Every year, millions of taxpayers receive correspondence from the IRS after submitting their tax return. Although some notices are sent at random to ensure taxpayer compliance with tax code, many of these letters can be anticipated by the tax professional.
One of the most common reasons for the IRS to send a letter is a mismatch between the income reported on a tax return and the income the IRS has on file. The IRS is thorough in matching reported income – and even a small difference will trigger an IRS notice. It is important to make sure clients provide you with all income documents they receive, in order to help them avoid a change in their tax liability.
Many notices are sent as a result of disproportionate deductions claimed by a taxpayer. The IRS tracks the amounts of deductions claimed for different categories based on income; amounts that are much larger than average will often receive a notice to verify that the information is accurate. Charitable contributions outside the norm, high unreimbursed employee expenses and medical expenses that rise in conjunction with income are all common red flags that trigger IRS correspondence.
In recent years, Child Tax Credits and Earned Income Credits have come under increased scrutiny. Taxpayers will often receive a letter to verify age, relationship, support, dependence, citizenship and residence for dependents. This is especially true for dependents who are claimed by a different taxpayer than the prior tax year, and if a disabled relative is claimed for the first time, the IRS will almost always investigate further.
Many returns will also receive a letter as a result of information provided on a Schedule C, especially if there is a loss reported. Returns with $0 gross revenue, with even revenue and/or expense figures, or with excessive expenses compared to revenue, are all red flags. Returns that claim a home office deduction with a Schedule C loss or returns that claim the deduction, but also show wages, are also likely to trigger a notice.
Some other situations that may generate an IRS notice include:
- Using Line 21, “Other Income,” to report 1099 or self-employment income.
- Moving expenses that do not seem to pass the time (employed for 36 weeks) and distance (move greater than 50 miles) tests.
- Educator expenses claimed in which it is not clear if the educator taught grades K-12 and worked more than 900 hours in the past year.
- Claiming 100 percent business use of a vehicle.
- Large deductions for business meals, travel and entertainment.
- American Opportunity Credits claimed more than four times.
- Taxpayers who changed addresses in the last year.
When a taxpayer receives a letter, it should never be ignored! Many will avoid dealing with the issue for as long as possible, but every notice has a deadline, and most notices require an action. IRS notices provide clear instructions, and these should be read and followed carefully. The issue can be resolved with an outcome most favorable to the taxpayer. Encourage your clients to contact you as soon as possible after receiving a notice or letter; as a tax professional, you can help them resolve the issue.
To learn more about this topic, join one of the IRS Red Flag webinars hosted over the next few months. Register today.
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