San Jose Tax Attorney

Correspondence from the IRS has a tendency to escalate a taxpayer’s pulse rate. However, most of the letters received are not of the feared “come on down” type that requests an appearance for a face-to-face audit; they would be more likely to just require a written explanation. Generally, all types of income (wages, interest, dividends, etc.) are reported by the payer to the IRS, which, in turn, matches the reported income to the recipient’s tax return based on Social Security number (SSN). Over the past few years, the IRS has become very proficient in using its matching software to pick up unreported income and other discrepancies on tax returns. Discrepancies will generate an IRS inquiry, so in addition to income, take note of the following items which are frequently monitored by the IRS computer:

  • Dependent SSN – The IRS allows only one taxpayer to claim the exemption for a dependent. Frequently, a dependent will claim the exemption himself or herself, or in other cases, separated or divorced individuals will both attempt to claim the dependent. Expect correspondence when the exemption for any SSN has been claimed twice.
  • Gross Proceeds of Sale – All brokerage firms are required to report security sales to the IRS as “gross proceeds of sale” on Form 1099-B. The 1099-B copy provided to the account owner is generally combined with interest and dividend reporting requirements and included in a consolidated 1099 statement. These statements can be confusing, and the “gross proceeds of sale” line is frequently buried in the multi-page statements. If a taxpayer fails to report these security sales, the IRS will treat the gross proceeds as all profit, recompute the tax owed and send a bill.
  • Stock Basis – For stocks purchased beginning in 2011, the IRS requires the brokerage houses to track the cost of the stock and report that information on Form 1099-B when the stock is ultimately sold, so the IRS can then verify profit or loss.
  • Pension and IRA Rollovers – Unless it is a direct (trustee-to-trustee) rollover, the plan administrator is required to issue a Form 1099-R whenever a taxpayer withdraws funds from an IRA or other type of qualified plan. If the 1099-R income is not properly accounted for on the tax return, the IRS may treat it as unreported, taxable pension income and issue a revised tax bill. Even if it is directly rolled over, ALWAYS bring rollovers to our attention.
  • Alimony – The person paying alimony must include the recipient’s name and Social Security Number with the deduction claimed for alimony payments. The IRS will match the payments to income reported by the recipient. If the two amounts are not the same, the IRS will initiate correspondence to both parties.
  • Home Sales – Technically, escrow companies are not required to issue 1099-S forms to taxpayers who sell their primary residence for less than the home sale gain exclusion amount and certify that they meet the exclusion qualifications ($250,000 for a single taxpayer and $500,000 for married taxpayers). Despite this, many escrow companies choose to issue them, making it necessary to report the home sale on the seller’s tax return to avoid IRS correspondence.
  • Home Mortgage Interest – Since all lenders who are in the business of lending money are required to report home mortgage interest, the IRS can verify the amount claimed as deductible mortgage interest on Schedule A of a tax return, and any significant discrepancy can lead to IRS correspondence. If a private party holds the loan (not in the course of business), Form 1098 is not required to be filed, but the taxpayer claiming the mortgage interest as a deduction is required to include that party’s name, contact information and SSN on Schedule A. The IRS can then match the claimed interest deduction to the amount reported by the private party as interest income. However, if a third party lent money to the taxpayer to purchase the home, the third party’s information is not required.
  • Education Benefits – Colleges and universities are required to report the tuition payments that may qualify for the American Opportunity or Lifetime Learning tax credits on Form 1098-T. Educational lenders report the amount of student loan interest paid on Form 1098-E. Both are used to match against claimed deductions and credits on the tax return

John Erik Fraker, Esq.

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John Erik Fraker, Esq.

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