Boost Your Tax IQ: Avoid Tax Mistakes, E-file Rejections, and Audit Triggers [1 ed.] 9781957518060, 9781957518077, 9781957518084, 1957518065

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Boost Your

TaxIQ

by Avoiding

Tax Mistakes

E-File Rejections

Audit Triggers

Easy Tax Tips & Solutions for All Taxpayers







Aki Stepinska, EA

© 2022 Aki Stepinska This book or any portion thereof may not be reproduced or used in any manner whatsoever without the express written permission of the author except for the use of brief quotations in a book review. No association with any organization or individual is intended, nor should it be inferred. First printing, 2022. This book is published by AkaAki Design. All Rights Reserved. Cover and interior design by Aki Stepinska Images, infographics, cartoons: Copyright @2022 Aki Stepinska

Aki Stepinska, EA [email protected] United States of America www.boostyourtaxiq.com ISBN 978-1-957518-06-0 (ebook) ISBN 978-1-957518-07-7 (paperback) ISBN 978-1-957518-08-4 (hardcover)
































ii

Disclosure

This book is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action outlined in this book, you should seek the assistance of a professional who knows your unique situation. All effort has been made to present accurate, up-to-date, and reliable information. Tax laws and regulations are complex and subject to change, which can materially impact investment results. The author cannot guarantee that the information herein is accurate, complete, or timely. Please verify information with a professional and/or against the IRS regulation. By reading this book, the reader agrees that under no circumstances is the author responsible for any losses, direct or indirect, which are incurred due to the use of the information contained within this book, including, but not limited to, — errors, omissions, or inaccuracies.












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Tax Assistance Programs

The two organizations that I have personally volunteered with and are truly worthy of your donation are listed below. They provide assistance to seniors and taxpayers in disadvantaged communities. However, many taxpayers qualify to use the service if they fall within scope of services. Your donation can help YOU take advantage of the programs. IRS Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE) Programs run by: AARP Foundation - National Tax Assistance Program - 89 Rating by Charity Navigator; Gold rating by GuideStar LadderUp in Chicago, IL - Financial Education and Tax Preparation - 100 Rating by Charity Navigator

You care. You make a difference.













iv






Consider Supporting

The tax system benefits the informed. Learn about your money.








v

Table of Content TABLE

CONTENT ............................................1

OF

Charts, Tables, Infographics & Other Visuals ......................9 Abbreviations and Acronyms .............................................13

INTRODUCTION ................................................16 1. About This Book ...............................................................16 2. Behavioral Insights for Tax Compliance ........................36 3. Quali cations ....................................................................40 4. Companion Website ........................................................42

TAXPAYER CHALLENGES _____________________44 Top TaxPayer Challenges ....................................................46 157 Million Overcomplicated Tax Code. ....................46 102 Million Dissatisfaction With the IRS Free-File. .....48 77 Million Lack of Tax Knowledge. ..............................50 70 Million Unable To Contact the IRS. .........................51 38 Million Misplacing Previous Tax Returns. ...............52 38 Million Using Inexperienced Tax Preparers. ..........53 34 Million Too Many Penalties. .....................................54 24 Million Not Reporting All Income. ..........................55 19 Million Unable To Pay all Tax Due. ..........................56 18 Million Complicated EITC Quali cations...............57 11 Million Committing Math Errors. ............................58 10.7 Million Underpaying Estimated Taxes. ...............59 10.6 Million Not Filing Tax Returns. .............................60







































































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10.3 Million Tax Refund Delay. .....................................62

1.8 Million Disregarding IRS Letters. ...........................64 900 Thousand Being Audited. .....................................65 44 Thousand Offer in Compromise Rejections. .........66 Tax Info and Forms ...............................................................68 Test Your Tax Knowledge ....................................................73 Understanding Your 1040 Form .........................................83 Where Should I Start ............................................................98

PART I: TAX MISTAKES (TM) __________________100 MISTAKE 1: FILING MISTAKES ...........................102 A. Not Filing Tax Returns ...................................................102 B. Filing at the Last Minute ................................................104 C. Amending Incorrectly ...................................................105 D. Not Filing for a Refund Within 3-Years ........................111 E. Not Considering Free Filing Options ..........................116 How To Avoid These Mistakes? ........................................123

MISTAKE 2: INCORRECT PERSONAL INFO ............127 A. Incorrect Name, SSN or DOB ......................................127 B. Incorrect EIN on Form W-2 or 1099-R .........................130 C. Filing With an Expired ITIN ..........................................131 D. Filing With a New Name ...............................................132 E. Incorrect Bank Account Number .................................135 How To Avoid These Mistakes? ........................................138

MISTAKE 3: MISSING DOCUMENTS ....................140

































































































A. Not Retaining a Copy of Tax Returns ..........................140

B. Not Including Documents ............................................144 C. Not Keeping Tax and Business Records .....................146 D. Not Tracking Investment Cost Basis ............................147 E. Not Including Power of Attorney (POA) ......................150 How To Avoid These Mistakes? ........................................151

MISTAKE 4: FILING STATUS MISTAKES ................154 A. Filing the Wrong Filing Status ......................................155 B. Claiming Dependents in Error .....................................159 C. Incorrectly Filing as Not a Dependent ........................160 D. Not Including Form 8332 .............................................162 E. Not Claiming Injured Spouse Relief ............................163 How To Avoid These Mistakes? ........................................166

MISTAKE 5: DEDUCTIONS & CREDIT ERRORS .......168 A. Incorrectly Claiming Credits & Deductions ...............176 B. Claiming Expired Provisions ........................................181 C. Not Claiming EITC.........................................................184 D. Missing Education Credits & Deductions ..................187 E. Not Reconciling Premium Tax Credit ..........................192 F. Not Claiming RRC for any Missing EIPs .......................196 G. Double-Dipping ............................................................200 H. Not Repaying Homebuyer Credit. ..............................201 I. Withdrawing Retirement Funds Early ...........................202 J. Missing Out on Home Sale Exclusion ..........................214 How To Avoid These Mistakes? ........................................218





































































































MISTAKE 6: MATH ERRORS ..............................221

A. Incorrect Taxable Income .............................................221 B. Wrong Amount of Credits or Deductions ..................222 C. Claiming Additional Standard Deduction..................223 D. Arithmetic Mistakes .......................................................225 E. 1040 Inconsistencies With Schedules .........................226 How To Avoid These Mistakes? ........................................228

MISTAKE 7: PAPER RETURN ERRORS ...................229 A. Mailing Return to the Wrong Address ........................229 B. Not Attaching Forms Required ....................................232 C. Not Signing and Dating................................................235 D. Not Including Enough Postage ...................................237 How To Avoid These Mistakes? ........................................238

MISTAKE 8: BUSINESS & SELF-EMPLOYMENT ERRORS ..241 A. Mixing Personal and Business Expenses ....................241 B. Filing Schedule C Without Expenses ..........................243 C. Business Income With Maximum EITC .......................246 D. Underpaying Estimate Taxes .......................................249 E. Not Claiming QBI Deduction .......................................255 F. Not Claiming Business Start-Up Expenses..................259 G. Writting off a Loss for a Hobby ....................................263 H. Not Reporting Rental Income ......................................266 I. Misclassifying Workers ...................................................268 J. Selecting Trader Status ..................................................273 How To Avoid These Mistakes? ........................................277





































































































MISTAKE 9: OMISSIONS ..................................282

A. Not Reporting Income ..................................................283 B. Not Declaring Virtual Currency ....................................285 C. Not Including a Payment ..............................................287 D. Not Reporting Foreign Bank Accounts .......................290 E. Ignoring IRS Letters .......................................................291 F. Not Reporting Domestic Workers ................................295 How To Avoid These Mistakes? ........................................298

MISTAKE 10: FALSE INFO = TAX EVASION ..........300 A. Reporting False Information ........................................301 B. How IRS Proves Tax Evasion .........................................304 How To Avoid These Mistakes? ........................................306

KEY TAKEAWAYS ............................................308 PART II: E-FILE REJECTIONS (ER)______________313 REJECTION 1: MISMATCHED PERSONAL INFO ......316 REJECTION 2: INCORRECT WITHHOLDINGS .........321 REJECTION 3: PREVIOUSLY ACCEPTED RETURN ....322 REJECTION 4: INELIGIBLE REJECTION 5: NEED

FOR A

CREDIT .............326

PAPER FILE ...................327

TO

REJECTION 6: MISSING FORMS ........................329

















































































REJECTION 7: CREDIT REPAYMENT MISSING .......332

REJECTION 8: INVALID TAX PAYMENT DATE ........333 KEY TAKEAWAYS ............................................334 PART III: AUDIT TRIGGERS (AT) _______________335 TRIGGER 1: NOT FILING TAX RETURNS ...............340 TRIGGER 2: FILING STATUS RELATED ..................343 A. Inconsistent Claim for a Dependent ...........................343 B. Filing as Head of Household (HOH)............................344

TRIGGER 3: INCOME RELATED ..........................345 A. Unreported Income ......................................................345 B. Retirees Not Taking RMDs ............................................348 C. Large Cash Transactions ...............................................353 D. Fluctuating Income .......................................................354 E. Most Income Wiped Out by Deductions ....................354 F. Earning a Lot of Money .................................................355 G. Claiming Child Support as Alimony ...........................356 H. Foreign Bank Accounts.................................................357 I. Virtual Currency Transactions ........................................358 J. Zero Of cer Salary for an S-Corp .................................360

TRIGGER 4: DEDUCTIONS .................................362 A. Very Large Itemized Deductions .................................362 B. Large Charity Donations ...............................................363























































































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C. Claiming Home Of ce Deduction ..............................365

TRIGGER 5: CLAIMING EITC ............................368 TRIGGER 6: MATH ERRORS...............................370 TRIGGER 7: BUSINESS RELATED .........................371 A. Schedule C Filers...........................................................371 B. Mixing Business and Personal Expenses ....................372 C. All Expenses Have Round Numbers ...........................373 D. Overly Lavish Meal Expenses ......................................374 E. Claiming Both Standard Miles & Actual Car Expenses .... 375 F. Claiming 100% Business Use of Vehicle .....................378 G. Claiming Hobby as Business .......................................380

TRIGGER 8: REPORTING LOSSES ........................381 A. Net Operating Losses (NOLs) ......................................381 B. Gambling Losses ...........................................................382 C. Rental Losses .................................................................385 D. Bad Debt Losses and Cancellation of Debt ...............387

TRIGGER 9: MISCLASSIFICATIONS .....................389 A. Improper Pay for Household Help ..............................389 B. Day Trader Misclassi cation .........................................391

TRIGGER 10: INFORMANT COMPLAINT ...............393 KEY TAKEAWAYS ............................................395











































































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PART IV: RESOURCES _______________________399

Tax Calendar .......................................................................401 Tax Brackets for 2021 ........................................................402 Legislative Tax Changes ....................................................404 Useful Websites / Publications / Organizations .............407 Tax Preparation Checklist ..................................................412 Tax Forms ............................................................................417

APPENDIX _________________________________437 Glossary ..............................................................................438 Bibliography .......................................................................451 Archival Links ......................................................................453 Index ....................................................................................454





















AUTHOR .......................................457



THE

























ABOUT

CHARTS , TABLES , INFOGRAPHICS & O THER V ISUALS Figure 1. Nine Ways the Wealthy Hide Their Money…Intro Figure 2. IRS Forms in the Appendix…Intro Figure 3. Code Title 26…Taxpayer Challenges (TP Ch) Figure 4. Many Exceptions to IRS Rules…TP Ch Figure 5. Tax Table for Income of $50,000…TP Ch Figure 6. Type of Filers in 2019…TM 1E Figure 7. Tax Filing Options…end TM 1 Figure 8. Sample ITIN Card…TM 2C Figure 9. Sample Check Information…TM 2E Figure 10. IRS Get My Payment…TM 5F Figure 11. Old 401(k) Options…TM 5I Figure 12. Addresses Where to Send 1040…TM 7A Figure 13. IRS Document Sequence Numbers…TM 7B Figure 14. EITC for Single & HOH in 2021…TM 8C Figure 15. Virtual Currency Question on 1040…TM 9B Figure 16. Business Miles Rules…AT 7F

Table 1. Abbreviations and Acronyms…TOC Table 2. Deductions & Credit Phase-outs for MFJ…TP Ch Table 3. Tax Court Cases that Won with Representative or Self-Representation (Pro Se)…TP Ch Table 4. 1040 Schedules 1-3…TP Ch Table 5. Simplified 1040 Tax Calculations…TP Ch















































Table 6. Standard Deduction for Tax Year 2021…TP Ch

Table 7. 2021 Federal Income Tax Brackets for Single…TP Ch Table 8. Where Should I Start?…TP Ch Table 9. When to Amend Your Return?…TM 1C Table 10. Last Year to Claim Your Refund…TM 1D Table 11. Filing Mistakes…end TM 1 Table 12. Average Cost to File with Tax Preparers…end TM 1 Table 13. Refund Timing…TM 2E Table 14. Incorrect Personal Information Mistakes…end TM 2 Table 15. Missing Documents, Records & Receipts…end TM 3 Table 16. Child Dependency & Credit for Form 8332…TM 4D Table 17. Special Rules for MFS…TM 4E Table 18. Changing MFS & MFJ Filing Status…TM 4E Table 19. Incorrect Filing Status & Dependency Mistakes… end TM 4

Table 20. Expired Provisions…TM 5B Table 21. EITC Eligibility Requirements…TM 5C Table 22. EITC for Tax Year 2021…TM 5C Table 23. Education Credits & Deductions for 2021…TM 5D Table 24. Reconciliation of Stimulus Payments through RRC on Tax Return…TM 5F Table 25. Stimulus Payments 2020-2021…TM 5F Table 26. Exceptions to 10% Early Distribution Penalty…TM 5I Table 27. Deduction & Credit Inaccuracies…end TM 5 Table 28. Math Error Mistakes…end TM 6 Table 29. Forms to Attach when Paper Filing…TM 7B

















































Table 30. Paper Return Mistakes…end TM 7

Table 31. Typical Business Expenses…TM 8B Table 32. How to Avoid Underpayment Penalty…TM 8D Table 33. Start-up Investigation & Prep. Expenses…TM 8F Table 34. Organizational Expenses…TM 8F Table 35. Expenses Never Considered Start-Up…TM 8F Table 36. Worker Classification…TM 8I Table 37. Long-Term Capital Gain Taxes…TM 8J Table 38. Trader Status Qualification…TM 8J Table 39. Business Filers Tax Mistakes…end TM 8 Table 40. Statue of Limitation for an IRS Audit…TM 9 Table 41. Omission Mistakes…end TM 9 Table 42. Providing False Information…end TM 10 Table 43. Difference Between Self-Select PIN & IP PIN…ER 1 Table 44. Direct Debit Payment Options…ER 8 Table 45. Most Frequently Litigated Tax Issues…AT Table 46. Income Filing Requirement for 2021…AT 1 Table 47. Taxable & Non-Taxable Income…AT 3A Table 48. Car Vehicle Deduction Methods…AT 7E Table 49. Federal Tax Due Dates…Resources Table 50. Reliable Tax Resources…Resources

Example 1. Simplified Form 1040 U.S. Individual Income Tax Return for 2021…TP Ch Example 1. Sch 1 (1040) Additional Income & Adjustments…TP Ch















































Example 1. Sch 2 (1040) Additional Taxes…TP Ch

Example 1. Sch 3 (1040) Add. Credits & Payments.…TP Ch Example 2. Support for Dependency…TM 4C Example 3. Standard vs. Itemized Deduction…TM 5A Example 4. PTC Reconciliation…TM 5E Example 5. Home Sale Exclusion for a Single Taxpayer..TM 5J Example 6. Standard Deduction Application…TM 6C Example 7. Max EITC with Sch C & No Expenses…TM 8B Example 8. Max EITC with Sch C & Inflated Expenses…TM 8C Example 9. Estimated Quarterly Payments…TM 8D Example 10. QBI Deduction Calculation…TM 8E Example 11. Hobby Income & Expenses…TM 8G Example 12. Overstated Basis…TM 10A Example 13. RMD Calculation & Penalty…AT 3A Example 14. Vehicle Deduction…AT 7E Example 15. Gambling Losses Deduction…AT 8B

Cartoon 1. This is Not a Dentist…Intro




































Cartoon 2. 1040 Chaos Theory…TP Ch

ABBREVIATIONS

AND

ACRONYMS

Below is a list of the most frequently used tax abbreviations and acronyms.

Additional Child Tax Credit Adjusted Gross Income Alternative Minimum Tax American Opportunity Tax Credit Automated Substitute for Return Program Child and Dependent Care Expenses Credit for Other Dependents Certi ed Public Accountant Child Tax Credit Discriminant Informant Function Date of Birth Enrolled Agent Employer Identi cation Number Economic Impact Payment Earned Income Tax Credit Estimated Tax Foreign Account Tax Compliance Act Federal Unemployment Tax Head of Household Identity Protection PIN Intelligence Quotient Individual Retirement Account Internal Revenue Service IRS Free File Interactive Tax Assistant Individual Taxpayer Identi cation Number Limited Liability Company



ACTC AGI AMT AOTC ASFR CDCE COD CPA CTC DIF DOB EA EIN EIP EITC ES FATCA FUTA HOH IP PIN IQ IRA IRS IRS FF ITA ITIN LLC

fi

De nition

fi

Term



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Table 1. Abbreviations and Acronyms

Term

De nition

MFJ MFS NOL OIC PEF PMI POA PTC PTIN QBI QW RRC SFR SSA SSI SSN TAC TAS TCE TCJA

Married Filing Jointly Married Filing Separately Net Operating Losses Offer in Compromise Presidential Election Fund Private Mortgage Insurance Power of Attorney Premium Tax Credit Preparer Tax Identi cation Number Quali ed Business Income Qualifying Widow(er) Rebate Recovery Credit Substitute for Returns Social Security Administration Social Security Income Social Security Number Taxpayer Assistance Center Taxpayer Advocate Service Tax Counseling for the Elderly Tax Cuts and Jobs Act The Treasury Inspector General for Tax Administration Taxpayer Identi cation Number Volunteer Income Tax Assistance

TIGTA

fi

fi

fi

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TIN VITA

“The hardest thing in the world to understand is the income tax.” —- Albert Einstein, physicist







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Boost Your Tax IQ

Introduction

1. ABOUT THIS B OOK

WHY I Wrote This Book: Improve Taxpayer Tax IQ

There are two reasons why I wrote this book. The first reason is to improve taxpayers’ tax IQ by going over the most frequent tax mistakes and challenges. According to Pew Research, most Americans hate (26%) or dislike (30%) doing their income taxes.1 One way to change peoples’ dislike is to improve their understanding of their tax situation. 

Cartoon 1. This is Not a Dentist https://www.pewresearch.org/politics/2013/04/11/a-third-of-americans-say-they-like-doingtheir-income-taxes/ 1

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Intro

Intro

Boost Your Tax IQ

There is no lack of tax information. There is a disagreement on the exact length of the IRS code, but most agree that IRS Title 26 is about 6,550 pages long, not including the 60,000 pages of related case law.2 Hence, for an average taxpayer, tax information is largely confusing, complicated, and overwhelming.  It takes patience and research to clarify certain tax positions. Even on the IRS.gov website, research on one topic can lead to different endpoints, and some of it may be outdated (archival). It takes a bit of experience to sort through all the noise to get a clear and definite result. And frequently, the final answer may still “depend” on several factors.  An additional challenge with tax information is that it frequently changes. For example, while writing this book, I had to update the content several times because of the passing of new legislatures (e.g., SECURE, FFCRA, CARES, ARPA listed in the Legislative Tax Changes section in Part IV).  Another challenge regarding tax information is the jargon, and inaccessible language used when taxes are discussed. Most financial and tax information is overly complicated.3 Sometimes, one word describing the regulation can steer the taxpayers from complying to NOT complying with the tax law. In Resources Part IV under Useful Websites, in Table 50, you will find a list of sources that discuss tax information in everyday language. When you have questions about a new tax concept or most current tax year information, you should use them.

https://www.politifact.com/factchecks/2017/oct/17/roy-blunt/tax-code-so-long-nobodysreally-sure-its-length/ 3 https://www.nytimes.com/2016/11/06/magazine/how-economic-gobbledygook-dividesus.html?searchResultPosition=1 2









17

Intro

The book’s primary purpose is to improve your overall tax knowledge and understanding, a general sense of how taxes work, and what you should avoid doing. By learning concepts about your current tax circumstances, you will improve your overall Tax IQ and take charge of your tax situation.  Pat yourself on the back for taking the first step to improving your Tax IQ and being less stressed during tax season. I can’t promise that you will ‘Love’ doing your taxes like the 5% of the taxpayers surveyed, but I believe you will dislike it less.  My MISSION: Tax Justice The second reason I wrote this book is to support the work of organizations for Tax Justice. In particular, Tax Justice Network, Inequality Org, Tax Justice Now Org, Institute for Policy Studies, and Taxpayer Advocate Service.4 This book is my way of contributing to leveling the playing field with the super-wealthy, who have access, support, and opportunity that the average taxpayers don't get.  The super-wealthy have teams of elite professionals and limitless resources to take aggressive positions and hide their money from tax.5 According to the University of Michigan, the top 0.5% of wealthiest Americans account for 20% of income hidden from the IRS, which equals $50 billion each year.6 The rich hire teams of professionals, lobbyists, and anti-tax activists that provide expertise on trusts, estates, offshore

https://taxjustice.net/; https://inequality.org/; https://www.taxjusticenow.org/#/ ;https://ipsdc.org/; https://www.taxpayeradvocate.irs.gov/ 5 https://www.propublica.org/article/ultrawealthy-taxes-irs-internal-revenue-service-globalhigh-wealth-audits 6 https://www.documentcloud.org/documents/5219189-The-Distribution-of-TaxNoncompliance.html#document/p10 4









18

Boost Your Tax IQ

operations, shell creation, and cross-border business transactions to dodge tax liabilities.7  The bottom 90% of earners are easier to catch when they don't report income on Forms W-2s or 1099s, even when the magnitude of their transgression is minimal in comparison. The tax situations of the rich and powerful are elaborate and convoluted. The tax returns are full of partnerships, LLCs, foundations, gifts, real estate properties, investments, losses, businesses, and overseas operations. It is hard to follow what is what.  On top of that, the current tax system is primarily designed to tax labor income. In comparison, the super-rich receive most of their wealth through flow-through businesses, capital gains, investments, real estate, life insurance, and inheritance with step-up basis accounting.8 The capital income that the wealthy receive often has an advantageous tax rate compared to labor income.  According to Pew Research Center, almost 60% of Americans are agitated that big wealthy corporations and wealthy individuals don't pay their fair share of taxes.9 We are frustrated, but we internalize it because most of us don't understand how it is done. I want to change that by first sharing my tax knowledge with average US taxpayers (in this book) and then demystifying the super wealthy's tricks (in the next book). 

https://nypost.com/2021/03/27/the-shocking-ways-billionaires-profitable-companies-hidemoney/ 8 https://www.cnn.com/2021/06/08/politics/what-matters-income-taxes/index.html 9 https://www.pewresearch.org/fact-tank/2021/04/30/top-tax-frustrations-for-americans-thefeeling-that-some-corporations-wealthy-people-dont-pay-fair-share/ 7









19

Intro

I am gathering examples of how the super-wealthy benefit from the tax code in a future short book titled "How the Wealthy Dodge Taxes." When you understand how all the tactics work, you can speak up against them and vote on legislatures that want to change that. It is hard to argue against ventures that we don't understand because we don't want to appear uninformed.  To be notified when the book is published, share your e-mail at www.boostyourtaxiq.com.  There are 9 main ways wealthy taxpayers avoid paying taxes. Unfortunately, many of these methods are not available to average taxpayers, or if they are, they can't create a similar benefit as they do for the rich. Each consists of different sub-tactics often described as 'legal' because they utilize loopholes to avoid paying fair share without breaking tax law.10  However, most tactics primarily benefit the top 0.01%. Therefore, they shouldn't even be allowed or at least have an income phase-out, just like the education credits are phased out for the middle class.11 The 9 ways the super-wealthy can hide 20% of their income from the IRS are through (see Figure 1):12  • • • • •

Wealth Defense Industry Businesses Loans Investments Real Estate

https://taxjustice.net/topics/tax-avoidance-and-tax-evasion/ https://www.considerable.com/money/economy/what-is-middle-class-in-every-state/ 12 https://www.bloomberg.com/news/articles/2021-03-22/tax-evasion-richest-1-of-americanshide-20-of-their-income-from-the-irs 10 11





















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Boost Your Tax IQ

• • • •

Trusts 

Transferring Wealth to Family

Foreign Jurisdictions

Unique Tax Shelters

Welcome to Tax Justice Movement. I am glad you are here. 

Figure 1. Nine Ways The Wealthy Hide Their Money



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Intro

WHAT You Won’t Find Here There is lots of tax information you won’t find in this book. Below are a few of the categories this book does not cover: ❖ ALL the tax situations and tax code. You know: The 6,550 pages of tax code that covers every single taxpayer situation, plus 60,000 pages of case law. If you want a more comprehensive book, I recommend J.K. Lasser’s Your Income Tax 2022 For Preparing Your 2021 Tax Returns.13 ❖ Step by step filing instructions. You won’t receive step-bystep instructions on how to file your taxes. Too many tools are constantly changing to cover them well in a book for the current tax season. In this instance, Google is your friend. Google to find the latest instructions, forms, and how-tos. Also, I will be creating YouTube how-to videos for the IRS-approved free tax software, so visit my website for more information at www.taxguide101.com. ❖ All possible deductions and credits that are available to taxpayers. You won’t find information on Olympic medals deduction, credit for federal fuel taxes, or deduction for whistleblower fees. These benefits are so rare that they would only muddy the water for the average taxpayer.  ❖ Scary messaging and scolding language. There won’t be any making-you-feel-bad language in these pages. It is never too late to change your approach, boost your understanding and improve compliance. There are people and organizations that can help you get on the right path: Taxpayer Advocate Service (TAS) and Taxpayer Assistance Centers (TACs).

https://smile.amazon.com/J-K-Lassers-Your-Income-2022/dp/1119839211











22



13

Boost Your Tax IQ

❖ Stuffy language and jargon. Specific tax terms are unavoidable; however, overly stuffy, full-of-jargon explanations are kept to a minimum. I am not fancy, therefore my delivery is to the point.  ❖ Blocks of text. There won’t be pages and pages of boring tax rules to make you feel discouraged and sleepy. ❖ Every possible red flag that will get you examined. Tax mistakes such as leaving your tax return in the trunk of your car or an audit triggered by including pets on your taxes are not covered. You are on your own with these ones. ⤜(⚆ᗜ⚆)⤏ ❖ Outrageous claims of saving you thousands with egregious loopholes. You won’t find sections in this book such as: “how not to pay any tax”; “how to travel for free for your business”; “how to make your home pay you”; or “how to pay for your daughter’s wedding as business expenses.” All the above will surely get you audited sooner or later. So just don’t do it. Know that if anybody advocates such tips, they don’t have your best interest at heart. 









23

Intro

WHAT Is In This Book What you will find in this book: most frequent, impactful, common, and relevant tax tips, solutions, and suggestions for US taxpayers. Below are a few of the categories this book does cover: ❖ Most serious tax mistakes. You will learn about common tax mistakes and how to avoid them. Many of the worst tax mistakes can lead to audit triggers, so you will learn how to prevent them in the first place.  ❖ Preventable e-file rejections. You will learn how to correct the most frequently experienced e-file rejections when you file your own taxes. You will learn what they mean and why they occur. ❖ Most significant audit triggers. You will learn how examinations are triggered and how to avoid them. You will learn how to spot which situations increase the possibility of being audited.  ❖ What are taxpayers' most significant challenges. You will learn about tax challenges and how many taxpayers are affected. It will make you realize how many people face similar problems and where to find help.  ❖ List of credits and deductions that are most beneficial to taxpayers. In Part TM 5, you will find a list of the most significant taxpayer benefits with potential savings for the tax year 2021.  ❖ How to make sense of most tax forms. You will learn how to read most tax forms and what each box contains. 

















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Boost Your Tax IQ

❖ How to get ready for tax filing season. You will learn what you need to do to be organized and prepared. In Part IV Resources, you will find a tax preparation checklist to get your documents in order. It covers simple to more complex tax situations with businesses and rentals.  ❖ Explanations and information in plain English. Specific tax and financial phrases are unavoidable, but discussion, instructions, and solutions are given with minimum jargon.  ❖ Examples and calculations of sample tax situations. Many sections of the book include calculations to help you learn through examples and visually understand a tax concept.   ❖ Encouragement and solutions to your tax challenges. All the sections in the book have references and additional places to seek further information. You are encouraged to boost your tax IQ by studying taxpayer stories, infographics, examples, and clear explanations.  ❖ Infographics and other visuals that help you understand taxes. 65% of people are visual learners, which means that most people learn best when they see things visually.14 ❖ Where to find help. You will learn how to find organizations such as TAS, VITA programs, and TACs to help taxpayers solve their tax challenges. You will learn how to file for free in-person or online. ❖ Sources to boost your tax IQ even further. All the book sections have information on where to find additional or updated information for most tax situations. https://www.forbes.com/sites/tjmccue/2013/01/08/what-is-an-infographic-and-ways-tomake-it-go-viral/?sh=4b3925d87272 14















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Intro

❖ Updated 2021 tax year information. All the information is as of Fall 2021 for the tax year 2021. Since Congress likes to pass changes and new laws even during the tax season, you must double-check what is current when filing your taxes. ❖ Strategies and tips that are legal and practical. All the methods discussed in the book are practical and legal. These are not revolutionary ideas but clarified tax concepts acquired with experience at tax preparation companies and volunteering with non-profits.  Important: Be aware that the circumstances of every taxpayer are unique, and multiple variables can affect the outcome - filing status, income, dependents, deductions, credits, risk tolerance, etc. Therefore, you should consult a tax professional and review other resources if you plan on making any drastic changes.







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Boost Your Tax IQ

WHO This Book Is For This book is for taxpayers who want to understand and learn about their taxes and how to manage their tax situation better, regardless of their current tax knowledge.  Taxpayers with a beginner level of tax knowledge. You can file your own taxes using the interview-style step-by-step software format. You feel most comfortable when a professional helps you with your taxes. It may be challenging for you to anticipate what your bottom line for the tax year will be. It is a puzzle why one year your tax refund was lower than another. You may not be aware of the consequences of non-compliance and don't know how omissions can impact you in the future.  You will learn basic tax terms and concepts and how to avoid the most severe errors that can get you in trouble with the IRS. You will also learn how to save time filing and where to get help. Taxpayers with an intermediate level of tax knowledge. You have a general understanding of your current tax situation and tax law. You may have filed your own taxes for a few years and understand why your tax liability was higher in the current year. You may use a tax professional, especially if you have a business or more complex tax situation. You are aware of what you don't know and want to learn about ways to save on your taxes next year. You know where to find help.  You will learn about additional deductions and credits you may qualify for. You will learn how and where to find more information if you want to dig deeper. Finally, you will be able to anticipate many red flags in the future. 













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Intro

Taxpayers with an advanced level of tax knowledge. You understand most tax and financial concepts and how the tax law affects your situation. You are hands-on with your taxes. You may have filed yourself for years or prefer to go to a professional because your case is complex and you are busy. You are constantly reading tax and financial information and want to learn all the ways you can save on your taxes. You are aware of the consequences of non-compliance and you know where to go for help.  You will learn many tips and methods to save on your taxes by following examples and specific resources. In addition, you will understand how to avoid red flags and how specific steps can lead you to better outcomes next year. 





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Boost Your Tax IQ

HOW to Use This Book There is a lot of information covered throughout the book. Feel free to skip around and go directly to the topic that interests you the most or is most relevant for your tax situation. Tackle the areas you are most comfortable with, so you start encouraged. Then move on to sections that you always wanted to learn.   Feel good about boosting your tax understanding and taking on information that can impact your future finances. Reference the areas that give you the most trouble and go through the examples and visuals.  This book is accessible to all taxpayers, regardless of tax knowledge and experience. If any sections don't apply to you, feel free to skip or come back to them in the future.  The book has 4 parts. The first three have a list of key takeaways at the end.  Part I: Tax Mistakes (TM) s the most important section as it introduces you to the 10 kinds of tax mistakes. Many tax mistakes that are not corrected can eventually lead to audit triggers discussed in Part III. Many of the TM include examples and summary tables. The last section in each chapter explains "How to Avoid These Mistakes" in the first place. Part I is a good place to start your journey.  Part II: E-FIle Rejections (ER) covers 8 main issues taxpayers face while using tax software. It contains a list of e-file rejections, what they mean and how to fix them so that taxpayers can complete the tax filing process. 















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Intro

Part III: Audit Triggers (AT) focuses on the top 10 categories of audit triggers. It covers red flags that lead to IRS examinations and how to avoid them. It also explains where to get help.  Part IV: Resources section provides valuable references to super-boost your tax knowledge in the most actionable ways. It includes a tax calendar listing notable tax dates. Second, you get a table of the most significant tax law changes. Third, there is a list of helpful websites, publications, and taxpayer organizations, so you know where to further your tax knowledge. Fourth, you can't be efficient without a tax preparation checklist to help you organize and gather your documents. Finally, you have access to most frequently used tax forms, with detailed information on how to read them.  The Appendix contains a glossary of tax and financial terms, a bibliography, archival links, and an index of topics covered.







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Boost Your Tax IQ

The CONVENTIONS in This Book ❖ All the visuals are listed under Charts, Tables, Infographics & Other Visuals.  ❖ There are many financial and tax terms used throughout the book. A list of them is listed under Abbreviations and Acronyms in Table 1. ❖ Tables contain tax summaries, references, and tax information.  ❖ Figures offer a visual representation of the topic discussed. ❖ Infographics simplify textual data and description in a graphic form.  ❖ Examples present an actual calculation to help you grasp the concept better. In addition, they help illustrate how taxes work exactly through math rather than talking about it.

All the examples are hypothetical for illustrative purposes only. All calculations are estimates. ❖ According to plain language rules, numbers, amounts, and percentages written numerically are easier to grasp. When reading a number written in words, you have to convert it in your head to a number you can visualize. That process reduces comprehension and accessibility. For that reason, numbers (1 to 10) are spelled out just like higher numbers. However, the number one (1) and zero (0) are

















31

Intro

sometimes written as words, as these numbers could be mistaken for the letter “I” or “O.15”  ❖ (TM X), (ER X), (AT X) abbreviate Tax Mistakes, E-File Rejections, and Audit Triggers. They are sprinkled throughout the book as a recommendation for additional information. In the eBook version, they are clickable and will take the reader directly to the appropriate section.  Search or Ask: provides you with keywords, phrases, or questions to use to find out additional information about the topic. You can type it into the Google search engine, tax software’s help search box, or ask your tax preparer. ❖ Bold text highlights important concepts throughout the book. If you want to skim a section, you can scan through the bold text. ❖ Italic text distinguishes or emphasizes parts in a section, and is used for information in (parentheses). ❖ Underlined text indicates a link to a website. Most links are also provided in footnotes unless they are spelled out as addresses already. For example, www.boostyourtaxiq.com is already a link with a full web address; therefore, it will not be footnoted. ❖ Bullet points are used to:  • Summarize tax information • Communicate data efficiently • Draw attention to main points https://contented.com/blogs/news/8370188-writing-tip-write-1-2-3-numbers-in-plainlanguage-and-legal-prose 15



















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❖ Companion website information. If supplemental information can be found online, it is noted with a computer icon. ❖ Footnotes16 provide source information and are listed at the bottom of the page where referenced. Web addresses to references are clickable in the eBook format. For the print readers, the exact web address is provided in the footnote. A shorter archival version is listed for many footnotes in the Appendix and on the www.boostyourtaxiq.com. Since many website addresses can break (called Link Rot17) over time, the archival (permanent) version preserves the exact copy used. Permanent links have been saved with either perma.cc or archive.st. ❖ At the end of TM chapters, the “How to Avoid These Mistakes” sections review measures to prevent the errors.  Taxpayer Story Contains a real story about taxpayer(s) that experienced a situation similar to the one discussed in the section. All the names have been changed to protect taxpayer privacy.

Such as this one. https://harvardlawreview.org/2014/03/perma-scoping-and-addressing-the-problem-of-linkand-reference-rot-in-legal-citations/ 16 17











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Intro

Figure 2. IRS Forms in the Appendix

❖ Forms listed in Part IV under Resources are visual references to many tax forms. Each box describes the information included. In addition, a source at the bottom of each form links to the most recent IRS copy. 




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Boost Your Tax IQ

HELP Spread the Word 13 ways to spread the word about this book: 1. Buy a copy of this book. 2. Review the book on Amazon, Goodreads, Barnes & Nobles, and others. 3. Share your thoughts about it on social media such as Facebook, Twitter, Instagram, Pinterest, Booktok, and YouTube. 4. Visit the www.boostyourtaxiq.com website. 5. Talk about the book with friends and family.  6. Spread the word on a podcast or video. 7. Sign-up for the author's newsletter. 8. Buy another copy of the book for a friend.  9. Request the book at your local bookstore.  10. Request the book at your library: Overdrive, New York City, Los Angeles, Chicago, or your city. 11. Share the book on paperbackswap.com, bookcrossing.com, bookmooch.com, or littlefreelibrary.org.   12. Follow the author on author pages on Amazon, Goodreads, BookSirens, Discovery, Barnes & Nobles.  13. Buy book merchandise. 
































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Intro

2. BEHAVIORAL INSIGHTS FOR TAX COMPLIANCE First of all, give yourself a break. To be great at doing and understanding your taxes, you have to know some things about our human nature. Behavioral Insight analyzes how people think and behave by studying psychology, neuroscience, and behavioral economics. TAS and the IRS are leveraging findings from behavioral science to improve tax compliance and taxpayer experience.18  Below are just a few ingrained habits that we have to fight against:  ❖ Daily we are faced with more decisions and information than we can consciously process. We have two ways of processing information: 1) fast or 2) slow. Most of the information we process is done fast without a lot of conscious thought. Slow processing is deliberate, requires more of our mental resources, and is harder. For example, tasks at the end of a very long tax form or tax appointment may be less accurate and complete because the taxpayer’s energy has already been depleted. ❖ When we face many challenges, tedious tasks and stress, we often become drained, which leads to sub-optimal decision-making. We make choices that may not be best for us and our future. Like instead of reviewing a very long tax form or searching our home for additional documentation, we fall for a quick option. ❖ When faced with very complex tasks, like doing our taxes, we take shortcuts because we feel overwhelmed by all the decisions we have to make. 18

https://www.irs.gov/pub/irs-soi/17rpirsbehavioralinsights.pdf













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❖ We are drawn to short-term gains (instant benefits), such as maximizing tax refunds. We are not as affected by outcomes in the distant future (future consequences), such as possible audit or penalties. ❖ We are influenced by first and easy choices than succeeding and more challenging options. Tax forms and letters that list sub-optimal options at the top or default can disadvantage taxpayers with a limited understanding. ❖ We are easily distracted and lose sight of critical priorities. Taxpayers not reminded about a due date or information needed will more likely procrastinate or not submit it, even if it could lower their tax liability. ❖ We are social beings who care what others think and do. We may not use a free service or software because of what we heard from others.  ❖ We are affected by the perception of what others do and what the consequences are. Hearing about rich corporations and wealthy individuals not paying their share of taxes decreases the overall tax compliance of average taxpayers.  ❖ We don’t feel the same when we sign tax information electronically. The responsibility and commitment feels less serious and real than signing paper documents. 













