If your 2017 return contains one or more of these red flags, you have a higher likelihood of receiving some sort of correspondence from the IRS. Don’t panic. You just need to double check your numbers and confirm you are organized with your documentation. You should be doing this regardless, but you may find it useful to know where to be extra careful.
Red flag #1: Page 1 of the 1040, Other Income (line 21), is filled out
This line is for very uncommon income items, such as jury duty pay or taxable distributions from a qualified tuition program. Instead, many taxpayers place self-employment income here. Even if you don’t have any expenses associated with the self-employment income, most should be using Schedule C instead. Schedule C will generate self-employment tax, unlike line 21.
Red flag #2: You are claiming a deduction for a home office
The code is very specific and detailed about what a taxpayer can deduct with regards to a home office. For example, the home office must be a space in your home that is used exclusively and regularly as your principal place of business. There are additional requirements if you are an employee. This doesn’t mean you shouldn’t claim a home office if you are eligible, but make sure you are doing it within the IRS code limitations.
Red flag #3: Not reporting all of your income, or input errors
Copies of the tax forms you receive, such as W2’s and 1099’s, are also being sent to the IRS. They have an automated system to confirm that what you report on your return matches those tax forms. If you make an error or fail to report income, they will notify you. When I left my job at a financial software company in New York City, the firm asked me to do consulting for them to help transition the employee taking over my position. I did it for a short time at the beginning of the year, and by the time next tax season rolled around, that small amount of income wasn’t on the top of my mind. The company sent my 1099 to an old address on file and I never received it. Thankfully, something jogged my memory shortly after filing and I immediately amended my return to include the income. It is easy to make mistakes, so keep good records and follow-up on any tax forms expected, but not received.
Red flag #4: You have a lot of even numbers on your return
We use even numbers in our financial plans because we are estimating and trying to make things simpler. This is not the way things work in real life or on your tax return. The IRS expects to see random numbers, so if they see a lot of deductions that are rounded to the nearest 100, for example, they may assume you are estimating and contact you for substantiation.
Red flag #5: There are unusually large amounts of business or charitable deductions on your return
The IRS keeps track of the average business expense associated with a given industry. Similarly, they track the average charitable contribution as a percentage of income. If you are taking these deductions at a rate that is higher than average, they may contact you for details. Along the same lines, if you only have one vehicle and claim it is 100% for business, that seems unrealistic. If it is the case, make sure you have detailed records to back up your claim.
What to do if the IRS contacts you
As a reminder, the IRS will initially contact you via USPS mail. They will not call, email or contact you via social media demanding immediate payment or ask for identifying information, such as your social security number or bank account. Here is more info on protecting yourself from tax scams.
When you receive a letter from the IRS, have comfort in the fact that many letters don’t carry bad news, don’t require a response or are very easy to answer. If you are working with a tax preparer, contact them as soon as possible and they will help you through the process. If not, read the letter in detail to make sure you understand what it is saying and that you agree with it, then move forward with a solution. Remember, the IRS makes mistakes too! If that is the case, respond with a detailed letter and any backup documentation necessary to correct the error. The most important thing to remember is to not panic or ignore the letter. By delaying your response, if required, you may be limiting your options to remedy the situation. Once you are done, scan and file the notice with the rest of your documentation for that respective tax year.