As much as we try to avoid dealing with the IRS, it may become necessary eventually. This section deals with what the IRS looks for, ways to stay off their radar, and how to respond if you get a letter from the IRS. It’s vital that you engage professional assistance if you receive communication from the IRS.
Alimony Paid or Received
If you pay alimony, you can deduct the amount of the payments. If you receive alimony payments you must report the amount as taxable income. The IRS will check to make sure those amounts match and will initiate correspondence if they don’t. This can be confusing as many taxpayers aren’t sure what qualifies as child support, spousal support, and alimony.
Cash contributions must be documented with a bank record or written statement from the donating (donee) organization showing the name of the organization making the donation, the date of the contribution, and the amount of the contribution.
The IRS may audit your charitable donations via correspondence audits because all contributions must be backed by written receipt or bank record.
Just because you received a notice doesn’t mean that the IRS is correct; they have hundreds of thousands of taxpayers to deal with and they are frequently wrong. Before responding to IRS correspondence, call us.
Gross Proceeds of Sale
When real estate, stock or other securities are sold, the IRS knows how much it sold for. It needs to be reported on the tax return even if there is no gain or loss. If you don’t, the IRS just assumes the whole sales price is taxable profit. If you report the sale on your return, you can show what you paid for the sold investment which can even give you a deductible loss.
Home Mortgage Interest
Mortgage lenders report interest paid on mortgages for the year to the IRS and issue 1098s to taxpayers for the same amount. If these amounts don’t match, expect a correspondence audit. This is a common issue when the loan is from a private party and the paying taxpayer must report the name and SSN of the individual to which the interest was paid, or two or more individuals are on the same loan but lenders report the interest paid only under one of the borrower’s SSNs.
Interest and Dividends
The IRS allows many financial institutions to issue substitute (differently formatted) 1099s. These substitute forms are easy to confuse with various types of interest and dividends reported separately and spread throughout lengthy annual account statements. On top of this, many brokerage firms have been issuing amended 1099 statements late in the tax filing season because of internal errors in determining the allocation of a taxpayer’s earnings between dividends, capital gains dividends, qualified dividends, and original issue discount interest. This means that if the taxpayer has already filed, the changes are significant, and the taxpayer does file an amended return, they will probably receive a correspondence audit.
Due to various education tax credits that can be claimed for paying tuition to a qualified education institution, the IRS requires those institutions to report tuition received and issue a 1098-T to the taxpayers. Any discrepancy could result in a correspondence audit.
Unreported Pension Income
If you withdraw money from one IRA account and roll it over into another IRA or qualified plan within the 60-day statutory limit, the income is not taxable. The financial institution from which the funds were withdrawn issues a 1099R and reports to the IRS that you made a withdrawal. Taxpayers must report on their tax return that the distribution was in fact rolled over.
An audit can come in many forms, from face-to-face audits to by-mail correspondence audits.
This type of in-depth audit is rarely encountered by wage-earning taxpayers who are faithful to report all their income and take typical deductions. Taxpayers who have omitted substantial income, self-employed high-income taxpayers, and taxpayers who repeatedly fail to show income to support their lifestyle are the more often subjected to these demanding audits.
Taxpayers are permitted to appear for the audit personally, but it is generally unwise since most of the public is untrained in the rules and regulations surrounding audit procedures and how much the IRS is allowed to delve into your private life. An authorized tax professional may represent you and you may choose whether or not to be present. This tends to be the best way to prevent the audit from escalating beyond the original areas that attracted the IRS’s interest in the first place. Tax advisors who are experienced with IRS audits are less likely to become emotional or to make statements that would lead to further questioning.
Dozens of parties, including banks, employers, schools, lending institutions, escrow companies, and brokerage firms send data about you to the IRS, which the IRS matches by computer to the data from your tax return. When there is a significant difference between these two sources, the IRS initiates communication with the taxpayer. These discrepancies sometimes result in additional tax liability, but sometimes a simple explanation of the mistake will satisfy the IRS. Below we’ve highlighted a few of the most common discrepancies.