my file saying that it was her judgment that I had been correct originally and no additional tax was owed.
This is great! Thanks for sharing! It is very rare to hear the words pleasant and IRS in the same paragraph! Or even on the same page! LOL!
Dave Briggs :~)
I'm totally ashamed about how horribly husband and I have dealt with taxes since we've been together (for only 1 of the 3.5 years of which he's been at a job where taxes are automatically taken out of your paycheck) and this really scares me.
At my school, all of the grad students in my department that I've asked have not been paying taxes on their stipends, so I thought that was normal. I'm alarmed to hear that it's not, but it never did quite seem right to me. Sh*t.
I am very curious as to the taxation of science fellowships. I was an ORISE participant at an Army base and my contract didn't necessarily say "independent contractor," but I was very concerned about the self employment tax because my ORISE office was being evasive about the tax status. Other participants that I talked to at my office said that they didn't pay it. I did pay quarterly estimated taxes.
However, my concern is about individual retirement accounts. I wanted to open up a Roth IRA since I didn't have any benefits with ORISE, and my CPA said I'm not eligible since I got a 1099 and not a W-2. So I am working, but I can't have an individual retirement account? Really?
All in all, there are many things I wish I had known about the ORISE program before I signed up. To those thinking of taking an ORISE fellowship, keep these things in mind...