Marc A. Hebert's Money Sense: Some things on a tax return that might trigger an IRS auditBy MARC A. HEBERT
June 03. 2017 1:48AM
Your tax return is done and filed. Now you are starting to wonder whether you did everything right. After all, the tax code is complicated. You might be wondering, "Can I expect an IRS audit?"
Your chances are pretty low. The Internal Revenue Service is short on personnel and funding. The IRS audited only .7 percent of all individual returns in 2016. However, if you are still concerned, here are a few things that might prompt the IRS to question the items on your income tax return.
Missing income. The IRS has copies of your 1099s and W-2s, so you can be sure if you miss including one of them, the IRS computers will know it, and generate a bill for the tax due. The other common problem in this area is when the 1099 is shown on the return, but for a different amount. If you find you receive a 1099 with incorrect data, contact the issuer to get it corrected.
Sky-high deductions. The IRS has ways to compare the deductions you have taken on the return to your income. If the deductions seem too high, then the return might be flagged for audit. This is an area where, if you have the proper documentation for the deduction, there is no reason not to take it.
Too charitably inclined. Giving to charity is a great deduction. It can make you feel good and can help others at the same time. This is another area, however, where if your charitable deduction is high in relationship to your income, you might get questioned by the IRS. Supporting documents are the key.
Hobby losses. Income earned from your hobby needs to be reported. You can deduct expenses up to the level of that income. The problem is when you start deducting amounts over the income level. In order to do that, the activity must be run like a business and have a reasonable expectation of making money. The IRS looks to see if your activity generates a profit in three out of every five years (or two out of seven years for horse breeding). Once again, keep your supporting documentation.
Early payouts from IRAs or 401(k)s. The IRS has found that almost 40 percent of taxpayers scrutinized made errors on their income tax returns related to early payouts. Most of the mistakes involved taxpayers who claimed an exception to the 10 percent penalty on early distributions made prior to age 59½, but didn't really qualify. Make certain you are truly eligible for an exception before claiming one on your taxes.
Deducting alimony payments. Alimony paid by cash or check is deductible by the payer and taxable to the recipient, provided certain requirements are met. One example of a requirement is that the alimony payments be made under a divorce, separate maintenance decree, or written separation agreement. The payer's liability for the payments must end when the former spouse dies. The other snag is when the payer's deduction and the income reported by the recipient don't match. These need to be equal or the IRS will ask questions. Alimony rules are complicated, so be sure to obtain professional advice.
These are just a few situations that might raise a red flag at the IRS. Whether you are being audited, or just answering an IRS letter, it takes time and energy to respond. The key is to understand how the tax law applies in your situation, have adequate documentation, and seek professional help when needed.
Marc A. Hebert, M.S., CFP, is a senior member and president of the wealth management and financial planning firm The Harbor Group of Bedford. Email questions to Marc at email@example.com. Your question and his response might appear in a future column.