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WHAT Does It All Mean? To improve taxpayer understanding and compliance:19 IRS letters and notices should use plain language. Communication from the agency should be clear and straightforward.  All letters, notices, forms, and instructions produced by the agency should be simplified. Reducing the amount of information taxpayers have to process improves understanding and compliance.  The IRS should reduce the number of options and choices on forms, letters, and notices. Choice overload is real and makes taxpayers make sub-optimal choices or not make a selection at all. It helps taxpayers receive well-organized communications that break large information into smaller sections. All forms and instructions should be organized with the taxpayers in mind. Choices should be straightforward, which would increase response and compliance. Taxpayers should receive reminders via email or text to complete the next necessary steps. Notifications during a process improve understanding and compliance.  Impersonal and hard-to-read letters have low response rates. With an accessible design, easy-to-read font, and plain language, taxpayers' will perform correct action and are more likely to respond because they understand what is being asked.  https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/07/ ARC18_Volume2_07_ImproveNotices.pdf 19

















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Boost Your Tax IQ

Taxpayers are more likely to take a specific action if they are provided with comparative information. For example, if they are told that 8 out of 10 people accept the offer in compromise. The IRS should ask questions on tax forms with easy words and avoid double negatives or fancy language. Taxpayers are more likely to cooperate and respond to questions when they understand what is being asked.   The IRS can reduce the tax gap by providing taxpayers with different options, access, and flexible service. Easier and cheaper tax preparation would increase taxpayer compliance. 







39

3. QUALIFICATIONS

“It is not important for you to appear smart. It is important for you to be understood. Because if you’re not understood, it doesn’t matter how smart you are, you have failed in your communication.”20 —- Dr. Anthony Fauci, M.D. I have a BA in Economics, and I am an IRS Enrolled Agent (EA).21 EA is an IRS designation received after passing a 3-part comprehensive test on individual and business returns. Right after college and few years in between, I have worked in international taxation and corporate transfer pricing, a very specialized area of taxation for global multinational companies. Since 2016, I have changed gears and am mainly focused on individual tax. I have worked at large tax preparation companies as Master Tax Advisor and Tax Expert, where I helped taxpayers prepare their tax returns, answer questions, and plan for their future. I also volunteered with the IRS Volunteer Income Tax Assistance (VITA)22 and the IRS Tax Counseling for the Elderly (TCE) programs.

https://www.pewtrusts.org/en/trend/archive/winter-2021/science-is-essential-to-publicpolicy 21 https://www.irs.gov/tax-professionals/enrolled-agents/enrolled-agent-information 22 https://www.irs.gov/individuals/free-tax-return-preparation-for-qualifying-taxpayers 20















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Boost Your Tax IQ

The Chicago Ladder-up organization23 runs the VITA site where I volunteer, and the AARP Foundation Tax-Aide24 runs the TCE site. The IRS-certified programs organize volunteers to prepare tax returns for the elderly and taxpayers in disadvantaged communities. Sharing my tax knowledge and best practices with few clients felt limited, motivating me to write this book and share it with a bigger audience. I quoted Dr. Fauci's at the beginning of this section because I find it so relevant. Experts who often talk bout taxes use jargon and overcomplicate terms. I wanted this book to be clear and accessible to all. I love simplifying and clarifying complex tax information into accessible content, infographics, presentations, etc. All the information that I share is honest and to the best of my knowledge. At times I had to simplify examples to explain complex tax concepts; however, the big-picture situations apply to most cases. It is important to remember that each tax situation is unique. Therefore, you should consult a tax or financial advisor who knows your exact circumstances before making drastic changes.

https://www.goladderup.org/our-services/tax-assistance/ https://www.aarp.org/money/taxes/aarp_taxaide/





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Intro

4. COMPANION WEBSITE The tax world is frequently changing. Therefore, some of the information in the book may need to be updated, and thus the companion website at www.boostyourtaxiq.com.  In addition, the website will contain many additional resources and bonuses such as: • List of all the sources used together with permanent archival links. • Other suggested content and articles. • Sign-up for a Boost Your Tax IQ Newsletter. • Link to few of the examples in the book as an Excel file. • Link to YouTube videos and podcasts (coming). • Link to a Boost Your Tax IQ Online Course (coming). • Pdfs, Quizzes, surveys, merchandise. • Additional charts, examples, presentations, and resources not published in the book. • Link to connect with me on social media. • Corrections. My goal is to have an even better Boost Your Tax IQ 2.0, but I can't do that without your feedback. So if you want to have an impact on the next version, please share with me: • What did you like (e.g., infographics, cartoons, examples, taxpayer stories, references, forms, summary tables, quizzes)? • Which sections did you like the most or would want to expand in the next version (e.g., Tax Challenges, Tax Mistakes, E-File Rejections, Audit Triggers, Resources)? • What needs more work? • What are your challenges? • How did the book help you?







































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Boost Your Tax IQ

• Did you find an errata (include section, page, and description)? You can also send feedback directly to [email protected].  Thank you! ( ＾◡＾)っ ♡







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TAXPAYER CHALLENGES

E

veryone makes mistakes, but some mistakes, especially tax mistakes, can be costly. Minor negligence can lead to a full-blown audit. However, only between 0.5 to 0.6 taxpayers get audited each year, so the likelihood is small. The best preventative measure you can take is to avoid tax mistakes in the first place.  Even if you receive a letter from the IRS, realize that the agency sends millions of letters each year to the taxpayers for many reasons. You could receive a letter because:  You have a balance due; You are due a larger or smaller refund; IRS has a question about your tax return; IRS needs to verify your identity; IRS requires additional information; IRS made changes to your return; IRS needs to notify you of delays in processing your return.

















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• • • • • • •





Taxpayer Challenges

Taxpayer Challenges

Boost Your Tax IQ

The Boxelder Consulting website lists over 100 different notices and letters that taxpayers can receive from the IRS.25 Fortunately, not all of them are audit notices, so when you receive a letter from the IRS, take a deep breath, read it carefully and find instructions on what you need to do.  Often tiny taxpayer mistakes, such as math errors, the agency fixes and notifies them about the change. On the other hand, the agency will not fix mistakes where the taxpayer misses out on valuable deductions and credits, thus lowering tax liability. The taxpayer is responsible to claim them correctly. Taxpayers put their best foot toward when they examine the tax mistakes they should avoid. If you make a mistake, you have the option to amend your tax return, up to 3 years. Starting with the tax year 2020, the taxpayers can amend their taxes on Form 1040-X electronically. This is extremely helpful to the 3 million taxpayers that file amendments each year.26  The section about e-file rejection codes reveals how to avoid the most common electronic filing rejections. About 37.5% of taxpayers self-prepare their tax returns and file online. Many of them receive e-file rejections, but these can often be easily fixed. Most e-file rejections are simple clerical errors such as incorrect spelling, SSNs, DOBs, EINs, etc. 

25 26

https://boxelderconsulting.com/irs-notices/ https://www.irs.gov/newsroom/now-available-irs-form-1040-x-electronic-filing









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Taxpayer Challenges

In the last part of the book, I discussed the most dreaded tax mistakes - audit triggers. Many of the audit triggers, however, are avoidable. Few are created by tax mistakes that the taxpayer neglected. You can think of audit triggers and red flags as the worst-case scenarios of tax mistakes. If you know how to prevent errors in the first place, your chances of being audited decrease exponentially. TOP TAX P AYER CHALLENGES Taxpayers face many challenges when dealing with taxes and the IRS. Top taxpayers' challenges and disappointments are listed below,27 with an estimated number of affected individuals. Whenever applicable, a section in the book addressing the problem is listed. In addition, many of the issues described below are discussed in the 2019 Annual Report to Congress28 published by the Taxpayer Advocate Service. 157 MILLION OVERCOMPLICATED TAX CODE. Every year there are major or minor tax law changes. Since 2001, there have been more than 3,250 changes to the tax code, which is thousands of pages long. Since 1975, the number of words in the code tripled.29 As a result, an overcomplicated tax code makes compliance difficult for all taxpayers.

https://www.irsmind.com/audits/top-6-tax-problems-encountered-by-taxpayers/ https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/ ARC19_Volume1.pdf 29 https://www.irs.gov/pub/tas/08_tas_arc_msp_1.pdf 27 28











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Boost Your Tax IQ

For example, the code has many temporary provisions that repeatedly expire and then get extended. Determinations for all provisions are not consistent. For example, the definition of a dependent varies widely across deductions and credits. In addition, there are various phaseout limits for many breaks. For example, the maximum phaseout limits30 for MFJ varies across different deductions and credits, as shown in Table 2. Table 2. Deductions & Credit Phase-outs for MFJ (2021) Roth IRA deduction: Traditional IRA deduction (with contributing spouse coverage): Student Loan Interest deduction: American Opportunity credit: Child and Dependent Care credit: Earned Income Tax Credit:

$208,000 $125,000

$170,000 $180,000 $440,000 $57,414 (3+ children) $198,000 (EIP1); Economic Impact Payments: $174,000 (EIP2); $160,000 (EIP3);

Phase-out is the amount of MAGI or AGI, or any other specified amount of income at which point the amount of credit is either limited or no longer available to taxpayers. 30



47

Taxpayer Challenges

There were 157 million tax returns filed for the tax year 2019.31 Taxpayer burden for the tax year 2018 was 7.9 billion hours for recordkeeping, learning about the law, and filing tax returns, which was equivalent to $271 billion in opportunity cost lost.32 About 52% of taxpayers paid someone to prepare their taxes,33 equal to $97 billion out-of-pocket costs. The tax preparation industry employs 3.8 million full-time workers. 102 MILLION34 DISSATISFACTION WITH THE IRS FREE-FILE. There were 154 million individual tax return filings for the tax year 2017. About 68% of the taxpayers (104.72 million) who filed were eligible to utilize the IRS Free File software; however, only 2.5 million used it.35 For the tax year 2019, there was a 50% growth in the number of taxpayers utilizing the Free File software. The main reason for the increase was the non-filer applications developed by the Free File software makers for taxpayers who didn’t need to file tax returns but qualified for the stimulus payments. That increased the awareness of the Free File program. However, from the 157 million tax returns filed for 2019, only 4.2 million taxpayers filed via Free File software.36

pg. 4: https://www.irs.gov/pub/irs-pdf/p55b.pdf Calculated by taking the 7.854 billions of hours times the US average of $34.72 per hour worked on non-federal civilian employee compensation in Dec 2019. https://www.ntu.org/ foundation/detail/tax-complexity-2020-compliance-burdens-ease-for-second-year-since-taxreform 33 For 2019 tax season 80.6 million used tax preparer out of 153.7 million tax returns processed. https://www.efile.com/efile-tax-return-direct-deposit-statistics/ 34 Calculated as 154 million total taxpayers filing in 2018 times 68% of those being able to utilize the free file program, minus 2.5 million who actually used it. (154 mil x 68%) - 2.5 mil = 102.22 million 35 https://www.taxpayeradvocate.irs.gov/news/ntablog-free-file-the-free-file-program-isfailing-to-achieve-its-objectives-and-should-be-substantially-improved-or-eliminated/ 31 32

pg. 93: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2021/06/ JRC22_FullReport.pdf 36











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Boost Your Tax IQ

Many taxpayers are unaware of the Free Filing software program or the free in-person IRS VITA and TCE programs. For the tax year 2018, 3.5 million taxpayers went to a VITA or TCE site to get help filing their taxes, and for the tax year 2019, 2.5 million taxpayers did. The sharp decrease was due to the Covid-19 pandemic and the closing of the many in-person sites. Another challenge with the Free File software program is the complexity of the options offered to taxpayers. For example, different software makers have various criteria for taxpayers in different states, ages, income, tax status, benefits claimed, etc. Another challenge with the Free File software program is the poor quality of the software. People expect modern and user-friendly programs, while many Free File options are oldfashioned and poor in design. From the people who use Free File software in one year, only 47% of them come back and use it the following year,37 which indicates that they were not satisfied with their previous experience. Finally, the last hurdle with the Free File program are the software companies themselves. Multiple sources have reported (ProPublica especially) that tax software makers steer eligible taxpayers away from the Free software products towards paid products by using all kinds of dark patterns.38

pg. 45: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/ ARC19_Volume1.pdf 38 Dark Patterns are tricks used in websites and apps that make you do things that you didn't mean to, like buying or signing up for something. 37









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Taxpayer Challenges

77 MILLION LACK OF TAX KNOWLEDGE.  Taxpayers who miss deductions and credits overpay on taxes. If you have low Tax IQ or use an inexperienced tax preparer, you lose on getting all the tax breaks you qualify for. That is why 52% of taxpayers pay someone to get their taxes done.39 Even if taxpayers are familiar with few benefits, they often don't know all the differences and advantages. For example, taxpayers who know one retirement plan don't necessarily know all the qualifications or benefits between the traditional IRA, Roth IRA, SEP IRA, 401(k) plans, etc.40 There is a strong link between taxpayer knowledge and understanding, and tax compliance.41 The very wealthy have sophisticated teams of professionals that help them find loopholes and eliminate their tax liabilities. But, unfortunately, average taxpayers, who want to take advantage of the tax code, can make inadvertent errors, leading to IRS penalties or an audit. The tax system works differently for taxpayers in the top vs. the bottom tax brackets. Average taxpayers have low Tax IQ. According to NerdWallet, 46% to 58% of individuals don't understand basic tax concepts.42 In addition, the Journal of Consumer Policy indicated that 30% to 79% of consumers have significant gaps

pg. 56: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/ ARC19_Volume1.pdf 40 https://www.irs.gov/pub/tas/08_tas_arc_msp_1.pdf 41 http://download.garuda.ristekdikti.go.id/article.php? article=1031092&val=11484&title=Why%20is%20Tax%20Knowledge%20and%20Tax%20Underst anding%20Important 42 https://www.nerdwallet.com/article/taxes/americans-dont-know-much-about-taxes-orthat-they-might-get-them-done-for-free 39









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Boost Your Tax IQ

in essential tax knowledge.43 As of 2020 Census data, in the United States, there were 258.3 million adults.44 Based on the percentages of individuals with low Tax IQ, conservatively speaking, more than 77 million45 adults lack basic tax knowledge. High Tax IQ also has to do with being aware of the most recent changes to the tax law, which frequently changes. For example, Congress passed ARPA during filing season, which created an EITC and ACTC 2019 Lookback Rule. The Lookback Rule allowed taxpayers to utilize their 2019 earned income when it was larger than their 2020 earned income in calculating the EITC and ACTC credits. Thus, higher earned income can result in higher credits. However, 2.5 million taxpayers failed to use this valuable benefit on their tax returns, losing $2.7 billion in additional EITC and $18.2 million in additional ACTC.46 70 MILLION UNABLE TO CONTACT THE IRS.  Of the 99 million telephone calls that the IRS received in 2019, customer service representatives answered just 29%.47 Therefore, 70 million taxpayers didn’t get to talk to an IRS agent and didn’t get their issue resolved. It is crucial to realize that this is pre-Covid data.

https://link.springer.com/article/10.1007/s10603-020-09460-2 https://www.census.gov/library/stories/2021/08/united-states-adult-population-grew-fasterthan-nations-total-population-from-2010-to-2020.html 45 This is a conservative range of 30% times the total population of 258.3 million (258.3 mil x 30% = 77 mil). The most aggressive estimate would be based on 79%, which would equal 204 million (258.3 mil x 79% = 204 mil). The main point is that many taxpayers don't understand the complex tax code and miss out on all the benefits. 46 pg. 13: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2021/06/ JRC22_FullReport.pdf 47 pg 26: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/ ARC19_Volume1.pdf 43 44











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The agency should reduce the number of calls by: • • • • • • • •

improving online options;  providing clear instructions;  offering relevant answers to FAQs; supplying tax preparers with helpful information; providing a callback option; creating chat as an alternative; creating secure messaging; increasing the number of customer representatives. 

In the past, the IRS had many local Taxpayer Assistance Centers (TACs) so taxpayers could receive in-person assistance. However, since 2011, the IRS has closed 43 TACs. As a result, the number of taxpayers helped dropped from 5.4 million in 2014 to 2.9 million in 2018.48 There is a lot of valuable information on the IRS website. However, some of it can be hard to follow for taxpayers not familiar with the tax jargon. Another option is to access reliable summary information on third-party websites. The sources listed Resources Part IV Table 50 are reliable and are written in clear English. 38 MILLION MISPLACING PREVIOUS TAX RETURNS.  Most tax software will ask for prior-year tax return information, such as AGI, to verify taxpayer identity. Referencing a tax return from the previous year also helps compare and contrast two years of data. In addition, it can serve as a reminder of the usual deductions and credits you qualified for in the past.

pg. 11: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/ ARC19_Volume1.pdf 48



























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However, many taxpayers don’t keep or save copies of their tax returns or misplace them. Sometimes taxpayers can’t access prior-year tax software because they don’t remember their login or email information. If they try to obtain IRS transcript data, they can fail the validation process. If they change the tax software or use a new tax preparer during the new tax season, they put themselves in a disadvantaged tax position. Many taxpayers face this challenge. For example, during 2020, there were 36.4 million requests to obtain online transcript information and 1.46 million mail inquiries.49 These requests are placed by the taxpayers or tax preparers and indicate the extent of the difficulty. 38 MILLION USING INEXPERIENCED TAX PREPARERS. Many taxpayers rely on paid tax preparers to help them file their taxes. Tax preparers with credentials such as enrolled agents (EAs), certified public accountants (CPAs), or attorneys must pass competency examinations and yearly continuing education requirements. VITA and TCE programs also require their volunteers to pass annual tax competency testing.

49

pg. 25: https://www.irs.gov/pub/irs-pdf/p55b.pdf











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Large tax preparation companies require annual tax refreshers for their employees; however, there is no set testing or license requirements. Therefore, 53% of tax returns (38 million) are prepared by unenrolled (non-certified) tax preparers,50 whose levels of expertise and experience vary. There are many excellent non-certified tax preparers; however, it can be challenging for taxpayers to identify the ones that are not. There are few things that you can do to make sure you are using a reliable and experienced tax preparer: • • • •

make sure your paid preparer has a PTIN number; they don’t rush you or ask for access to your refund; their fee is not based on a percentage of the refund; they freely disclose their experience and credentials.

Several tax software companies offer tax review services if you are not entirely comfortable preparing your own taxes. It may be worth the extra fee if it prevents error penalties or tax return examination. 34 MILLION TOO MANY PENALTIES. For tax year 2019, 34 million taxpayers receive tax penalties.51 The most common ones are failure to pay (57%), failure to file (7%), and not paying estimated taxes (32%). All three account for 96% of all penalties to individuals. As of 2020, there were 150 different types of penalties,52 up from 14 in 1954.53

pg. 56: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/ ARC19_Volume1.pdf 51 pg 60 Table 26: https://www.irs.gov/pub/irs-pdf/p55b.pdf 52 https://www.jacksonhewitt.com/tax-help/irs/irs-audits-notices/top-6-tax-problemsencountered-by-taxpayers/ 53 https://www.irs.gov/pub/tas/08_tas_arc_msp_1.pdf 50



















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There are two things that taxpayers can do to avoid this challenge. The primary way to avoid penalties is to file taxes on time and apply for installments if you can't pay on time. The second thing that taxpayers can do is request penalty abatement, especially if this is a first-time offense. The IRS may abate the first-time penalty for a reasonable cause.54 Many taxpayers are not aware they have a right to request an abatement, and even though about 9% of requests get accepted,55 it is worth a try. In more complicated cases, taxpayers also have a right to appeal adverse IRS determinations. 24 MILLION NOT REPORTING ALL INCOME. About 24 million taxpayers don’t report all income. The IRS sends notices to about 3.7 million of them, targeting the tax returns with the most considerable adjustments and highest potential of funds recovery.56 In addition, about 16 million Schedule C filers underreport their income, especially those in cash-intensive businesses (see AT 7). Make sure you report all your earnings because sooner or later, the IRS will send you a notice about unreported income. If you have trouble obtaining documents from an employer or institution, request an IRS transcript.

https://www.irs.gov/businesses/small-businesses-self-employed/penalty-relief-due-to-firsttime-penalty-abatement-or-other-administrative-waiver 55 https://www.jacksonhewitt.com/tax-help/tax-tips-topics/penalties/dos-and-donts-whenrequesting-irs-penalty-abatement-for-failure-to-file-or-pay-penalties/ 56 https://www.journalofaccountancy.com/newsletters/2017/feb/irs-not-giving-upcompliance-enforcement-.html 54











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19 MILLION UNABLE TO PAY ALL TAX DUE. As of 2018, about 19 million taxpayers owe back taxes but can’t pay.57 The IRS is working with 1/3 of these taxpayers through payment plans, 1/3 it is trying to chase, and the last 1/3 is not pursuing. For the tax year 2019, the IRS accepted 12.5 million payment settlements,58 allowing taxpayers to resolve an outstanding tax debt for less than what was originally owed. The agency also accepted 965,418 online installment agreements. If you can’t pay the entire balance, set up a payment plan with the IRS or check if you qualify for an offer in compromise (AT 9C). As the statistics indicate, many taxpayers take advantage of the available options and are successful in doing so. On the other hand, from the 1/3 taxpayers that the IRS is trying to chase are high-income taxpayers with AGIs of over $200,000. A Treasury General Inspector 2019 analysis identified 685,555 high-income taxpayers, owning a total of $38.5 billion in back taxes.59 The way the IRS goes after these taxpayers is ineffective as many of them actually earn high incomes and can pay at least part of their debt.

https://www.journalofaccountancy.com/newsletters/2017/feb/irs-not-giving-upcompliance-enforcement-.html 58 pg. 25: https://www.irs.gov/pub/irs-pdf/p55b.pdf 59 https://www.treasury.gov/tigta/auditreports/2021reports/202130015fr.pdf 57









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Since 2017 the IRS has started assigning delinquency cases to private collection agencies (PCAs). Many cases of lowincome taxpayers with Social Security Disability Insurance (SSDI) benefits, Supplemental Security Income (SSI) or with incomes below the 200% poverty level were assigned to PCAs.60 In 2021, Congress changed the program to avoid additional economic hardship on taxpayers at the very bottom income level. If you have trouble paying your tax and don't know where to start, reach out to TAS. 18 MILLION COMPLICATED EITC QUALIFICATIONS.  Earned Income Tax Credit (EITC) is a refundable tax credit for low and mid-level income earners. In 2020 about 25 million claimed it, with an average amount of $2,461.61 Households earning less than $57,414 (for the tax year 2021) can qualify for the credit depending on the number of children and their filing status. At the same time, taxpayers that earn below $73,000 in income qualify for Free Filing programs.62 Therefore most taxpayers who claim EITC (earnings below $57,414) should be able to file their tax returns for free. However, because of the tax code’s complexity, 72.5% of the low-income taxpayers end up going to paid tax preparers to file their taxes.63 As a result, 18 million low-income working families64 have to pay for tax preparation instead of using that money on more essential things.

pg.98: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/ ARC19_Volume1.pdf 61 https://www.eitc.irs.gov/eitc-central/about-eitc/about-eitc 62 https://www.irs.gov/filing/free-file-do-your-federal-taxes-for-free 63 https://www.irs.gov/pub/tas/08_tas_arc_msp_1.pdf 64 25 million (2020 data) * 72.5% (2014 data). The data is from two different periods but it can sever as an approximation. 60









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On top of that, the low-income taxpayers often don’t have out-of-pocket funds to pay for the tax preparation service. To solve that predicament, they frequently opt-in for Refund Transfer for an extra $30 to $40, which pays tax preparation fees from the refund.65 What’s more, 1 out of 5 EITC eligible taxpayers don’t receive it. Some don’t receive it because they don’t know about it or are unsure how to claim it. Others don’t have a tax filing requirement and are unaware that they could receive this valuable refundable credit. If you make less than $73,000 and have EITC, you have several Free Filing options (TM 1E). In addition, the IRS has a list of approved Free-File tax software and a list of in-person VITA and TCE sites. At the VITA and TCE sites, the taxpayers can file tax returns for the current and past two years for free, and no products are sold to them. 11 MILLION COMMITTING MATH ERRORS.  For the tax year 2020, the IRS identified 11 million math errors, which surged from 1.9 million for the tax year 2019.66 80% of the 2020 errors involved Recovery Rebate Credit (RRC) associated with the Economic Impact Payments (EIPs). Congress passed multiple tax laws in 2020 (see Part IV Resources) due to the Covid-19 pandemic. Several of the new tax provisions were enacted in the middle of the tax filing season. They impacted millions of taxpayers, further increasing the error rate.

https://www.nclc.org/images/pdf/taxes/rpt-tax-time-jan2020.pdf https://www.wsj.com/articles/the-latest-irs-headache-for-taxpayers-11-million-math-errornotices-11630661402 65 66











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The problem with many of the math error notices is that they are often confusing and lack clarity.67 Often the letter specifies number of different possible reasons for the error, which may be hard for the taxpayer to determine what needed to be corrected.68 More taxpayers in the lower income bracket are affected by the math error notices. If the taxpayers cannot understand the IRS notice, they may not be sure whether they should accept the correction or reject it. If you made any tax return errors, the best way to correct them is to file an amended return. If you receive a math error notice from the IRS and are unclear about what was changed, you can request clarification or penalty abatement. 10.7 MILLION UNDERPAYING ESTIMATED TAXES.  In the tax year 2019, 10.7 million taxpayers underpaid their estimated taxes.69 Since 2007 there has been a 33% increase in the number of taxpayers that receive a penalty for the underpayment. One variable impacting the growth is the increase in popularity of the gig economy.

https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/07/ ARC18_Volume1_MSP_12_MathError.pdf 68 https://news.bloombergtax.com/daily-tax-report/irs-to-taxpayers-receiving-notices-whatlike-math-is-hard 69 pg. 60, Table 26: https://www.irs.gov/pub/irs-pdf/p55b.pdf 67











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Gig workers, freelancers, and other non-traditional job earners don't work for typical employers that withhold taxes on their income. However, since the US tax system requires taxpayers to pay taxes as they earn, estimated quarterly payments are needed throughout the year.70 If you receive non-traditional earnings and anticipate the same income as last year, an easy way to figure out how much in estimated taxes you need to pay per quarter is taking your total tax liability for the year and dividing it by 4. However, if your income changes, you will have to make adjustments. 10.6 MILLION NOT FILING TAX RETURNS.  About 10.6 million individual filers neglect to file their taxes, based on unmatched W-2 and 1099 data for the tax year 2017.71 The number is probably higher if we include cashbased workers who don't receive any formal documents. Under the Automated Substitute for Return (ASFR) program, the IRS can put together a Substitute for Return (SFR) for taxpayers using the information that it has on hand.72 The program was paused in 2017 due to a reduction of resources but reinstated in 2019. It is not in the taxpayers' best interest to accept an SFR because:73 • the IRS uses only income information • the standard deduction is assumed while itemized deduction may benefit the taxpayer If the tax liability is above $1,000 for the current tax year. There are exceptions for certain professions such as farmers, fishers, and others. https://www.usatoday.com/story/money/ 2017/08/14/irs-penalizes-more-earners-mistakes-underpayment-estimated-tax-filings/ 565185001/ 71 https://www.treasury.gov/tigta/auditreports/2019reports/201930063fr.pdf 72 https://www.jdsupra.com/legalnews/did-you-know-that-irs-reinstated-the-65715/ 73 https://www.irs.gov/pub/irs-utl/2013_NTF_Dealing_with_SFRs.pdf 70















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• it uses filing status of single or MFS • it doesn't include dependents • expenses, deductions, or credits are not included • an SFR with a tax liability may result in a refund hold on another return to secure payment.74 For these reasons, the SFR will most likely have an inflated tax liability, disadvantaging the taxpayer. Therefore, the best option for the taxpayer is to file the return themselves utilizing all the allowed deductions and credits.  Many taxpayers that may be identified as non-filers and not complying with taxes could actually receive a refund. However, taxpayers have only 3 years to claim a refund due; after that statute of limitation, unclaimed refunds go to the US Treasury. If you are not sure whether you have a filing requirement, you should utilize the free filing options (Figure 7). They will aid you in verifying whether you can get reimbursement on any withholdings or qualify for credits that lead to a refund. Especially working families with dependents may be eligible to receive a refundable EITC credit, which results in a refund even if the tax liability is zero.

74

https://www.treasury.gov/tigta/press/press_tigta-2017-27.htm















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10.3 MILLION TAX REFUND DELAY.  The IRS has designed tax return filters to prevent refund fraud. However, these filters can delay taxpayer refunds for legitimately filed returns, which can cause financial hardship for filers. In addition, the 2020 TAP report to Congress stated that the false-positive rates have been as high as 71%. That means that returns are marked for review because the information looks suspicious, but actually, it is legitimate. As of July 24, 2021, the IRS had a backlog of 14.7 million unprocessed individual returns.75 Since 70% of processed returns included refunds,76 about 10.3 million77 taxpayers were still waiting for their payments. As a result, many taxpayers had to wait 3 weeks longer than the usual processing time to receive their refunds, and some had to wait over 40 days.78 Moreover, it is hard for taxpayers to find out the exact reason for the delay.

https://abc7chicago.com/my-tax-refund-irs-unemployment-trump/10932669/ https://www.nytimes.com/2021/07/01/business/irs-tax-return-backlog.html 77 This is a conservative calculation because the taxpayers who filed early and had their tax refund delayed are not included in the 14.7 million. It is calculated by taking the total returns unprocessed (14.7 million) multiplied by the percentage of refunds issued during the year (70%) = 14.7 x 0.70 = 10.29 million. 78 pg 34: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/ ARC19_Volume1.pdf 75 76







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Low-income households rely heavily on their tax refunds and are disproportionally impacted by tax refund delays. Each tax filing season, taxpayers claiming EITC and ACTC credits have their tax refunds delayed until mid-February or even March. That produces unexpected consequences, such as low-income families in need of cash applying for tax loans against their refunds. These financial products can have interest rates as high as 24% to 45%.79 Still, households making less than $60,000 are between 34% and 61% more likely to apply for them than taxpayers in higher income brackets.80 During tax season 2020, there were additional circumstances that made the tax refund delays even worse. The Covid-19 pandemic impacted all Americans, and Congress passed several new tax regulations, many midst filing season. In particular, issuances of Economic Impact Payments (EIPs), the creation of the 2019 EITC lookback rule, partial exclusion of unemployment income, and elimination of excess Advanced Premium Tax Credit (APTC) repayments for the tax year 2020.81 For example, the partial exclusion of unemployment income enacted in March 2021 led the IRS to make over 8.7 million unemployment compensation refunds after many taxpayers already had their tax returns processed.82

https://www.nclc.org/images/pdf/taxes/rpt-tax-time-jan2020.pdf Households making between $20,000 - $29,999 were 34% more likely to pay for financial products and households making between $30,000 - $39,999 were 61% more likely to pay for such products. https://www.gao.gov/assets/700/699047.pdf 81 pg. 20: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2021/06/ JRC22_FullReport.pdf 82 https://abc7chicago.com/my-tax-refund-irs-unemployment-trump/10932669/ 79 80





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1.8 MILLION DISREGARDING IRS LETTERS. When a taxpayer's tax return doesn't match the IRS's data received from tax forms issuers, such as employers, the agency will send a CP 2000 notice to the taxpayer. These notices indicated unmatched information on the tax returns. The IRS sends about 6 million CP2000 notices to taxpayers every year.83 About 30.8% of taxpayers don’t respond to IRS letters,84 which is about 1.8 million of taxpayers.85 It is a correspondence audit automatically generated by an automated system that informs taxpayers about tax filing discrepancies. The notices also propose changes, assess additional tax and interest, give instructions and provide an opportunity to respond. The tax letters can contain a lot of information which is not always easy for taxpayers to follow. The Taxpayer Advocate Service has been urging the IRS to utilize plain language, avoid jargon or overly technical words, and simplify their notices to improve taxpayer understanding and response rate.86 Many taxpayers are scared of IRS letters and don't take time to read them. Unfortunately, there is a limited amount of time to respond, usually 30 days. If taxpayers don't address them immediately, the IRS will assess penalties, interests and send a Notice of Deficiency.87

https://taxcure.com/tax-problems/irs-letters/cp2000 pg. 85: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/ ARC19_Volume1.pdf 85 Calculated by taking the number of CP2000 notices (6 mil) times 30.8% non-response rate, which equals 1.8 million of taxpayers (6 mix x 30.8% = 1.8 mil) 86 pg. 195: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/07/ ARC18_Volume2_07_ImproveNotices.pdf 87 https://bench.co/blog/tax-tips/cp2000/ 83 84











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In 2020, the IRS also sent 0.5 million Combination Letters to taxpayers, combining two letters. They contained information from a typical Initial Contact Letter and the 30-Day Letter for correspondence audits.88 That made it even more confusing for taxpayers. If you receive a letter from the IRS, make sure that you take the time to read it and follow the instruction carefully (TM 9E). 900 THOUSAND BEING AUDITED. In 2018 the IRS audited 900 thousand individual tax returns, an audit rate of 0.6% (1 out of 167 people).89 More than 70% of all the audits that the IRS conducts are correspondence audits.90 Taxpayers often don't realize that they are being audited, as nowhere does it state on the notice that it is an audit. So, for example, the taxpayers who received a CP2000 correspondence audit notice from the IRS over a quarter of them do not understand they are being audited.91 Taxpayers need to respond to audit notices within the 30day window. However, about 45% of taxpayers with incomes under $50,000 do not respond to IRS audit notices.92 Each IRS letter has a phone number and case number listed. However, the IRS toll-free phone customer service is not responsive, and no single examiner works the case. Therefore even if a pg 80: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/ ARC19_Volume1.pdf 89 https://www.taxpolicycenter.org/taxvox/irs-data-book-tells-story-shrinking-staff-feweraudits-and-less-customer-service 90 pg. 38: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2021/06/ JRC22_FullReport.pdf 91 pg. 56: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2021/06/ JRC22_FullReport.pdf 92 pg. 56: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2021/06/ JRC22_FullReport.pdf 88











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taxpayer talks to an IRS agent, that person holds no responsibility for the action or determination regarding the examination.93 If you receive an IRS notice and are unsure how to respond, you should talk to a tax attorney, Enrolled Agent (EA), or CPA. You can also reach out to TAS for help if you can't afford paid service. Per TAS analysis of tax litigated cases between June 1, 2018, and May 31, 2019, out of 523 cases, the ones with tax representatives won twice as often as those where the taxpayers represented themselves (pro se).94 Table 3. Tax Court Cases that Won with Representative or Self-Representation (Pro Se) All Cases Won Self Representation 247 (47%) 26 (11%) Represented 276 (53%) 60 (22%) Total 523 86 (16%) 44 THOUSAND OFFER IN COMPROMISE REJECTIONS.  The IRS’s “offer in compromise” program (OIC) allows taxpayers to settle tax debt for less than the full amount, a favorable option for those who can’t pay their entire tax liability. In 2020, the IRS received 44,809 OICs,95 the lowest since 2008. The agency should do better informing taxpayers about this opportunity to increase higher participation. Unfortunately, low-income individuals are less likely to be aware of OIC than taxpayers in higher tax brackets.

pg. 104: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2021/06/ JRC22_FullReport.pdf 94 pg. 110: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/ ARC19_Volume1.pdf 95 pg. 41: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2021/06/ JRC22_FullReport.pdf 93









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The IRS has stringent and unrealistic acceptance criteria for OIC, which discourages taxpayers from making any payments.96 The agency rejects 40% of its offers even though it never gets what it estimates the taxpayers should pay anyway. However, it is still worth applying for the OIC, as 60% of the taxpayers get into the program. If you need assistance, reach out to TAS for help.

pg 89: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/ ARC19_Volume1.pdf 96



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TAX INFO

AND

FORMS

From the get-go, taxes are complicated. They can be confusing, full of exceptions and contradictions, noncommon-sense definitions, and references to many other rules and regulations. If you are exposed to taxes only once a year, everything you learn during your filing you forget because you won’t touch it for a while. Forms There are almost 400 IRS Forms and instructions97 that the agency publishes on its website. IRS website also has a list of almost 120 publications and guides98 on different tax topics. The agency provides access to information but does not guarantee clarity of it. Not only did Form 1040 has been changing each year, but it also contains a reference to 5 schedules and 9 forms. Schedule 1 through 3, which flow into 1040, contain references to other forms and schedules, and the taxpayer is asked to “see instructions” 15 times. You can see the complexity of taxes first hand just by examining the Form 1040 instructions which are 115 pages long99 and: • reference other forms (480) and schedules (254) many times; • mention additional “worksheets” 135 times; • list exceptions 44 times;

https://www.irs.gov/instructions https://www.irs.gov/publications 99 https://www.irs.gov/pub/irs-pdf/i1040gi.pdf 97 98



















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• ask you to add (39), subtract (62), multiply (25), and divide (4);

• compare things that are smaller (22), larger (6), or ask you to combine items (9). 

Cartoon 2. 1040 Chaos Theory



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Definitions Tax code terms don’t follow common-sense everyday usage, which creates confusion for taxpayers. For example, the definition of “qualifying child” is different when claiming EITC, CTC, or another benefit.100 Some definitions rather than define the tax item itself define what it is NOT, such as with capital asset.101 Over time, per case laws and additional IRS regulations, the definition becomes clarified. However, there is a lag between when the tax term was used and when it is defined. Code The tax code is between 2,600 and 70,000 pages long. Why such a discrepancy? Some organizations count all the supporting IRS regulations and revenue rulings, which explain how to apply the tax code, as part of it.102 Regardless of how you see it, the tax code is long and not written in plain English. If you want to look at Title 26 of the Internal Revenue Code, the pdf version has 6,571 pages.103

https://www.brookings.edu/testimonies/tax-simplification-issues-and-options/ https://www.law.cornell.edu/uscode/text/26/1221 102 https://irisreading.com/how-long-would-it-take-to-read-the-entire-u-s-tax-code/ 103 https://uscode.house.gov/browse/prelim@title26/subtitleA/chapter1/subchapterB/ part1&edition=prelim 100 101











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Figure 3. Code Title 26

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Exceptions

Another obstacle to a clear tax code is the number of exceptions that it has. Even if you believe that you have a good understanding of some general rules, you may not be aware of several exceptions. 

For example, if you look at the rules for claiming a dependent, which is a frequent tax term, there are 4 exceptions listed. The summary table for the definition is also only an overview of the general rules for a dependent. For details, you have to review publication 501, which is 29 pages long.

Figure 4. Many Exceptions to IRS Rules



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TEST Y OUR TAX K NOWLEDGE Take the quiz below if you want to have a little fun and test your tax knowledge. 1. Typically, not including extensions, your tax returns are due on: May 17 April 15 July 15 October 15

A. B. C. D.

2. What is the tax form used most often to file individual taxes? 1040-SR 1040-EZ 1040-A 1040

A. B. C. D.

3. What are the tax filing statuses? Dependent Head of Household Single Married Filing Jointly Senior Qualifying Widow(er) Married Considered as Unmarried Married Filing Separately

A. B. C. D. E. F. G. H.











































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4. What are two significant deductions that all taxpayers can take? Family deduction Standard deduction Business deduction Itemized deduction

A. B. C. D.

5. What is the effective tax bracket? The value of deductions and credits for the amount of taxable income. The amount of additional tax paid for every extra dollar earned as income. The lowest income tax bracket. The percentage of your income that you pay in taxes.

A. B. C. D.

6. What is the difference between a tax deduction and a tax credit? Deductions are worth half what credits are worth. Deductions reduce your taxable income, while credits reduce your tax due. They are the same. Credits reduce your gross income, while deductions reduce your taxable income.

A. B. C. D.

7. Which is the most significant tax penalty? Failure-to-file penalty Underpayment of estimated taxes Failure-to-pay penalty

A. B. C.







































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8. What income is taxable? A. B. C. D.

Unemployment compensation Economic Impact Payments (EIPs) / stimulus payments Child support payments Alimony

9. Which of the following is/are tax-deductible? A. B. C. D.

Gambling losses Rental losses Losses on the sale of primary residence Hobby losses

10. What is the worst mistake? A. B. C. D.

You owe taxes and don’t file. You are due a refund, but you file late. You owe taxes; you file but don’t pay on time. You are due a refund, and you don’t file.































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Count the number of answers that you got correctly. If you had: 0-3 Correct: There is nowhere for you to go but up. You are in the right place to boost your tax IQ. 4-7 Correct: Given the complexity of our tax system, you did pretty well. Visit the sections of the book that would benefit your financial and tax situation the most. You can boost your tax IQ even more by examining the areas that you got wrong. 7-10 Correct: Congrats on your results. You have a solid foundation of tax knowledge. You are qualified to tackle the more advanced areas in the book. Keep building your skills to take advantage of the tax code and improve your financial situation even more.









