I got a letter in the mail from the IRS stating that I owed $10k from my 2005 tax return (with interest and penalties). Turns out that there was a reporting error from my bank which caused this problem. Apparently, I had some stocks that the bank sold in favor of more favorable stocks, but the purchase of the new stocks was never reporeted by my bank. So, in a nutshell, I was supposed to have paid taxes on the full amount of the sale - not the cost basis.

I contacted my bank and they are able to furnish the documents to me to fight this rediculous bill. So, back to my original question: How do I fight the interest and penalties??

Thank you from the bottom of my wallet!

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The IRS has a dispute process that you should take advantage of. The paperwork should have been include with the letter they send you. If not, go to IRS.gov and find it.

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You have to get amended tax form and amend your taxes. You only have a few months after you file taxes so i would do it fast so you dont have to pay penalties.

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The purchase of new stocks is never reported to the IRS, only the sale of stocks is. You should have received something from your bank indicating what stocks they sold for you in 2005, and you would have needed to report them on Schedule D. What the irs got from your bank was the sale amounts of the stocks, and since they weren't reported on your 1040 for 2005, the irs calculated a return for you with 100% gain on the sale of those stocks. What you need to do is file an amended return, 1040X, and include a corrected 1040 with the stocks reported on Schedule D. You will need to report the sale proceeds and the costs for the stocks that were sold in 2005. That will reduce the tax that you owe, and maybe even get you a refund if you sold those stocks at a loss. If you don't owe any additional tax for 2005 that will also eliminate the interest and penalties that the irs is seeking. If you live in a state that has a state income tax you should also see if you need to file an amended state return for 2005 as well.

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