The IRS collected roughly 128 million tax returns during the 2018 failing season. Even the world’s most advanced computers could not possibly look at all these deduction allowances. But the Service does not need to look at all of them. 90 percent of these people used the greatly increased standard deduction.
So, there were under 13 million itemized deduction returns. That’s still a lot, but it is a much smaller universe. Therefore, if the taxpayer itemized, the IRS will probably scrutinize the return. If there are statistical discrepancies, or a year-to-year amount discrepancy, enforcement action will almost certainly follow.
The IRS has almost unlimited time to examine returns. If a tax planning professional lacks the proper training, it is difficult to respond to enforcement inquiries in a way that deters the IRS from further action.
“Enforcement action” includes both formal audits, which have declined significantly in recent years, and informal audits, which are usually document requests.
Real Estate Rental
The 2017 Tax Cut and Jobs Act prompted many people to rent their homes, or a portion of their homes, for at least part of the year. The TCJA gutted many deductions, such as the SALT (State and Local Taxes) deduction, but left others largely intact, such as the rental activity deduction.
If taxpayers rent a portion of their home for more than fourteen days, they may deduct a pro-rata share of expenses on Schedule E. These expenses include advertising, listing, and any other related costs. However, they must also report all rental income as well. Many taxpayers are overzealous about the former and overlook the latter. That’s a potentially disastrous combination.
Additionally, taxpayers may report rental losses, but they cannot manufacture them. For example, the Smiths cannot rent their guest house to someone for the summer and then claim a rental loss for the other nine months of the year, at least in most cases.
Charitable Expense Deduction
These deductions have long been a bedrock policy measure. Increasing charitable giving helps keep taxes lower and government bureaucracies smaller. So, the TCJA did not do much to upset this deduction.
However, the higher standard deduction forced many taxpayers into some financial sleight of hand. Since the standard deduction doubled in many cases, many taxpayers had to double their charitable giving to exceed the higher limit. As a result, many families doubled their 2018 charitable giving to claim the deduction, and they plan to give little or nothing in 2019.
There is nothing inherently wrong with giving more money to charity. But the IRS knows how much people in certain income brackets give to charity. Furthermore, the IRS has instant access to a taxpayer’s prior returns. If the 2018 giving amount is not statistically consistent or spiked tremendously, official inquiries are almost sure to follow.
At that point, it is incumbent on the taxpayer to establish all the elements of a charitable contribution deduction, i.e., an actual contribution to a 401(c)(3) organization. This showing is usually not a problem, assuming the taxpayer gave cash, there are no question marks about the recipient organization, and the taxpayer has the right documents.
Count on a certified tax coach near you to provide the support you need to weather a formal or informal audit.
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