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Answers 1. The answer is (B) April 15. For the tax year 2021, because April 15 falls on Good Friday, the tax due date is April 18, 2022. This means that the tax due date has not been April 15, even once for the past three years. However, that is the tax due date in the IRS Section 6072(a) code.104 May 17, 2021 was the due date for the tax year 2020, which was extended due to the Covid-19 pandemic and IRS delays. B. April 15 C. July 15, 2020 was the due date for the tax year 2019, which was extended due to the Covid-19 pandemic. D. October 15 is the due date for taxpayers who file Form 4868, a 6-month extension. The extended due date gives taxpayers extra time to file, but the payment date is still April 15. A.

2. The answer is (D) 1040. Form 1040, US Individual Income Tax Return, is used to file federal income taxes. 1040-SR was first published for the tax year 2018. It is primarily to file tax returns for seniors. It has a larger font and gives greater prominence to tax benefits for taxpayers with retirement benefits.105 B. 1040-EZ was used for simple tax returns of filers with primarily W-2 income. The form was retired in 2018.106 C. 1040-A was used for taxpayers that made less than $100,000 a year and didn’t itemize their taxes. The form was retired in 2018. D. 1040 A.

https://www.irs.gov/pub/irs-drop/n-11-17.pdf https://www.investopedia.com/taxes/seniors-get-new-simplified-tax-form/ 106 https://www.irs.gov/forms-pubs/about-form-1040-ez 104 105























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3. The answer is (B-HOH, C - Single, D - MFJ, F - QW, HMFS). There are five types of tax filing statuses. Dependent is someone who another person financially supports. A dependent could be single or married but could not be HOH or QW. Taxpayers who file HOH or QW need to be financially supporting dependents. B. Head of Household (HOH) C. Single D. Married Filing Jointly (MFJ) E. Senior refers to a taxpayer who is over 65 years old and qualifies for the additional standard deduction. Seniors can be single, HOH, MFJ, QW, MFS. Being a senior is not a filing status. F. Qualifying Widow(er) (QW) G. Married Considered as Unmarried is a definition used to qualify married taxpayers who want to file as HOH. They have to pay more than half of the cost of keeping up a home for a dependent and had to live apart from their spouse for at least 6 months of the tax year (July-Dec). H. Married Filing Separately (MFS) A.

4. The answer is (B and D). (B) The standard deduction is a flat amount that taxpayers can deduct on their taxes based on their filing status, age, and blindness. (D) Itemized deduction can be claimed on Schedule A with detailed information of various expenses, such as health care expenses, mortgage interest, real estate taxes, etc. Family deduction - there is no such thing B. Standard deduction C. Business deductions are only available for taxpayers who have businesses and vary. D. Itemized deduction A.





























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5. The answer is (D) the percentage of your income that you pay in taxes. It is the average rate at which all your income is taxed. It is calculated by taking your tax liability and dividing it by taxable income. If your taxable income is $50,000 and you are single, your marginal tax bracket is 22%. However, your effective tax rate is much lower. At $50,000, with no other benefits, the tax liability would be $6,796. That means that the effective tax rate is 13.6% ($6,796 / $50,000). The effective tax rate doesn’t take into account state taxes. The value of deductions and credits for the amount of taxable income. There is no such tax bracket. B. The amount of additional tax paid for every additional dollar earned as income. That is a marginal tax rate, which is dependent on the amount of income a taxpayer has. Currently the US tax system has 7 tax brackets - 10%, 12%, 22%, 24%, 32%, 35%, 37%. If your taxable income is $50,000 and you are single, your marginal tax bracket is 22%. C. The lowest income tax bracket. From the US federal marginal tax rates of 10%, 12%, 22%, 24%, 32%, 35%, 37%, it would be the 10%. D. The percentage of your income that you pay in taxes. A.











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6. The answer is (B) Deductions reduce your taxable income while credits reduce your tax due. For example, a $500 tax deduction would reduce your taxable income from $25,000 to $24,500. On the other hand, a $500 tax credit would reduce the amount of tax you owe from $2,800 to $2,300. Thus, a tax credit is often more valuable because it reduces your taxes dollar for dollar. Some significant tax credits include EITC and AOTC. The two largest tax deductions include standard or itemized deductions. Deductions are worth half what credits are worth. B. Deductions reduce your taxable income, while credits reduce your tax due. C. They are the same. D. Credits reduce your gross income, while deductions reduce your taxable income. A.

7. The answer is (A) penalty for not filing your taxes is larger than the penalty for not paying or underpayment. It is a penalty for not filing on time and is 5% per month of the tax amount owed, plus interest, up to 5 months. The 2021 interest rate for underpayment of taxes is 3%.107 Failure-to-file penalty B. Underpayment of estimated taxes occurs when taxpayers owe more than $1,000 in federal taxes for the year. There are a couple of safe harbor rules to avoid the penalty and waivers for first-time offenders. The calculation is complex. It involves the period when taxes were underpaid and the current interest rate for the underpayment.108 A.

107 108

https://www.efile.com/tax-penalties/ https://www.irs.gov/payments/interest-on-underpayments-and-overpayments

















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Failure-to-pay penalty is a penalty for not paying your tax amount due on time and is 0.5% per month, plus interest, up to 25% of back taxes. C.

8. The answer is (A) unemployment compensation is taxable. However, for the tax year 2020, up to $10,200 of unemployment income was excluded from tax. Unemployment compensation B. Economic Impact Payments (EIPs) / stimulus payments are not taxable. They are included on tax returns to ensure you receive the full amount that you qualify for and if you didn’t, to claim the Rebate Recovery Credit (RRC). C. Child support payments are never taxable to the recipient and are not deductible for the payer. D. Alimony is not taxable for court orders dated after 12/31/2018. Up to that time, alimony payments were taxable, and the payer could deduct them on taxes. A.

9. The answer is (A) gambling losses and (B) rental losses, with some limitations. Gambling losses are tax-deductible up to the amount of winnings and only if the taxpayer itemizes on Schedule A. B. Up to $25,000 of rental losses could be taxdeductible for taxpayers who actively participate in the management and if their AGI is below $150,000. Taxpayers can deduct most of their rental losses if they qualify as real estate professionals. C. Losses on sale of primary residence are not allowed. If they qualify, taxpayers can exclude up to $250,000 of gain from the sale of their primary home. However, a loss on a personal residence is disallowed. A.





















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Hobby losses are not allowed. Before the passing of TCJA in 2018, taxpayers could deduct hobby expenses up to hobby income. Currently, taxpayers have to declare their hobby income, but hobby expenses are not deductible at all. D.

10. The answer is (A) you owe taxes and don't file. The penalty for not filing is worse than the penalty for not paying. Deliberately not filing and owing can lead to audit and fraud charges. Additionally, the statute of limitation, which is the time when the IRS may assess and collect federal income taxes, doesn't start until taxpayers file their tax returns. That means that the IRS can audit the un-filed return at any time. Lastly, if you just need more time to get organized, request a 6-month extension. It doesn't extend the time to pay, but there won't be any penalty for not filing. 1. You owe taxes and don’t file. 2. You are due a refund, but you file late. There is no deadline if you are due a refund, and you have 3 years to file and receive it. However, you won't receive the money if you don't file. 3. You owe taxes; you file but don't pay on time. The important thing is that you filed. The penalty for not filing is higher than for not paying (5% vs. 0.5% plus interest, per month). Many options are available if you can't pay the entire amount, such as IRS payment plans. 4. You are due a refund, and you don't file. If you are due a refund, there is no penalty for not filing your taxes; however, the statute of limitation on that tax return also doesn't start. Taxpayers also have only 3 years to get the money. After that, it goes to the US Treasury.













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U NDERSTANDING Y OUR 1040 F ORM It is all well and good talking about taxes, but before we move any further, we should have a quick look at Form 1040 on how taxes are calculated. Keep in mind that this is a simplified version of the form to help you see the big picture and not get bogged down in the details. For more detail look at my short book on 1040: Understand YourTax Form 1040 In a perfect world, according to our elementary school math, we would calculate our tax like this: (Income - Deductions) * Tax Rate = Tax Tax - Credits = Total Tax Total Tax - Payments = Refund or Amount Due However, since we are dealing with tax calculations, the computations are anything but simple. Several categories are added and subtracted on the 1040 form multiple times. There are several reasons for the numerous entries. First, different income is taxed at varying tax rates (e.g., wages (Form 1040 line (L1) vs. capital gain(L7)). Second, nonrefundable credits can reduce your tax liability only to zero (e.g., foreign tax credit (L20)). In contrast, refundable credits (e.g., EITC, AOTC, RRC (L27-30)) can lead to a refund even if you have zero tax liability. Finally, taxes outside the 1040 form must be added to your tax due amount (e.g., selfemployment taxes (L23)).















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Additionally, multiple schedules are listed on Form 1040. For example, three Schedules are split into two parts each and are listed six times on the two pages of 1040, which is confusing. Furthermore, they are not even listed in order (Sch 3, Part I before Sch 2, Part II). Table 4. 1040 Schedules 1-3 Sch 1, Part I Sch 1, Party II Sch 2, Part I Sch 2, Part II

- additional income (addition) - deductions (subtraction from income) - other taxes (addition to tax due) - additional taxes (addition to tax due) - other non-refundable credits that can reduce the tax liability to zero (subtractions from tax) - additional refundable credits that can reduce tax liability below zero and lead to a refund (subtractions from tax)

Sch 3, Part I Sch 3, Part II

The information from the three schedules flows into Form 1040. Additionally, so does information from many other Forms (8995, 8863, etc.) and Schedules (A, D, EIC, etc.). The complex layout, unfamiliar terms, and the many choices that taxpayers need to analyze, make preparing taxes very challenging (see The Behavioral Insights for Tax Compliance on how our natural habits make preparing taxes a challenge). However, we have to work with what we have, at least for the time being. To calculate the amount of your refund or how much you owe in taxes, Form 1040 breaks up the tax computations into six steps (see Table 5). Example 1 presents an easy example we will use throughout the book to go through each step and calculation. You can download some of the tables at www.understand1040.com/resources for free or all for a minimal fee.









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Table 5. Simpli ed 1040 Tax Calculations step 1

step 2

Total Income (L9) + Additions to Income - Subtractions from Income = AGI (L11)

step 3

AGI - Standard or Itemized Deduction - QBI = Taxable Income (L15)

step 4

Taxable Income * Tax Rate = Tax (L16)

step 5

Tax + Other Taxes - Non-refundable Credits = Total Tax (L24)

step 6

Total Tax - Payments - Refundable Credits = Refund (L34) or Amount Due (L37)

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Example 1. Simpli ed Form 1040 U.S. Individual Income Tax Return for 2021 Item (line on 1040) Wages, salaries (1) Taxable interest, dividends. Sch B (2b,3b) Taxable IRA, pension, annuity & taxable social security (4b,5b,6b) Capital gain or (loss). Sch D (7) Other income - Sch 1, Part I & Sch C, E, F (8) Total Income (9)

Add $60,000 $400

$500 $3,500 $66,900 $4,250 $62,650

Standard or itemized (Sch A) deduction & QBI (12-13) Taxable income (15) Tax (from tax table) (16)

Federal withholdings, estimate & prior year prepayments (25-26) Refundable credits such as CTC, EIC, ACTC, AOTC, recovery rebate credit (EIPs) (27-30) Refundable credits - Sch 3, Part II (31) Total Payments (33) Refund (34) Amount you owe (37)

$12,550 $50,100 $6,776 $250 $500 $1,750 $350 $5,126 $4,500 $500 $800 $5,800 $674 -

IRS Form 1040

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fi

Total

$2,500

Adjustments to income - Sch 1, Part II & charitable donations (10c) Adjusted Gross Income (AGI) (11)

Other tax - Sch 2, Part I (17) Non-refundable Child tax credit or credit for other dependents (19) Non-refundable credits - Sch 3, Part I (20) Other tax - Sch 2, Part II including selfemployment tax (23) Total Tax (24)

Subtract

Boost Your Tax IQ

Your Total Income (L9), often referred to as gross income, includes earned and unearned types of income. Earned income is from labor received as wages, salary, selfemployment, tips, commissions, and bonuses. Unearned income is from passive activities such as investments, rentals, or retirement and is reported as dividends, interest, capital gains, Social Security (SS), pensions, or annuity. Not all of your income is taxable. For example, the federal government doesn't tax child support, life insurance proceeds, municipal bond interest, or disability income, etc (Table 47). The additional income that is taxable is listed on Schedule 1, Part I (Example 1), and added to Total Income (L9). In our example, our single taxpayer had $66,900 of Total Income from variety of sources, including $3,500 from additional income listed on Sch 1, Part I. After you arrive at your total income, you can subtract deductions listed on Sch 1, Part II, including educator expenses, HSA deduction, half of the self-employment tax, student loan interest deduction, and traditional IRA deduction. Once you subtract these items from your total income, you arrive at Adjusted Gross Income (AGI) (L11). AGI is an important item on your tax return. It is frequently referenced in determining qualifications for credits. Plus, prior year AGI is regularly used for verification purposes by tax preparation software.











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Example 1. Sch 1 (1040) Additional Income & Adjustments Part I: Additional Income 1 Taxable refunds 2a Alimony received 2b Divorce date (must be before 12/31/2018) 3 Business income 4 Other income 5 Rental / royalties / partnerships 6 Farm income 7 Unemployment 9 Other income 10 Total (Form 1040 line 8) Part II: Adjustments to Income (Deductions) 11 Educator expenses 12 Business expenses 13 HSA deduction 14 Military expenses 15 Self-employment tax 16 Self-employment retirement plan 17 Self-employment health insurance 18 Savings withdrawal penalty 19 Alimony paid 20 IRA deduction 21 Student loan interest 23 Archer MSA deduction 25 Other adjustments 26 Total (Form 1040 line 10a) IRS Schedule 1 (Form 1040)

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$250

$2,000 $250 $1,000 $3,500

$250 $1,000

$2,500 $500

$4,250

Boost Your Tax IQ

In our example, our taxpayer had $4,250 worth of deductions. The deductions were subtracted from her Total Income of $66,900 to arrive at $62,650 AGI. Deductions are valuable benefits because they reduce the amount of income subject to tax (taxable income). After arriving at AGI, you can subtract one of the most significant deductions on your tax return —either the standard deduction or itemized deduction (Sch A). The standard deduction amount varies based on your filing status, age, and whether or not you are blind (Table 6).  Table 6. Standard Deduction for Tax Year 2021 Single

HOH

MFJ

MFS

QW

$12,550

$18,800

$25,100

$12,550

$25,100

Extra for each —> if over > 65 or blindness $1,700

$1,700

$1,350

$1,350

$1,350

Before the passing of the TCJA in 2018, about 31% of taxpayers itemized. However, because of the increase in the standard deduction to almost double that from the tax year 2017 and reduced value of certain itemized deductions, in the tax year 2018, only 14% of taxpayers itemized.109

https://taxfoundation.org/standard-deduction-itemized-deductions-current-law-2019/





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The advantage of the standard deduction is that you don't have to provide any supporting documentation to receive it. However, taxpayers always have an option of itemizing110 if it is better for them. If you choose to itemize, you have to substantiate your deductions with records supporting mortgage interest, real estate taxes, health care, and other expenses. After deducting the standard or itemized deduction from AGI, you can subtract two other deductions that don't require itemization. First, introduced in the tax year 2020 and only available for taxpayers who use the standard deduction, taxpayers can deduct up to $300 per filer for a charitable donation.111  The second valuable deduction for taxpayers who are selfemployed, have a business or a rental, is the Qualified Business Income (QBI) deduction. QBI is very advantageous and can be up to 20% of your taxable or QBI income, so always check if you qualify to claim it.  After subtracting the standard, itemized, charity, and QBI deduction, you arrive at Taxable Income (L15).  In our example, our single taxpayer opted for the standard deduction of $12,550 for the tax year 2021. That amount was subtracted from AGI to arrive at a taxable income of $50,100.

Except taxpayer filing MFS whose spouse itemizes or a taxpayer for a period that is less than 12 months. https://www.irs.gov/taxtopics/tc501 111 There was a slight change in the amount of charitable donation being deductible in the tax year 2020 vs. 2021. For 2020, taxpayers could deduct up to $300 per tax return, while in 2021, taxpayers can deduct up to $300 per filer (so MFJ can deduct $600 now).   https://www.cnbc.com/2021/08/30/some-donors-may-get-a-smaller-tax-benefit-for-2021charitable-gifts.html 110











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To figure out the amount of tax due for the tax year, we need to use the tax brackets and rates for your filing status. Because our federal tax system is progressive, higher-income gets taxed at higher rates than lower-income, incrementally. There are two ways to figure out how much tax you are liable for the year. Both are described in detail in the Understand Your Tax Form 1040 book.

Figure 5. Tax Table for Income of $50,000

https://www.irs.gov/pub/irs-dft/i1040tt--dft.pdf

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The first way is to calculate the tax by using the tax brackets and rates for your filing status (Resources & Table 7 below). For example, for the tax year 2021, all taxable income up to $9,950 for a single filer gets taxed at 10%. If the single filer makes more than that, the income between $9,951 and $40,525 ($40,525 - $9,951 = $30,574) gets taxed at the next tax rate of 12%, etc. Table 7. 2021 Federal Income Tax Brackets for Single Rate 10% 12% 22% 24% 32% 35% 37%

Single (S) $0 to $9,950 $9,951 to $40,525 $40,526 to $86,375 $86,376 to $164,925 $164,926 to $209,425 $209,426 to $523,600 $523,601 or more

Tax Amount (L16) 10% of taxable income $995 + 12% over $9,950 $4,664 + 22% over $40,525 $14,751 + 24% over $86,375 $33,603 + 32% over $164,925 $47,843 + 35% over $209,425 $157,804 + 37% over $523,600

The second way of calculating your tax due is by using the Tax Tables in the 1040 instructions (see Figure 5). You have to locate your taxable income (L15) on the left of the table and select your filing status across the top. Wherever they meet is the amount of tax you are liable for the year. Again, if you are using tax software, it will perform the calculation for you.  In our example, our single taxpayer with a taxable income of $50,100 has a tax liability for the year of $6,776, based on our calculations. The taxpayer is in the 22% marginal tax bracket.





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Before we finalize this section, we should discuss one more important tax term—the effective tax rate. We learned that our single filer was in the 22% marginal tax bracket. That meant that the last dollar of her income was taxed at 22%. However, some of her income was taxed at 10% and 12%. The effective tax rate is closer to the average tax rate that the taxpayer pays in taxes compared to taxable income.  If we want to compare similar items, we should take the calculated tax amount (L16) and divide it by Taxable Income (L15). In our example, the effective tax rate for our taxpayer would be 13.5% ($6,776/$50,100), which is much less than the 22% marginal tax bracket.  The tax amount that we calculated is a starting point to figuring out what you actually owe or receive as a refund for the year. After calculating our Tax (L16), we have to refer to Sch 2 for any additional taxes. First, we add AMT and advanced premium tax credit repayments from Part I (L17) of Sch 2. Then, we need to perform two subtractions before adding other taxes from Part II (Example 1, Sch 2).







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Example 1. Sch 2 (1040) Additional Taxes Part I: Tax 1 AMT tax 2 Alimony received 3 Total (Form 1040 line 17) Part II: Other Taxes 4 Self-employment tax 5 SS & Medicare tax on Unreported Tips 6 Uncollected SS & Medicare tax 8 Additional tax on retirement plans 9 Household employment tax 10 Repayment of rst-homebuyer credit 11 Additional Medicare or Net Investment tax 12 Net investment income tax 13 Uncollected SS & Medicare tax on Tips 14 Interest on Installment income Interest on deferred tax on installment 15 sales 16 Recapture of low-income housing credit 7a-z Other taxes 19 Additional tax from Sch 8812 20 Sec 965 net tax liability installment 21 Total (Form 1040 line 23) IRS Schedule 2 (Form 1040)

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$250 $250

$350

$350

Boost Your Tax IQ

Non-refundable credits, mainly the non-refundable part of child tax credit, credit for other dependents (L19) and other non-refundable credits listed on Sch 3, Part I (L20), are deducted. The credits listed on Sch 3 Part I include foreign tax credit, education credits, retirement savings contribution credit, adoption credit, etc. (Example 1, Sch 3). These subtractions are a dollar-for-dollar reduction in tax liability. The non-refundable credits can't get your due tax amount to be less than zero. So if the amount of non-refundable credit is more than what you owe in tax liability, they will reduce your tax liability to zero, and that's it.  One significant change in 2021 to the CTC and child & dependent care expenses credits was making them refundable for taxpayers living in the US. At the final stage of calculating the Total Tax (L24) for the year, we go back to Sch 2, Part II (L23) and add other taxes such as half of the self-employment tax, household employment tax, net investment tax, additional IRA tax, etc. This addition increases your tax liability and finalizes your Total Tax. In our example, our taxpayer had $600 of additional taxes, which were added to her tax liability of $6,776 ($6,776 + $600 = $7,376). She also had some non-refundable and child tax credits of $2,250, which were subtracted from her tax liability, arriving at Total Tax of $5,126 ($7,376 - $2,250 = $5,126).











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The Total Tax (L24) is the actual tax liability for the year. However, that is not what you will necessarily need to pay because we are still not finished. At this point, any payments made toward your tax liability, like federal withholdings, quarterly estimate payments, or prior year prepayments, will be subtracted from your Total Tax.  Additionally, we will subtract the most valuable type of credits– the refundable credits such as refundable part of CTC, EITC, ACTC, AOTC, and EIPs (L27-L30), plus refundable credits from Schedule 3, Part II (Example 1, Sch 3). The refundable credits are most valuable because they can reduce your tax liability below zero and lead to a refund. If the payments you made and all the refundable credits you qualify for are more than your tax liability for the year, you will receive a refund (L34). However, if they are less than your Total Tax, you will have an amount due at tax time (L37). In our example, our taxpayer had $4,500 of withholdings and payments toward her tax during the tax year. She also qualified for $500 of refundable credits listed on 1040 directly and $800 from Sch 3, Part II. Therefore she will receive a refund of $674 (($4,500 + $500 + $800) - $5,126 = $674).









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Example 1. Sch 3 (1040) Additional Credits & Payments Part I: Non-refundable Credits Foreign tax credit 1 Child & dependent care expenses* 2 Education credits 3 Retirement savings contributions credit 4 Energy credits 5 6a-z Other non-refundable credits Total (Form 1040 line 20) 8 Part II: Other Payments & Refundable Credits Premium Tax Credit 9 Payments made with extension to le 10 Excess SS tax withheld 11 Fuel tax credit 12 Other payments & refundable credits 13 b Sick and family leave credits g Child & dependent care expenses* h Sick and family leave credits 15 Total (Form 1040 line 31)

$50 $1,200 $500

$1,750

$800 $800

IRS Schedule 3 (Form 1040) *Notice that the child and dependent care credits are listed in nonrefundable (how it used to be) and refundable credit areas. The refundable section is new for tax year 2021 and available for taxpayers living in the US more than half a year.

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WHERE S HOULD I START If you want a help deciding where you should start first, choose the items below that are true. The book has three main parts. Based on the number selected from each category, you will get an indication of which Part, Part I, II, or III, would be the best place for you to start.  On the www.boostyourtaxiq.com website, there are over 110 questions and pointers where you should start. Put in a check mark on the left in column “True” for any statement that applies to you. Circle on the right in column “Sec.” which part of the book you should start with. Table 8. Where Should I Start? TRUE Question

Sec.

Sample

Sec.

I missed out on a refund in the past.

TM 1D

My tax situation is relatively simple, but I still pay a lot to file my taxes.

TM 1E

IRS informed me that I used the wrong filing status.

TM 4A

I never know what credits or deductions I can claim on my taxes.

TM 5

Although I think I qualified for them, I didn't receive all/any of the stimulus checks.

TM 5F

I didn't know what expenses I could deduct from my selfemployed business.

TM 8B

I didn't file because I could not pay my taxes.

TM 9C

I file my own taxes.

ER

I received an e-file rejection when I failed my own taxes.

ER









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TRUE Question

Sec.

I never know which number to provide when tax software asks for prior year AGI.

ER 1

When I filed my taxes, I received a rejection stating that I had already filed.

ER 3

The tax software rejected my tax return when I tried to claim my dependents.

ER 3

My identity was compromised. Someone filed taxes with my SSN and stole my refund.

ER 3

I could not e-file my tax return and had to send a paper copy via mail.

ER 5

I have not filed taxes for a few years.

AT 1

I received a CP2000 adjustment letter from the IRS.

AT 3A

Each year I itemize very large deductions.

AT 4A

I am an employee, paid on W-2, who worked from home and claimed home office deduction.

AT 4C

I file Schedule C for self-employment and receive EITC.

AT 7A

I don't keep track of all the business expenses, so I estimate what I need to.

AT 7C

My business has made a loss in 3 out of 5 years.

AT 8A

Count the number of: ____ TM (Tax Mistakes) ____ ER (E-File Rejections) ____AT (Audit Triggers)

—> go to Part I —> go to Part II —> go to Part III




















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PART I: TAX MISTAKES (TM)

M

istakes happen in taxes and life, but it is essential to try your best to avoid them in the first place. Some mistakes are minor, and the IRS can even correct them for you at times. While other mistakes can be very costly, delay the processing of your return, and lead to an audit. The most critical matter is to check your basic informationcheck your SSNs, names, address, EINs on all the forms, and double-check all the numbers. If you change anything on your tax return, go over it one more time, as one change can affect several items. It is wiser to take extra 10 minutes, double-check your work rather than have to file an amendment later.





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Tax Mistakes

Tax Mistakes

Boost Your Tax IQ

If you are filing your taxes yourself, make sure you take proper breaks. Most tax software saves your progress so you can take adequate rest and come back to it later to finalize. It is important not to feel pressured to finish your return in one go. If you are filing with a tax preparer, make sure that you prepare for your appointment by reviewing the tax preparation checklist at the end of the book. The checklist is helpful regardless of how you fix your taxes -- through a paid tax preparer, self-preparing, or using free-file options through the IRS at https://www.irs.gov/filing/free-file-do-your-federaltaxes-for-free.





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Mistake 1: Filing Mistakes The process of filing tax returns can lead to mistakes. The worst mistake of all is not filing when you should. The penalty for not filing is more than not paying, but the typical 3-year statute of limitations doesn’t start if you don’t file.  If you rush through the process or file at the last minute, you may forget to include documents or claim valuable credits. Some taxpayers file two returns for the same tax year instead of amending their original return. Any of these mistakes can delay the processing of your tax return and refund. Furthermore, some taxpayers don’t file tax returns to get refunds and miss the 3-year window to receive their money. If you miss the window to get your refund, the money goes to the US Treasury. In such circumstances, the taxpayers may miss getting withholdings back and miss receiving valuable refundable credits like EITC.  Finally, taxpayers sometimes don’t file because they don’t’ want to pay a tax preparer or purchase tax software to file a simple tax return. However, there are several alternative IRSapproved options to file online or in-person for free. A. NOT FILING TAX R ETURNS Taxes can be stressful, but they are inescapable. The number one mistake taxpayers make is not filing at all and thinking that the IRS will not catch them; waiting to the last minute to file; filing late; not requesting an extension. 















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If you need more time to file, request an extension on Form 4868.112 From all the IRS forms, it is one of the shortest - 9 lines long. Most tax services, online software, and free file options offer filing an extension for free. The extension gives you extra six months to file by October 15 of the current tax year.  Search or Ask: What are the consequences for not filing tax returns? Important: Extension to file DOESN’T mean extension to pay. If you owe taxes, the IRS will assess interest and penalties for paying late; however, you should always file, even if you can’t pay. Why? The IRS penalty for NOT filing is larger than the penalty for NOT paying.113  • Failure to File penalty: 5% of the unpaid tax for each month being late, up to 25% maximum; • Failure to Pay penalty: 0.5% of the tax not paid by the due date for each month, up to 25% maximum. If you don’t file on time and don’t pay, the IRS applies a blended penalty.

https://www.irs.gov/pub/irs-pdf/f4868.pdf https://www.irs.gov/businesses/small-businesses-self-employed/understanding-penaltiesand-interest 112 113













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B. FILING AT THE LAST MINUTE If you don’t gather your documents in time and wait until the last minute to file your tax returns, you may miss income information resulting in an audit (AT 3A). If you don’t include all the necessary documentation for certain deductions and credits, you can have them disallowed and lose out financially.  Some taxpayers wait too long to file their taxes. 33% wait until the last minute to file taxes.114 The taxpayers that file first, starting in January and February, usually have refunds coming their way. In March, you see many filers who had to wait to receive certain documents such as retirement income or brokerage statements. In April and after the due date, you see many filers who: • • • • •

are small business owners, owe money feel taxes are stressful and complicated are worried they owe money are procrastinators. 

There are plenty of taxpayers that don’t follow these rules. Some filers who are due refunds don’t file at all, while some business owners file early because they have everything well organized.  It is possible to file accurately at the last minute if you have everything well organized and all the documents needed. Having everything in one folder or a binder makes it easy to get through the taxes smoothly regardless of when you file. However, the last-minute filers often don’t have all their

114

https://www.ipx1031.com/americas-biggest-tax-procrastinators-2021/



















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information organized and rush through the process, which leads to costly mistakes. Organization is a key in taxes as in life. C. AMENDING INCORRECTLY Tax season is a tumultuous period for many taxpayers. Some rush through the filing process and file their tax returns on Form 1040 (Original 1040) too quickly before gathering all the documents. That can result in mistakes. In addition, if the taxpayers try to go back to an already electronically filed tax return and resubmit it with changes, it will be rejected (ER 3).  The IRS system won't let taxpayers electronically resubmit a second version of the already accepted Original 1040 return. So, to bypass the e-file rejection process, some taxpayers mail a paper copy of the tax returns (Second 1040), which confuses the IRS.  In the Form 1040 and 1040-X instructions, the IRS declares: "Don't file more than one original return for the same year, even if you haven't received your refund or haven't heard from the IRS since you filed. Filing more than one original return for the same year, or sending in more than one copy of the same return (unless we ask you to do so), could delay your refund."115 Instead of figuring out which tax return is the original one, the IRS prefers taxpayers to file an amendment Form 1040-X (Amended 1040-X)116 for major tax mistakes (Table 9). 

115 116

pg 5: https://www.irs.gov/pub/irs-pdf/i1040x.pdf https://www.irs.gov/forms-pubs/about-form-1040x













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How the IRS treats the Second 1040 also depends on when it was sent. If the Second 1040 was sent after the original (April 15) or extended (October 15) due date, it will not be accepted and must be re-filed on Form 1040-X as an amendment.  Search or Ask: What happens if I file two original tax returns? Each year 3X million taxpayers file amendments. The taxpayers have 3 years after the due date or 2 years from paying the tax to file an amendment. There are extra time allowances for taxpayers with disabilities and bad debts or worthless securities.  If the taxpayer decides to fix tax return errors, they have to fix ALL the mistakes they identify, not just those that benefit them. However, taxpayers are NOT required by law to file amended returns; therefore, amending may not necessarily be beneficial in some instances. Additionally, it is vital to realize that amendments receive more IRS scrutiny and can lead to a closer examination (audit). What happens if the Second 1040 is filed before the due date of the original (April 15) or extended (October 15) tax returns? There is a less-known option of treating it as a superseding return (Superseding 1040). If you have never heard of it, don't feel bad, it is a rare alternative not entirely clarified by the IRS. Each year about 20,000 tax returns are filed as Superseding 1040 returns.117 With the ' Superseding ' label at the top, these returns must be paper-filed before the tax return due dates. These returns are treated as a https://www.taxpayeradvocate.irs.gov/news/nta-blog-did-you-file-a-superseding-return-ifso-read-on/ 117







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replacement of the Original 1040 and NOT as an amendment.  This option is not well understood or explained. As mentioned earlier, the IRS warns taxpayers against filing two Original 1040 returns. However, the Taxpayer Advocate Service (TAS), Forbes, American Institute of Certified Public Accountants, and several other credible agencies recommend using 'superseding' filing with caution under certain circumstances.  What circumstances may warrant using Superseding 1040? Amended 1040-X allows many changes to the Original 1040. However, there are some options not available on the Amended 1040-X. Two cases that come to mind are:  1) Taxpayers that filed MFS are allowed to file an amendment and change their status to MFJ. However, taxpayers are NOT allowed to amend their status from MFS to MFJ. Therefore, using the Superseding 1040 option may be the only alternative for taxpayers to try switching their filing status.  For example, a couple that divorced early during the tax year may not want to have filed MFJ for that year. Instead, they would rather keep their tax information separate, especially if they received the stimulus checks. In that case, filing the Superseded 1040 may be the only option. One important note worth mentioning is that the Superseded 1040 tax return must be filed by the due date (April 15), which does not include the October 15 extension. 













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2) Taxpayers who select the current year's overpayment to go toward next year's taxes can't change their minds by filing an amendment. That election on Original 1040 is irrevocable. Thus, for example, taxpayers due a refund for the current tax year could not have anticipated the loss of employment during the Covid-19 pandemic and urgent need for that money. In that case, using the Superseded 1040 option may be the only way for the family to opt out from having the overpayment go toward the following year's taxes. As we can see, the Superseded 1040 option may be a necessary last resort under certain circumstances.118 However, the IRS is not clear on its usage and doesn't recommend it. Hence, use it with caution and for everything else amend (see Table 9). You don't need to amend when:  ❖ You receive an IRS CP2000 or an audit notice, which is an underreporting notice. In this case, you should respond to the letter and provide any documents requested. However, you should not amend. It would confuse the IRS since it would go to another IRS office rather than the office that sent you the CP2000 letter. ❖ You forgot to attach a copy of your W-2 or another form. The IRS receives copies of all the forms as well. If it needs something from you, they will send you a request. ❖ Your e-file was rejected. Try fixing the errors first. If the errors can't be corrected and you didn't receive an e-filing confirmation, you may have to mail a paper copy of the return. https://www.taxpayeradvocate.irs.gov/news/nta-blog-taxpayers-may-file-a-2020superseding-return-changing-their-joint-filing-election-to-receive-the-third-economic-impactpayment/ 118













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❖ You made a mathematical error. The agency runs the tax returns through a computer system that looks for and corrects clerical errors. If they find it, they will send you a correction notice. ❖ The IRS prepared a substitute for return (SFR) for you. You didn't file an Original 1040, and the agency created a return for you based on the documents that it received from third parties such as your employers or financial institutions. If you receive an SFR, you don't file an amendment but rather file an Original 1040 to replace the SFR. ❖ If you received an IRS letter with penalties, you should try requesting first-time penalty abatement rather than filing an amendment. Amendment won't help you in this situation. You should or may want to amend when: ❖ You forgot to include a copy of your W-2 or another form, and the IRS didn't send you a CP2000. Sooner or later, the agency will find the discrepancy. If more than 25% of income is unreported, it could lead to a 20% penalty of the net understatement of tax or more. On the other hand, you may have withholdings and payments not accounted for on your taxes. ❖ You received a corrected W-2 or another form. This is a similar situation as above.













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❖ You want to change your filing status, or dependents claimed. The only way to make such changes is to amend your return. If you filed single but should have filed HOH, then the amendment will give you a higher standard deduction and affect your tax liability if everything else stays the same.   ❖ You missed claiming deductions and credits that you qualified for, such as EITC, AOTC, etc. In this case, your tax liability would decrease, and you could receive a refund from the IRS. On the other hand, if you claim credits that you shouldn't have, you may be banned from claiming them in the future. Therefore, correcting now may be better, although an amendment can also lead to a closer examination. Suppose everything on the tax return is accurate. In that case, you should never hesitate to claim all the benefits you qualify for. Even if the IRS examines your tax return, the agency will come to a 'no change' conclusion, and you will benefit from lower tax liability. ❖ Want to take advantage of tax extenders that Congress may have extended for another year after you already filed (see TM 5B). ❖ If you experienced a federally declared disaster, you could amend the prior year's return to claim the losses and receive a refund. The amendment can't be filed later than 6 months after the previous year's tax return due date, hence by Oct 15 of the current year. The Amendment 1040-X forms are currently available electronically for tax years 2019, 2020, and 2021,119 making the amending process less challenging. While the Superseded https://www.forbes.com/sites/robertwood/2020/06/01/irs-says-you-can-amend-yourtaxes-electronically-but-should-you/?sh=7872d70a13c6 119









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1040 filing option still has to be done on paper. Paper returns take much longer to process, and using this rare election may lead to confusion and processing delay. Finally, the IRS has clarified that even if taxpayers use the Superseded 1040 option, the Original 1040 return is used as the beginning of the statutory period for additional assessment of tax and refund claim.120 So the benefits are rare and may not be worth the hassle.  Table 9. When to Amend Your Return? Don’t Amend

Should / May

Received IRS CP2000 notice.

Change in ling status.

Received IRS audit notice.

Change in dependents claimed

Forgot to attach a form.

Forgot to include a form.

Received e- le rejection. The IRS prepared substitute for return (SFR) for you.

Take advantage of tax extenders. Change in deductions and credits claimed. Experienced federally declared disaster.

Received IRS letter with penalties. Made a math or clerical error.

D. NOT FILING

FOR A

R EFUND WITHIN 3-Y EARS

Taxpayers have a 3-year window to claim their refunds. Each year millions of taxpayers leave billions of unclaimed refunds. For the tax season 2020, the taxpayers had until May 17 (extended filing tax date) to file and claim a refund for the 2017 tax returns.  We are not talking about a handful of taxpayers that don’t file and claim their refunds. For the 2017 tax filings, 1.3 million Americans had refunds held for them by the IRS, but they had

https://www.taxpayeradvocate.irs.gov/news/nta-blog-did-you-file-a-superseding-return-ifso-read-on/ 120





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to file a tax return to claim them.121 That is almost $1.3 billion in unclaimed tax refunds for 2017.122 Any refunds not claimed in time become the property of the U.S. Treasury. The majority of the unclaimed refunds are taxes withheld or prepaid by the taxpayers. Some taxpayers don’t want to file and pay for tax return preparation to claim a small refund. However, half of the 2017 tax year refunds are worth more than $800.  In addition, many low-income taxpayers would be eligible for EIC, which was worth up to $6,318 for the tax year 2017. Particularly taxpayers with super-easy tax returns should always use free filing options for the current year and claim their refunds.123 The free-file online option is only available for the current year, but most free-file in-person options will process returns for the past 3 years. Search or Ask: What is the last day I can file for a tax refund? The table below indicates which tax filings 3-year window expires for the next five years. Make sure that you don’t miss out on getting your money from Uncle Sam from now on.

Hold your horses people. We are not Sweden that will automatically file taxes for its taxpayers. https://www.theatlantic.com/business/archive/2016/03/the-10-second-tax-return/ 475899/ 122 https://www.cnbc.com/amp/2021/04/05/irs-still-has-2017-tax-refunds-for-over-1-millionamericans-who-did-not-file.html 123 Online free filing options only cover current tax year. All prior year tax software are paid. However, there are few IRS approved in-person filing options that will prepare your prior tax returns for free, if you qualify. Mainly the IRS VITA and TCE programs. https://irs.treasury.gov/ freetaxprep/ 121









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Table 10. Last Year to Claim Your Refund Filing Tax Year 2020 2021 2022 2023 2024 2025

3-year window closing for tax year 2017 2018 2019 2020 2021 2022

What if you can’t locate all your tax forms from 3 years ago? You can either contact your past employers or request a free wage and income transcript from the IRS by filing Form 4506-T.124 It is important to note that the IRS can hold your 2017 refund, for example, if you didn’t file the tax returns for the next two years, such as 2018 and 2019, to apply it against any federal or state debts you have outstanding. Nevertheless, if you expect refunds in all three years, file them all. Even if you do have any debts outstanding, the refunds will clear some of your debt, which is still an advantageous outcome.

