Common IRS red flags

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 a 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, so even a small difference will trigger an IRS notice. It is important that clients provide you with all income documents 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, claiming employee expenses for taxpayers other than military reservists and performing artists, 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 disabled relatives claimed for the first time.

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, even revenue and/or expense figures, the home office deduction, or with excessive expenses compared to revenue are all red flags.

Some other situations that may generate an IRS notice include:

• Using Line 8, Schedule 1, Form 1040, “Other Income,” to report 1099 or self-employment income.
• 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 and travel.
• American Opportunity Credits claimed more than four times.
• Taxpayers who changed addresses in the last year.
• Taxpayers who claim the alimony deduction after 2018. Only divorces settled prior to January 2019 are allowed to take this deduction.

When a taxpayer receives a letter, it should never be ignored! Many taxpayers will avoid dealing with the issue for as long as possible, but every notice has a deadline and most notices require action. IRS notices provide clear instructions, and these should be read and followed carefully to reach 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.

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This article was originally published on Sept. 11, 2017, and republished with updated content on Aug. 13, 2021.