Your tax return could be flagged by the IRS. Here’s when it may happen

Personal Finance

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This tax season may end up being even less fun for many filers.

On top of figuring out how Covid relief might affect their return, those complications could result in more taxpayers making mistakes and hearing from the IRS, experts say. And depending on the specifics, it could mean a smaller refund or a larger amount due than anticipated.

“Everyone’s world has been turned upside down,” said Henry Grzes, lead manager for tax practice & ethics for the American Institute of CPAs.

“You have things you wouldn’t ordinarily have like stimulus payments, or who should have gotten them but didn’t, or think they should,” Grzes said. “It’s clearly going to be a challenging year for taxpayers, no doubt about it.”

While most people will never face an audit — just 0.15% were audited in fiscal year 2019 — there are other types of IRS inquiries, such as a notice of income-reporting discrepancy and proposed additional tax due. Those things fall short of an official audit, which the IRS generally gets three years to initiate after the challenged return is filed.

This means you could still hear from the IRS. And once the agency looks closely at one part of your return, the rest is fair game.

It’s clearly going to be a challenging year for taxpayers, no doubt about it.

Henry Grzes

Lead manager for tax practice & ethics for the American Institute of CPAs

“They may just say everything else looks okay, but they certainly have the right to request substantiation for all aspects [of a return],” Grzes said.

In fiscal year 2019, the IRS collected more than $121 billion in unpaid assessments on returns with additional tax due.

This year, the IRS will handle an estimated 150 million returns, with the filing deadline set for the usual April 15th . The agency began accepting returns on Friday.

2020 income tax brackets

IRS

Here are some common things that could prompt the IRS to look more closely at your 2020 return.

Unreported income

One sure-fire way for your tax return to grab IRS attention is a discrepancy between the income you report and the information that the agency has.

All those forms you receive showing income also go to the IRS. That could include a W-2 from work, a 1099-NEC or similar form showing income earned as an independent contractor, a 1099-INT showing taxable interest of $10 or more on a bank account or a 1099-G showing unemployment income (yes, it is taxable and you must report it).

And if you fail to report any of those earnings, you’ll hear from the agency — the discrepancy will generate an automatic letter.

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Also, for the cryptocurrency investors out there: Don’t forget you should be reporting your gains (and losses) on bitcoin and its brethren whether you receive a form from a crypto exchange or not.

“The rule is that even if you didn’t get a 1099, it should be reported,” Grzes said. “Some people are under the mistaken impression that cryptocurrency is nontaxable.”

Additionally, if you receive a Form1095-A showing premium tax credits received in 2020 for an insurance plan through the federal health-care exchange or your state’s marketplace, be aware that the IRS also gets a copy. In other words, you must account for it on your return.

Charitable deductions

For 2020 returns, taxpayers can take an above-the-line deduction — which reduces taxable income — of up to $300 for qualified charitable cash donations without having to itemize. (Most people take the standard deduction, which is $12,400 for individuals or $24,800 for married couples).

If you do itemize deductions, and those write-offs include donations, be aware that the IRS knows how much taxpayers at various income levels typically donate. So if your charitable-contribution deduction is high relative to your income or in comparison to your income peers, look out.

“If you have income of $100,000 but show $80,000 in contributions, that’s clearly going to cause questions,” Grzes said. “You may have just inherited money that isn’t taxable and wanted to give a lot away, but on the face of it, it won’t jibe.”

Of course, as long as you have the documentation to back up your donations, you shouldn’t fear hearing from the IRS. 

For your 2020 return, you can make a cash donation to a qualified charity worth up to 100% of your adjusted gross income. (This is a one-year adjustment from the usual limit of 60% of AGI.) 

Other types of donated property also face limits, depending on the type of asset and the organization it’s given to.

Business expenses

If you have a business or you operate as an independent contractor, the IRS allows you to deduct legitimate expenses against your income. And if you use a spot in your home exclusively for work, you can take the home office deduction (Full-time workers who are telecommuting do not get that tax break).

Some taxpayers choose to take a simplified home-office deduction based on the square footage of their workspace, while others calculate specific expenses to deduct, such as a portion of the home’s utility bills, mortgage interest, taxes, etc. Your car, to the extent that it is used to conduct business, also can generate a deduction.

However, tax preparers say they’ve seen where receipts counted as deductions clearly show items that are not business-related. Or, the amounts they deduct against their business never change.

“I’ve seen numbers submitted by taxpayers and it seems like they photocopied all those expenses from the previous year,” said Rhonda Collins, director of tax content and government relations for the National Association of Tax Professionals.

“For example, are your utility bills really the exact same every year? If there’s no variation from year to year and the IRS is comparing them, that can be a trigger also,” Collins said.

Again, though, if you have the documentation to back up your business expenses, you should be in the clear if the IRS does reach out for proof.

High rental losses

While it’s perfectly justified to write off expenses against rental income as it is with any business, high losses can trigger IRS interest, especially if it’s a continuing pattern, Collins said.

Rentals seem to be where folks try to write off a lot of cash expenses, but they can’t really prove the expenses if they are audited.

Rhonda Collins

Director of tax content and government relations for the National Association of Tax Professionals

“Rentals seem to be where folks try to write off a lot of cash expenses, but they can’t really prove the expenses if they are audited,” Collins said.

For example, as with any business you operate, your personal cell phone probably isn’t used exclusively for professional reasons. Only the portion used for business counts as an expense for tax purposes.

Earned income tax credit

This credit is generally available to working taxpayers with children, as long as they meet income limits and other requirements. Some low earners with no kids also may be eligible.

Because it’s refundable — meaning it could result in a refund even if your tax bill is zero — it’s considered valuable to working parents with low or modest income.

However, returns that claim it are generally scrutinized more closely due to abuse from some taxpayers. Even if you are legitimately entitled to the credit, your return could raise a red flag.

“If you claimed one child last year and this year you claim four, it might get attention from the IRS,” Collins said. “Of course, it could be true — you could have married someone with three children.”

The bottom line is that you should never try to cheat on your taxes, experts say.

“If you tell the truth, you don’t have to worry about it,” said Grzes at the American Institute of CPAs. “It’s the people who don’t always do that who run into trouble.”

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