124

https://www.irs.gov/individuals/get-transcript







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James Story James was a young adult taxpayer in his mid-twenties that was still living with his parents. He worked odd jobs and always earned less income than the filing requirement threshold for W-2 earners. He came into the tax preparation office where I worked and wanted to file taxes for the past three years and receive his withholdings back. He had about $300, $550, and $400 in withholdings that he could get back for the past three years.  If James went to a free in-person VITA site, he would be refunded all the withholdings without paying anything for return preparations because non-profits run VITA sites. However, he went to a tax preparation retail store, which meant that he had three filings for which he had to pay. Even though his tax returns were simple, most tax retail places based their fee on forms used and not on the complexity or amount of income a taxpayer has.  James had to pay about $200 to file the three super simple tax returns. He didn’t have a bank account; thus, he wanted all the refunds on a pre-paid credit card. He didn’t have access to a computer and didn’t have a smartphone to access the internet. So there were several technical disadvantages that James was facing.   One day, James showed up at the office with his parents, who were very angry and yelling that the tax preparation company had stolen the refunds. When I called the credit card company, it verified that 2 refunds were deposited a few weeks ago, but the current balance was zero. James’ family insisted that they didn’t see any money, but James said that he did use the credit card couple of times. 











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The credit card company listed several charges made during the past few weeks, all for small amounts, including $20, $40, $15 purchases, and ATM withdrawals that had fees. I asked if James wanted me to help him create an online account that he could monitor, but he didn’t want to as he wouldn’t be able to access it. I requested a statement sent to the family, but that would take at least a week.  How could James' family avoid this situation? James should go to an in-person VITA site to file tax returns for free.  • Receiving the refunds via check could have been easier to monitor what was received and how it was spent.  • James shouldn't wait 3 years to get his withholdings back. He missed out on one year of withholdings because it was already past the statute of limitations to receive a refund (see Table 40).











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E. NOT CONSIDERING FREE FILING OPTIONS From the 153.7 million tax returns filed for the tax year 2019, 10 out of 100 taxpayers filed via paper, while 90 out of 100 filed electronically. 38 out of 100 people self-prepared their filings using online software, while 52 out 100 went to a tax preparer.125  Only 2 out 100 taxpayers utilized the IRS Free File (IRS FF) options. There is a lack of data on the number of tax returns prepared by the IRS VITA, TCE, or AARP free in-person filing programs. However, it is less than 1%.  One thing is known for sure; the IRS FF program is underutilized. According to the IRS, around 70% of taxpayers qualify to file using the program, but only about 2% use it each year.126 What is disturbing about these numbers is that the IRS Free File program at the time of its launch in 2003 had about 5.3% of taxpayers use it. What caused it to drop? Lobbying Congress by the tax preparation giants lead to many restrictions on the program.127 Filing taxes with a tax pro can be expensive - the average tax return preparation price is $230 per taxpayer, while business filers (Schedule C, E, or F) pay around $440.128 Even if you self-prepare your taxes online, the price range can vary from free up to $200 and more, while you still have to do the tax preparation yourself. 

https://www.efile.com/efile-tax-return-direct-deposit-statistics/ https://www.irs.gov/pub/irs-utl/How%20to%20Free%20File%20Infographic_508%20FINAL.pdf 127 https://www.propublica.org/article/inside-turbotax-20-year-fight-to-stop-americans-fromfiling-their-taxes-for-free 128 pg 105: https://www.irs.gov/pub/irs-pdf/i1040gi.pdf 125 126











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Many tax software companies advertise free filing options on their websites. However, they are not the same as the IRS FF on the agency’s website, making the process confusing. Frequently, taxpayers that start with a free version on the tax preparation companies’ websites end up with a paid version. Just by adding a form to your tax return, it can upgrade you to a paid version, or by clicking a link that implies free Live help, it may end up costing taxpayers money.129 Search or Ask: How to or do I qualify to file my taxes for free? Find a VITA or TCE site near me. For example, when you go to the TurboTax website and notice the advertisement for a free file option, it is different from the IRS FF with TurboTax on the IRS page. Why would a top tax preparation company make such a baffling error? This is no oversight. It is intentionally designed to be confusing. Making things unclear leads to higher product sales.  ProPublica has reported extensively on this tactic.130 Some ways companies advertise and offer “free” options on their websites are ways for the users to get lost in the never-ending circle of information and end up paying anyway. These are called dark patterns tactics.131 If there is one thing that you should learn from our discussion here, it is that if you want to file for free, you should use the IRS FF on the IRS page.. 

https://www.propublica.org/article/turbotax-just-tricked-you-into-paying-to-file-your-taxes https://www.propublica.org/article/inside-turbotax-20-year-fight-to-stop-americans-fromfiling-their-taxes-for-free 131 https://www.darkpatterns.org/ 129 130









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Figure 6. Type of Filers in 2019 118

Boost Your Tax IQ

Taxpayers that make less than $73,000 a year have several IRS FF online options.132 Most IRS FF options offer free federal tax filing only and do up-charge for state filings. You can browse the different choices and filter for the ones that would be free for both federal and state tax returns. Some of the IRS FF have additional requirements based on age, income, and location. These variations add to taxpayer hesitancy.  If you decide to hire a tax preparer to help you with your taxes, as 52% of taxpayers do, you must remember that you are still responsible for any mistakes on your tax returns. That is why it is crucial to pick a tax preparer that you can trust, especially if your tax return is complex. The IRS has a database of federal tax preparer credentials and qualifications.133 Another nuisance taxpayers experience when using tax software, or tax preparation service is the additional offers and products they are bombarded with during the filing process. The products that are often offered are not free:134 • Refund advanced loans - loans against your incoming refund for faster access to the money (price is incorporated in tax prep fee and it is used as a marketing tool); • Refund transfers - using your refund to pay for tax services (around $34-$40). • Audit support services - claim to cover you in cases your tax return gets audited. • Tax identity protection - claim to help you resolve any tax identity theft if your tax identity gets compromised.

https://apps.irs.gov/app/freeFile/ If you are curious, you can even check my credentials, just check for my full name Agnieszka Stepinska https://irs.treasury.gov/rpo/rpo.jsf 134 https://www.propublica.org/article/where-is-my-tax-refund-1? 132 133















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These additional products can cost $0, $20, $40, or even be over $70. Some, like advanced loans, are ‘free’ in the sense that you don’t pay for them upfront, but they are incorporated into the overall tax preparation fee, or they serve as a marketing tool for taxpayers that are in financial need.  Some offers, such as tax identity protection, don’t cover everyone on the tax return but instead have to be purchased for each taxpayer separately, which can be expensive. There are few alternatives to the paid tax preparation services. These are free non-profit IRS-approved (IRS FF) inperson choices,135 mainly:  • The IRS Volunteer Income Tax Assistance (VITA) program; • The IRS Tax Consulting for the Elderly (TCE) program; and  • the AARP Foundation’s Tax-Aide program.  Since 2017, I have volunteered with all three programs preparing and reviewing tax returns for seniors, non-English speakers, and low-income taxpayers. All the volunteers have to be IRS-certified, and there is a review process in place to make sure that the tax returns are accurately prepared. There are also number of volunteers with tax credentials who want to give to community. These options are best for easy to medium tax returns. The most complex tax returns (e.g., rental income, virtual currency transactions, or NOLs) are out of scope under the IRS programs. VITA, TCE, and AARP programs cover a wide range of taxpayers and have many locations throughout the United

135

https://www.irs.gov/individuals/free-tax-return-preparation-for-qualifying-taxpayers















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States. To find a place where you can go in person for tax preparation help, see the links on the IRS website.136  If you are in the military, your tax return consists of several unique rules, which many tax preparers may not be familiar with. However, two free-filing options specialize in military filings. One is through MilTax,137 a service provided by the Department of Defense; another is through the VITA program on many military bases,138 staffed with volunteers that are certified in military tax returns. Table 11. Filing Mistakes Not ling tax returns at all. Not ling on time or requesting an extension, as penalties for not ling are higher than the penalties for not paying on time. Waiting until the last minute and not having time to gather all the necessary records. Amending incorrectly. Not ling for a refund within 3-years. Not considering free ling options using IRS-approved online software or in-person alternatives such as VITA, TCE or AARP.

https://www.irs.gov/individuals/find-a-location-for-free-tax-prep https://www.militaryonesource.mil/financial-legal/tax-resource-center/miltax-military-taxservices/ 138 https://www.military.com/discounts/free-tax-preparation-for-military.html 136 137





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Jane's Story Image a taxpayer that makes $17,000 from three W-2 jobs and who has a 10-year-old daughter. Jane has a relatively straightforward tax return - no self-employment income, no business, no rental, no itemized deductions, no education credits. Jane doesn't even have a filing requirement. She made under the $18,800 filing requirement for the tax year 2021. So the only reason why Jane wants to file taxes is to get her withholdings back and receive valuable credits. How much do you think Jane would have to pay for her tax return at certain tax retail places? $100? $200? How about $360!! The base fee was around $170, but because she qualified for the EITC, CTC, and ACT credits, which required additional forms, they cost an additional $130. Also, she could not pay that amount out-of-pocket, so she would have to pay an additional $40 for a refund transfer, which takes the tax preparation fees from her refund. Jane had a relatively easy tax return. She could pay $0 and file her tax return in person at a VITA site. However, she didn't know where to go and how to schedule an appointment. She felt it was a hassle. Jane could also pay $0 and utilize the free IRS-approved tax software (Figure 7). However, Jane was not computer savvy and didn't know how to do that on her own. Going to a VITA or TCE site would have been the best option for Jane. It may be a bit of a hassle or unnerving the first time; however, after that, Jane would know how the process worked and would be able to keep $360 extra in her pocket.















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H OW

TO

AVOID THESE MISTAKES ?

Taxes can be stressful, but they are unavoidable. You can make the process less taxing by proactively organizing your documents into an annual folder, binder, or big envelope. Indicate the tax year on it, such as Tax Year 20XX. Throughout the year, put anything for that tax year (e.g., receipts, documents, statements, notes, etc.) in that annual tax folder, including a copy of that tax year return. If you find yourself in a situation where you have not filed for a couple of years, don’t feel guilty. Taxpayers file multi-year tax returns all the time. You are not the only one. Take a deep breath and start fixing your standing by:  • filing the current tax year; and • any tax return close to the 3-year statute of limitation for a refund.  The statute of limitation on refunds is 3 years from the deadline or 2 years from the date you paid.139 What it means is that after that time, you won’t be able to get the refund if you don’t file your tax return. The refund that you were due will go to the US Treasury. If you have more tax returns for prior years that need to be filed, you should consult a tax professional who can review your case and provide more specific counsel. The first steps will include contacting the IRS and determining how many years you must file. In order to be considered in good standing with the IRS, the agency has a general rule that taxpayers should file six years of back tax returns.140

139 140

https://www.thebalance.com/irs-statute-of-limitations-3192947 https://www.irsmind.com/unfiled-tax-returns/unfiled-tax-return-advice/















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Even if you can’t pay your taxes fully, make sure you file them, as the penalty for not filing is higher than the failure to pay. If you can’t pay all the tax liability at once, make arrangements with the IRS to pay the rest.  IRS offers the following payment options for taxpayers:141 • Full payment agreement to pay the entire amount at a certain point in time. • Installment agreements to pay a certain amount over time. • Offer in compromise to settle your tax debt for less than the total amount. • Temporarily delay collection to delay payment until your financial situation improves. If you make a mistake on your original tax return, file an amendment, never file a second original tax return. That only creates confusion for the IRS and delays the processing of your filings. The average cost to prepare tax returns with a tax preparer is $230 and can go up to over $440 for taxpayers with selfemployment income (Schedule C, E, F).142  Table 12. Average Cost to File with Tax Preparers Filers All Taxpayers Nonbusiness Business (Schedule C, E, F)

141 142

Average Cost ($) $230 $140 $440

https://www.irs.gov/payments pg 105: https://www.irs.gov/pub/irs-pdf/i1040gi.pdf

















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There are several IRS free filing options for different taxpayers.143 If you are able and want to prepare a tax return yourself, you have 8 choices of IRS-approved tax software to choose from. You may have to meet certain criteria, like not making more than $73,000 or so, but for most taxpayers at the lower-income spectrum, you can file for free.  Not everyone is computer savvy or feels comfortable filing their own taxes or because their situation may be more complex. Some taxpayers feel more comfortable having someone with tax experience and knowledge to do their tax returns. You should find a trustworthy tax preparer that will serve your best interests. In addition to the standard paid tax preparation options, there are also free in-person filing options. These programs are reviewed and audited yearly by the IRS. Many volunteers come back to them year after year; some have been paid professionals in the past (like myself).  These programs have processes in place to double-check each volunteer’s work. The two that I can recommend and have volunteered with are the Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE) programs.144 

143 144

https://apps.irs.gov/app/freeFile/browse-all-offers https://www.irs.gov/individuals/free-tax-return-preparation-for-qualifying-taxpayers












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Figure 7. Tax Filing Options 126

Boost Your Tax IQ

Mistake 2: Incorrect Personal Info Many mistakes made on tax returns have nothing to do with taxes but are clerical. Incorrectly entered name, SSN, DOB, EIN, account information are easy to make mistakes.  In order to process tax returns, the IRS has to verify taxpayers’ personal information and identity first. If it fails at this step, the tax return is rejected.  Although we think we know our personal information well, it can be a typing mistake or a transposed character that ends in error. Long numbers such as employers’ EINs are not familiar and are easy to mess up. Bank account and routing numbers on a check are not always clearly presented.  With the growth of technology, many taxpayers who file independently don’t just do their taxes on their desktops. Many taxpayers do their taxes on their phones or iPads, where it is not always easy to review and double-check the information. A. I NCORRECT NAME , SSN

OR

DOB

Surprisingly, incorrect personal information is the number one reason why a tax return can be rejected or gets a followup by the IRS (ER 1). Things like wrong name, incorrect SSN, or date of birth (DOB) are the IRS's primary identification and validation items to confirm taxpayers' identity.  Sometimes the mix-up is because the taxpayer's name on the tax return does not match what is in the Social Security Administration (SSA) database, which the IRS uses to verify identity.

















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Some people misspell names, but that doesn't explain why there are so many rejections for incorrect personal information. With the SSNs, sometimes taxpayers transpose two numbers or can't read the numbers on a very faded SSN card. You may remember your own and even your spouse's SSN, but very few parents remember all their kids' SSNs.  With taxpayer's names, there are a couple of challenges. Some taxpayers use their official name that is on their SS card only when they file taxes. For example, some taxpayers have a middle name that they don't use at all when they apply for a job or a driver's license.145 The requirements to prove the spelling of your name when you apply for a bank, brokerage, job, or other accounts are not as strict as tax return information. These entities don't always require to show the original SS card to match it against the SSA database. One advantage of filing with the IRS free-file (IRS FF) inperson programs such as VITA, TCE, and AARP is that an original SS card is required for everyone on the tax return. Since these programs are free and audited by the IRS, their chief goal is to process the returns for as many taxpayers as possible successfully. Another hurdle is often confronted by taxpayers who immigrated to the US and modified their original names to fit the American standards. For example, many Spanish taxpayers have two surnames. However, the SSA assigned one of the last names on the SSN as a middle name rather than a double last name. If a taxpayer's name is Anna Martinez Garcia, her name Martinez is not her middle name, With the passing of the REAL ID requirements by the US, many states have by 2023 to issue driver licenses based on legal documents such as SS cards & passports. https:// www.dhs.gov/real-id/real-id-faqs 145







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but on the SS card, it shows up as a that. If the taxpayer puts Martinez Garcia as her last name on the tax return, it can get rejected.  Search or Ask: What happens if i put the wrong social security number on my tax return? That is why it is crucial to have your prior-year tax return as a reference when you are filing your current year's taxes. Since you know that the IRS accepted the prior-year tax return, you can be sure that it will be processed if you follow the same name format. If your name on the SS card is incorrect, you have to correct it with SSA before filing your taxes with the correct name.  Another issue can occur for taxpayers that use their middle name as their primary name, and they forget to flip it when they file their tax returns.  What is good about electronic filing, which 90% of taxpayers use,146 is that if you make a mistake in your name, SSN or DOB, the software will most likely notify you. Either the tax software or the IRS database will reject the tax return, and an e-file rejection code will specify what needs to be fixed. Most e-file rejections occur immediately or at least within a day, and the taxpayers can fix these errors quickly. There is a much worse problem for the 10% of taxpayers that still paper file. They may not find out they made a mistake until weeks later when the IRS reviews and re-enters their tax return into their system. That leads to processing delays and even penalties if the tax return is marked as late.

146

https://www.irs.gov/pub/irs-utl/oc-e-file.pdf











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B. INCORRECT EIN

ON

FORM W-2

OR

1099-R

Employee Identification Number (EIN) is similar to a taxpayer’s SSN. It identifies business entities by the IRS to report taxes. It is also sometimes referred to as a Federal Tax Identification Number (TIN). Contrasting to SSNs, EINs are not confidential. Although EINs of employers, banks, and brokers are a matter of public record, they can also be considered sensitive. Search or Ask: How to find my employer EIN? EIN Lookup. EINs are found on all properly issued Form W-2s or 1099-Rs. It is important to correctly enter them on the tax return because the IRS matches the information from the form received by the taxpayer to what they received from the employer/broker. If the numbers are incorrectly entered, the return will most likely be rejected (EF 1).  The EIN is nine-digit long, just as an SSN. However, it is divided in the format of XX-XXXXXXX rather than XXX-XXXXXX as SSN, which is easier to enter incorrectly, especially the last seven digits. Numbers broken into shorter chunks are easier to read and remember than ones that have longer parts.







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C. FILING

WITH AN

E XPIRED ITIN

As we discussed in TM 1B, taxpayers that file their tax returns at the last minute may rush through the process to get their documents in order. They may realize that something needs to be corrected (e.g., incorrect Form W-2) or obtained (e.g., brokerage statement, new ITIN, etc.). Nowhere is the filing problem at the last minute as significant as when you have an expired ITIN. Individual Taxpayer Identification Number (ITIN) is a 9 digit number that starts with the digit 9. It is assigned to taxpayers who are ineligible to obtain SSN. ITINs are issued by the IRS so that taxpayers without SSN can file their taxes.147  IRS will accept tax returns with expired ITINs. However, you should renew them before you file, as you won’t receive all the exemptions and credits you qualify for when you use an expired ITIN.148  How do you know if your ITIN is expired? All ITINs not used on a federal tax return at least once in the last three years will expire on December 31, 2021. Additionally, ITINs with the below middle digits expired December 31, 2021:  70-79, 80-88, and 90-99 if assigned before 2013 For example, 9XX-88-XXXX is an expired ITIN and should be renewed before the taxpayer files his/hers tax return.

https://www.irs.gov/individuals/international-taxpayers/taxpayer-identification-numberstin#itin 148 https://www.irs.gov/individuals/individual-taxpayer-identification-number 147

















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Figure 8. Sample ITIN Card

To renew an ITIN, you need to file Form W-7,149 which requires several original identification documents to be submitted. IRS will also accept a certified copy of the original documents assembled by an IRS-authorized Certified Acceptance Agent (CAA).150 The filing process can take up to 60 days, so you have to plan accordingly if you are filing a tax return without an extension.

Search or Ask: What happens if I file my taxes with an expired ITIN number? Which ITIN numbers expire in 2022? How do I apply for an ITIN? D. FILING

WITH A

NEW NAME

As mentioned previously, the IRS relies on your information in the Social Security Administration (SSA) database. If you had your name changed due to a marriage or a divorce, it is necessary to either: 

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• use the name that is still officially with the SSA; or  • change your name with SSA, and only after you receive confirmation and new documents file taxes with the new name. I had cases when the taxpayer was very enthusiastic about using their brand-new name. At the same time, they failed to update their new information in the SSA database. Thus the tax return got rejected when the taxpayer tried filing.  I remember working with a young bride who experienced this oversight. She got married in December and could not wait to use her new last name. She sent all the paperwork to SSA to change her surname, but she didn’t receive a confirmation or new documents just yet.  It can take between 2 to 4 or 6 weeks to change your name with SSA and receive a new SS card.151 The young woman’s application was still in the process, and SSA still had her old surname in the database, which the IRS was using to verify her tax information. When the personal data didn’t match, her return got rejected.  Search or Ask: When is it safe to file my taxes after I change my last name? Changing my name during tax season. Can I file taxes with my maiden name? If you change your name, you should either wait until your receive a new social security card before you use your new name or file with the old name. The ideal situation is to avoid changing your personal data too close to filing your tax return.

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https://faq.ssa.gov/en-us/Topic/article/KA-01981















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Mrs. John’s Story Getting married is exciting. Some people can't wait to change their surname and share it with their spouses. For example, I assisted a taxpayer with taxes who was in her twenties and married in December the year before. This would be the first time she would be filing a joint return. She was quite excited that she was Mrs. Johns on her 1040. However, she neglected to update her new surname information in the SSA database in time, so they were rejected. Mrs. Johns said that she did send a name change request to SSA but didn't receive any confirmation or new SS card from the agency. It can take between 2 to 6 weeks to change your name with SSA and receive a new SS card. If there is no confirmation of the name change, it means that the SSA database still has your old surname, which is what the IRS uses to verify your tax identity. When the personal data doesn't match, the tax return gets rejected. How could Mrs. Johns avoid this situation? • She should send name request to SSA at least 2 months before she was planning on using it on the tax return. • If the couple would be filling taxes before receiving name change confirmation, Jane should still use her old surname so that it would match in the SSA database.













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E.

INCORRECT

B ANK ACCOUNT NUMBER

Finally, another frequent mistake is providing the wrong direct deposit information. The good news is that if the IRS cannot verify that you are the rightful owner of the bank account, they will send you a paper check instead. Paper checks do take longer to be processed, about 3 to 4 weeks.  However, 9 out of 10 refunds issued by the IRS take less than 21 days. 8 out of 10 taxpayers use the direct deposit option as it is the fastest way to receive a refund.152  Table 13. Refund Timing If you ( le + refund type) Receive Refund e- le + direct deposit paper le + direct deposit e- le + check paper le + check

1-3 weeks 3 weeks 4 weeks 8 weeks

The frequent mistakes with direct deposits are incorrect account or routing numbers. Some software does ask you to verify the account and routing numbers twice to make sure they are entered correctly. However, it is not always the case, and some errors still get through. Another issue is when taxpayers rearrange the account and routing numbers. It may not be apparent on every check which one is which. The routing number is first from the left at the bottom of the check, and the account number is listed right after. 

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https://www.thebalance.com/tax-refund-options-2385793











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Sometimes, right after the account number, a check number is also listed, which some taxpayers try to combine with the account number. If you know your account number but not the routing number, you can find out the routing number for your bank online.153 

Figure 9. Sample Check Information

Some taxpayers put their debit card number as account number, which is not correct. For most banks, the debit card numbers are not the same as checking account numbers. 

Search or Ask: What happens if i provide incorrect bank account numbers on tax return? Can I update bank account numbers on tax return? How taxpayers receive their refunds can be a sensitive topic. Some taxpayers don’t want a paper check to be sent to their address as they may be living with other people and would like privacy. Or they live in a large building and don’t completely trust that it would be delivered safely.

https://bank-code.net/routing-numbers



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Other taxpayers may want to receive the check so they actually ‘see’ the money being sent to them. Others don’t have a checking account so receiving a check is their preferred method, while others may want a check for even other reasons.  I had a very emotionally charged situation once when a couple came to file their taxes. They were in an excellent mood, almost lovey-dovey, I would say. The woman placed her legs on her husband’s lap, an awkward situation in itself. Everything was going well through the entire informationgathering process. In the end, the taxpayers were due a substantial refund, and I asked how they wanted to receive it. The primary taxpayer requested to have it sent to their checking account via direct deposit. The spouse wanted it to be mailed as a check.  They argued for a good few minutes. The spouse took down her legs from her husband’s lap and walked off. The situation was tense. The tension was not due to how the refund would be delivered - direct deposit or a check, but rather it was about who had access to the money. If the refund was directly deposited, the spouse felt that she would not have access to the funds, while if the check came to the house, she would. Taxes can be very emotional.







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Table 14. Incorrect Personal Information Mistakes Incorrect name, SSN, date of birth of anybody on the tax return. Incorrect EIN for employers or brokers listed on Forms W-2 or 1099-R. Filing with an expired ITIN. Filing with a new name after a marriage or a divorce, without rst updating it with the SSA. Providing incorrect bank account number.

H OW

TO

AVOID THESE MISTAKES ?

When you prepare your taxes, use the name listed on the SS or ITIN card for everyone listed on the tax return. Refer back to the prior year’s tax return to double-check the spelling and social security numbers used. Since the IRS already accepted the prior-year tax return, you can safely assume it should be good to use for the current year unless you made changes with the SSA.  Double-check the EIN for the employers and brokers listed on your W-2 or 1099-R forms. The EIN is similar to an SSN used by individuals, but it is an identification number used for businesses. The number is significant because the IRS matches the forms that it receives with the ones you submit.  If anybody on your tax return has an ITIN, double-check in early January whether it needs to be renewed for this tax year. ITINs not used in the past 3 years expire. The process to get your ITIN renewed can take up from 7 to 11 weeks after you file Form W-7.154  154

https://www.irs.gov/individuals/itin-expiration-faqs









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The IRS will accept tax returns with expired ITINs, but you won’t receive all the deductions and credits. If you are running close to the original tax due deadline, you could request a tax return extension by filing Form 4864 so that you can renew your ITIN(s) in time.  If a life or filing situation changes and you have a new name, before you file a tax return using the new name, make sure it has been updated with the SSA.155 If you can, don’t request name changes during tax season to avoid complications.  Double-check your direct deposit information that you are entering the routing and account information accurately. If it is incorrect, you will receive a paper check with your refund. If you recently moved, make sure the address on your tax return matches where you currently live.

https://www.ssa.gov/






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Mistake 3: Missing Documents Why does our life require so much paperwork? It sometimes feels like we are drowning in medical, financial, business, education, and personal mail. In taxes, it is the same. You need to keep copies of your tax returns for a minimum of 3 years with all the backup. Some things require longer documentation. You need to support many things that you include on your tax return. For example, if you are filing tax returns on paper, you have to attach supporting documents. If you are filing taxes on someone else’s behalf, you need to file a Power of Attorney as well. If you get audited or receive a letter from the IRS, you have to produce proper documents to substantiate all your deductions, credits, and expenses. Half the battle with taxes and other things in life is organization. I seriously think these skills should be taught in school. ☜(⌒▽⌒)☞ The organized taxpayers are less anxious and get through their taxes faster. They don’t lose or misplace documents. To make our tax preparation process more manageable, we should gather all of our tax documents into one folder or binder. This simple step reduces a lot of anxiety around tax preparation. A. NOT R ETAINING

A

COPY

OF T AX

R ETURNS

A couple of suggestions may be essential but are crucial to having a smooth experience filing your taxes: • Keeping all documents in one annual tax folder;

















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• Electronically filing; • Retaining a copy of your tax return. Keep a copy of your tax return for at least 3 years. This is because the IRS has 3 years to review your tax return unless they find unreported income or tax fraud. However, for most taxpayers, 3 years is the minimum to keep a copy readily available.  Why is it important? Having a copy of a prior tax return is not only a safeguard in case your get audited. Having a copy of your previous tax return saves you work and time to remember everything you typically claim and deduct on your tax return. Even if your tax situation changes, you have a starting point from which you can move forward.  Search or Ask: Why and for how long should I keep a copy of my tax returns? It also helps you identify places that have changed in your life or the tax code. Last year’s tax filing flags items that you may have forgotten or identify sections where you may have a document missing. For example, if you receive retirement income in the prior year from two accounts, if you are filing in the current year and notice only one 1099-R, it will compel you to double-check why the other 1099-R is missing.  If you received child tax credit the year before but didn’t see it on the tax return in the current year, you may realize that it was because your dependent reached a certain age or that you didn’t answer all the questions correctly in the software.















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Having a prior-year tax return helps improve the accuracy of your current taxes and makes sure you receive all the deductions and credits that you qualify for. For example, on your 2020 and 2021 tax returns, you could use your prior year earned income to calculate the current year EITC and ACTC if your 2019 earned income was higher.156 However, I have seen taxpayers not take advantage of this valuable benefit, even though that could lead to much higher EITC. This is because the taxpayers couldn’t find their prior tax returns and didn’t want to take the time to obtain a transcript from the IRS.  Another reason why you want to keep a copy of your previous tax return because most tax software asks you for prior year Adjusted Gross Income (AGI) to verify your identity. If you are changing tax software or using a new tax preparer, it may lead to e-file rejections without that information (ER 1). When taxpayers don’t have that information readily available, they often guess that the AGI was the total wages from the year prior, which is incorrect.  AGI is a tax term regarding distinct income on your tax return. It is your gross income from your wages, dividends, capital gains, business income, retirement distributions, and other income, less certain adjustments listed on Schedule 1 Part II, such as educator expenses, student loan interest, or contributions to a retirement plan. When the taxpayers try to guess too many times what their AGI is because they don’t have a prior-year tax return as a reference or don’t want to go through the IRS website to https://www.irs.gov/newsroom/new-option-for-claiming-the-earned-income-tax-creditand-additional-child-tax-credit 156











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obtain their transcript, the tax system will reject their tax return (ER 5). If you try to e-file multiple times with different information, the IRS system will block your return from being e-filed and will only allow paper filing.  Finally, you should also keep a copy of your prior tax return in case you need to file an amendment in the future on Form 1040-X. The way you file an amendment is to enter everything in the software that you listed originally and then add your changes. If you are using the same tax software or working with the same tax preparation company, you can easily add new information. However, if you change tax software or the tax preparer, you will have to re-enter everything from your original tax return before adding new changes. If you don’t have a copy of your original tax return, you won’t be able to file an amendment. What are best practices for keeping a copy of your tax returns? If you file electronically, download a copy to your computer, phone, or Google drive. Save it with a name that is obvious such as Tax Return for year 20XX. If you have a paper copy of your tax return, keep it together with all the supporting documents. You can also scan or take a picture of your tax return, so you have a digital copy. My favorite free scan application is Adobe Scan,157 which offers a free account. If you work with a tax preparation service, ask for access to a digital copy. Most tax preparation companies offer free online access to your current and even prior tax returns. It is a great way to have immediate access to your filings. 

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https://apps.apple.com/us/app/adobe-scan-mobile-pdf-scanner/id1199564834











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B. NOT INCLUDING D OCUMENTS Many taxpayers want to get through their tax preparation as quickly as possible. Sometimes they rely on their tax refund to make certain payments such as real estate property tax or medical expenses. Having to wait additional weeks can have a tangible impact on their financial well-being. Crunch time can lead to rushing through the process and forgetting to include all the forms such as 1099-B or 1099-NEC. For taxpayers that have moved during the year and worked someplace briefly, they can have trouble obtaining a copy of their Form W-2. I worked with a taxpayer that tried numerous time to contact his past employer to get his Form W-2. The employer went bankrupt and was unresponsive.  The taxpayer tried to obtain the W-2 information through the IRS transcript but failed to verify his identity online several times and got lacked out. He didn’t want to request the transcript via mail as it would have taken a couple of weeks to receive it, and he thought it was a hassle considering he worked very little with that employer.  One option was to recreate Form W-2 from his paystubs using Form 4852, Substitute for Form W-2.158 To use this form, the taxpayer has to take measures to obtain a copy of it from the employer first, which he had, and document the steps taken. Taxpayers should also call the IRS at 1-800-829-1040 and provide the information on the employer if they are having trouble obtaining the W-2. 

https://www.irs.gov/forms-pubs/about-form-4852









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The taxpayer felt that it was a lot of work to receive a W-2 for a few hundred dollars. In such situations, most taxpayers file without the missing form. When the adjustment to income is minor, the IRS may start processing the tax return, make a correction and send a letter to the taxpayer with a proposed tax liability change. In that situation, the taxpayer won’t have to file an amendment but rather, if he/she agrees with the proposed changes, can just send the letter back to the IRS with any assessed payments.  Majority of the forms that taxpayers receive, IRS also receives. Therefore if you misplaced your original, you can try requesting a copy of your W-2 using Form 4506-T and checking box 8 for Forms W-2 and 1099 series.159  Search or Ask: I forgot to attach a document with my tax return. Obtaining a copy of the form is the best practice. However, some taxpayers rely on the refund and need it urgently, so they decide to file without it. In that case, once they can obtain a copy of the form, they can file an amendment. An amendment, however, takes time and can lead to refund adjustments and back payments.  If the forms you are missing have a significant impact on your tax liability, the IRS can assess back taxes, interest, and big penalties. I worked with a taxpayer, who had one Form W-2 that didn’t get processed in the tax software that he was using, and because it was for a large amount, $45,000, he received a hefty penalty from the IRS. 159

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The taxpayer responded to the IRS letter with an explanation of what happened and that the omission was accidental. The agency doesn’t have to release the taxpayer from any of the penalties or interest. However, if it is the first transgression and looks like an honest mistake, it never hurts to ask for a penalty waiver. There may be some room for negotiation and reduction of the assessment. C. NOT K EEPING TAX

AND

B USINESS R ECORDS

For each tax year, you should get a simple envelope, folder, or binder to keep all the documents, receipts, information, and ultimately, a copy of your tax return. Label it as Tax Year 20XX, and whatever you receive that pertains to that year, you just stuck it in the folder.  A tax return is a legal document that you sign under the penalties of perjury, which means that everything you claim and deduct you may have to support with documentation. If the IRS requests verification of certain expenses, deductions, or credits, you will have all the supporting documents in one place. Search or Ask: Why is keeping good business records important? How to organize my business paperwork? Don’t get discouraged if you were disorganized in the past. Life is busy, and each of us has many responsibilities. Another year is coming, and you have an opportunity to be more organized from now on. Having everything in one place ensures that you receive all the deductions and credits you qualify for. If you can’t find











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certain receipts for your self-employment business, you may forget to claim them on your tax return. At the same time, resist the temptation to estimate and make up numbers for expenses that you missing receipts. The IRS knows full well that many taxpayers don’t often keep good records, and some inflate their deductions or credits, which can lead to an audit (AT 4). For example, taxpayers can deduct gambling losses up to gambling winnings if they itemize their deductions. Some taxpayers claim that their losses were equal to the winnings, which eliminates their entire gambling tax. However, the IRS recognizes that very few taxpayers actually keep a good record of their losses, so once they ask for documentation number of taxpayers won’t be able to support the deductions, and the IRS can disallow it entirely. D. NOT TRACKING INVESTMENT COST B ASIS An adjusted basis is the cost of what you paid for the property or investment plus any additional fees and expenses. It is used to determine whether there is a gain or a loss on the capital asset when you sell it. Sometimes it is also referred to as a cost basis or tax basis.  Basis = purchase price (cost) + fees + improvements There are special rules for property that is inherited or received as a gift. Although that is beyond the scope of our discussion here, the basis is calculated on the date of the event in question.













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Tax Mistakes

The amount of capital gain tax taxpayers have to pay on investments, and capital assets is the difference between the sale price and adjusted basis. With a higher adjusted basis, you pay less in tax.  Capital Gain = Sales Price - Adjusted Basis Since 2011, brokerage firms are required to report the cost basis of securities to the IRS. However, there are many equities that taxpayers own that were purchased before that date or transferred to the broker, and thus, the cost basis is not readily available.  If a taxpayer sells stocks for a total of $1,000 and the broker doesn’t have the cost basis information, all of the $1,000 would be considered gain and be taxable, which is not accurate. Unless it was a gift or inheritance, the taxpayer paid a price for the stocks.  Unfortunately, frequently taxpayers don’t have statements or information for how much they purchased the securities or investments many years ago. That is why you should keep most records between 3 to 7 years; except for all your investments, you should keep purchase information until you dispose of the property.  In circumstances when taxpayers don’t have cost basis information readily available to calculate their taxable gain: • some taxpayers try to guess the amount that they paid for the asset (wrong approach); • others estimate pennies on the dollar (aggressive approach); • and others leave the entire amount as taxable (a very conservative approach).

















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The IRS is aware that taxpayers may not have information on very old transactions, but the agency expects the taxpayers to attempt to get THE BEST estimated information that they possibly can.  Search or Ask: How to track tax basis? Historical stock price information. One alternative to finding that information is to look at the historical prices of the securities to calculate the cost basis. It will not be entirely accurate information, especially if the investment has gone under many adjustments such as stock splits, mergers, distributions, or spinoffs. However, it is an alternative if there is no other option but to pay tax on the total selling amount.  There are two good options for historical stock price information:  • Yahoo Finance Historical Data160  • Your broker website (e.g., Fidelity, TD Ameritrade, Charles Schwab, E*Trade, etc.). Yahoo information is free to everyone; while most brokers also have historical data for securities, they don’t share it publicly but only with their account owners.  In case you need to support how you calculated the basis of your investments, keep a copy of your research. If your security went through spinoffs, splits, etc., you should try to stay conservative in your cost estimates. The IRS will less likely challenge a conservative position (which results in more tax) rather than an aggressive one (less tax).

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E. NOT INCLUDING P OWER

OF

ATTORNEY (POA)

If a taxpayer’s spouse dies during the tax year, the surviving spouse may file a joint tax return for the year of death if she/he didn’t remarry. The surviving spouse can also file as a qualifying widow(er) for the next two years after the spouse’s death, contingent on supporting a dependent.  When filing the tax return with a deceased, the taxpayer should write “Deceased,” the decedent’s name and date of the death across the top of the tax return. The return needs to be signed for the deceased taxpayer by writing in the signature area “Filing as a surviving spouse.161” If there is a refund on the tax return, Form 1310162 needs to be included. Search or Ask: How to file as a surviving spouse? Power of attorney for surviving spouse. If you are filing for a parent, relative, or anybody else, you will need to include Form 2848, Power of Attorney and Declaration of Representative (POA) for taxes.163 You must attach a signed copy of the form with 1040 that you are filing for the deceased.164  If you neglect to include the POA with the filing, the IRS will send a letter requesting a copy. Form 2848 can only be mailed and can’t be electronically signed, so you can either paper file the tax return and attach a copy of the POA or send the form separately after e-filing.

https://www.irs.gov/help/ita/how-do-i-file-a-deceased-persons-tax-return https://www.irs.gov/forms-pubs/about-form-1310 163 https://www.irs.gov/taxtopics/tc311 164 https://www.getcarefull.com/articles/how-to-file-a-tax-return-for-a-parent 161 162













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Table 15. Missing Documents, Records & Receipts Not keeping copies of prior year tax returns and referencing them for current year taxes. Filing tax returns without including all documents missing W-2s, 1099-NEC, 1099-Rs, 1099-B. Not keeping tax and business records that support credits, deductions, and expenses (e.g., receipts, mileage records). Not retaining investment cost basis information, especially for those investments that brokers don’t have historical price. Not including Power of Attorney (POA) if ling tax return for or with a deceased taxpayer. H OW

TO

AVOID THESE MISTAKES ?

The number one thing that taxpayers can do to reduce the amount of stress they experience during tax filing season  compile a folder, a binder, or an envelope where they keep all the documents for the current tax year. Label it with the Tax Year 20XX.  Once you file your taxes, you add a copy of your tax return to the folder, so all the documents for that tax year are together. If you need to support any of your deductions, credits, or expenses, you have everything in one place.  If you are filing via paper, make sure you read the instruction to Form 1040 under “Assemble Your Return” on what to attach to your tax return.165 You should always attach Form W-2 and any forms with withholdings, such as Forms W-2G and 1099-R. pg 64: https://www.irs.gov/pub/irs-pdf/i1040gi.pdf



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Generally, you should keep your records166 for: • 3 years for most situations; • to claim credit or refund after you file, keep records for 3 years from the date you file the original return or 2 years from the date you paid; • 7 years if you file a claim for a loss from worthless security or bad debt deduction • 6 years if you didn’t report income and it was more than 25% of the gross income; • Indefinitely if you didn’t file a tax return; • Indefinitely if you file a fraudulent tax return; • Keep records relating to property (e.g., capital assets) until the period of limitation expires for the year in which you sell/dispose of it.  • Longer if you need them for other purposes such as insurance.  Don’t file your tax return before receiving all your documents such as W-2s, 1099-NECs, 1099-Rs, 1099-Bs. If you know a form is missing, contact the employer or broker to see if they could resend it or try to download it from their website. If the employer or broker is not responsive, you can obtain a copy of many forms from the IRS.  Any notes, calculations, receipts that support your expenses, deductions, and credits, keep in your annual folder should you need to substantiate them. 

https://www.irs.gov/businesses/small-businesses-self-employed/how-long-should-i-keeprecords 166























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Records supporting property purchase or investment should be kept until you sell it, which is often much longer than 3 years. These are important for cost basis and capital gain calculations. If you don’t have that information, IRS can dispute and disallow the cost basis amounts.  If you are filing a tax return after your spouse passed away, you can still file it as MFJ if you didn’t remarry and have a dependent. However, you do have to note on the tax return that the spouse was deceased and sign the tax return for your spouse as “Filing as a Surviving Spouse.” For everyone else that you are filing taxes and who is deceased, you have to make sure you include a copy of Power of Attorney (Form 2848). Otherwise, the return may not be processed, or you will receive a follow-up letter from the IRS.







