During 2010 the client had received a prize valued at $5000.00 and (wrongly) assumed that because it was not cash, it was not taxable. The company that had given away the prize did, in fact, provide my client with a 1099-Misc to file with the 2010 tax return. Subsequently, the IRS sent out a notice to the taxpayer advising them of additional taxes owed. The client should have immediately consulted a tax professional, but did not. Instead, they believed the IRS assessment and agreed to pay the additional tax! Basically, since there was tax owed, my client thought that the IRS would garnish the refund due for 2011. It is entirely possible that may happen, but we can still try to rectify the situation before it does.
Now, I'm not saying that there isn't tax owed, but never just take the IRS's word for it on how much you owe. They don't know your individual tax situation. All they know is you had unreported income and they want their share of the taxes from that income. The right way to handle this is to amend the tax return from 2010. This way you will be sure to pay only what you have to pay, not what the IRS says you owe them.
I had a long conversation with my client about this particular situation and advised that they contact the IRS immediately to notify them that an amended 2010 return will be submitted shortly. I also advised that they contact the company that awarded the prize to receive a duplicate 1099-Misc as we would need to attach it to the amended return.
So, if you ever find yourself in a similar situation immediately contact your tax professional and be sure to show them the notice from the IRS. Do not pay more than you owe. EVER! In fact, if you receive any notices from the IRS or your state agency, contact your tax professional as soon as possible.