I have a tax question.  In 2001, I incurred a tax that I think is
inappropriate, and I'm wondering if the IRS will reduce my tax
penalty.  I have not filed my taxes for the 2001 year yet.

Here's what happened:

1.  I purchased stock in the company I worked for through an employee
stock purchase program at a total cost of $5000.00.

2.  The stock rose in value to something like $40,000 with the
Internet bubble.

3.  The stock decreased in value to around $2000.00, at which time I
sold the stock,, figuring I would just suck up the loss.

4.  I held the stock for a year and 9 months before selling it.

When I sold the stock, I was under the impression that I would not be
taxed on it, since I made no profit from it and held it for long
enough to qualify for long-term capital gains.  But I later discovered
that, since I didn't hold the stock for a minimum of two years, that I
would be taxed on the average between the high and the low prices of
the stock over the period in which I held the stock.

So, the upshot is that I lost $3,000 on the stock (since I sold it at
a $3000.00 loss), and was then taxed an additional $8,000 because the
stock had such an extreme rise and fall.

I was an inexperienced investor, and acted in the belief that I was
following the rules (not knowing that the normal rules for short and
long term capital gains don't apply to employee stock purchases).  I'm
now wondering if I can petition the IRS to reduce my tax burden, since
I didn't realize any profit from the transaction.

My questions are:

1.  Can I petition the IRS to reduce my tax burden (with any
reasonable chance of suceeding)?
2.  If I can, who do I contact and where do I contact them?

Thanks!

Dear  jkuyken,

1.  Can I petition the IRS to reduce my tax burden (with any 
reasonable chance of succeeding)? 

You can always petition IRS to reduce your taxes if you 
really believe you don't owe them. 

That doesn't mean you'll succeed. But you can certainly ask.
It never hurts.

The only thing is, you've already created a larger problem for
yourself
by not filing your tax return before all the extensions ran out last 
week, on October 15th. 

You see, even if IRS does agree to reduce your tax burden on the
stock sale, they can't reduce your non-filing penalty of up to
25% on the total tax due. 

For future reference, anytime you are confused about a tax issue,
FILE A RETURN before all the extensions end. You cut off non-filing
penalties, have three years to amend, and can spend months, even 
years, arguing with IRS about paying the balance due. 


2.  If I can, who do I contact and where do I contact them? 

IRS has a special program for just this sort of situation, disputed
taxes.
It's called an Offer in Compromise. 

While many people use it to reduce their taxes because they simply
don't
have the money to pay (doubt as to collectability), there is also a
provision
for 'doubt as to liability' - doubt about owing the tax. 

You would use Form 656, which comes as workbook, with several 
pages of forms, financial reports for you to fill out, and 
explanations for you to provide. (48 pages)
http://www.irs.gov/pub/irs-pdf/f656.pdf

a) READ the whole book before sending in your application for the
Offer
in Compromise (OIC). 

b) Enclose ALL the requested documents. The IRS folks told me, at a
seminar
just last week, that they return most of the OICs they receive because
they are simply incomplete. 

While you are an inexperienced investor, and don't have the knowledge
you need about how to handle the sales of company stock, odds are not
in your favor. IRS would have expected you to get professional help
before selling the stock. Not knowing the law may not be a good enough
excuse to get the taxes waived. 

Please, don't think I'm criticizing you. I'm really not. You have my
total sympathy. After all, you lost money on the deal AND IRS wants 
you to pay taxes on it? It boggles the mind. 

And, gee, even Congress doesn't want to help you.
"HOUSE CANCELS VOTE ON INVESTOR TAX PACKAGE 
House GOP leaders have decided to postpone consideration of an
"investor
relief" tax bill that had been tentatively scheduled for October 16."
according to Tax Analysts
http://www.cpa2biz.com/News/Treasury+Developing+Fundamental+Tax+Reform+Proposals+for+White+House.htm

By the way, you can't file for the OIC until after you file your tax
returns.
 
This is the process you asked about. 

It's not easy. But it can work if you are 
persistent and accurate. 

Good luck. 

Your TaxMama-ga

Excellent answer--answered all of my questions fully.  Thanks!!