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Mistake 4: Filing Status Mistakes Choosing the correct status on your tax return is critical because it determines the amount of deductions and credits. If a taxpayer selects the wrong filing status, it impacts the tax liability or tax refund amount. Even though this is a primary item on the tax return, it remains a relatively common mistake for taxpayers. Not all filing statuses are easy to grasp; some have more complex IRS requirements to qualify for, such as the Head of Household (HOH) filing status. What trips many taxpayers is that the filing status definition that we refer to in daily life doesn’t match the definition set by the IRS.  Even though it may be challenging, it is imperative to get your filing status right. Besides the deductions, credits, and how much tax you will owe, each status also has different filing requirements, and so if you choose the wrong one, you may believe you didn’t have a requirement to file when you did.  Choosing the wrong status can also lead to an audit (AT 2), assessment of additional tax, interest, and penalties, especially if the IRS determines that you intentionally chose the more beneficial status when you didn’t qualify for it.  On the other hand, you may qualify for more than one filing status, and if you don’t select the most advantageous, you will lose on receiving credits, deductions, and paying less in tax.













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A. F ILING

THE

WRONG FILING S TATUS

Picking the correct filing status when you are single without dependents is easy, but it can get complicated when you have dependents or are still married and not living with your spouse. If you are using tax software or filing with a tax preparer, it is crucial to honestly answer all the filing status determination questions.  Presently, there are many blended families, and it can be challenging figuring out the current tax rules, which were intended for more traditional families. While the norm of what a family unit is has changed, the tax rules have not caught up. You can use the 5-minute IRS Filing Assistant167 to determine your filing status if you are unsure of your filing status. There are five filing statuses.168 You determine your filing status on the last day of the year, December 31. Therefore a single person who married on that day would be classified as married for the entire year and could either use MFJ or MFS filing status. Single (S). Typically this status is for taxpayers who aren’t married or who are divorced or legally separated under state law. If you have dependents, you may qualify as HOH, contingent on additional criteria. Married Filing Jointly (MFJ). If taxpayers are married, they can file a joint tax return. If a spouse died in the current year, the widowed spouse could often file a joint return for that year. 167 168

https://www.irs.gov/help/ita/what-is-my-filing-status https://www.irs.gov/newsroom/correct-filing-status













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Filing a joint return equals joint and several liability. You and your spouse are jointly responsible for the entire tax liability. The IRS may also offset any refunds to pay one spouse’s debt (e.g., child support, student loans, or other federal debt). Suppose there is any debt that one spouse has, and they don’t want to file MFS because they would lose valuable credits. In that case, another option is to file MFJ with Form 8379, Injured Spouse Allocation. Form 8379 determines how much of the refund belongs to each spouse, and the spouse without debt, will receive his/her share (TM 4E). Married Filing Separately (MFS). A married couple can choose to file two separate tax returns. Filing two separate returns may benefit them if it results in less tax owed than filing jointly.  Taxpayers may want to compare their tax returns by running two different scenarios and picking the best filing status for their situation. The best filing status is not always the one with the smallest tax liability, as there are also different reasons why taxpayers opt for the MFS status.  Taxpayers use the MFS status if they want to be responsible only for their tax liability. MFS may also be the best filing status for taxpayers that are married but are living apart.  MFS status is the least advantageous status, but it does separate tax liability, which can benefit certain taxpayers. Certain credits and deductions are not available to taxpayers filing MFS (Table 17 in TM 4E).













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Below are certain situations when a married couple may consider filing MFS as it may benefit them for reasons that not necessarily have to do with taxes: • If one spouse wants to file taxes while the other one doesn’t. • If one spouse doesn’t want to be held responsible for the payment on the joint return, as their spouse has federal debts or owes past-due taxes. • If spouses want to keep their financial situation separate during separation and going through a divorce.  • If a spouse suspects certain items on the return that are associated with the other spouse may not be accurate, and she/he would not want to be held liable.  Head of Household (HOH). In most cases, this status applies to a taxpayer who is not married, but there are some unique rules for married taxpayers with dependents who are considered unmarried.169  To claim HOH, you have to meet all of the below criteria:  • You are unmarried or considered unmarried on the last day of the year;170 • You paid more than half the cost of keeping up a home for the year; • A qualifying person171 lived with you in the home for more than half the year.172 Because of the complexity and benefits of the HOH filing status, it is one of the most audited filing statuses (AT 2B). 

pg 8: https://www.irs.gov/pub/irs-pdf/p501.pdf Your spouse could not live with you in your home during the last 6 months of the tax year. 171 Qualifying child or relative lived with you more than half a year. People who are not related to you can’t be claimed for HOH filing status. 172 Except dependent parents who don’t have to live int eh same home with you. 169 170























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Qualifying Widow(er) with a Dependent Child (QW). This status applies to a taxpayer if their spouse died during the previous two years, and for that year, the taxpayer was able to file MFJ. For the next two years, the taxpayer can file as QW if they didn’t remarry, and they have a child or stepchild they can claim as a dependent. Search or Ask: How to change my tax filing status? When can I file as head of household? Sometimes the reason why taxpayers make tax filing mistakes is not understanding the tax definitions and requirements. The difference between commonly understood definitions and the IRS definitions makes it challenging to explain why taxpayers don’t qualify for certain filing status. I had a taxpayer challenge me on this once when he could not comprehend why he couldn’t file HOH when, in his words, he was the head of his household, and he was taking care of his house (there were no children). ᵔ ᴥ ᵔ That does not fit how the IRS defines HOH, but I did see his point and understood why it was confusing.  There are also mistakes where some taxpayers want to file MFS, but their spouse is trying to file MFJ on their behalf. Every tax return has to be signed and reviewed by each spouse. However, that is not always the case, especially if taxpayers are filing online themselves. If you file with a tax preparer, each spouse must sign and agree to the tax return per IRS rulings. Finally, a person can only file as qualifying widow(er) two years after their spouse passed away AND have dependents that they are supporting AND if they didn’t remarry. Some taxpayers mark the widow(er) status on the tax return









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because, by standard definition, their loved one died. However, the IRS definition of the QW filing status is much stricter and only available for two years after the spouse’s passing and if there are dependents supported in the home. MFJ couple where one spouse dies and the other tries to file QW whose children are all grown up won’t qualify. B. CLAIMING D EPENDENTS IN E RROR Filing status mistakes also occur because taxpayers don’t communicate with their spouses, partners, parents, children about taxes. Mistakes are common with the HOH status, especially where two parents are involved in raising a child and both try to claim the same child.  Each taxpayer may think they are supporting the dependent more and have more right to the claim. However, if both parents file as HOH for the same dependent, the IRS system will reject the second filing (ER 3).  Because of the many blended and mixed family units and the fact that living situations can change multiple times during the year, it can create circumstances where more than one person is trying to claim the same person as a dependent.  Search or Ask: Who can you claim as a dependent? What if I was claimed as a dependent in error? More than one taxpayer can think they provided more than half support toward the household or the dependent, but it is necessary to review the IRS support worksheet.173 Even https://apps.irs.gov/app/vita/content/globalmedia/teacher/ worksheet_for_determining_support_4012.pdf 173













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if you do have the right to claim certain dependents, taxpayers are not always able to discuss tax claims.  If the taxpayer can rightfully claim a dependent but can’t e-file because the tax return is being rejected, he/she can file the tax return via paper and include support for the claim. The IRS will review both claims and either issue a verdict on who has a right to claim the dependent or request further information. C. INCORRECTLY FILING

AS

NOT

A

D EPENDENT

Another frequent scenario is when parents of young adults try to claim them as dependents, while the young adult already filed as not a dependent. Sometimes the question of who provided more support can’t be easily resolved except by performing calculations on an IRS tax worksheet for determining support. The taxpayer who provided more than half of the support has the right to claim.  If the dependent is a full-time student until they are 24, regardless of how much income they make, the parents can claim them as a dependent, contingent the child didn’t provide more than half of his/her own support for the year.  For example, an 18-year-old taxpayer that worked and earned $10,000 at a job while his parents contributed another $5,000 in support could claim himself/herself. However, if we take the same example, but the 18-year-old had his parents provide $20,000 toward his education and living expenses, the parents could claim the taxpayer in that scenario. The main question is who provided more than half of the support.













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Example 2. Support for Dependency Earnings

Not a Dependent

$10,000 67% $10,000 33%

Dependent

Parent's Support $5,000

Total Living Expenses $15,000

$20,000

$30,000

Some families can discuss whether they will claim the student on their tax return or whether the student will claim herself. However, not all taxpayers can have these discussions, and they can be more challenging for families in more difficult financial situations.  I worked with a young taxpayer who was still living with her one parent but working and supporting herself otherwise (e.g., paying all expenses, paying some rent, food, school expenses), but her parent claimed her by the time she tried filing. When I suggested a discussion with her parent about the situation, the taxpayer was about to cry as she knew that such a suggestion was not realistic in her case. Search or Ask: Who can you claim as a dependent? How to change my filing status? Most likely, her parent was still paying more than half of the taxpayer’s support, but unfortunately, the taxpayer may not have known that as she felt like she was contributing a lot of her own money. Again without the actual support information and calculations, it is hard to determine who had the right of claim.









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If there is a mistake who claimed the dependent, there is an opportunity to amend the tax returns, but the processing can take up to 16 weeks. In addition, it is often not a practical recommendation when taxpayers who are involved don’t have a good relationship. Therefore, the other best option is to have the IRS review the claim by sending supporting documents. It may take much longer to resolve the situation, but in the future, it should make filing easier once the IRS makes a determination.  D. NOT INCLUDING FORM 8332 For taxpayers with divorce agreements where they alternate claiming the dependents, it is vital to communicate with each other and know who is claiming the children in the current year. The custodial parent can release their right to claim a child as a dependent to the non-custodial parent by filing Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent.174  Form 8332 releases the claim to the dependent so the noncustodial parent can receive the child tax credit, additional child tax credit, and credit for other dependents. Form 8332 does not impact EITC, child and dependent credit, or HOH filing status, and the custodial parent can still claim these benefits. These tax rules are complex; therefore, it is crucial to honestly represent your situation to the tax preparer or answer questions in the tax software you are using. 

174

https://www.irs.gov/forms-pubs/about-form-8332











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Table 16. Child Dependency & Credit for Form 8332 Custodial Parent

Non-custodial Parent

EITC Child and dependent care credit Head of Household ling status

Child tax credit Additional child tax credit Credit for other dependents

There are several court cases where non-custodial taxpayers have tried to claim a dependent merely because they were paying child support (which is not taxable nor deductible income).175 Additionally, if you are a non-custodial parent, you have to attach a copy of Form 8332 to your tax return to claim the credits. If the form is missing, you may receive a letter from the IRS disallowing the credits or asking for supporting information (AT 2B).Per Form 8332 instructions, the form can’t be e-filed. You will have to send it separately together with Form 8453, US Individual Income Tax Transmittal for an IRS e-file Return. Search or Ask: How to file form 8332 with taxes? How to claim a dependent as a non custodial parent? E. NOT CLAIMING INJURED S POUSE R ELIEF For taxpayers who are married, they have two filing statuses to choose from- MFJ or MFS. In the majority of cases, filing MFJ is more advantageous as a status. When a couple files MFS, they lose all these valuable benefits:176 

https://www.journalofaccountancy.com/issues/2019/sep/tax-claim-child-dependencyby-noncustodial-parents.html 176 pg 22: https://www.irs.gov/pub/irs-pdf/p17.pdf 175









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Table 17. Special Rules for MFS Higher tax rate than for MFJ Can't take credit for child and dependent care expenses Can't claim EIC Can't claim adoption credit Can't claim education credits or deductions Can't exclude interest income from quali ed US savings bonds used for higher education expenses Most other credits are reduced Can’t take standard deduction, if your spouse itemizes Once you file a tax return using the MFS status, you do have an option to file an amendment and change the filing status to MFJ. However, you can’t file a return as MFJ and then amend to MFS, with some exceptions.  Table 18. Changing MFS & MFJ Filing Status Original Return Amendment MFS can amend to MFJ MFJ CAN’T amend to MFS If you file MFJ and have a refund, certain creditors can legally intercept it to pay your or your spouse’s debts. Most creditors can’t seize tax refunds, but government agencies can, such as:177 Federally backed student loans; Delinquent alimony obligations; Past-due child support; Federal and state tax debts due on separately filed returns; • Unemployment compensation debts. • • • •

177

https://www.thebalance.com/requesting-injured-spouse-relief-from-the-irs-4164917

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In the case when one spouse owes all or majority of the debt, the other spouse can file Form 8379, Injured Spouse Relief, and request their share of the refund. This is an excellent alternative to filing MFS. The taxpayers can reap the benefits of the MFJ filing status and not have their entire refund offset one of the spouse’s debts, which frequently is why couples want to file MFS in the first place. The way to file form 8379178 is to either: • • •

File it with an MFJ return; Include it with an amendment on Form 1040-X; or File it by itself after filing the tax return. Search or Ask: What if my spouse owes back taxes? How to file injured spouse?

The injured spouse relief can only address refunds, not tax liabilities. In order for a taxpayer to use it, the taxpayer must have contributed to income and paid some taxes on the return in withholdings or estimated payments. 

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Table 19. Incorrect Filing Status & Dependency Mistakes Filing the wrong ling status such as ling as HOH when you should le as Single without a dependent. Claiming dependents that others supported or claimed. Filing as not a dependent when you were supported by others. Not including Form 8332 by the non-custodial parent, when a custodial parent releases the claim to the dependent. Filing MFS instead of claiming Injured Spouse Relief on Form 8379 for refund offset due to spouse's solely owed debts. H OW

TO

AVOID THESE MISTAKES ?

It is crucial to select the correct filing status for yourself as filing requirements, deductions, credits, and tax liability will be affected. The best way to avoid choosing the wrong filing status is to answer all the tax preparer or tax software questions honestly.  If you are claiming a dependent, make sure you have supporting documents that can confirm expenses paid for education, medical services, living costs. If a situation arises when the IRS requests information to claim the dependency, you will have everything ready.  File your tax return early to make sure someone else doesn't claim your dependent first. Once one taxpayer uses a SSN on a tax return, the IRS e-filing system will reject any other filings that try to claim the same SSN. If that happens, the only way to dispute the claim is to file via paper and provide supporting information.



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Recognize that the definitions that the IRS uses for tax purposes are not the same that taxpayers use in daily life. For example, according to the IRS definition, your child may not be your dependent because you didn't provide more than half of his/her support, and he/she didn't live with you for at least half the year, but he/she is still your child.  If you have young adult children working who are in college, communicate with them to make sure it is clear how they should file their taxes. Communication is the key here.  If you have a signed divorce or separation agreement that includes Form 8332, a release of claim to the dependent by the custodial parent, make sure you include a copy of it with your return; otherwise, certain credits could be disallowed. If you or your spouse have legally enforceable past-due debts that will offset part of your refund, instead of filing MFS and losing valuable credits and deductions, consider including Form 8379 for Injured Spouse Relief with your tax return. Form 8379 provides a way to receive all the benefits of filing MFJ and not loose part of the refund allocated to the spouse without the debt obligations. 









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Mistake 5: Deductions & Credit Errors Claiming credits and deductions reduces tax liability taxpayers have to pay or increases their tax refund. The benefit of claiming credits and deductions also comes with the responsibility of making sure that taxpayers qualify for each. The IRS takes the qualification process very seriously.  The Protecting Americans from Tax Hikes (PATH) Act of 2015 requires that the IRS not process certain credits, particularly EITC or ACTC, until after February 15179 to ensure the taxpayers who claim them are truly eligible.  The IRS has many Interactive Tax Assistant (ITA)180 tools for different deductions and credits, which taxpayers are encouraged to utilize to check their own qualifications before claiming them.  Here is a list of ITAs available for taxpayers on the IRS website: Deductions Can I claim a deduction for student loan interest? How do I claim my gambling winnings and/or losses? Can I deduct my medical and dental expenses? Can I deduct my mortgage-related expenses? Can I deduct my charitable contributions?

• • • • •

Credits Am I eligible to claim an education credit? Does my child/dependent qualify for the child tax credit or the credit for other dependents?   Am I eligible to claim the premium tax credit?

• • • 179 180

https://www.irs.gov/newsroom/path-act-tax-related-provisions https://www.irs.gov/help/ita































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Am I eligible to claim the child and dependent care credit? Do I qualify for the credit for the elderly or disabled? Do I qualify for the retirement savings contributions credit? Am I eligible to claim the foreign tax credit?

• • • •

Below are the most common deductions available to taxpayers.

Standard or Itemized

State & Local Taxes

DEDUCTION

ITEMIZED DEDUCTION

Form: 1040 line 12

Form: Sch A

Amount: $12,550 (S); $25,100 (MFJ)

Amount: $10,000

Available to all. Reduces taxable income.

Property tax, state & local income tax or sales tax.

Medical Expenses

Charitable Donation ITEMIZED DEDUCTION

ITEMIZED DEDUCTION Form: Sch A

Form: Sch A on 1040

Amount: over 7.5% of AGI

Amount: $300 per filer on 1040 line 1 or 60%-100% on Sch A

Deduction of unreimbursed qualified medical expenses.

Charitable gifts as cash or property.



















































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Gambling Loss

Mortgage Interest

ITEMIZED DEDUCTION

ITEMIZED DEDUCTION

Form: W-2 G on Sch 1 & loss on Sch A

Form: 1098 on Sch A Amount: $100% on $750,000 of debt

Amount: up to winnings Receipts of losses up to winnings, only if itemize.

Mortgage on primary or second home residence or substantial improvement.

401(k) Contribution

IRA Contribution

RETIREMENT DEDUCTION

RETIREMENT DEDUCTION

Form: W-2

Form: 5498 on Sch 1

Amount: $19,500 pre-tax; + $6,500 for > 50 yrs

Amount: $6,000; $7,000 for > 50 yrs

Pre-tax retirement contribution from paycheck.

Based on income & retirement plan availability

Scholarship Student Loan Interest

EDUCATION DEDUCTION

EDUCATION DEDUCTION

Form: Form 1098-T

Form: 1098-E on Sch 1

Amount: up to the amount of qualified education expenses

Amount: $2,500 per return Interest payment on student loan.

Expenses such as tuition, books, supplies.



























































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Educator Expenses

Capital Loss

EDUCATION DEDUCTION

DEDUCTION

Form: Sch 1

Form: Sch D

Amount: $250 per filer

Amount: up to amount of capital gains + $3,000

Educator for > 900 hrs at K-12, expenses for classroom supplies.

Health Savings Account (HSA)

Qualified Business Income (QBI)

HEALTH DEDUCTION

BUSINESS DEDUCTION

Form: 8889 on Sch 1

Form: 8995 ON 1040 LINE 13

Amount: $3,600 (self); $7,200 (family); + $1,000 if > 55 yrs

Amount: 20% of business or taxable income

Tax-free contributions & withdrawals for qualified medical expenses.

For pass-through business income from LLC, Sch C, rental or S-Corp.

Self-Employed Expenses BUSINESS DEDUCTION Form: Sch C

Form: 8929 on Sch C

Amount: 50%-100% actual

Amount: Actual or Simplified Method $5 x up to 300 sq. ft of space Space used regularly & exclusively for business.



















































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Home Office BUSINESS DEDUCTION

Business vehicle, insurance, utilities, etc.



Claim losses on investment to offset taxable income.

Tax Mistakes

Start-up Expenses

Foreign Tax

BUSINESS DEDUCTION

DEDUCTION

Form: Sch C & Form 4562

Form: Sch A

Amount: $5,000

Amount: up to amount paid

Expenses in connection with creating, investigating, or acquiring a new business.

For foreign taxes paid to a foreign government to avoid double taxation.

Foreign Earned Income Exclusion

Sale of Home Exclusion DEDUCTION

DEDUCTION

Form: 1099-S & Sch D

Form: 2555 Amount: $108,700

Amount: $250,000 (S); $500,000 (MFJ)

For US citizens living & working abroad all year.

Sale of primary residence with 2-year ownership & use test.

Alimony Paid

Moving Expenses

DEDUCTION

DEDUCTION

Form: Sch 1

Form: 3903

Amount: 100% for agreements signed prior to 12/31/2018

Amount: 100% for one trip with lodging Actual or standard miles for moving for active members of the Military.

Paid to a former spouse under a divorce decree.





























































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As we discussed before, credits are super valuable as you can deduct them against the tax due. And refundable credits are the best because you can receive them as a refund if you had no tax due. Non-refundable credits are deductible from your tax due only up to zero tax liability. Below is a list of the most common refundable and nonrefundable credits available to taxpayers.

Child Tax Credit (CTC)

Advanced Child Tax Credit

REFUNDABLE CREDIT

REFUNDABLE CREDIT

Form: Sch 8812 & 1040 lines 19 & 28

Form: 1040 line 19

Amount: $3,600 for than 1/2 year >25 and 19 (2021)

Source: https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/ who-quali es-for-the-earned-income-tax-credit-eitc

Under the American Rescue Plan Act of 2021, EITC provisions have been extended.195 The five main differences are: • The increase of EITC for taxpayers without children (only for 2021); • Age limit for single taxpayers have been dropped to over 19 without age cap (only for 2021); • Taxpayers can use their 2019 income for EITC purposes (for 2020 and 2021 tax years only); • The maximum amount of investment income has increased to $10,000 (2021 & all future years); • Taxpayers whose children don't have SSN can claim the credit (2021 & all future years).

https://www.irs.gov/newsroom/irs-offers-overview-of-tax-provisions-in-american-rescueplan-retroactive-tax-benefits-help-many-people-now-preparing-2020-returns 195













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The amount of EITC also depends on filing status, the number of dependents, and income. It is a key credit that you should always check if you qualify for it. Don’t leave money on the table. If you realize you could receive the credit on past returns, you have 3 years to amend and request a refund. After that time, the money will go to the US Treasury. Table 22. EITC for Tax Year 2021 Filing Status Max Credit

Qualifying Children Claimed 0 1 2

3

$1,502

$3,618

$5,980

$6,728

$21,000

$42,158

$47,915

$51,464

$27,000

$48,108

$53,865

$57,414

Single, HOH, QW Up to Max AGI

MFJ or QW Up to Max AGI

Includes changes from passing the ARPA of 2021: increase in EITC for single taxpayers and increase in maximum AGI for single lers.

D. MISSING E DUCATION CREDITS & D EDUCTIONS Taxpayers miss many credits on their tax returns, but besides EITC, education credits deserve particular mention.  It can be challenging to understand all the qualifications and rules concerning the education credits. Still, as long as the taxpayers know that such credits are available, they can either ask their tax preparer about them or search for Deductions/Credits in the tax software they use.







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There are three education deductions and credits summarized below for the 2021 tax returns.196 As of Summer 2021, the Tuition & Fees deduction has been eliminated after tax year 2020 with the passing of Consolidated Appropriations Act of 2021.197 However, that deduction has been extended each year by Congress and may be extended next year as well. These type of provisions that expire at the end of the year but frequently get extended mid-tax season, are called Tax Extenders (See TM 5B). You should double check when you file your taxes what is the status of the deduction. Most education credits: • have income limits;  • can’t be claimed by MFS;  • cover only certain education benefits (tuition, fees, and books are covered by all);  • can be claimed by either the taxpayers or students who paid for them. One frequent mistake that taxpayers make when claiming education credits is claiming them when their income is too high. There are income limits for all education benefits, which means that you cannot claim them if you make above certain amounts. 

https://www.irs.gov/pub/irs-pdf/p970.pdf https://www.taxwarriors.com/blog/consolidated-appropriations-act-of-2021-individualprovisions 196 197



















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Table 23. Education Credits & Deductions for 2021 Criteria

AOTC

LLC

Student Loan Interest

Credit or Deduction

Credit - 40% of refundable

Credit - nonrefundable

Deduction

Maximum bene t

Up to $2,500 credit per student

Up to $2,000 credit per return

Up to $2,500 adjustment to income per return

MAGI limit for MFJ

$180,000

$180,000

$170,000

MGI limit for Single, HOH, QW

$90,000

$90,000

$85,000

Can MFS claim it? Dependent status Number of tax years bene t available Type of program required Number of courses Is Form 1098-T required? School’s EIN required? Other

No Cannot claim bene t if someone else can claim you as a dependent on their return 4 years of postsecondary Unlimited education Does not need to Must be pursuing a Must be pursuing a be pursuing a degree degree degree At least half time At least half time Available for one for at least one for at least one or more courses academic period academic period Yes

-

Yes

-

-

can’t have felony drug convictions

-

-

Quali ed Expenses Tuition & Fees

Yes

Books

Yes

Course materials

Yes

Transportation

No

Yes

Room & board

No

Yes

Insurance, Sports, Non-credit courses

No

No

For whom can you claim the bene t?

You, your spouse or a student you claim as a dependent

Who must pay the quali ed expenses? Ban on claiming the bene t.

You or your spouse, student or third party From 2 to 10 years if disallowed for claiming the credit incorrectly.

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Taxpayers must be legally liable for the loan

Tax Mistakes

Another eligibility detail that taxpayers miss for AOTC is whether the qualified student is enrolled at least half-time in school. The taxpayer and student may see their school attendance and participation as half-time, but if the institution does not check it on the 1098-T form, then the AOTC credit will be disallowed. Most institutions are required to issue Form 1098-T to each student with a summary of expenses paid. However, sometimes taxpayers don’t receive them in the mail. Most of the time, the institution issued the 1098-T, but it is only available online in the student account. If you check your school account and that information is still missing, you should contact the school.  If the school does not issue Form 1098-T, the student can still claim the education credit. Other documents, such as confirmation of enrollment and receipts, can be used to substantiate expenses paid. Search or Ask: Education tax credits and deductions for 2021. What education expenses are tax deductible? Some of the education benefits are more valuable than others. For example, AOTC has a 40% refundable component, which means that even if the taxpayer has no tax liability, they can still receive a refund of up to $1,000. For that reason, AOTC is more frequently reviewed, and if taxpayers don’t claim it correctly, they can be banned from claiming the credit for 2 to 10 years. Sometimes taxpayers are unsure who should claim the education credit or deduction - the parents or the student. One rule to follow is that a dependent can’t claim an











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education credit. If a student is NOT a dependent, he/she can claim the credit only if they paid for it, but if the student is a dependent, the parents can claim the benefit. Finally, the taxpayers can only claim the education credits and deductions if they paid for the education expenses. If the student received a scholarship that was more than the school expenses, the taxpayers can’t claim the benefit. You must reduce your expenses by the amount of scholarship or grant that you received for free.198 Similarly to receiving a scholarship or a grant, another type of education assistance that is better than any education deductions or credits is receiving something that can be entirely excluded from income. One such item is an employer-provided educational assistance up to $5,250 that can be excluded from the employee income.199 That amount would not even be listed on the taxpayer Form W-2 and can be used to cover undergraduate and graduate education. Finally, taxpayers can’t double-dip by claiming credits or deductions using the same expenses for the same student in a given tax year. Even if the taxpayers use their 529 funds to pay off education expenses, they cannot then turn around and try to claim an education credit for the exact costs.200  On the other hand, if a taxpayer had both expenses for tuition and room and board, he/she could claim the expenses paid for tuition to claim AOTC and use the funds from the 529 plan to pay the costs for room and board, which would not be eligible for AOTC.

https://www.creditkarma.com/tax/i/claiming-education-credits https://www.irs.gov/pub/irs-pdf/p970.pdf#page=67 200 https://www.nytimes.com/2017/08/18/your-money/a-2500-tax-credit-for-students-has-afew-pitfalls.html 198 199











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E. NOT R ECONCILING P REMIUM TAX CREDIT The Affordable Care Act (ACA) was passed in 2010 and has often been referred to as 'Obamacare' for President Obama, who signed it into law. Starting in 2014, ACA required taxpayers to purchase health care insurance for themselves and their dependents. If taxpayers had a filing requirement but lacked health insurance, they were assessed a shared responsibility penalty. In 2016-2018 the penalty was $695 per adult and $345 per child, or 2.5% of income for the family, whichever was higher.201  The taxpayers who were hit hardest with the penalty were the mid-income level, working class. They didn't qualify for large subsidies and didn't have health insurance through their employers but were required to have health coverage. Some families were hit with a penalty of $1,200 or more on their annual tax return.   To verify that taxpayers had health care coverage, the taxpayers would receive a coverage confirmation on: • Form 1095-A (Marketplace Insurance); • Form 1095-B (government coverage such as Medicaid); or • Form 1095-C (employer coverage).  These forms were used o verify taxpayers' health care coverage.  In 2018 the Tax Cuts and Jobs Act (TCJA) passed by President Trump reduced the shared responsibility payment penalty to zero, starting with the tax year 2019.202 That meant https://www.thebalance.com/individual-shared-responsibility-payment-3193068 https://www.irs.gov/affordable-care-act/individuals-and-families/aca-individual-sharedresponsibility-provision-calculating-the-payment 201 202

















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that for federal taxes, health care coverage no longer had to be verified.  However, Form 1095-A doesn't just verify healthcare coverage; it also reveals whether taxpayers received Advanced Premium Tax Credit (APTC), or otherwise knows as subsidies, toward their healthcare costs. The amount of subsidies that taxpayers receive is based on their estimated income for the year.  Therefore, when the taxpayer is filing taxes, the APTC must be reconciled on Form 8962 for Premium Tax Credit (PTC). If the taxpayers receive too much in APTC as subsidies toward their healthcare coverage, they will have to repay the excess on Form 8962 (PTC calculations). The main reasons why you may have to repay the advanced PTC is: • • • •

Inaccurate estimation of income; Change in filing status; Change in household size; Change in employment. Search or Ask: What is Premium Tax Credit (PTC)? Excess PTC or repayment of APTC. Reconciliation and repayment of PTC.

The biggest mistake is an inaccurate estimate of income and opting to receive the maximum amount of APTC subsidies. Taxpayers don't always realize that if they receive too much in subsidies because they provide a low estimate for their income, they may have to repay some of them when they file their taxes for the year.





















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To help taxpayers whose employment situations changed during the Covid-19 pandemic, Congress eliminated the PTC repayment for the tax year 2020 under the American Rescue Plan Act (ARPA). Taxpayers could receive additional Premium Tax Credit (PTC) but didn't have to pay anything back if they received more in subsidies for the year. Thus far, there is no indication that it would be extended for 2021, which means that if taxpayers will receive too much in advanced PTC in 2021, they will need to repay it. TAS created an APTC repayment estimator203 to help taxpayers estimate whether they may need to repay some of the subsidies they received when they file their taxes. I worked with a waitress who changed how she was filling her ACA application each year. Instead of underestimating her income for the year and receiving most in subsidies, she moved away from taking any APTC and overestimating her income. After the first year, when she had to make large APTC repayments, she started receiving PTC at the end of the year.  Per example 4, a single taxpayer who estimated that her income for the year would be $36,000, would receive $2,900 in subsidies toward a $4,804 silver plan (thus paying $1,904 out of pocket).204 If the taxpayer files her taxes for the 2021 taxer and her income was actually $24,000 instead of $36,000, she would receive $1,539 in Premium Tax Credit.

203 204

https://www.taxpayeradvocate.irs.gov/estimator/premiumtaxcreditchange/index.htm https://www.kff.org/interactive/subsidy-calculator/







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Example 4. PTC Reconciliation US Average data / Single 30 year old Taxpayer Estimate Actual Income $36,000 $24,000 Poverty Level 282% 188% Yearly Cost of Silver Plan $4,804 $4,804 Yearly Subsidies from Gov't $2,900 $4,439 Taxpayer Yearly Cost $1,904 $365 Additional PTC for Taxpayer $1,539 For taxpayers who would like to estimate plan costs, or changes to their PTC, there are two great PTC estimators: TAS Estimator and Kaiser Foundation Estimator. There are two other important things relating to Form 1095A and the PTC reconciliation. Taxpayers who don't have a filing requirement, if they receive form 1095-A with advanced premium tax credit (Part III, Column C), have to file taxes and include Form 8962.205  Secondly, if a taxpayer files without Form 1095-A or 8962, their tax return can be rejected (ER 6). They can also receive a letter from the IRS requesting a copy of 1095-A, may have to file an amendment, or can be selected for an examination. A final thing worth mentioning is that although the federal healthcare mandate has been repealed, several states still require health care coverage, and taxpayers who don't have it can pay the penalty on the state tax return.206 

https://www.irs.gov/affordable-care-act/questions-and-answers-about-health-careinformation-forms-for-individuals 205

https://www.ehealthinsurance.com/resources/individual-and-family/does-yourstate-require-you-to-have-health-insurance 206









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As of July 2021, five states and the District of Columbia have their own individual health insurance mandates.  • • • • • •

California Rhode Island The District of Columbia Massachusetts New Jersey Vermont (mandate but no penalty)

F. NOT CLAIMING RRC

FOR ANY

MISSING EIP S

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was passed in March 2020 by President Trump, and it provided financial aid to families and businesses impacted by the Covid-19 pandemic.  A significant aspect of the CARES Act was the Economic Impact Payments (EIPs), otherwise referred to as stimulus payments, paid out to taxpayers. The CARES Act gave two stimulus payments to taxpayers - EIP1 and EIP2. If taxpayers didn’t receive the full amount of EIPs, they could claim it on their 2020 taxes by claiming the Recovery Rebate Credit (RRC).207  In March 2021, Congress passed the American Rescue Plan Act (ARPA) with additional monetary assistance to taxpayers by giving another EIP3. Taxpayers who didn’t receive EIP3 can claim it as RRC on their 2021 tax return. All the EIPs were sent to taxpayers via:  • direct deposit • paper check 207

https://www.taxpayeradvocate.irs.gov/covid-19-home/coronavirus-covid-19-tax-relief/





























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• prepaid debit card

If taxpayers are not sure whether they received their last EIP, they can check it on the IRS Get My Payment208 page. You are asked for your Social Security Number (SSN) or Individual Tax Identification Number (ITIN), your date of birth, address, and zip code to verify your identity. To double-check the status of previous EIPs, you have to create an account on the IRS website.

The easiest way to think of the EIPs and RRC is to think of them as two sides of the same coin. If taxpayers receive all their EIPs, they don’t need to claim the RRC, but if any of the EIPs are missing, they can claim RRC to receive the stimulus payments.

Figure 10. IRS Get My Payment

208

https://www.irs.gov/coronavirus/get-my-payment



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The only difference between EIPs and RRC is that EIP1 and EIP2 were based on taxpayer’s income from the tax year 2018 or 2019, while RRC for these payments is based on the tax year 2020. EIP3 was based on either 2019 or 2020 tax returns, while RRC for that stimulus will be based on the 2021 tax year data. Table 24. Reconciliation of Stimulus Payments through RRC on Tax Return RRC Tax Return Year 2020

EIP - Single Filer (Child)

Received

03/25/20

EIP 1 - $1,200 ($500)

April Dec 2020

12/27/20

EIP 2 - $600 ($600)

Jan 2021

2020

03/11/21

EIP 3 - $1,400 ($1,400)

Apr 2021

2021

Law

Enacted

Coronavirus Aid, Relief, and Economic Security (CARES) Act Consolidated Appropriations Act of 2021 American Rescue Plan Act (ARPA)

One bonus for taxpayers receiving EIPs is that if your situation changes, you can always receive more in stimulus payment, but you won’t have to pay any back.209 For example, if you had a child not listed on the 2019 tax return but listed on the 2020 tax return, RRC would give you more money. Search or Ask: The 2021 Recovery Rebate Credit. I didn’t get the (any / first / second / third) stimulus check(s). Do I qualify for the stimulus checks? However, if your dependent child in 2019 left home in 2020 and your EIPs were based on having the additional dependent, you won’t have to pay any stimulus back when

Except if you received an EIP in error. For example, taxpayers who received EIPs for deceased persons. 209







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you file your tax returns. IRS provides many scenarios and FAQs about the EIPs at: https://www.irs.gov/coronavirus/ economic-impact-payments To qualify for the EIPs, taxpayers had to have AGI under a certain amount and be of certain age and status. There were different qualification between the three EIPs, shown in the table below.  Table 25. Stimulus Payments 2020-2021 EIP1 Adult $1,200 Child $500 65 or 2) blindness $1,700 $1,700 $1,350 $1,350 $1,350 For example, if you have taxpayers filing MFJ and both are over 65, while one of them is blind, it would be three additional standard deductions.  MFJ Standard deduction

$25,100 Additional standard deduction for MFJ over 65 or blind

$1,350 Number of additional standard deductions: 3 additional (2 for age + 1 for blindness)

$29,150 = $25,100 + (3 x $1,350) That additional standard deduction is only available to eligible taxpayers. However, some taxpayers mistakenly claim it on their tax returns, which inaccurately calculates their taxable income and tax liability. Once the IRS math error program recognizes a mistake on a tax return, it calculates the correct tax liability, adds interests and penalties, and sends a letter to the taxpayer with adjusted amounts. This tax mistake seldom occurs if you use tax software as the additional standard deduction is calculated for you based on your date of birth and whether you checked that you or your spouse are blind. One place where taxpayers can still make a mistake in the tax software is answering the







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blindness question. Taxpayers’ definition of blindness may not be the same as that of the IRS.  Search or Ask: Additional standard deduction for elderly / blind taxpayers for 2021. Blind taxpayer definition. To be considered blind per IRS definition, the taxpayers can’t see better than 20/200 in the better eye with glasses or contact lenses, and their field of vision would be 20 degrees or less.234 The first year that the taxpayers select the additional deduction for blindness, they must include a certified statement from an eye doctor. Once the IRS accepts this, the taxpayers don’t have to include supporting information in future years unless things change. D. ARITHMETIC MISTAKES The most frequently encountered errors, especially on paper returns, are arithmetic mistakes. They can range from simple addition and subtraction to more complex calculations. Some errors can include transposed numbers or additional zeros, etc. The magnitude and the effect on the bottom line of the tax return make them either minor slip-ups or significant errors that can lead to large corrections or even audits. The best preventative measure against arithmetic mistakes is using tax software and filing electronically. E-filed returns have a better accuracy rate than paper filings. Electronic software detects the most common errors and will notify you

234

pg 22 https://www.irs.gov/pub/irs-pdf/p501.pdf











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when there are inconsistencies, so you have a chance to correct them. Many of the IRS forms are super complicated. It is not unusual to have multiple steps to calculate one number. For example, the Qualified Dividends and Capital Gain Tax Worksheet is 25 steps long in figuring out how many ordinary dividends are qualified.235 Consequently paper filings, especially more complex ones, are automatically prone to many more errors. E. 1040 INCONSISTENCIES

WITH

S CHEDULES

Form 1040 is a summary document for all the schedules and forms that flow into it. It has a line item for the following schedules: Schedule A, B, C, D, E, F, 1, 2, 3 Many of the schedules also have two different parts, which are also referenced separately on the 1040. It also contains links to credits and deductions that are calculated on other forms or worksheets. There is a lot of referencing back and forth, which is very hard to do if you are doing it by hand. This leads to discrepancies and inadvertent errors. A taxpayer may include a schedule with their filing that shows different calculations from what is entered on Form 1040. The IRS will mark it for review. Search or Ask: Should you e-file or file taxes by mail? Efile vs. paper file. The pros and cons of e-filing. The advantages of filing your taxes online.

235

pg 35: https://www.irs.gov/pub/irs-pdf/i1040gi.pdf















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The best way to avoid arithmetic and reference errors is to use tax software. As of the tax year 2018, about 90% of tax returns are electronically filed, and another 6% of paper filed returns are computer prepared.236 If your income is below $73,000, there are several free tax filing options to file your taxes.237 The IRS automatically fixes some math errors, and a correction letter is sent to the taxpayer. If the taxpayer agrees, he/she needs to accept the changes and send the letter back to the IRS with additional payment if demanded. If the taxpayer disagrees, he/she can either provide additional information why the adjustment is wrong or file an amendment. If the IRS disagrees with the taxpayer objection, the agency can continue examining the return. Some of these innocent math errors can lead to an audit trigger (AT 6). Table 28. Math Error Mistakes Calculating the wrong amount of taxable IRA distributions, SS income, pensions or annuity. Determining the wrong amount of EITC, other credits or deductions. Claiming an additional standard deduction for age and/ or blindness. Arithmetic mistakes, on paper returns mostly. Form 1040 entry that is inconsistent with a supporting Schedule or Form.

236 237

https://www.irs.gov/statistics/soi-tax-stats-historic-table-2 https://www.irs.gov/filing/free-file-do-your-federal-taxes-for-free









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H OW

TO

AVOID THESE MISTAKES ?

The best way to avoid math errors is to use electronic tax preparation software. Tax software does most calculations and flags common errors. It will prompt taxpayers if something is missing and will reject the electronic filing unless items are fixed.

Electronic filing is not only more accurate, but it is also much faster in processing. The IRS strongly advocates e-filing.238 Some software can also spot red flags in the tax return to prompt the taxpayers to review their entries to make sure the information is correct. Two years ago, I was helping one taxpayer who was preparing his tax return in tax software. He was deducting a considerable amount of expenses and losses from his businesses. He didn’t know why the software didn’t allow him to file the return. There was a preventative measure in place, where the tax software identified several red flags and inconsistencies. Before the taxpayer could file, he had to confirm that all the information was correct and that he was aware of being in a higher bracket for an audit. Such tax software feature is beneficial in prompting taxpayers to take a second look at everything they entered. 

238

https://smartasset.com/taxes/irs-tax-refund-schedule











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Mistake 7: Paper Return Errors Some mistakes are equally made by taxpayers who paper or e-file, like not including payment or claiming incorrect credits and deductions, but other errors occur more with paper filings. Math errors (TM 6D) are prevalent on paper returns as tax software takes care of most calculations. The other frequent paper filing mistakes are listed below. Most of them can be avoided by electronically filing, which the IRS strongly advocates. A. M AILING R ETURN

TO THE

WRONG ADDRESS

If you are mailing a paper return, you need to be careful to send it to the correct address; otherwise, processing of your tax return could be delayed. On the last page of the 1040 instructions, under a section titled “Where Do You File?” there are 16 different addresses to choose from.239  The address where you send your paper return depends on your location and whether you include payment. To add more to the confusion, the address you send your tax return to can also depend on when you are mailing it. As a result, there are many opportunities for taxpayers to make unintended mistakes.

239

End of 1040 instruction: https://www.irs.gov/pub/irs-pdf/i1040gi.pdf













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Tax Mistakes

Figure 12 lists addresses where to send your original Form 1040. Other types of tax returns (e.g., non-profit), amendments,240 and to file specific forms (i.e., estate taxes) have different addresses241 where to send your documents.  Another point to keep in mind is that the addresses can also change from year to year. For example, one year (2019), the taxpayers living in Alaska are asked to send their filings with payments to San Francisco, CA, while the following year, they are asked to mail it to Cincinnati, OH (2020). This is important as sometimes taxpayers save addresses electronically and may not think to double-check the following year.  Search or Ask: Where to file paper tax returns with or without a payment? To summarize - you should double-check the addresses you send your: • Tax returns - there are different addresses when you include payment or not. • Other forms such as non-profit tax returns or estate taxes. • Amendments. All these options and possibilities only add to taxpayers’ confusion and increase the likelihood of a mistake. 

https://www.irs.gov/filing/where-to-file-addresses-for-taxpayers-and-tax-professionalsfiling-form-1040x 241 https://www.irs.gov/filing/where-to-file-tax-returns-addresses-listed-by-return-type 240

















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Figure 12. Addresses Where to Send 1040

231

Tax Mistakes

B. NOT ATTACHING FORMS R EQUIRED When you use tax software and electronic file, once you enter information from your tax forms, the software creates an electronic version of them, which are transmitted during your filing. Therefore, when you use electronic software, you don’t have to worry about attaching the correct forms to your tax returns, as the software does it for you. Search or Ask: What forms do I need to include with my 1040 paper filing? When you paper file, you have to attach certain forms with your tax return manually. The 1040 instruction section titled “Assemble Your Return” lists what needs to be included with your paper filing. You should always attach Form W-2. In addition, forms W-2G and 1099-R need to be included if you had any tax withheld. Finally, even though it is not specified in the instruction, if you used any Schedules A-F and Schedules 1-3, you should attach them with your filing since they provide backup calculations that flow through to Form 1040. Additionally, there are many forms that you need to include if you used them. For example, Form 8962, Premium Tax Credit calculations, or Form 8995, Qualified Business Income Deduction, must be included with your paper filing.













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How do you organize all these documents when you paper file? If you try to use common sense and order the forms in ascending order, you would be wrong. According to tax law, that would be too easy.242 You have to order the schedules and forms in order of the “Attachment Sequence No.” shown in the upper-right corner.

Figure 13. IRS Document Sequence Numbers

I am pretty sure most taxpayers don’t notice that each form or schedule in addition to its number or letter in the UPPER LEFT corner has a different sequence number in the UPPER RIGHT corner. After learning all of this, do you still want to use paper to file your taxes? (ಠ_ಠ) If nothing else, I hope at least at this point you are ready to file electronically. There are several free tax preparation software available on the IRS Free File page.243

242 243

I couldn’t help it. Nobody said we can’t have some fun while we discuss Form 1040. https://www.irs.gov/filing/free-file-do-your-federal-taxes-for-free







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Tax Mistakes

Table 29. Forms to Attach when Paper Filing Attachment Sequence Number Form(s) W-2 Form(s) W-2G with withholdings Form(s) 1099-R with withholdings Form or Schedule

IF used Schedule 1 Schedule 2 Schedule 3 Schedule A Schedule B Schedule C Schedule D Form 8949 Sale of Capital Assets Schedule E Schedule F Schedule SE Self-employment Tax Schedule EITC Form 8862 Credit after Disallowance Form 8995 QBI calculations Form 8888 Allocation of Refund Form 8959 Additional Medicare Tax Form 8962 PTC calculations Form 8453 Transmittal Form

1 2 3 7 8 9 12 12A 13 14 17 43 43A 55 56 71 73 -

If you don’t want to utilize electronic filing, consider what 6% of paper filers do. They use a computer and tax software to prepare their tax returns, and then they print and mail them out.



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Not attaching certain forms or schedules can delay the processing of your return and refund. A missing form or schedule will not always trigger an IRS letter, as the agency also receives copies of most forms from the issuers; however, the tax return can be red-flagged for further review (AT 3A). Some of the in-person filing options that I volunteer with and run by the IRS VITA and TCE programs give taxpayers options to either e-file or paper file. The calculations, where most mistakes occur, are all done in the tax software, but the taxpayer can mail out the tax return. C. NOT S IGNING

AND

D ATING

Taxpayers must sign and date their tax return under penalties of perjury. A tax return is a legal tax document. The IRS won’t accept or process any tax returns not signed by the taxpayers listed. If you don’t date and sign the tax return, the IRS will send it back to you for signatures, which may mark your tax return as late. The tax return is a legal document, and without a signature, it is not valid. The signatures are there for verification and legal reasons.  The taxpayers also forget that even though they may be electronically filing, they still require to sign their tax returns in the software. The signature process may look a little different than signing on paper, but it also serves as identity verification and confirmation. Taxpayers can be asked to sign: • • • •

using a self-generated PIN;  by typing their name in a box;  by providing id or driver-license number;  furnishing prior-year AGI.





















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Tax Mistakes

If two people are listed on the tax return, both of them are required to sign. If you are filing a joint return as a surviving spouse, you have to list the date of death at the top of the return and type “Filing as surviving spouse” in the signature area for the spouse.244  Search or Ask: What happens if I forgot to sign my tax return? Suppose a taxpayer is signing for their living spouse or somebody else such as their parent. In that case, they require to include Form 2848 Power of Attorney (POA)245 for taxes to be included, either together or separately. The reasons why a taxpayer may need to file taxes on somebody’s behalf can range from a spouse being in the military and overseas, having an incapacitated parent, or any other reason why a taxpayer cannot sign the tax return.  The POA form is also used by tax professionals when representing taxpayers before the IRS. Some of the recurring problems with processing POA forms are:246  • The date of the taxpayer’s signature is later than the date signed by the representative’s signature;  • Using outdated Form 2848; • Each year for representation is not spelled out separately (e.g., 2020, 2021, 2022); • The POA is prepared more than 2 years in advance.

pg 80: https://www.irs.gov/pub/irs-pdf/i1040gi.pdf https://www.irs.gov/pub/irs-pdf/f2848.pdf 246 https://www.thetaxadviser.com/issues/2016/apr/power-of-attorney-and-declaration-ofrepresentative.html 244 245

















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D. NOT INCLUDING E NOUGH P OSTAGE Most tax returns are several pages long, especially when they include multiple forms and schedules, and often weigh more than 1oz, which is the max weight for a US single stamp. Taxpayers should weigh their tax return envelopes when they mail them out and put extra postage to ensure they won’t get returned.247 Search or Ask: How to mail my tax returns to the IRS? Sufficient postage for tax returns. If the tax return is postmarked by the filing date deadline, the IRS considers it mailed on time. However, not always can you see the postmark date on the stamp. Thus the US Post Service advises to certify your envelope or give yourself plenty of time before the due date. Since the Covid-19 pandemic, the post office has been under great strain, processing a record amount of mail. That has caused many delays, which affect paper filings. Taxpayers have to take extra steps so that their tax return is not returned or marked late.

https://www.usps.com/taxes/









237



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Tax Mistakes

Table 30. Paper Return Mistakes Mailing the paper return to the wrong address (Form 1040 instructions list 16 different addresses depending on taxpayer location and whether payment is included or not). Not attaching forms required and/or forms with withholdings (e.g., Form W-2, 1099-R, W-2G). Not signing and dating the tax return by all parties. Not including enough postage on the tax return envelope, especially when the tax return includes many forms. H OW

TO

AVOID THESE MISTAKES ?

Check the 1040 filing instructions section “Where Do You File?” or the IRS website to confirm where to send your tax return. The address you need to send the tax return to depends on your location and whether you have to include payment.248  Check the 1040 filing instruction section titled “Assemble Your Return” of what you have to attach to your tax return. Attach any Schedules A-F and Schedules 1-3 that you used for calculations that flow to Form 1040. Attach your W-2s, and if you had any withholdings, also attach W-2G and 1099Rs.  Additionally, you may have to attach other forms to your tax return, while others will need to be mailed to a different address (such as Form 2848 POA). Double-check the place where everything needs to be mailed.249 

248 249

End of 1040 instruction: https://www.irs.gov/pub/irs-pdf/i1040gi.pdf https://www.irs.gov/filing/where-to-file-tax-returns-addresses-listed-by-return-type









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If you can, include a payment voucher when you file. If you can’t pay everything at once, pay as much as you can and review the different IRS payment options.250 Before your mail your tax return, double-check that you signed and dated it. If you are filling MFJ, make sure your spouse also signed and dated the return. A tax return is a legal document, and without a signature, it is not valid, and the IRS will return it to you for signing.  Make a copy of your tax return, so you have it for your records. Having your prior year’s return is a good reference for what you previously claimed. It is also a must in case you need to file an amendment.  If you are mailing your return, include enough postage. Most tax returns have additional forms and schedules, so they will probably require extra postage. To have peace of mind, go to the post office to certify it and postmark it by the due date.  Additionally, make sure your writing is legible. If you can’t read your scribbles, the IRS and postal workers will even less likely know what it says. Your handwriting on the tax return should be even more readable as it indicates dollars and cents that you may owe.   When you electronically file using tax software, you don’t have to worry about where to send your tax returns, what forms to attach, and whether you have enough postage. If you don’t pay through direct debit, the payment voucher you print to mail has an address where to send it.

250

https://www.irs.gov/taxtopics/tc202













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Electronic filing is not only easier but is also a preferred choice by the IRS.251 Tax software doesn’t only perform calculations for the taxpayers. It also indicates common errors and prompts taxpayers for missing information.

https://www.irs.gov/newsroom/avoid-common-tax-filing-errors-irs-encourages-e-filingcareful-review 251



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Mistake 8: Business & Self-Employment Errors For taxpayers that file Schedule C (self-employed income), Schedule E (supplemental income from rental, royalties, Scorp, partnerships, etc.), or Schedule F (farm income), taxes are a bit more complicated than those of taxpayers that work in traditional jobs and receive wages on Form W-2. The further complexity of these schedules and mixture of personal and business aspects lead to additional scrutiny by the IRS. The agency knows that the tax code is complex, and the taxpayers don’t know all the business regulations well, which leads to mistakes. Below is a list of the most common mistakes made by small businesses. A. M IXING P ERSONAL

AND

B USINESS E XPENSES

Most successful and long-established businesses master the art of keeping their business finances separate from personal. They know that mixing the two is a big no-no and can be a red flag (AT 7B). If you are starting your venture, you should set up a separate checking account and credit card for your business as soon as you can. This single step avoids:  • depositing business income into personal accounts; • talking money from a business account for personal use; and • writing checks from a personal account to pay for business expenses.



















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Tax Mistakes

The IRS loves to review business expenses mixed with personal as it gives the agency an excuse to audit financials. If there is no apparent separation of function, the IRS can easily question whether some of the expenses are legitimate.  Search or Ask: Legitimate business expenses for (your business). Which expenses I can’t deduct? There are several reasons why you should keep personal and business expenses separate. Intermingled expenses are:  • unprofessional;252 • unorganized; • hard to track; • lead to tax mistakes; • lead to missed deductions; • create legal exposure; • give an IRS an excuse to classify your business as a hobby. If it is an early stage of your business, the IRS can understand why you are using one account for business and personal expenses. However, if you have been operating your business for a couple of years, the IRS will be much less understanding.

https://www.thetaxdefenders.com/what-are-the-dangers-of-mixing-business-andpersonal-expenses/ 252























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B. FILING S CHEDULE C WITHOUT E XPENSES The IRS is not in the business of encouraging deductions or identifying credits that you qualify for but are missing. If you don't report income, the IRS will audit you, but the IRS won't complain if you don't claim expenses unless the amount of income you claim without expenses qualifies you for EITC.253 Or if the IRS would expect to see costs for your type of business, but you have none and only claim cash income, they may come knocking then also. If a small business income on Schedule C without typical expenses leads to EITC, particularly if it leads to maximum EITC, that is a big red flag for the IRS (AT 7A).  For example, an HOH Schedule C filer has a cash business income of $15,000 and no expenses in the tax year 2021. The taxpayer also has two children. The dependents qualify him for a maximum EITC of $5,716.  Example 7. Maximum EITC with Sch C & No Expenses HOH Taxpayer with 2 qualifying children (7 & 10 yrs old) Tax Year 2021 No Expenses

Income $15,000 Expenses $0 Earned Income $15,000

True Account

Difference

$15,000 $6,545 $8,455

Refundable EITC $5,716

$3,390

$2,326

https://www.eitc.irs.gov/tax-preparer-toolkit/schedule-c-and-record-reconstructiontraining/scenario-4-no-expenses/scenario 253









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The IRS has information on other taxpayers who file Schedule C in that field. Based on that information, if the agency expects average expenses in ratio to gross income to be around $6,545, the net income would fall to $8,455. Thus, the drop in earned income would decrease the amount of EITC to $3,390. Based on this analysis, the IRS may select the tax return and Schedule C for an examination. There are some industries where the IRS expects certain expenses on Schedule C. For example, the IRS might expect equipment-related costs, vehicles expenses, and supplies for a landscaper. If there are no expenses and on top of that, the taxpayer claims mainly cash income and qualifies for maximum EITC, it looks like the revenue is fabricated. Search or Ask: Typical business expenses for selfemployed / (your business). Am I an employee or an independent contractor? Taxpayers who just started a business may not bring receipts and fail to claim expenses on Schedule C, E, or F. Sometimes, they don't want to lose on these deductions, so they provide round figures that can trigger an audit (AT 7C). If you have a business and encountered expenses, you have a right to claim them. Place all your receipts in one annual tax folder throughout the year to have supporting documents ready when filing your taxes. 









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Before you complete Schedule C,254 E,255 or F,256 print it out and review the list of allowable expenses that you can deduct for business. If you go to a tax preparer and are unsure what can be subtracted, ask for a list of usual expenses. Below is a list of common categories for many businesses.  Table 31. Typical Business Expenses Advertising Car and truck expenses Cost of goods sold (COGS) Commissions and fees Contract labor Depletion Depreciation and section 179 expense deduction Employee bene t programs, pensions and pro tsharing plans Insurance Interest Legal and professional services Mortgage, rent or lease Of ce expense and supplies Other expenses Repairs and maintenance Taxes and licenses Travel and meals Utilities Vehicles, machinery, and equipment Wages

https://www.irs.gov/pub/irs-pdf/f1040sc.pdf https://www.irs.gov/pub/irs-pdf/f1040se.pdf 256 https://www.irs.gov/pub/irs-pdf/f1040sf.pdf 254 255

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  If you do have a self-employment income and no expenses, though, you may have been misclassified as an independent contractor by your employer. As a result, the employer issued you a 1099-NEC, which flows to Schedule C, rather than providing you with a W-2 (TM 8I).  C. B USINESS INCOME

MAXIMUM EITC

WITH

Although previously mentioned, I think this tax mistake is so significant we need to elaborate. Taxpayers with selfemployment income whose profit (income less expenses) from their business qualifies them for maximum EITC can trigger an audit (AT 5).257 The IRS is on the lookout for these returns, and the agency frankly discusses the connection between Schedule C and fraudulent EITC. IRS estimates that about 33% of annual tax payment shortage is due to under-reported income or overstated deductions on Schedule C. Let's look at an example of Schedule C filer overstating business expenses to maximize EITC in the tax year 2021. A taxpayer filing as head of household (HOH) with two qualified children made $40,000 in self-employment income and claimed $21,500 of expenses. That would qualify the taxpayer for a maximum EITC of $5,716. The self-employment income, high expenses, and maximum EITC all together are something the IRS may flag for a review. 

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Example 8. Max EITC with Sch C & Overstated Expenses HOH Taxpayer with 2 qualifying children (7 & 10 yrs old) Overstated Expenses True Account

Income $40,000 Expenses $21,500 Earned Income $18,500 Refundable EITC $5,716

Difference

$40,000 $9,230 $30,770 $3,163

$2,553

For the type of business that the taxpayer files Schedule C, the IRS may expect fewer expenses. If the typical deductions for similar activity were around $9,230, the business income would increase to $30,770 from $18,500, which would decrease the EITC amount by $2,553. Based on this analysis, the IRS may select the tax return and Schedule C for an examination.  Search or Ask: Claiming EITC when self-employed. Claiming self-employment income without expenses. The IRS has data on various businesses and their typical expenses. So if you claim expenses that are not typical for your business, it can be a red flag. For example, a landscaper with a lot of meal and travel expenses will raise an eyebrow. Although a high-end landscaper could experience such costs, they are not ordinary and necessary and may trigger an audit (AT 7A).







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Based on the two examples discussed in this and the prior section, you may notice that higher earned income leads to higher EITC in Example X and lower EITC in Example X. The reason why is that the amount of ETIC that each taxpayer receives increases to some income level, then it stays flat, and then it decreases for higher income workers. It is a rising, flat, then falling line (see Figure 14). 

Figure 14. EITC for Single & HOH in 2021

If you are claiming any expenses on Schedule C, make sure you have contemporaneous documents and receipts. Then, when the IRS requests them for review, your deductions and credits won't be disallowed. If your self-employment income leads you to maximum EITC and you have all the supporting documents, file exactly like that. Many businesses receive IRS examination notices, and at the end of the review, the agency makes no adjustments because everything claimed was adequately supported. 



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D. UNDERPAYING E STIMATE TAXES The US tax system is a pay-as-you-go system, which means that you are legally obligated to pay taxes as you earn your income. That is usually automatically done for you when you are a regular employee and receive a standard Form W-2. However, when you are self-employed or an independent contractor, you don't have withholdings taken from your earnings. Therefore you are required to make an estimated quarterly payment. Search or Ask: Do I have to pay quarterly taxes? How to determine estimated taxes. Estimated taxes calculator / assistant. Estimated tax is used to pay not only income tax but other taxes such as self-employment tax. For estimated tax purposes, the year is divided into four quarters. You may send estimated tax payments with Form 1040-ES258 by mail, or you can pay online.  The quarterly due dates are: • • • •

258

April 15 June 15 Sep 15 Jan 15 of the following year.

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The IRS is aware that self-employed and small business owners can have fluctuating income and can't know with certainty how much they will earn during the year. However, the government expects taxpayers to be within $1,000 of their tax liability at the end of the tax year; otherwise, taxpayers have to pay an underpayment penalty.259  There are special rules for farmers and fishermen, who receive a lot of seasonal income, and taxpayers with prioryear AGIs of over $150,000. However, for most taxpayers, they can avoid underpayment penalty if:  • they owe less than $1,000 in tax after subtracting their withholdings, estimate payments and credits; • or if they paid at least 90% of the tax for the current year; • or 100% of the tax shown on the return for the prior year, whichever is smaller.  Table 32. How to Avoid Underpayment Penalty Owe less than in tax liability for the year $1,000 No tax liability prior year Pay at least in current year's tax liability* 90% Pay at least from prior year tax liability* 100% *whichever is smaller

Taxpayers may also be charged a penalty if their estimated tax payments are late, even if they receive a refund for the year. What it means is that if you have a good quarter, you may have to pay more in estimated tax during that time, even if you paid enough tax for the year. 

https://www.irs.gov/taxtopics/tc306











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Taxpayers can also have an additional 20% penalty260 if they underreport their income. In the first year of an underpayment violation, the taxpayers can request a penalty waiver on Form 2210;261 however, after the first year, the IRS expects taxpayers to be more accurate with their estimates.  You can request a penalty waiver if you can justify an unusual or significant change in circumstances, such as retiring or changing from W-2 to self-employment, or if you didn't have tax liability last year. As long as you can show reasonable cause and not willful neglect, many taxpayers get the first penalty waved. How do you know how much should you pay as your estimated quarterly payment? You can use Form 1040-ES262 to do all your estimation. However, when you look at the form, 15 lines of calculations, many taxpayers won't go through figuring out their quarterly estimate payments. The second option is to use the IRS Interactive Assistant263 to help you figure out whether you have to make estimated payments.  Finally, a simplified option that I like to use as it is quick and easy is to take the prior year's tax liability and divide it by 4 to calculate how much you were short on your withholdings each quarter. Now, this only works if your current year's situation will be the same or similar to prior year one; therefore, use it with caution. 

https://www.irs.gov/pub/irs-news/fs-08-19.pdf https://www.irs.gov/pub/irs-pdf/f2210.pdf 262 https://www.irs.gov/pub/irs-pdf/f1040es.pdf 263 https://www.irs.gov/help/ita/am-i-required-to-make-estimated-tax-payments 260 261











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Example 9. Estimated Quarterly Payments Amount owed prior year $3,000 Quarters 4 Amount short to pay per quarter $750 You can also adjust the calculation if you know how much more you will earn to increase or decrease the payment. This is not an exact calculation, but it is quick and easy to approximate how much you should anticipate paying each quarter.  Another suggestion, if you are fortunate to receive a refund for the year, you can opt to have some of it applied to next year's quarterly payments. Especially during April, when taxes are due for the prior year, it is helpful not needing to pay quarterly estimates in addition to do your annual taxes.  Finally, be aware that we are discussing the federal taxes here while each state also has an underpayment penalty for not paying enough in state taxes during the year. Each state is different in how much will trigger the underpayment penalty, so check your state's IRS website.264 Tom’s Story The gig industry in the United States employed around 57 million freelancers in 2020. By 2027, the number of freelancers is expected to grow to 86 million.* Gig industry includes:  • transportation-based services such as driving with Uber; • asset-sharing services such as Airbnb property rentals; 

https://www.irs.gov/businesses/small-businesses-self-employed/state-governmentwebsites 264















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• design services such as web design;  • IT services such as programming and software development; • education services such as tutoring and teaching.  However, just because gig and freelance work is more prevalent, it does not mean that most taxpayers understand how to account for their gig income on their annual tax return. Gig income is considered selfemployment income which often has unexpected consequences for taxpayers, especially for those receiving it the first year instead of the traditional W-2 pay.  I was assisting a taxpayer who had two jobs. One was traditional W-2 employment as a bartender in a restaurant, and another was gig work as a music instructor. John came in very friendly and upbeat. We had a chat about music as my kids were receiving piano lessons at that time.  Tom worked as a bartender for only a few months. The majority of his income came from teaching music. That was an unusual year, as in the past, most of his income came from a traditional job, while music instruction was a side gig. Tom didn't pay any estimated taxes for his selfemployment gig work since, in the past, the withholdings from his W-2 work were sufficient in offsetting his cash work.  Even though Tom didn't make a lot of money during the year, he made more than $400 in net earnings from selfemployment income as a music instructor. Therefore he had to file Schedule C with his taxes. Most tax software companies and retail tax preparation services charge extra













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for additional tax forms, regardless of income. So a taxpayer who made $2,000 from self-employment will be charged the same amount for filing Schedule C or purchasing software with that schedule as the taxpayer who made $50,000.  The price for Tom’s tax return was over $400, which was a lot. Taxpayers should never feel obligated to finalize the tax return if they consider the price is too much. However, most taxpayers think that they already spend so much time on the process, they decide to pay the preparation service fee and feel quite frustrated about it.  In addition, Tom procrastinated in filing the tax return. He needed a copy of his tax return for the Medicaid health coverage application due that day. In addition to the $400 for the tax preparation service, John had over $1,000 due to the Federal government. He didn't withhold enough from his W-2 job to cover his selfemployment pay. He also didn't pre-pay any quarterly estimated taxes because he didn't have to do that in the past. Tom never showed his frustration and anger during the tax preparation service, but it was evident when he sent back his feedback a day later. He was frustrated and angry about the cost of the tax preparation service and how much he owed in federal taxes.  How could Tom avoid this situation the following year? • He could pre-pay quarterly estimated taxes during the year; • He could work more for W-2 income as an employee;

















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• He could withhold more from his W-2 to make up for his self-employment income. Update Form W-4 with his employer.  • He could file taxes through a free in-person VITA site or use one of the free tax software. Free on-site locations (TM 1E).  • He could gather all his gig receipts earlier to reduce his self-employment income. • He could avoid feeling pressured to file if he filed at least a few days earlier before his healthcare coverage deadline. * https://brodmin.com/case-studies/gig-economy-case-study/ E. NOT CLAIMING QBI D EDUCTION Under the 2017 TCJA, Congress passed a new tax deduction for small business owners and passthrough entities265 called Qualified Business Income Deduction (QBI).266 When it originally came out, the provision wasn’t clearly written, and tax preparers were trying to figure out what was and wasn’t covered under it.  Over the past few years, the IRS has clarified many the QBI sections and what it covers. The entities that can receive the QBI deduction are:267 • • • •

Sole proprietors (including independent contractors); Partnerships; Limited liability companies; S-corporations; and

https://www.irs.gov/newsroom/qualified-business-income-deduction Sometimes referred to as 199A deduction. 267 https://www.irs.gov/newsroom/facts-about-the-qualified-business-income-deduction 265 266

























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• Rental real estate enterprises (by using the safe harbor rules relating to hours of rental services performed). These entities are flow-through, meaning that business owners report their share of business income on their personal tax returns. To claim the deduction, taxpayers have to answer QBI related questions.  Regardless of whether the taxpayers itemize or use the standard deduction, they can claim QBI. Certain income has to be excluded for QBI calculations, such as: • Income earned outside of the US • Investment income like capital gains, dividends, or interest • Wage income like W-2 salary • Guaranteed partner payments Search or Ask: Do I qualify for the QBI deduction? QBI deduction Safe Harbor rule for rental real estate. How to claim QBI for 2021? Additional specified service trade or business (SSTB) income limits are imposed on particular industries like a law firm or an accounting firm. In general, total taxable income in 2021 must be under $164,900 for single filers or $329,800 for joint filers to qualify. Businesses with even higher earnings have additional limitations.268

https://www.fool.com/millionacres/taxes/real-estate-tax-deductions/qbi-deductionswhat-you-need-know/ 268



















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Smaller taxpayers can qualify for this very valuable deduction which is: • 20% of your QBI; or  • 20% of your taxable income minus net capital gain, whichever is smaller.  You have to review some additional criteria with your tax preparer or by answering all the questions in the QBI section of the tax software to make sure you qualify. The QBI calculations are done on Form 8995.269  The below is a simplified QBI calculation and the impact that it has on taxable income. This is a very valuable deduction as you pay taxes on 80% of your qualified business income and thus reduce your effective tax rate. QBI does reduce your income taxes but does not affect Social Security, Medicare, and self-employment taxes.  Example 10. QBI Deduction Calculation Taxpayer: MFJ QBI from Schedule E, S-Corp K-1 $50,000 QBI Deduction Calc. $10,000

20%

Taxable income b/f QBI deduction $60,000 Less net capital gain 500 $59,500 QBI Deduction Calc. $11,900

20%

Lesser QBI $10,000

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In our example, the taxable income before QBI was $60,000, but after the deduction, it will be $50,000. So for MFJ, the $10,000 less in taxable income at their marginal tax rate of 12% would be about $5,608 vs. 6,808, a $1,200 less. That is a lot of tax savings.  If you do qualified for QBI but didn’t claim, see how it would affect your tab liability and consider amending your tax returns. You have 3 years to claim additional refunds. On the other hand, make sure you claim QBI if you undeniably qualify. Although the IRS did add some clarification to its 2017 TCAJ bill, the QBI is still complex and prone to errors. The Treasury Inspector General for Tax Administration has reviewed 12,980 tax returns filed for the tax year 2019 with 57 million worth of erroneous QBI deduction.270 The report was published in early 2021, which means that you should be particularly diligent when claiming this deduction in the next few years. The IRS will be making various QBI qualification reviews based on the Inspector General’s recommendations.  Although the report redacted most of the errors identified, few errors mentioned regarding QBI were:  • not including Form 8995; • not qualifying for it; • misplacing entries such as the standard deduction amount or taxable income amounts incorrectly reported as QBI deduction; • data entry errors; and • filing QBI incorrect calculations on paper filing.

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5% of the QBI cases reviewed in the Inspector General’s report were denied QBI incorrectly. This means that if you have proper documentation and you qualify, you should claim the deduction. Unfortunately, sometimes the IRS also makes mistakes. Finally, note that you can only receive a QBI deduction if you have made a profit from your activity, and if you have a loss, you won’t receive it. F. NOT CLAIMING B USINESS START-U P E XPENSES If you start a new business, there are many one-time expenditures that you have to pay for before you begin operations; these are called start-up costs. You can only claim these expenses once and before you start your operations.  Most start-up costs are treated as long-term capital assets, which have to be depreciated over multiple years. This is called amortization and is listed in Part V of Schedule C under "other expenses." Search or Ask: Writing off the expenses of starting your own business? Business start-up costs deduction. However, you can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs spent as you start your business, as long as your total costs don't exceed $50,000. Any excess amount over the first-year limit must be amortized over 15 years (180 months) on Form 4562 part VI.271

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It is imperative to understand that start-up costs ARE different from organizational costs and ARE distinct from operating business expenses. If taxpayers don't understand the difference well, they can make a mistake on their tax returns and trigger IRS review (AT 7A). Therefore, you should consult a tax professional to claim the start-up and organizational costs correctly.  You can't incur start-up expenses after your business starts operating. After you begin operations, all expenses become operating expenses and are treated as such. Many start-up expenses can be operating expenses in the future, but the difference is that they incurred BEFORE the business started. For example, advertising or training expenses you paid for before you started operations are start-up costs. However, after you went 'live,' would be considered operational. The below is a list of typical start-up investigation and preparation expenses that may be deductible:272 

https://www.freshbooks.com/hub/expenses/write-off-expenses-before-incorporation





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Table 33. Start-up Investigation & Preparation Expenses Investigation: Market research and analysis Travel for location scouting Preparation: Advertising for the opening of the business Construction (improvements to make a place workable) Costs for employee training before the business opens Expenses related to obtaining nancing, suppliers, Insurance Of ce rent and utilities paid before the business begins Of ce supplies and business cards Startup nancing (investments and loans) Website and web hosting service Organizational expenses affect the formation of your business. There are different rules for costs involving forming a corporation, partnership, or LLC,273 so you should review IRS Publication 535, Business Expenses.274 Organizational costs that may be deductible for sole-proprietors on Schedule C are:  Table 34. Organizational Expenses Costs of organizational meetings Legal and accounting fees Licenses, permit, and other fees State incorporation fees

273 274

https://bench.co/blog/tax-tips/startup-costs-deduction/ https://www.irs.gov/pub/irs-pdf/p535.pdf

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Some expenses are never considered start-up expenses and, when deducted as start-up, can trigger an audit: Table 35. Expenses Never Considered Start-Up Costs of issuing and selling stocks Inventory Long-term assets such as computers, of ce equipment, Real estate taxes Research and development costs One question that taxpayers often have is how do you know when exactly you start operating your business?  You start operating: • if you are available for hire;  • if you are starting to build products for sale;  • or if you are doing business.  Products don't have to be completed, nor sale has to be made, but work has to be started.275 Regardless of whether you are earning money, offer services, or products, as long as you work in your business, you started operations. Once you start operating as a business and start selling your first product or service, all the expenses that you incur from that point on are considered operating expenses. It is a tricky line between start-up and ordinary expenses, which the IRS knows not all taxpayers understand.

https://www.microsoft.com/en-us/microsoft-365/business-insights-ideas/resources/ business-startup-costs-deduction 275









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One note of caution for taxpayers, before you start deducting everything under the sun as operating expenses, the IRS is very strict on which operating business expenses can be deductible. They have to be ordinary and necessary for your trade.  G. WRITTING OFF

A

LOSS

FOR A

H OBBY

Before the TCJA of 2017, taxpayers could deduct hobby expenses up to hobby income if they itemized their deductions and the deductions exceeded 2% of their AGI.  Starting Jan 1, 2018, hobby expenses were no longer deductible. If you have a hobby, you have to report your hobby income, but you CAN’T deduct any associated expenses.276   Example 11. Hobby Income & Expenses Your Activity Hobby Income $500 Hobby Expenses $1,000 On your Tax Return Hobby Income $500 Hobby Expenses (disallowed) $0

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A couple of years back, I had a client who came in to do his taxes and wanted to deduct his hobby losses from a bike restoration activity. I told him that he could not subtract the expenses from a hobby, but he was obligated to report the income on his tax return. The client was angry because his brother was always able to deduct hobby expenses when he helped him with his taxes. ヽ(O_O )ﾉ The new Schedule A no longer has the miscellaneous itemized deduction subject to the 2% AGI threshold listed. Unless the taxpayer’s brother netted his hobby income and expenses (which is wrong), the hobby expenses can’t be deducted. What most likely happened is that the taxpayer’s brother was not aware of the 2018 TCJA tax law changes. It was lucky that my client didn’t receive any letters from the IRS disallowing the deduction. The IRS has up to three years (indefinitely if it determines tax fraud) to audit tax returns. Major tax law overhauls don’t happen frequently, but minor tax law changes are common. It is imperative to check each year for new tax regulations as you never know what changes can affect you. Use the tax sources listed in Table 50 to find a summary of tax law changes for the year.  Search or Ask: Is my side income a business or a hobby? How to prove your business is not a hobby. How can you make sure that the activity that you engage in is a business rather than a hobby? If you operate a business, you can deduct your ordinary and necessary expenses. Sometimes there is a tiny line between what is considered a business vs. a hobby. The main deciding factor is whether you engage in the activity because you want to









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make money - called profit motif. You can have a business that brings you pleasure or entertainment that produces income, but in the eyes of the IRS, a business always has to have a goal of profit-making in mind.  IRS recognizes that not every business starts making money right away or every year, but its primary purpose is to make money. Under IRS code, a company that reports a net profit in at least 3 out of 5 years can be treated as a business and deduct expenses.277 There is an exception for ventures that involve horses (profit in 2 out of 7 years). The IRS has developed 9 factors that help taxpayers decide whether an activity is a business or a hobby.278 There is no rule set in stone on how each of these factors is weighted by the IRS. They are only meant as a guide in helping the taxpayers understand whether their activity has a profit motive.  1. Do you carry on the activity in a business-like manner by maintaining complete and accurate books and records?  2. What are your motives for carrying out the activity? Forprofit, sport, recreation, or pleasure? 3. Are you spending time & effort to make the activity profitable - to make money? 4. Do you depend on the income to support yourself & your family? 5. If you experience losses in the activity, are they beyond your control, or are they ordinary startup losses? 6. Do you have the knowledge needed to make this a successful business? 7. Have you been successful in making a profit in similar activity in the past? (pg 10)- https://www.irs.gov/pub/irs-utl/irc183activitiesnotengagedinforprofit.pdf https://www.irs.gov/faqs/small-business-self-employed-other-business/income-expenses/ income-expenses 277 278





















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8. From the past five years, how many were profitable? If fewer than 5, what is the % profitability (profit years/total years in business)? 9. Can you make a profit in the future from the assets used in the activity? If the activity looks more like a hobby based on your answers, don’t claim the expenses on your tax return as it can lead to an audit (AT 7G). However, you have to report the income, regardless of whether it is a hobby or a business. H. NOT R EPORTING R ENTAL INCOME Rental income/loss reported on Schedule E is considered passive income and can’t be written off against ordinary income unless:  • You actively participated in the management of the rental real estate property; or  • You were considered a real estate professional.279  There are specifics that you should review before you select either one.  If you actively participate in the management of your real estate property, you can deduct up to $25,000 of real estate loss against your other income if your MAGI is below $100,000 and up to $150,000 (with smaller phaseouts for MFS). Some taxpayers make the mistake of claiming rental loss deduction year after year, which is a red flag (AT 8C). The IRS assumes that if you are in the business of trying to make a

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profit, you will not hold rental property that losses money year after year. If you can’t deduct the rental loss in the current year because you didn’t actively participate in the management decisions, you can use the losses in the future against future income.  Some taxpayers neglect to report rental income, especially for renting a basement or a room that they consider small in scope. Unfortunately, for the IRS, there is no such thing as a minimum benefit. If the agency finds out that the taxpayer didn’t report all rental income, they could consider it fraud rather than negligence. Search or Ask: When is rental income taxable? Consequences of not reporting rental income. Sometimes a disgruntled tenant reports omitted rental income to the IRS. One taxpayer that I worked with was distressed because she had an argument with her tenant and was afraid the person would report her to the IRS. Owners of rental properties have to report income on their Schedule E, but they can also claim valuable deductions and depreciation expenses. Sometimes even if property owners are making money on the rental property, they could be experiencing losses on paper. That is a valuable benefit that some taxpayers overlook. 











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There is one exception to reporting rental income. If you rent a dwelling for less than 15 days, you do NOT need to report that income.280 It is called Minimal Rental Use. You can’t deduct the expenses either, but it is a unique way of earning a little bit of extra money that is not taxable, which is very rare.  Finally, if you materially participate in real estate, the losses are not limited as this is your profession. A wealthy real estate professional can take advantage of deducting all their expenses for the real estate business without limits.  I. MISCLASSIFYING WORKERS If your business is growing and expanding, you may need help running its operations. However, how do you know if the person you hire to help you is an independent contractor or an employee? Is a virtual assistant an employee or a freelancer? What about a saleswoman? Many people prefer hiring independent contractors because it is often more flexible and less costly. Hiring full or part-time employees involves more regulation, is more expensive, and tax intensive. However, just because hiring an independent contractor is more straightforward, it doesn’t mean it is correct.  If you misclassify your workers, it can lead to back taxes and penalties. The Labor Department’s Wage and Hour Division is the primary enforcer of the Fair Labor Standards Act (FLSA),281 which relates to worker classification.282 Financial penalties https://www.irs.gov/taxtopics/tc415 https://www.dol.gov/agencies/whd/flsa 282 https://www.insperity.com/blog/employee-or-contractor/ 280 281











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can be as much as $2,050 per violation in addition to back taxes and wages.  Search or Ask: Is my assistant / nanny / other an employee or a contractor? Difference between an employee and an independent contractor. The Department of Labor can randomly select a business for an audit, or it can be triggered when one or multiple parties (especially former employees) submit a complaint.  How do you determine whether the people you hire should be classified as independent contractors or your employees? Unfortunately, after several US Supreme Court cases, NO SINGLE RULE or test determines whether a worker is an employee or a contractor but rather entire activity is evaluated.  It is also important to point out that a signed contract with a hire that specifies worker status DOES NOT determine whether the taxpayer is an employee or an independent contractor, even if it is notarized and signed by an attorney.283 Instead, it is the factors listed below that determine worker classification.  To help businesses in the determination process, the IRS considers three categories that help evaluate the amount of control over work performed.

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Table 36. Worker Classi cation Behavioral Control Autonomy - How the task is done? Schedule - When do they work? Location - Where do they work? Tools - What tools or equipment do they use? How does the worker perform tasks? What type of training does the business gives to the worker? Judgement - What order or sequence does the worker follow? Does the worker have a business license?

Financial Control How does the business pays the worker? Can the worker realize a pro t or loss? Does the worker makes his or her services available to others? Does the worker have unreimbursed expenses? Does the worker invest in the facilities and tools? What taxes does the business pay for the worker? How are wages paid?

Type of Relationship Employment agreement - how can the worker be red or can the worker quit? What is the permanency of the relationship between the worker and the business? How is the relationship described? Does the business provide the worker with employee-type bene ts such as health plan, pension plan or sick pay? Are the services performed by the worker signi cant to the business operations? Business Dissimilarity - does the services that the worker performs are similar or unlike those of the business? Legal Protection - what type of legal protection does the worker receive?

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In essence, independent contractors are self-employed, gig workers, or freelancers that work for themselves. They are free to choose when, where and how they perform their work. They can serve multiple projects and employers at the same time. They usually contract per job or project and can recognize loss or profit from work. They invest in their tools, equipment, and their businesses. Independent contractors have to pay self-employment taxes and can work under individual business licenses.  On the other hand, workers that are considered employees can work full or part-time for an employer. They have minimal control of how, when, and where they have to perform their work. They are trained by their employer and have to work on what the employer wants them to. Employees are paid regularly and can be fired at any time. They don’t invest in the business but often receive benefits such as health insurance or pension plan from their employer. The employer takes out taxes for Social Security, Medicare, and income tax from their paychecks. Finally, employees are covered by many legal rights such as minimum wage or overtime pay.  Suppose you are a small business owner, and after reviewing the different aspects of worker classification, you realize that you have been incorrectly classifying your employees as independent contractors. There are few things you can do to correct it. You could adjust how you manage the worker’s performance to be more autonomous, change pay structure or change the relationship. 











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If you are not sure whether your worker is an employee or an independent contractor, you can fill out the IRS Form SS-8284 and ask the agency to help you determine worker status. If you do go this route, it will put you on the correct path from the start. Many taxpayers learn too late that they should have been classified as employees rather than independent contractors. Taxpayers with lower income or non-legal status don’t have much choice when accepting certain jobs. Usually, an arrangement between the employer and misclassified worker lasts for a while until a problem occurs. For example, if the taxpayer becomes injured on the job and tries to file for worker’s comp, they will find out that they are not eligible. This is because their employer didn’t pay for the workers’ comp insurance. After all, they misclassified the taxpayer as an independent contractor.  There are several costs to the taxpayer that is misclassified as an independent contractor rather than an employee:285 • Paying self-employment taxes to cover social security and medicare taxes; • Being ineligible for unemployment benefits; • Being ineligible for worker’s compensation benefits; • Being ineligible for healthcare coverage; • Not having employee rights to overtime pay, meal breaks, and a right to minimum wage.  How do you correct your worker classification status? The first step is to talk to your employer. But, unfortunately, that may not result in a change in classification but rather in https://www.irs.gov/pub/irs-pdf/fss8.pdf https://www.nolo.com/legal-encyclopedia/what-should-you-do-if-youve-beenmisclassified-independent-contractor.html 284 285



















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discharge. So the other option is to get the IRS involved, which means breaking the relationship with your employer anyway.  If the taxpayer gets fired or is injured on the job, they should file an employment insurance or workers’ compensation claim with their state agencies. The taxpayer would include a statement explaining how they have been misclassified as independent contractors rather than employees. The corresponding state agencies will investigate the matter on the taxpayer’s behalf.  J. SELECTING TRADER STATUS Trading by average taxpayers surged in 2020 to 1.6 million trades per day from 716,000 in 2019.286 With the advancements in technology, accessibility, no-commission trading, and the COVID-19 pandemic, the surge has created a new category of traders - inexperienced taxpayers that trade on aside. Many of these new traders are not aware of the tax consequences of their trading activity. Some taxpayers are surprised when the following year, they receive their first tax form of several pages long and when they have to pay taxes on their trading. Investors report their capital gain and loss on Schedule D or Form 8949.287  Most tax software allows taxpayers to import their broker information, although it doesn’t always work well. Taxpayers can also group their trades into a set of similar batches to report a summary on their Schedule D of 1040. However, it 286 287

https://www.wsj.com/articles/the-tax-moves-day-traders-need-to-make-now-11599816642 https://www.irs.gov/taxtopics/tc429











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can become very complicated if you have many unique trades besides equities, such as options. Investors pay capital gain tax on the transactions depending on the length of time they hold the securities. For all capital assets that you own more than a year, you receive an advantageous capital tax rate lower than that for ordinary income. That is one advantage of being taxed as an investor.   Table 37. Long-Term Capital Gain Taxes Tax Rate 0% 15% 20%

Single $0 $40,000 $441,450

HOH $0 $53,600 $469,600

MFJ $0 $80,000 $469,600

Additional net investment income tax 3.80%

MAGI > $200,000

MAGI > $250,000

If you make a loss as an investor, you can deduct it against other capital gains. If it is more than $3,000, you can deduct up to that amount against your ordinary income, and the rest you can carry forward to other years. Any expenses associated with these investments that you had to pay you can’t deduct. However, expenses can be added to the basis (cost) of your investments. These are tax consequences when you are treated and classified as an investor.  On the other hand, if you are classified as a trader, you are considered to be in the BUSINESS of buying and selling securities. The advantage of the trader status is that you can file Schedule C and claim your expenses. The expenses can







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include tangible property, depreciation, education, home office, margin interest, and other costs.288  Search or Ask: Are you a trader or an investor?What’s the difference between trading and investing? There are also differences in how wash sales (loss on repurchase of the same security within 30 days) are accounted for by traders vs. investors, with a slight benefit for the traders. However, this is a somewhat complicated matter outside the scope of this book. By default, the IRS treats all taxpayers as investors. Many conditions have to be met to be classified as a trader, which would be an uphill battle for a new trader. The IRS makes it very hard to qualify for the trader status.  There are no black and white rules about how often, how much, and for how long you have to trade to qualify for the trader status. However, several recommendations can help taxpayers determine if they are close to the IRS guidelines based on tax court cases.289  Table 38. Trader Status Quali cation Trade substantial volume - of at least 4 trades per day, 15 per week, 60 per month or 720 per year; Trade frequently - at least 4 days a week or 75% of available trading days continuously with few breaks; Short holding period - hold trades for less than 31 days; Run it like a business and make a living; Materiality - amount of funds invested of $15,000 or more; https://traderstatus.com/traders/securities-trader/trader-tax-deductions/ https://www.forbes.com/sites/greatspeculations/2019/10/01/how-traders-get-enormoustax-deductions-and-investors-do-not/?sh=8a4c6bb48ab0 288 289







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None of these recommendations are hardline, and all of them together determine trader status rather than any one in particular. IRS often challenges the trader status (AT 9B), and courts have repeatedly ruled against taxpayers who mistakenly select this designation to deduct expenses. This area has to be approached with delicacy, especially by new traders.  Table 39. Business Filers Tax Mistakes Mixing personal and business expenses. Underpaying estimate taxes if the federal tax due at the end of the year is more than $1,000. Filing Schedule C without expenses when expenses would be expected. Reporting Schedule C, E, F business income to qualify for maximum EITC. Not claiming Qualifying Business Income deduction (can be worth up to 20% of business income or AGI). Not claiming business start-up expenses for the rst year of operations. Writing off a loss for a hobby and disguising it as a business. Not reporting rental income or claiming a rental loss. Treating employees as independent contractors. Selecting the trader status to deduct expenses on Schedule C, but not trading frequently or substantially to justify it.

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H OW

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AVOID THESE MISTAKES ?

With the ownership of a business comes added tax return complexity, leading to additional mistakes. Some errors can be minor, while others can lead to more exposure and even audit.  Taxpayers are not powerless. We can reduce and avoid exposure to the IRS examination and even take advantage of the tax code. Just by studying what we should not do, we also learn what we can deduct and claim. Don’t Mix Personal and Business One of the easiest and best practices is for the taxpayers to keep personal and business accounts separate. Have separate bank and credit card accounts for your business to track an accurate record of income and expenses. Keep all your current year documents in one folder so they are readily available.  Allocate Expenses Between Business and Personal Correctly If you use assets, such as a vehicle or a phone, for business and personal purposes, make sure you track your usage either in a logbook or an application to allocate the expenses correctly. Don’t claim a convertible 100% business use if it is your only family vehicle.















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Schedule C Receipts If you are paid on 1099-NEC or 1099-MISC, you are considered self-employed and a Schedule C filer. Most selfemployed ventures have expenses such as a phone, vehicle, supplies, etc. If you really have no business expenses, determine whether you should have been classified as an employee rather than an independent contractor.  Schedule C and Maximizing EITC Don’t inflate your expenses on Schedule C to try to maximize your EITC. EITC is one of the most audited credits; therefore, you must be careful not to get yourself selected for a review. In 2018, IRS estimates that 25% of EITC claims were paid in error. That error was worth $18.4 billion.290 The IRS has a watchful eye for Schedule C businesses with maximum EITC, only cash income, and no expenses since cash can be easily manipulated291 (AT 7A). Save all your receipts so you can support your deductions should your return be selected for an audit.  Quarterly Estimate Payments If you have self-employment income, you may have to pay quarterly estimate payments if the amount of withholdings from other sources doesn’t reduce your tax liability below $1,000. If you owe more than that amount at the end of the year, you may have to pay an underpayment penalty. 

https://www.eitc.irs.gov/tax-preparer-toolkit/schedule-c-and-record-reconstructiontraining/eitc-due-diligence-and-self 291 https://www.eitc.irs.gov/tax-preparer-toolkit/schedule-c-and-record-reconstructiontraining/eitc-due-diligence-and-self 290















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The following year, to avoid the underpayment penalty, use Form 1040-ES or the IRS Interactive Assistant to calculate your quarterly payments. Another option, if you expect a similar business income next year, you can divide the amount you owed for the current year by 4 (quarters) to figure out how much more in taxes you have to pay quarterly. Then you can adjust it based on whether you are making more or less than in the previous year. QBI Deduction If you are a sole-proprietor or have a pass-through income from S-Corp, Partnership, LLC, etc., double-check that you qualify for QBI deduction. The deduction is up to 20% of your taxable or QBI income with some restrictions; therefore, it is very valuable. However, it is a relatively new deduction since 2018; thus, the IRS and tax court are still clarifying some parts.  When you use tax software or file with a tax preparer, ask about it and thoroughly answer all the tax questions. If you have a rental property, you could also qualify for QBI, depending on the number of service hours worked. Start-up Expenses If you started a new business and before you started operations, you paid for certain expenses, you could qualify for start-up deductions. However, the IRS code section on start-up and organizational costs is nuanced and complex, so you may want to reach out to a tax professional for assistance. 













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You have to have good records classifying which expenses you paid when and you have to be careful not to deduct costs that never qualify as start-up expenses, such as the cost of issuing stocks or real estate taxes. Some of these costs will have to be amortized instead. The IRS is aware of taxpayer’s naiveté regarding start-up cots and thus can flag them faster. Reviewing these returns gives the agency more bang for the buck. Claim them if you qualify but keep all contemporaneous documentation and receipts should you need to support your deductions.  Report Rental Income If you rent a dwelling for more than 15 days during the year, you must report all your rental income on Schedule E. You also can claim investments and expenses for operating this business. If you experience a loss, IRS has several rules on how you can treat the loss depending on whether you actively participated in the business operation or if you were a real estate professional or other. Do your research or take time to find a tax preparer that understands the nuances of filing Schedule E and how to treat and classify your activity. Hobby as Business Any business that experiences loss after loss can be redflagged by the IRS and increase the likelihood of an audit (AT 7G). Therefore, before you claim your hobby as a business and deduct all the expenses, go through the IRS 9 defining factors to decide if your hobby is a business.292

https://www.irs.gov/faqs/small-business-self-employed-other-business/income-expenses/ income-expenses 292















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If you can say for sure that it is, then file Schedule C, E, or F. However, if more likely than not the IRS would see it as a hobby, you have to report your income from the activity, but can’t deduct the expenses. Trader Status Finally, be cautious if you started to trade securities more frequently in the current year and are tempted to classify yourself as a trader rather than an investor. Evaluate the list of items that a trader would experience and see how many of them relate to your trading activity (Table 38). Are you holding investments for longer than a year? Are you trading daily or weekly? Are you supporting your livelihood with your trading activity, or is it a side gig?  The trader designation has several provisions that are very stringent. The courts and the IRS have a rigorous interpretation of who should receive a trader status and thus deduct expenses on Schedule C. Take precautions before classifying yourself as a trader. The IRS sees all taxpayers by default as investors, and only very few can be traders. 










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Mistake 9: Omissions I am not a tax lawyer; therefore, I won’t attempt to go over legal differences and definitions of different tax crimes. For all crimes, the severity of the charges depends on the magnitude and intent of the taxpayer. The tax courts look differently on cases where the taxpayer made an honest mistake of forgetting something, vs. evidently neglecting and purposefully evading taxes. The tax code is complex and challenging for most taxpayers. An honest mistake may still lead to a 20% penalty, while a tax fraud can include a 75% civil penalty, criminal charges, and even jail time.293  There is a statute of limitations during which the IRS can audit your tax return. For typical taxpayers, 3 years is when the IRS can review your filings, but only if the agency doesn’t find that you underreported income or committed tax fraud.294 If you didn’t file at all but should have, the IRS has an indefinite time to audit you. Therefore, just by filing your tax return, you protect yourself and start the statute of limitation countdown.  Table 40. Statue of Limitation for an IRS Audit 3 years IRS has three years to audit your return If you underreported your income by 6 years more than 25% If you committed tax fraud or you didn't Inde nitely le a tax return

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https://taxattorneydaily.com/fraud-and-tax-crimes/ https://www.americanbar.org/groups/business_law/publications/blt/2017/08/06_wood/









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Taxpayers sometimes make omissions on their tax returns because they don’t realize the seriousness of the offense. They may not understand that the IRS not only receives information from different sources but also has the authority and ability to check your bank accounts, electronic records, request summons, or file warrants to review your information with different institutions.295  If you don’t take care of filing your tax return accurately and avoid omissions, sooner or later, Uncle Sam may send a letter requesting an examination of your filing. This can lead to a full-blown audit, penalties, and additional tax. Sometimes avoiding small amounts of tax can lead to severe consequences that will seem senseless in hindsight. A. NOT R EPORTING INCOME Tax return preparation is not pleasant for most taxpayers; therefore, taxpayers often rush through the process. When a tax preparer or tax software asks about information from the prior year, it can trigger the taxpayer’s memory that they forgot to gather all the documents. Sometimes the taxpayer takes the time to obtain the information, and at other times they continue with their DIY process. If you receive a 1099-NEC for a side gig or a project, the IRS also gets a copy of it. The IRS receives a copy of most 1099 tax forms. The agency matches the SS number you put on your tax return against what was sent to them on the forms by banks, brokers, employers.

https://www.irs.gov/irm/part9/irm_09-001-002#idm140038589941552









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If the IRS identifies an unmatched income that you didn’t include on your tax return, it will send you a letter with tax correction or ask you to amend the filing. Search or Ask: How the IRS knows you didn’t report income? IRS Interactive Tax Assistant (ITA). What happens if I don’t report all of my income? Sometimes, a taxpayer forgets a W-2 because they worked at that job briefly or moved or don’t know how to contact the employer to receive a copy. If you have trouble obtaining income records from your employers, you can file a transcript request with the IRS.296 If you don’t claim all your income, the IRS can assess a 20% penalty of the net understatement of tax. Suppose the IRS determines that the taxpayer carelessly and recklessly disregards the IRS rules by knowingly filing information that is not true, like missing income information and substantial understatement (larger of 10% of the correct tax or $5,000 for individuals). In that case, the civil penalty will take place.297 If you don’t report cash income and get audited by the IRS, they can review your bank transactions to check for cash deposits. If the amount of underreported income is large enough, it can lead to fraud charges.

https://www.irs.gov/pub/irs-pdf/f4506t.pdf https://www.irs.gov/pub/irs-news/fs-08-19.pdf







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On the other hand, many taxpayers also miss notable deductions such as dependent care credit or education credit when they don’t obtain supporting information. If you can claim certain credits and deductions, take the time to gather your documents; otherwise you are leaving money on the table.

B. NOT D ECLARING V IRTUAL CURRENCY

The IRS doesn’t have clear guidance regarding cryptocurrency - at least not yet. However, starting with the tax year 2020, Form 1040 has a question at the very top asking each taxpayer whether at any time during the year they received, sold, sent, exchanged, or acquired financial interests in any virtual currency.298 This is a way for the agency to start tracking more cryptocurrency transactions, which are hard to trace.

Figure 15. Virtual Currency Question on 1040

The IRS treats virtual currency as property. Therefore, any gain or loss is treated as capital gain and reported on Schedule D. Losses can offset other capital gain transactions. There is a limit of offsetting ordinary income up to $3,000 per year, with the excess loss being carried forward to future years.

https://www.cnbc.com/2021/02/24/failure-to-report-crypto-on-tax-returns-can-lead-totrouble-with-irs.html 298

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The agency has been requesting information from virtual currency brokers and exchanges, and it would not be surprising for the IRS to have a reporting requirement on one of the 1099 forms soon. Virtual currency transactions have their own set of tax consequences. However, taxpayers are taxed on the gain only, so the transgressions are not as large as by taxpayers paid in cryptocurrency who fail to report it. There is no purchase of capital but rather an exchange of an asset for service, and all of it is taxable.299 The compensation needs to be valued on the date of the receipt.300 There is another potential risk for taxpayers that are paid in cryptocurrency; besides the reporting matter. The loss in the value of currency paid as salary can’t be deducted, as is the case when trading cryptocurrency and treating it as property. Search or Ask: Is virtual currency taxable? How to declare cryptocurrency transactions? This is an introductory discussion on tax consequences of cryptocurrency transactions. It doesn’t address things such as ‘forkin,’ ‘mining,’ or converting cryptocurrency. It is essential to mention it briefly, as more taxpayers are starting to engage in virtual currency transactions. Taxpayers should do thorough research and seek help from an experienced tax preparer to accurately report virtual currency transactions.

https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-onvirtual-currency-transactions 300 https://www.marketwatch.com/story/need-to-report-bitcoin-trades-on-your-taxes-hereare-5-things-to-know-first-11614196467 299











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C. NOT INCLUDING

A

P AYMENT

After all the hard work of preparing your tax return and filing, taxpayers can forget the most consequential part of the entire process - making a tax payment.  If you file electronically, you may forget to print the payment vouchers and mail them. Some taxpayers like making tax payments with direct debit, but the majority still prefer to send a physical check. If you request an extension for your tax return on Form 4868,301 you receive an extra 6 months until October 15 to file your taxes. It is crucial to realize that the extension to file does not extend the time to pay. When you prepare Form 4868, you will have to estimate your total tax liability for the year and include a payment. Never mind the fact that most taxpayers don’t include the payment with their extension. The IRS can and will assess interest charges and penalties for paying late.  Search or Ask: What if I don’t / can’t pay my taxes? How to set-up an IRS payment plan? If you can’t make full payment of your tax liability, the IRS offers payment options. There are several ways you can make a payment:  • Paying in person at a local IRS office;302 • Paying via check or money order; • Pay via phone at 1-800-829-1040

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https://www.irs.gov/pub/irs-pdf/f4868.pdf https://www.irs.gov/help/contact-your-local-irs-office



















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• Paying through tax preparation software by setting up a direct debit from your bank account; • Paying via electronic funds transfer using DirectPay service303 on the IRS website or by using the IRS2Go mobile application304 (no processing fee); • Pay by using the Electronic Tax Federal Payment System (EFTPS),305 which is frequently used to make estimated quarterly payments (no processing fee); • Pay via IRS approved payment processors such as PayUSATax.com, pay1040.com, or ACI Payments, Inc. by using your debit or credit card (processing fees apply);  • Set-up IRS Individual Installment Payment Plan306 that can vary from: a full payment plan (no fee),  a short-term (less than 120 days; interest and penalties apply) or;  a long-term payment plan (set-up fee; interest and penalties apply). The taxpayers are often mistakenly fearful of the penalty for not paying taxes, but the penalty for not filing is more significant. Failure to file is 5% of the unpaid tax up to 25% maximum, while failure to pay is 0.5% of the tax not paid by the due date up to 25% maximum.307 Filing is more important as it starts the statute of limitation counter, which reduces the amount of time the IRS can audit you. 

https://www.irs.gov/payments/direct-pay https://www.irs.gov/newsroom/irs2goapp 305 https://www.eftps.gov/eftps/ 306 https://www.irs.gov/payments/payment-plans-installment-agreements#costs 307 https://www.irs.gov/businesses/small-businesses-self-employed/understanding-penaltiesand-interest 303 304



















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When you include a payment via check, make sure you make the check payable to U.S. Treasury. Many taxpayers write IRS on their checks or even put “Uncle Sam.” Always keep in mind that Form 1040 is a legal tax document. How you act, sign, how mindful you are can impact how the IRS sees you should you get examined. If the amount you owe is not something you can pay off easily or it is above the $50,000 limit for a long-term payment plan, you have two other options to settle your tax debts.  You can try settling your tax debt for less than the full amount that you owe by requesting an offer in compromise. This option is ideal for taxpayers whose ability to pay the tax liability may cause financial hardship. The IRS considers few factors and circumstances before they approve an offer in compromise. Such facts as: • • • •

Ability to pay; Income; Expenses; and Asset equity.

The IRS often approves offers in compromise when it realizes that the amount offered by the taxpayers is the most they can expect to collect. So if you propose a reasonable repayment amount based on your circumstances, you can successfully settle your outstanding tax bill.  Another possibility is to request a temporary delay of the tax collection process. This is a probable option when the IRS determines that the taxpayer is not in a position to pay any of the tax debt owed and can only pay it if his/her circumstances improve. It does not eliminate the debt but rather puts it on hold. 



















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Finally, if you are struggling with figuring out what options you have and need somebody to assist you through the process, reach out to the Tax Payer Advocate Service (TAS),308 an independent organization within the IRS. TAS helps taxpayers with all sorts of tax problems, including the inability to pay. Each state has local TAS offices that can help taxpayers resolve their tax matters. D. NOT R EPORTING FOREIGN B ANK ACCOUNTS Another big tax omission is not reporting foreign bank accounts by failing to file the Foreign Bank Account Report (FBAR) form,309 which can lead to either criminal or civil penalties. Jail time can be up to 5 years or $250,000 in fines or both. Some penalties are up to 50% of the account value, which is particularly steep.  You don’t have to be a millionaire to face this filing requirement. Many taxpayers would fall into this category, especially if they moved from overseas. You are required to file FBAR if the total value of all your foreign accounts exceeded $10,000 at ANY TIME during the year for any filing status (so MFJ threshold is the same).  With the rise of technology and global cooperation, the IRS can easily get its hands on your foreign bank information. Most foreign jurisdictions cooperate and comply with IRS requests promptly because they sign the Foreign Account Tax Compliance Act (FATCA) that requires foreign financial

https://www.taxpayeradvocate.irs.gov/ https://www.irs.gov/businesses/small-businesses-self-employed/report-of-foreign-bankand-financial-accounts-fbar 308 309









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institutions to collect and report certain information about accounts owned by US persons.310  Search or Ask: How does the IRS find foreign bank accounts? Penalties for not disclosing foreign bank accounts. So even if you owe $14,000 in foreign bank assets, don’t consider failing to file FBAR. If you don’t report that information, you can be assessed a 50% penalty of up to $7,000, which is half of your account value. The FBAR form is not used to determine tax but rather to identify and trace funds used for illicit purposes.   You can’t file FBAR with your regular filing; you have to file it electronically with the Financial Crimes Enforcement Network BSA E-filing system.311 Filing is due April 15 each year. E. IGNORING IRS L ETTERS Some taxpayers ignore, stall or panic when they receive an IRS letter. However, taxpayers should realize that the IRS sends millions of letters every year. I see taxpayers come to complete their tax returns with unopened IRS letters because they are afraid to open them.  There are numerous reasons why the IRS can send a letter to taxpayers: • You have a balance due. • You are due a larger or smaller refund. • IRS has a question about your tax return. 310 311

https://www.taxsamaritan.com/tax-preparation-services/expatriate-tax-services/fbar/ https://bsaefiling.fincen.treas.gov/main.html





















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• IRS needs to verify your identity. • IRS wants additional information. • IRS made changes to your return. • IRS requires to notify you of delays in processing your return. The Boxelder Consulting website has a list of over 100 different notices and letters that taxpayers can receive from the IRS.312 Taxes and finances can be sensitive matters. They can create fear, especially in taxpayers who struggle financially and don’t believe they can afford assistance. You have to open all correspondence from the IRS promptly. The problem will not go away if you wait longer. It can lead to penalties or, worse, if you get audited, it can indicate that you were careless and negligent. The IRS letters look very intimidating and complicated because they are written in legal tax jargon. If you receive a letter from the IRS, take a deep breath, open it, and then read it a couple of times, line by line, highlighting all the main points.  Search or Ask: Understanding your IRS notice or letter. Do’s and don’ts for taxpayers who get a letter or notice from the IRS. How to respond to IRS letters? Frequently, the letter includes definitions or regulations or different situations that may not apply to you. There may be a logical statement addressing different scenarios (e.g., and, or, “NOT” hidden somewhere), which you can easily miss if you skim it quickly. 

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The most important part of the letter is the instruction section, explaining what the taxpayer needs to do. If you talk to most taxpayers, they will tell you that they have received a letter from the IRS at least once or twice during their tax lifetime.  Be aware of scam letters sent to you that are NOT from the IRS. If you receive such a letter and are suspicious, contact the IRS. Additionally, know that the IRS will never call taxpayers directly. The agency will include a phone number in the top right corner of its letters so the taxpayer could reach a person to discuss their case, but they will never make the first call. Anne’s Story I was assisting a young college student Anne with her taxes. She was a full-time student under 24, still living with her parents. Anne was a dependent filing taxes because she made over $400 in net self-employment income as a gymnastic instructor.  There was no difficulty with her tax return. However, Anne brought in an IRS letter that her father received in regards to prior year taxes. It related to the family claiming the American Opportunity Tax Credit (AOTC). Currently, the IRS requires education institutions to issue Form 1098-T to report how much in qualified tuition, expenses, and scholarship each student paid and received. The family didn't receive Form 1098-T from Anne's college for the previous year but claimed the credit.  Anne’s dad responded to the IRS letter confirming that he qualified for the credit but didn't provide any supporting











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records. This was a second follow-up letter from the IRS. I read the letter slowly with Anne, highlighting important information and instructions. All the IRS wanted was supporting information; however, the letter didn’t clearly state that. Since Anne’s college didn't provide Form 1098-T, Anne’s family needed to prove in another way they paid the tuition and expenses to the school. It could be a printout from the school or a statement that showed the dates and amount paid.  After Anne’s family did just that, the following year when Anne came in to do her taxes, she told me that everything was resolved.  How could Anne’s family avoid this situation? • Read the IRS letter slowly and follow the instructions precisely.  • When claiming AOTC or Lifetime Learning Credit (LLC), Anne’s family should have tried to obtain Form 1098-T from the institution. The form may be available online through a student account.  • If no Form 1098-T were available, the family could have printed out college financial statements with the amounts paid for tuition and other expenses and included them with the taxes. 













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F. NOT R EPORTING D OMESTIC WORKERS Taxpayers often employ household workers, such as house cleaners or babysitters, in the underground economy. A big part of the underground economy are cash services, such as work performed by domestic workers.  The IRS recognizes household workers as employees and not independent contractors. If you control the work people do and how they do it, they are considered you employees, and you are required to pay and withhold social security and Medicare taxes.313 (TM 8I) Household work is work done in or around your home by the following workers: • • • • • • • • • • •

Babysitters Caretakers Cleaning people Domestic workers Drivers Health aides Housekeepers Maids Nannies Private nurses Yard workers

If taxpayers paid cash wages of $2,300 or more for 2021, they have to withhold social security and Medicare taxes for the workers, 7.65% of pay in total. There are few exceptions to this rule specified in the IRS Publication 926, Household Employer’s Tax Guide.314  https://www.irs.gov/taxtopics/tc756 https://www.irs.gov/pub/irs-pdf/p926.pdf

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When you are withholding FICA and federal income tax from your employees’ wages, you will need to issue Forms W-2 or W-3 for each employee. The additional burden includes paying federal unemployment tax (FUTA) if you paid more than $1,000 in any quarter and on the first $7,000 of cash wages you pay to each household employee.  We have not even started to discuss that domestic workers are considered non-exempt employees, which means they need to be paid overtime when they work over 40 hours per 7-day week.315 Finally, the taxpayers who employ domestic workers also have the burden of filing Schedule H, Household Employment Taxes,316 when they file their taxes. Taxpayers need to register themselves as an employer and apply for Employee Identification Number (EIN).  Search or Ask: How to pay your nanny / babysitter / maid / domestic worker(s)? Nanny tax rules. Household payroll and taxes. How to file Schedule H? There is so much compliance connected to employing domestic workers that only 5% of Americans actually complete all the necessary paperwork for their domestic help.317 If the IRS simplified the rules and requirements, they would receive more compliance from taxpayers. A little bit of simplicity would reduce the tax gap. 

https://www.homeworksolutions.com/knowledge-center/nanny-overtime-minimumwage/ 316 https://www.irs.gov/forms-pubs/about-schedule-h-form-1040 317 https://www.wsj.com/articles/youre-not-the-only-one-whos-not-paying-your-nannytax-1539336600 315











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The relationship between the taxpayer and the domestic worker can often last for years and benefit each party differently. Many domestic workers are undocumented immigrants who don’t have SS or even ITIN for tax purposes. The relationship between the two parties can last years until a problem arises, such as an argument, injury, or firing.  If you would like to be compliant with the tax law and avoid any problems with the IRS, you have options. You can hire a company that specializes in household payroll and nanny tax compliance services. Check this list of the 10 Best Nanny Payroll Services for 2021.318 Some include federal and state tax filings, Schedule H reporting, quarterly compliance, form W-2 printing, etc. If something is too complex to handle yourself, it may be beneficial to outsource to a specialist and have peace of mind.  Table 41. Omission Mistakes Not reporting cash or 1099-NEC income. Not reporting virtual currency transactions or payments in virtual currency. Not sending a payment or applying for an installment agreement. Not reporting foreign bank accounts. Not responding to IRS letters in a timely manner (usually within 30-60 days). Not reporting domestic workers.

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If you receive an income tax form, report it on your tax return because Uncle Sam also gets a copy. Sometimes it may take a couple of years for the IRS to follow up with you on your missing forms, but eventually, they may and will. The longer you wait, the more you will owe in back taxes, interest, and penalties.  If you are trading and using virtual currency, know that the IRS treats it as property and has reporting requirements. Although virtual currency transactions are not required to be reported by the virtual brokers yet, the IRS can request user account information.  Think of virtual currency similarly to securities; if you sell them for profit, you have to pay taxes on the gain. If you make a loss, you can deduct it against other capital gains or up to $3,000 in a loss against ordinary income. If you are paid in virtual currency, you have to claim it as income.  If you can’t pay your taxes, make sure you at least file them. The penalty for not filing is higher than for not paying, and it starts the statute of limitation countdown. In addition, if you don’t file, the IRS can file a substitute for return on your behalf by using the forms that it receives. In 2020 it filed 662,611 such substitute for returns for taxpayers.319 That will never be as advantageous to you as filling yourself. You will claim credits and deductions, while the IRS will mainly report all the income you received for the year and be less concerned about which credits you should claim. 

pg: 34 in IRS 2020 Data Book https://www.irs.gov/pub/irs-pdf/p55b.pdf









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Considering this, even though the agency knows that 20% of taxpayers are eligible for but don’t claim ETIC,320 the IRS never sends the taxpayers the EITC refunds proactively. Instead, it requires that taxpayers claim them. If you can’t pay your taxes in full when you file, you have several options. You can pay your taxes either through a short or long-term payment plan, offer in compromise, or by requesting a temporary delay of collection. If you need someone to walk you through your options, reach out to Tax Advocate Service (TAS).  If you have any foreign accounts that total more than $10,000 during any time during the year, file FBAR or Fin 114 the Financial Crimes Enforcement Network BSA E-filing system.321 The due date is April 15 of each year, like tax returns, but the form must be filed separately. If you receive a letter from the IRS, take a deep breath but open it immediately. You have between 30 to 60 days to respond to all IRS inquiries. Find the section with instructions and highlight what your next steps are. Don’t give the IRS a reason to document your non-compliance by stalling, not responding, or ignoring letters from them. Finally, if you hire domestic workers and don’t want to deal with the complex IRS regulation, outsource tax compliance to a nanny payroll service. They specialize in this work, and it may be a worthy investment in keeping things easier for yourself and be fair to your employee.

https://www.taxpolicycenter.org/briefing-book/do-all-people-eligible-eitc-participate https://bsaefiling.fincen.treas.gov/main.html







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Mistake 10: False Info = Tax Evasion There is a difference between forgetting or not knowing versus deliberately reporting or concealing information. Tax evasion is a crime and has serious legal and criminal consequences.  Nonetheless, very few people are convicted of tax crimes. For example, in 2019, only 2,000 taxpayers were convicted of tax evasion, which is less than 0.0022%. That is a small number considering that the IRS estimates that 15.5% of taxpayers don’t comply with all the tax laws.322   Tax evasion or filing a false tax return is a felony and carries up to a five-year prison sentence and $250,000 in fines for individuals.323 Most tax evasions fall under two categories: • Avoiding tax by filing a false return that omits income or claim deductions to which the taxpayer is not entitled to; or • A willful attempt at avoiding tax payment by concealing money and assets from which the tax could be paid. We will primarily focus on the first type, which occurs when you are preparing the tax return. What you include or exclude on your tax return could be determined as tax evasion.

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https://taxattorneydaily.com/fraud-and-tax-crimes/ pg 2: https://www.irs.gov/pub/irs-utl/tax_crimes_handbook.pdf















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A. R EPORTING FALSE INFORMATION Deliberately underreporting cash, gambling, or other income may result in the assessment of additional tax due, interest on the unpaid amounts, penalties, and civil or criminal fraud charges. There is a broad spectrum of tax evasion and what type of false information classifies as fraud.324  A government study found that most underreporting of income is done by self-employed restauranteurs, clothing store owners, car dealers, salespeople, doctors, lawyers, accountants, and hairdressers. The most over-deducted expenses relate to car and entertainment expenses.  The two topmost commonly charged tax crimes are to intentionally fail to file a tax return (#1) and willfully fail to pay tax (#2).325  Some taxpayers don't file taxes because they don't have money to pay, and they believe that if they don't file, the IRS won't find them, or at least it will take a while. The truth is that even if you can't pay, you should file because the penalty for not filing is higher than for not paying.  If you can't pay your taxes in full, there are several options in paying in installments (TM 1E). Finally, if you don't file your taxes, the statute of limitation for your tax return doesn't start, and hence the IRS has unlimited years to audit you.326 The last reason should be something that motivates you to file your tax returns. 

https://www.fedortax.com/en/understanding-tax-fraud https://www.sambrotman.com/blog/irs-tax-crime/tax-crime-omission-definition 326 https://www.jacksonhewitt.com/tax-help/tax-tips-topics/irs-audits-notices/what-is-thestatute-of-limitations-for-an-irs-audit/ 324 325













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If you have sufficient money and assets and avoid paying your taxes by concealing foreign bank accounts or assigning income to relatives in a lower bracket, it can also result in a tax fraud charge. That is considered a willful attempt at avoiding payment when you have funds. Intentionally underreporting or omitting your wages, such as not claiming virtual currency income or not reporting rent payments, are examples of serious offenses, especially if they are large in magnitude. If the understatement of income is over 25%, the IRS can audit you 6 years back, and if found guilty of tax fraud, there are more serious charges. Search or Ask: What happens if you lie on your taxes? Tips on amending tax returns. When can IRS audit you? On the other hand, taxpayers can face tax fraud charges when claiming false or overstated deductions, such as rounding and inflating expenses. If a taxpayer has a $100 expense but inflates it to $1,000 or claims charity deduction that can't be substantiated, that is considered tax fraud. The IRS scrutinizes paying your spouse for work they didn't do to reduce business income, especially in wealthier households. Claiming personal expenses as business expenses may lead to having the deduction disallowed and fraud charges. Such an example would be a taxpayer who claims a computer, phone, or car expenses completely for business while also using it for personal purposes. Another way taxpayers can try to falsify information is by overstating their basis in investment to reduce the amount of taxable gain. A basis is what you pay for an investment,











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property, or tangible assets, and it includes the front cost, fees, and any improvements you have made.  Here is an example X of an overstated basis. A taxpayer sells an investment property for $900,000. The taxpayer claims that the costs to purchase plus other expenses and improvements (basis) were $600,000, so he/she pays taxes on $300,000. However, the actual basis was lower, and he/she should have paid taxes on $500,000. The IRS would consider this a tax fraud (not paying taxes on the additional $200,000). Example 12. Overstated Basis Investment Property Overstated Basis Actual Basis Sell Price $900,000 Purchase Cost $350,000 Improvements / other expenses $250,000 $50,000 Total Expenses $600,000 $400,000 Capital Gain $300,000 $500,000 Falsifying records and documents is even worse. Some taxpayers try to create 'sham transactions' or create phony receipts to support their deductions. When asked for supporting records, it will quickly become apparent that the expenses were falsified.  Some taxpayers become even more creative in trying to avoid paying their taxes. They place properties in the name of another person or a relative to transfer assets that they have, so it looks like they don't have money to pay their tax obligations, which is illegal. That is a tactic used by some wealthy taxpayers to avoid paying tax assessments. Suddenly the building is owned by nana, who has no other income, instead of the taxpayer. 









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Finally, claiming dependents that already left home or using SS numbers that don't belong to the taxpayers or members of their household relate to identity thefts which are felony offenses. Tax identity thefts are real and are a big hassle for taxpayers who have their identity compromised.  Many taxpayers receive an Identity Protection PIN (IP PIN) from the IRS. The taxpayers have to use the IP PINS when they file their taxes because their identity was compromised in the past. That IP PIN changes each year, and it adds a level of additional verification that most identity thieves don't know.  Starting in 2021, any taxpayer may request an IP PIN327 from the IRS to add a level of security to their tax returns. If the taxpayers suspect possible foul play from somebody they had a relationship with, they should request an IP PIN to use with their filings. B. HOW IRS P ROVES TAX E VASION The IRS has many ways to prove tax evasion or fraud. Some of the more frequent methods include: • checking your bank account transactions and bank account transfers;  • estimating your living expenses and change in net worth from the prior year;  • noting that you primarily operate with cash; • reviewing excessive spending; • percentage markup on retail business with inventory.328  For example, IRS will check taxpayer’s assets at the beginning and the end of the year. If the net worth increased 327 328

https://www.irs.gov/identity-theft-fraud-scams/get-an-identity-protection-pin https://irstaxpros.com/tax-fraud-and-evasion/methods-of-proof/





















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much more than what is reflected on the filed tax return, the agency can declare that the extra increase in net worth was due to unreported income. Another way the IRS can find proof that taxpayers committed fraud is by reviewing their bank accounts and transactions. If the number of deposits in the account over the year was $100,000, but the taxpayer only claimed $50,000, IRS can ascertain that the other half was falsely underreported.  Similarly, the IRS can look at the taxpayers’ spending pattern, and if they see expenditures close to $100,000 for the year while the taxpayer claimed only $30,000 in income, they can assume the rest was underreported.329  To find non-filers, IRS matches W-2 and 1099 forms against tax returns filed. The agency also analyzes last year's filing data against current data and requested extensions to identify taxpayers that didn't file in the current year.330  IRS agents even use the information found on school media accounts to expose lifestyles that don’t match the tax return filings.331 Lavish vacations and outlandish purchases could indicate much higher income than taxpayers claimed. Search or Ask: Tax evasion vs. avoidance: what is the difference? How the IRS proves tax evasion? Tax crime handbook.

There are also other possibilities such as inheritance, savings, investments, etc. https://www.treasury.gov/tigta/auditreports/2016reports/201630085fr.pdf 331 https://www.investopedia.com/articles/personal-finance/041515/how-irs-catches-taxcheats-liars.asp 329 330













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Finally, the IRS can review books of small businesses by looking into their inventory level and multiplying it by expected profit margin for the industry.332 This estimates the income that the IRS would expect the company to make. Everything less than what the IRS estimates it can declare underreported. Table 42. Providing False Information Intentionally failing to le a tax return. Willfully failing to pay tax. Intentionally underreporting or omitting income. Hiding or transferring assets or income. Claiming false or overstated deductions and expenses. Overstating basis to reduce capital gain taxes. Falsifying personal expenses as business expenses. Engaging in “sham transactions.” Using a false Social Security number. Claiming ctitious or inaccurate dependents. Falsifying records or documents. H OW

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Make sure to include all forms that you receive that relate to income. IRS won’t penalize you for not claiming a credit (e.g., foreign tax credit), but it will impose interest and penalties if you don’t include income. If you received a form, understand that the agency also gets a copy.

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Mark-up percentage can also be debated but it gives the IRS a range to start with.





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Although the IRS may not immediately spot a problem with your tax return, they have up to 3 years to examine your taxes.333 I have seen taxpayers bringing letters regarding tax returns from two years ago. It is tough to remember what transpired that long ago and much more challenging to find all the paperwork to claim all the deductions.334 Especially during the Covid-19 pandemic, the IRS has a significant backlog of unprocessed paper returns and amendments. In addition, the agency's resources have been strained with additional work like processing stimulus checks, additional CTC, etc. Therefore, some taxpayers may receive a notice about their last and current tax return two years later. 

Doing things right at the beginning beats mediocre corrections later when your memory is fuzzy. Don’t put any false information on your tax return because if you are caught, you can face severe charges, criminal and civil penalties, and even jail time. If you get yourself in trouble, reach out to Tax Advocate Service (TAS)335 for help. Don’t try to handle the problem on your own. The steps that you take at the beginning of resolving the matter can make or break your case.

Unless fraud is committed. Create a separate annual tax folder where you keep everything for each tax year. 335 https://www.taxpayeradvocate.irs.gov/ 333 334









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Key Takeaways • Don’t procrastinate and wait until to last minute to file. Even if you can’t pay, file your tax returns.  • The tax penalty for not filing your taxes is higher than for not paying, so make sure you file even if you can’t pay. Filing your taxes also starts the statute of the limitation period.  • Make sure you don’t file more than one original tax return each tax year.  • You have only 3 years to get your refunds from the IRS. • Consider free in-person VITA sites for filing your tax returns or free IRS-approved tax software (Figure 7).  • Double-check everything on your tax return: SSNs, DOBs, EINs, bank account numbers to avoid e-file rejections and refund delays. • Renew your ITINs before filing your tax return to receive all the benefits you qualify for.  • Don’t file tax returns with a new name if you haven’t changed it with the SSA. • Organize your tax documents in an annual folder where you keep all your forms, receipts, and tax records.  • Keep cost information for all your investments (e.g., stocks, property, real estate) until you sell them.  • Double-check the qualification for Head of Household (HOH) filing status.  • To claim dependents as a non-custodial parent, include Form 8332 with your taxes.  • If your spouse has individual debts, consider Injured Spouse Relief to receive a portion of the refund. 





























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• Double-check credits and deductions for the current year.  • Single taxpayers with SSN and earned income below $21,430 for the tax year 2021 qualify for EITC.  • Don’t underestimate your income when applying for Marketplace Health Insurance because you may have to repay some subsidies when you file your taxes.  • If you qualified but didn’t receive the stimulus checks, claim RRC on your tax return for 2021 (3rd stimulus) or 2020 (1st & 2nd stimulus).  • You can’t claim the same expense for two different deductions or credits.  • Withdraw your retirement funds as a last resort only, but if you have to, review if you qualify for any of the 10% penalty exceptions. • Taxpayers who have owned and lived in their primary residence for more than 2 years could qualify for the $250,000 home gain exclusion (per person). • Electronic filing is easier, faster, and more accurate than paper filing. It is also a preferred method by the IRS. • If you decide to paper file, make sure everyone on the tax return signs and dates the filing. Check the amount of postage and the address where it needs to be sent. • Never ever mix personal and business expenses. Get separate accounts and credit cards. Keep track of business expenses in an annual folder/envelope (i.e., Tax Year 202X). • If you are filing Schedule C, check what expenses you can claim.























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• If you owe more than $1,000 for your federal taxes, you may want to pay quarterly estimated taxes to avoid an underpayment penalty.   • Some businesses, farms, pass-thru entity and rental property owners may qualify for a 20% QBI deduction. • If this is your first year starting a business, you may qualify for investigation, preparation, or organization start-up expenses.  • Before you claim your hobby as a business, verify it against the IRS 9 factors that it would qualify (TM 8G). • Most rental income has to be reported unless you rent for less than 15 days during the year.  • You can’t classify a worker as an independent contractor if you control how, when, and where they perform the work.  • Just because you trade few stocks from time to time, that doesn’t make you a trader. • If you don’t report your income, the IRS has 6 years to audit you for missing more than 25% of the gross income. If you had income and didn’t file, the IRS can examine you indefinitely. • Virtual currency transactions are taxable. IRS is increasingly reviewing taxpayers’ compliance. • If you can’t pay all your tax liability at once, set up a payment plan with the IRS. • If you have any large tax debts outstanding, reach out to TAS and request an offer in compromise.  • If you have any foreign bank accounts with a balance of over $10,000 at any time, you need to declare them by























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filing the FBAR form. Failure to do so is a 50% penalty of the account balance.  • Don’t ignore IRS letters. • If you pay any of your babysitters, maids, nannies, or other domestic workers over $2,300 in cash in 2021, they are considered your employees. You will need to withhold social security and Medicare taxes and file Schedule H with your taxes.  • Tax avoidance is considered a legal method and loophole to minimizing tax liability. Some can be borderline illegal and considered tax evasion. • Tax evasion is illegal and considered a fraud. Intentionally failing to file or pay are the two most frequent tax evasions. • The IRS can prove tax evasion by checking your bank account transactions, estimating living expenses, reviewing spending patterns, and even examining social media posts.













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A Special Request Your brief Amazon review will help others find this book. The link below will take you directly to the Amazon review page. Thank you in advance. ( ◠‿◠✿) https://www.amazon.com/author/ akistepinska









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F

irst, let’s start with the good news: congratulation on being one of the 90% of taxpayers that electronically file their tax returns. It is the most accurate and fastest way of filing taxes.  The bad news, or rather the so-so news, is that sometimes your e-filings do get rejected. However, even if that is the case, the rejection code will provide you with information about what is wrong and how to fix it. But, of course, to e-file again, you have to correct your mistake in the filing first.





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Rejections

Many of the e-file rejections can be easily fixed. However, sometimes taxpayers get frustrated and feel as if they came across the Great Wall of China, but they don’t even take the time to read the rejection note. Indeed, the rejection code is not exactly in plain English. It sometimes is writtenasonelongline.  You can receive a rejection code that says “SpouseNameControlTxt” or “ExemptSpouseNameControlTxt” which is not exactly user-friendly. There is usually a short explanation of what it means. If you still can’t figure it out, you can either reach out to your tax software support or Google it.  Check the eFiile.com website for a list of many 2020-2021 e-file rejection codes.336 The most frequent e-file rejection errors are due to the following: • Incorrect personal information such as names, SSNs, birth dates; • Inexact employer name or Employee Identification Number (EIN) on Form W-2 or Form 1099; and  • Mistaken self-selected PIN or prior year AGI used during the e-filing verification process. The main reason tax returns get rejected is that the IRS information on file doesn’t match what you entered into the tax return. Most tax software will let you know immediately or within few hours whether there was an e-file rejection.

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The most important thing to remember about e-file rejections is that you should re-submit it ONLY after fixing the error. Otherwise, if you keep re-submitting and getting a rejection, at some point, the IRS will block your tax return from being electronically filed even if you fix the error. The IRS sees this activity as suspicious at this point, and the only option you will have is to file your tax return via paper.  Most rejections are quick and easy fixes, but some may take time to obtain necessary documents. Therefore make sure you plan accordingly and watch out for the due date. If you file on the last day when tax returns are due, and your tax return gets rejected, you have a grace period of 5 days to re-file. If you re-file within that period, your tax return will be considered to be filed on time.337

https://www.hrblock.com/tax-center/filing/efile/irs-efile-rejection-grace-period/





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Rejection 1: Mismatched Personal Info There are five different e-file rejection codes with mismatched information: SSN - Your, spouse’s or dependent(s)’ SSN is incorrect or doesn’t match the Social Security Administration (SSA) record. DOB - The date of birth of someone on the tax return doesn’t match the SSA database. EIN - Payer federal ID or Employer Identification Number (EIN) on W-2, W-2G, or 1099-R is incorrect. AGI - Your or your spouse’s prior-year AGI or your prior-year self-selected PIN doesn’t match. Identity Protection (IP) PIN338 - your six-digit IP PIN assigned to you by the IRS to verify your identity when filing tax returns is incorrect. These rejection codes are responsible for the bulk of all efile rejections. However, they are the primary keys to filing tax returns. These errors indicate problems with taxpayer personal information and are clerical rather than tax-related. If this information is incorrect, the IRS e-filing system won’t recognize or accept the tax return. One advantage of these errors is that they are easy to fix. When taxpayers receive a rejection because of an incorrect SSN, they must verify that everyone listed on the tax return has a correct SSN. The error will note which person listed on the tax return has a wrong SSN. 

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Every tax software has different SSN error prevention methods. Sometimes taxpayers have to enter SSN(s) twice to verify their information; however, often, that is only true for the primary taxpayer and not everyone else listed on the tax return. In other software, the taxpayers have to repeatedly reenter the SSN in more than one place, such as Form 8863 for education credit, doubling the probability of making a mistake.  The DOB e-file rejection code most likely occurs when two digits are transposed or a wrong DOB format is used (DayMonth-Year instead of US Month-Day-Year). Taxpayers who moved from another country with a different date format can unintentionally make this mistake. The EIN e-file rejection code occurs when the numbers from forms W-2 and 1099 are entered incorrectly. As the IRS uses SSNs to identify taxpayers, so are EINs used to identify businesses, employers, banks, and brokers. The information reported on taxpayer forms is matched in the IRS database against what it received from the companies. If there is a mismatch in the system, the taxpayer will have to correct it before re-transmitting. The EIN is a long 9-digit number unfamiliar to taxpayers and can easily be transposed or entered incorrectly. Rarely do tax software guard against making this mistake. Tax software will tell taxpayers when the number is too short or too long but not if it is wrong. The only way to receive confirmation that all the EINs are correct is to e-file and not receive a rejection notice. The prior-year AGI e-file rejection code is an error that taxpayers that file their own tax returns often experience and struggle correcting. The reason why tax software requests this









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information is for identification purposes. In contrast with the SSN error, which taxpayers have an easier time fixing, prioryear AGI can often be a mystery.  If a taxpayer has a prior-year tax return readily available, he/she can quickly check what the AGI was on the prior year 1040. Sometimes, tax software may offer taxpayers another way to verify their identity by entering driver’s license information. When taxpayers can’t easily find or access their prior-year tax return, they sometimes guess their prior-year AGI by believing it was the total earnings from W-2 wages or they put the current year AGI. If the AGI information is still wrong, the tax return will be rejected a second time.  Some taxpayers don’t give up so fast and will try guessing multiple times up to the point when the tax software will no longer let them e-file their taxes. The IRS database will mark the e-filing as suspicious, and the only way the taxpayers will be able to file will be by preparing a paper return, which will be much longer to process.  Taxpayers should have a copy of their prior return, either on paper or digitally. Sometimes taxpayers don’t save a copy digitally from the software they were using. They don’t remember their login credential in the current year, plus they have trouble resetting or confirming their identity. Another way to obtain a prior year AGI is by requesting a prior-year transcript,339 but very few taxpayers want to go that route. That is why having a copy of your filings is very helpful (TM 1).

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Finally, the IP PIN e-file rejection code happens when taxpayers assigned the IP PIN failed to include it on their tax returns. The IP PIN is a six-digit number assigned to a taxpayer with a compromised identity in the past. The IP PIN changes each year, so when you receive it, keep it with all your current tax information.  If the taxpayer misplaces the IP PIN letter, they can retrieve it on the IRS website.340 However, some taxpayers cannot get through the identity verification process because they don’t answer all the questions accurately. If the verification process doesn’t work, you can call 1-800-908-4490 for specialized assistance or paper file without the IP PIN. What is confusing about the IP PIN is the similarity to SelfSelect PINs used to sign your tax return electronically. The SelfSelect PINS are 5-digit long and can be re-used. You may put prior-year AGI or the Self-Select PIN you created the year before when you have to verify your identity on the current tax return. However, taxpayers rarely remember their selfselect PIN from prior year. The table below summarizes the difference between the two, but it would be better if the IRS would name them uniquely. As far back as 2011, the IRS saw this matter as confusing but have not changed them.341 

https://www.irs.gov/identity-theft-fraud-scams/retrieve-your-ip-pin https://www.irs.gov/pub/irs-utl/8_panel.pdf





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Table 43. Difference Between Self-Select PIN & IP PIN Self-Select PIN A random 5-digit number that you enter as your electronic signature when e- ling your return.

IP PIN A 6-digit number that the IRS assigns to victims of tax-related identity theft or can be requested by the taxpayer as identity theft prevention. You can use this 5-digit You have to include this IP number or prior-year AGI to PIN when you le sign the current tax return. electronically. You can re-use this PIN The IP PIN can’t be reused. each year when you sign The IRS sends you a new 6your e- ling or create a new digit number each year. one each year. For taxpayers that suspect somebody may compromise their tax identity, starting with the tax year 2020, they can request an IP PIN as an extra step in the identity verification process.

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Rejection 2: Incorrect Withholdings The e-file rejection code regarding incorrect withholding often has to do with transposing numbers or adding an extra digit to the withholding amount. That creates withholdings larger than the actual wages earned, which the system recognizes as improbable. To fix the e-filing rejection, taxpayers have to go to the form listed in the rejection code, often it is Form W-2 or Form 1099-R, and double-check the amount of federal and state withholding entered into the software. Once you fix and verify the amount, you can resubmit the tax return again. The rejection code can also specify that the total amount of withholding on page 2 of 1040 doesn’t equal the sum of the federal withholdings from all your documents, which is the same thing.









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Rejection 3: Previously Accepted Return There are five different frequent scenarios for this type of efile rejection code:  Previously accepted return - Taxpayer or spouse’s SSN has been used on another return filed for the current year. Dependent claimed on another return - Dependent has been claimed on another return or filed their own return and didn’t indicate that they should be claimed as a dependent. Married Filing Separately (MFS) - Primary taxpayer is already listed as a “spouse” on a previously filed return with filing status MFS. Covid-19 Simple 2019 return already filed - Taxpayer filed a Stimulus, Simple or Non-Filer return in 2020 to receive stimulus payment, which was considered a replacement for 2019 tax return.  Identity Theft - Someone filed a tax return using the taxpayer’s personal information to claim the refund.  The first scenario cover cases where the SSN has already been used. It could be a partner who already filed the tax return with the SSN claiming themselves. Another possibility is a married taxpayer that has not lived with their spouse for the last half of the tax year and who would qualify to file as Head of Household (HOH),342 filed their tax return. When the other spouse tries to file as either MFJ or MFS, the system will reject it. Essentially, the IRS system won’t let you submit a tax return where the SSN was already used. 

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https://www.irs.gov/faqs/filing-requirements-status-dependents/filing-status

















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You can discuss the situation with your partner, and one way to correct it would be for the other person to file an amendment, which could take up to 16 weeks to process. Another way to fix these e-file rejection codes is to file via paper and provide supporting documentation for your claim.  The second scenario is similar to the first one because the SSN used on the tax return has already been filed with the IRS. However, this SSN relates to a dependent being claimed. One likelihood is when partners that support the same child don’t discuss who has the right to the claim. The tax law allows only one taxpayer to claim the same child during a current tax year. There are situations where divorced taxpayers can rotate who claims the dependent from year to year (TM 4B).  Another possibility is for a dependent, such as a college student, to file a tax return claiming themselves while their parent tried to claim them on their return. To correct this e-file rejection code, the student would need to file an amendment and change their status to filing as a dependent in order for the parents to claim him/her on their tax return.  The third scenario relates to married taxpayers where one of them tries to file MFS and the other tries to file as MFJ. When a taxpayer files MFS, they have to include the SSN of the spouse, so the IRS system can match that the spouse also files as MFS. When the other spouse tries to file MFJ, the system will reject the return. If one spouse files MFS, the other spouse automatically has to use the same filing status.343

Except if they didn’t live with their spouse the last half of the year and qualify for HOH status. 343









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The fourth scenario is specific to the 2019 tax returns. In response to the Covid-19 pandemic, the IRS created a tool that allowed taxpayers that didn’t have filing requirements for 2019 to file a Stimulus, Simple or Non-Filer return344 in order for the agency to receive the taxpayers’ personal and banking information. The agency used that information to send stimulus payments to the taxpayers.  The problem with this tool was that only taxpayers who DIDN’t have filing requirements were supposed to use it. Nonetheless, many who did use it should have filed real 2019 tax returns. The taxpayers with the 2019 filing requirement that used the tool later tried to file their actual 2019 filing, and the IRS rejected them.  It rejected them because the Simple 2019 tax returns were considered a substitute for the actual 2019 tax returns. So now, the taxpayers that wanted to file their real 2019 tax return had to file an amendment.  The fifth scenario refers to tax returns that involved tax identity theft. In 2018, the Federal Trade Commission received 38,967 reports of identity theft for tax fraud.345 When someone gains access to taxpayer personal information, including SSN, and files a tax return claiming their refund, they commit tax identity theft. Thieves try to file very early on in the season before taxpayers have a chance to do so. That is why IRS usually doesn’t process tax returns before mid-February in order to give more time to file for taxpayers with valuable refundable EITC and ACTC credits.346

https://www.irs.gov/newsroom/use-irs-non-filers-enter-payment-info-here-tool-to-geteconomic-impact-payment-many-low-income-homeless-qualify 345 https://money.usnews.com/money/personal-finance/taxes/articles/what-to-do-ifsomeone-files-a-fraudulent-tax-return-in-your-name 346 https://www.irs.gov/newsroom/2021-tax-filing-season-set-to-begin-february-12 344









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How do taxpayers find out they have been victims of identity theft? You can’t e-file your tax return as the system recognized that somebody else already used your SSN. The IRS could also notify you about suspicious activity.347 When that situation happens, the electronic system will not let you e-file your tax return; therefore, you will have to paper file to claim your refund. You can also contact the Taxpayer Protection Program at 1-800-908-4490 if you need help. If you are a victim of identity theft, file IRS Form 14039, Identity Theft Affidavit,348 where you report the circumstances to the agency. You may also need to reach out to the IRS Identity Theft Victim Assistance to get help on your case.349  After your identity has been compromised, the IRS will issue you an Identity Protection PIN (IP PIN), which will change each year, and you will have to include on your tax return to verify your identity. In the tax year 2018, the IRS issued 4 million IP PINs350 for taxpayers. Starting with 2021, taxpayers can request IP PINs to protect themselves from tax identity theft as a preventative measure.

https://www.irs.gov/newsroom/taxpayer-guide-to-identity-theft https://www.irs.gov/pub/irs-pdf/f14039.pdf 349 https://www.irs.gov/individuals/how-irs-id-theft-victim-assistance-works 350 pg 21 https://www.irs.gov/pub/irs-pdf/p55b.pdf 347 348










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Rejection 4: Ineligible for a Credit These e-file rejection codes have to do with credit being claimed incorrectly on the tax return.  CTC - Child is ineligible for CTC due to their age (older than 16). EITC / AOTC / CTC / ACTC / ODC - You claim credit after the IRS disallowed it in a prior year, and you may need to file Form 8862. The first ineligibility code has to do with an incorrectly entered birth date, which can easily be fixed. Double-check the birthday of the dependents listed on the tax return, and once corrected and verified, you can re-submit your return. The second rejection code has to do with the IRS rejecting the taxpayer’s claim for a specific credit in the past. To claim it in the current year, the taxpayer has to file Form 8862.351 The form is divided into several sections; each section asks questions about corresponding credit - EITC, AOTC, CTC, ACTC, ODC.  To fix this error, the taxpayer has to completely answer all the questions that correspond to the credit he/she is claiming. If there is more than one credit that the taxpayers claim after disallowance, they must complete all the corresponding sections on the same Form 8862.

351

https://www.irs.gov/pub/irs-pdf/f8862.pdf















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Rejection 5: Need to Paper File There are three main reasons why a taxpayer may not be able to file electronically: Under 16 or/and never e-filed - For taxpayers under 16 or who never e-filed tax returns, they have to paper file. Too many attempts - If a taxpayer tries to e-file several times and receives a rejection, at a certain point, the IRS won’t let the taxpayer e-file, and the only option will be to paper file. Previously accepted return - If a tax return is found in the system for that SSN because somebody else used that information to file, the only way to rectify it is via paper. For first-time filers and taxpayers who are under the age of 16 who have never filed a tax return with the IRS, there is a requirement that the first time they file taxes, they have to do it via paper. Taxpayers under 16 but who filed a tax return in the past will be able to e-file.  Whenever the taxpayer receives multiple e-filing rejections at some point, the IRS system will lock the taxpayer out from being able to file electronically. That can happen when the taxpayer keeps guessing prior-year AGI or their IP PIN or some other information on the tax return. It is similar to being locked out from accessing your phone if you try to enter an incorrect password too many times. 















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Finally, suppose the taxpayer files his/her tax return, and the IRS system marks it as a previously accepted return. In that case, somebody else used one of the SSNs listed on the tax return and filed it before the taxpayer. It can happen when two parents try to claim the same child as a dependent or when a college student files as not a dependent after his/her parents already claimed him/her as a dependent.  One way to fix these e-filing errors is for the other taxpayer to file an amendment, which can take up to 16 weeks to process.352 An alternative is to file the tax return on paper and mail it to the IRS, with a statement and supporting documents substantiating why the taxpayer should be the one claiming the dependent.

https://www.irs.gov/filing/wheres-my-amended-return



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Rejection 6: Missing Forms These e-file rejection codes have to do with missing forms on the tax return.  Missing 8962 - PTC reconciliation form, for the advanced premium tax credit received by the taxpayer that has 1095-A marketplace healthcare coverage, is missing. Missing 8862 - in the past, the taxpayer had a disallowed credit for EITC, CTC, ACTC, or AOTC, and to claim it in the current year, a Form 8862 has to be attached. Missing 8863 - the taxpayer is claiming an education credit on the tax return but is missing the credit calculation on Form 8863. Missing Schedule A-F, EIC, SE - Somewhere on the tax return, there is an indication that information from one of the schedules is reported, but the schedule is missing. You should be notified of these errors before you file them electronically. Most tax software has systems in place to flag missing forms before taxpayers e-file. If the taxpayer e-files with a missing form, the IRS will reject the tax return, and the error code will specify which one is missing. 















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Rejections

Taxpayers who receive marketplace health insurance receive their annual advance prime credit summary for the year on Form 1095-A. That form needs to be filed with tax returns regardless of whether the taxpayer has a filing requirement. Since the tax year 2019, there is no healthcare insurance mandate,353 making some taxpayers believe that they no longer have to include the health care coverage information on their tax returns. Taxpayers that receive forms 1095-B and 1095-C, which indicate health care coverage through the government or employers, no longer have to include them on their tax returns. However, Form 1095-A is an exception.  Form 1095-A shows how much subsidies as advanced premium tax credit taxpayers received from the government towards their health insurance. The amount of subsidies taxpayers receive is based on their estimated income for the tax year.  Therefore, when taxpayers file their tax returns, they have to include form 1095-A and Form 8962 that reconcile the amount of income they had for the year against their subsidies. Sometimes taxpayers have to pay back some of the advanced premium credits, and sometimes they receive more in credits from the government. If the 1095-A form is missing from the tax return, the tax return can be rejected.  Sometimes the tax return may not be rejected at all, but the IRS will send a follow-up letter to the taxpayer requesting a copy of their Form 1095-A so they can perform reconciliations of the advanced tax premium credits. 

353

https://www.healthcare.gov/fees/fee-for-not-being-covered/









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If a taxpayer receives an e-file rejection code regarding Form 8862, it is because, in the past, the taxpayer filed a tax return claiming credit for EITC, CTC, ACTC, or AOTC that the IRS disallowed. Therefore, when the taxpayers try to claim the credit in the current year because their current situation changed, they must include Form 8862 with supporting information.  Suppose a taxpayer receives an e-file rejection code regarding Form 8863. In that case, the taxpayer is claiming education credits, but the form is not included on the tax return, or the form is present but is incomplete. Form 8863 requires information on the student for whom the credit is being claimed and information about the educational institution and expenses paid. Therefore, it is essential to include it with a tax return if education credit is claimed. Finally, if there is information on Form 1040 that references another schedule, such as Schedule A - F, EITC, or the Selfemployment (SE) schedule, but the form itself is missing, efiling rejection occurs. Sometimes it can happen when the taxpayer enters information manually on Form 1040 in the software. The way to fix this error is to complete the missing schedule and re-submit the tax return.







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Rejections

Rejection 7: Credit Repayment Missing This rejection code occurs when the return is missing a repayment of the First-time Homebuyer credit that the taxpayer(s) received between 2008 to 2010. The credit repayment period was set for 15 years, or whenever the house was sold, whichever was earlier.354  First-time homebuyer credit - First-time homebuyer credit installment payment on Form 5405 is missing. Taxpayers may not remember how much they still have to repay the credit in the current tax year. The IRS website has a first-time homebuyer credit account look-up to help taxpayers access their account information.355 To fix the rejection, taxpayers must add Form 5405 with a sufficient repayment amount and resubmit their return.

https://support.taxslayerpro.com/hc/en-us/articles/360009294953-Common-Form-1040-eFile-Reject-Codes 355 https://www.irs.gov/credits-deductions/individuals/first-time-homebuyer-credit-accountlook-up 354











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Rejection 8: Invalid Tax Payment Date This e-file rejection code has to do with an invalid direct deposit withdrawal date on the tax return.  Invalid payment date - the date specified for direct debit withdrawal is outside of what the IRS considers to be an acceptable date range.356  There are often two scenarios for this kind of error. One is when the taxpayers file before the due date of the return. In that case, the rejection code will ask the taxpayers to specify the payment date to be before the due date but not more than 5 days before the date they e-file the return. The second scenario is when taxpayers file AFTER the due date of the tax return. In that case, the rejection code will specify to schedule payment on or before they e-file but no more than 5 days prior to e-filing.  To fix the error, schedule the date for direct withdrawal as specified in the error description and described above. Once that is corrected, you can re-submit your return. Table 44. Direct Debit Payment Options Filing On (examples) Direct Debit Payment Before due date on or before due date but no more than 5 days before 15-Mar Between March 10 - April 15 After due date on or before you e- le but no more than 5 days before 15-Apr Between April 10-April 15

https://kb.drakesoftware.com/Site/Browse/10428/EF-Reject-FPYMT













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Key Takeaways • Double-check all the SSNs, DOBs, EINs on your tax returns. If you are using an IP PIN or prior year AGI for verification purposes, double-check it.   • Double-check the amount of withholdings on your Form W-2 for the federal and state. • If your dependent has been incorrectly claimed on another return, you can file via paper with supporting paperwork so that the IRS compares the two claims.  • If you suspect that someone has compromised your identity, contact Taxpayer Protection Program at 1-800-908-4490. If you purchased identity protection from a tax software or tax retail company, call their number first.  • When claiming CTC, double-check the DOB for all your children that the month and day are not transposed. • If an EITC / AOTC / CTC / ACTC / ODC credit was disallowed in the past, you might have to include Form 8862 with your tax return.  • If this is your first time filing tax returns, you may have to file via paper.  • If you forgot to attach a form to your tax return, read the instructions on how to resubmit your filings.  • Double-check whether you still have to repay any FirstHomebuyer Credit by checking your account on the IRS website.357  • If you are filing after the due date, the direct debit date can’t be later than date of filing.  https://www.irs.gov/credits-deductions/individuals/first-time-homebuyer-creditaccountlook-up 357
























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PART III: AUDIT TRIGGERS (AT)

O

ver the past ten years, there have been fewer IRS audits because of shrinking budgets and staff reductions.358 Audit rates have dropped by 47% across the board, with the most significant drops for filers in the highest income brackets.  IRS audits taxpayers to minimize the “tax gap,” or the difference between what it should receive from the taxpayers and what it actually does.  Your overall chances of being audited are 1 in 200 (0.5%); however, certain categories and items can increase your chance of an audit. Many red flags can get you audited if you are not careful and take an aggressive position.  https://www.taxpolicycenter.org/taxvox/irs-data-book-tells-story-shrinking-staff-feweraudits-and-less-customer-service 358







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Audit Triggers

IRS performs random audits using a computer program called Discriminant Informant Function (DIF)359  which identifies tax returns that fall outside the norm for similar returns.  I have compiled the most common audit triggers from several resources, and IRS 2017 Audit Triggers information.360 Many of the triggers are tax mistakes that went bad, especially tax returns with aggressive positions. It is crucial to avoid the errors altogether as they often lead to red flags and audit triggers.  The IRS audits returns in three ways:361 • Correspondence Audit - by mail; • Office Audit - at an IRS office; and • Field Audit - in person at your home, business, or accountant’s office. The IRS will notify the taxpayer by a letter, informing them which type of audit is initiated. The agency will never call the taxpayers. If you receive a letter informing you about an IRS examination, it will specify what the agency is requesting from you for further review and the next steps you should follow. The letter will explain how to contact your case agent if you have questions.

https://www.irs.gov/businesses/small-businesses-self-employed/irs-audits https://www.irs.gov/pub/irs-utl/2017ntf-irsauditstriggers.pdf 361 https://www.irs.gov/businesses/small-businesses-self-employed/irs-audits 359 360















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The typical items that IRS can request include:362 • • • • • • • • • • •

Receipts Bills Canceled checks Legal papers Loan agreements Logs or books Tickets Medical and dental records Documents detailing theft or loss Employment documents Schedule K-1s

The agency can also ask you to fill out a questionnaire, especially if you have Schedule C business.  Most letters give taxpayers 30 to 60 days to respond. It is crucial to respond timely, and if you need additional time, request it. The IRS usually reviews returns for the past 3 years but can add additional years if it finds inaccuracies. Most of the time, it won’t ask for records beyond 6 years.  The audit can result in three ways:  • No Change - taxpayer was able to substantiate all information on the tax return; • Agreed - the IRS proposed changes, and the taxpayer agreed with the changes; • Disagreed - the IRS proposed changes, and the taxpayer disagreed with them.ew If you agree with the IRS proposed changes, you have to sign the examination report and if you owe any taxes, settle on payment options. 362

https://www.irs.gov/businesses/small-businesses-self-employed/audits-records-request







































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If you disagree with the IRS proposed changes, you can request a conference with the IRS manager and file an appeal.363 From then on, the process can get complicated and is beyond the scope of this book.  If you need tax assistance and help resolving problems with the IRS, reach out to the Taxpayer Advocate Service (TAS).364 TAS is an independent organization within the IRS that advocates on taxpayers’ behalf. According to TAS, the most frequently litigated tax issues365 that make them more dangerous audit triggers are listed below. The challenges discussed in the book have links to the corresponding section.

https://www.irs.gov/appeals https://www.taxpayeradvocate.irs.gov/ 365 pg. 107: https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2020/08/ ARC19_Volume1.pdf 363 364







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Table 45. Most Frequently Litigated Tax Issues Tax Issue Trade or Business Expenses, Double Dipping, Hobby Losses, Home Of ce Use, Collection Due Process Accuracy-Related Penalty Gross Income Summons Enforcement Civil Actions to Enforce Federal Tax Liens or to Subject Property to Payment of Tax Failure to File Penalty, Failure to Pay Penalty, and Failure to Pay Estimated Tax Penalty Schedule A Deductions, casualty/ theft loss, mortgage interest, state and local taxes, medical expenses, Gambling Charitable Contribution Deductions Frivolous Issues Penalty

1

2 3 4 5 6

7

8

9 10



















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Book Section TM 8A & AT 7B TM 5G TM 8G & AT 7G AT 4C TM 9E TM 6 AT 3A -

TM 1A & AT 1 TM 9C TM 8D TM 5A & AT 4A AT 8B

AT 4B TM 10

Audit Triggers

Trigger 1: Not Filing Tax Returns The IRS may impose a range of civil and criminal penalties on non-filers. If you don’t file your tax returns, you are subject to the failure to file penalty and, if you owe, additional failure to pay. Failure to file penalty is steeper than failure to pay; therefore, you should always try to file by the due date or request an extension even if you can’t pay. If you can’t file on time, don’t wait to request an extension to file on Form 4868.366 That extends your filing time until October 15 of the year. The extension doesn’t prolong your time to pay, but it gives you more time to gather your documents and file accurately for the current year. Filing an extension is free and easy (TM 1A). Does filing an extension increase or decrease your chances of an audit? There is no publicly available data to answer this question. However, since filing an extension gives taxpayers more time to gather all the necessary documents and not rush through the process, it should result in a more accurate return, thus decrease the chance of an audit.367  Taxpayers that don’t file and hope that the IRS won’t notice may be surprised when the IRS recreates a “substitutes for returns” (SFRs)368 for the taxpayer, based on the forms that it receives (e.g., forms W-2, 1099s). When the IRS pieces together SFRs for you, it primarily focuses on the income information. It may not consider or include deductions and credits that the taxpayer is eligible to claim. Consequently, it is always the taxpayer’s advantage to file their own tax return.  https://www.irs.gov/pub/irs-pdf/f4868.pdf https://paragonaccountants.com/top-10-red-flags-that-trigger-an-audit/ 368 https://www.yourirsproblemsolvers.com/irs-response/ 366 367











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If you receive an SFR from the IRS, you have an option to agree with the information presented or petition the Tax Court within 90 days if you don’t want to pay the amount that the IRS requests in the notice.369  If you have not filed for the past few years, the situation can seem daunting. Start with the current and prior year returns. Very likely, the tax returns that you should have filed six years ago, the IRS won’t ask for unless the agency identifies fraud.370 Don’t beat yourself up and file what you can. On the other side, many taxpayers don’t file tax returns because their income is under the threshold for filing requirements. However, taxpayers don’t realize that they may want to file tax returns regardless of whether they are required. Some of the reason why you may want to file tax returns even if you don’t need to are:371 • Receiving a refund for withholding, which you can only get within 3 years of the tax return due date; • Qualifying for refundable credits such as EITC or AOTC; • Start the clock on the statute of limitations for an assessment and collection of taxes or an audit; • Prevent tax identity theft by others who may claim fraudulently with your information. A failure to file a tax return is one of the most commonly charged tax crimes.372 That is one mistake that a taxpayer can easily avoid. Filing requirements don’t change often, but it is a good idea to check from time to time whether you are still not required to file, especially if you are close to the borderline. https://www.thebalance.com/when-you-haven-t-filed-tax-returns-in-a-few-years-3193355 https://taxattorneydaily.com/filing-tax-returns/ 371 https://www.irs.gov/newsroom/help-yourself-by-filing-past-due-tax-returns 372 https://www.sambrotman.com/blog/irs-tax-crime/tax-crime-omission-definition 369 370

















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As shown in Table 46, most taxpayers have to file Form 1040 if they work and have a gross income above a certain amount. That is called the filing requirement. It is based on three factors: gross income, filing status, and age.  Table 46. Income Filing Requirement for 2021 Filing Status

Age at the end of 2021

Gross income over

Single (S)

under 65 > 65

MFJ

under 65 (both spouses) > 65

MFS

any age

$5

HOH

under 65 > 65

$18,800 + $1,700

QW

under 65 > 65

$25,100 + $1,350

$12,550 + $1,700 $25,100 + $1,350 per spouse

Draft 1040 Instructions for 2021: Chart A: https://www.irs.gov/pub/irs-dft/i1040gi--dft.pdf

However, there are additional reasons why a taxpayer may need to file a tax return, even if their income is below the threshold amount.373 For example, if you are self-employed and your net earnings are above $400, you must file a tax return. Similarly, taxpayers who receive subsidies toward their marketplace health coverage also have to file taxes each year. Description of situations when you may need to or want to file even if you are not required to are described in Understand Your Tax Form 1040.

373

Chart A, B, and C: https://www.irs.gov/pub/irs-dft/i1040gi--dft.pdf







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Trigger 2: Filing Status Related A. I NCONSISTENT CLAIM

D EPENDENT

FOR A

Blended families have become much more common, and the rules of who can claim a dependent are complex. Complex family circumstances that change during a year can make it very difficult for taxpayers to figure out who can claim their dependents (TM 4B). If two people claim the same dependent, IRS will try to review both claims and send an inquiry notice to the taxpayer that shouldn’t claim the dependent. If it can’t determine who should claim the dependent, the IRS can send an examination notice to both taxpayers and compare which one can better substantiate their claims.374 Tax returns that consistently claim the same dependent over the years are less likely to raise a red flag or be selected for an audit than tax returns that claim different dependents on and off, even if that is the reality.

https://www.thebalance.com/claiming-same-dependent-audit-risk-3193030









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Audit Triggers

B. FILING

AS

H EAD

OF

H OUSEHOLD (HOH)

Filing as Head of Household (HOH) is a much more advantageous filing status for unmarried taxpayers because it has a higher standard deduction and more favorable tax rates. HOH also lets taxpayers qualify for many valuable credits. However, it is also the most complex filing status to choose correctly. There are several requirements for eligibility that are not well understood by taxpayers, leading to tax mistakes (TM 4A).  The IRS HOH definition is much stricter than the definition used in everyday language. How the IRS defines a dependent, household, support, etc., is more stringent than what taxpayers may think when they hear these terms. There are several criteria that you must meet to claim the HOH filing status; some of the main ones are:  • You must be unmarried or considered unmarried; • You must have paid more than half of the cost of keeping up a home for the year; • A qualifying person/dependent must have lived with you more than half a year (except a parent); Suppose the IRS sends you an audit notice regarding your filing status and possibly EITC.375 In that case, you need to provide all the necessary supporting documentation to show that you are entitled to claim the filing status. You may have to complete Form 886-H-HOH376 with supporting documents.

https://www.irs.gov/taxtopics/tc654 https://www.eitc.irs.gov/eitc/files/downloads/f886-h-hoh.pdf














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Trigger 3: Income Related A. U NREPORTED INCOME The most frequent audit trigger and adjustment notice sent to taxpayers is regarding unreported income. If you received a Form W-2 or 1099-Rs, the IRS also gets a copy of them. The IRS receives information from employers, banks, brokers and compares it to the information reported by taxpayers.  Taxpayers who frequently change their employment can overlook a lacking Form W-2. I have worked with taxpayers who filed 12 W-2s, making it possible that one missing form can go unnoticed. Especially if the W-2 form was not sent to the taxpayer via post but is available online only. We all have busy lives, and although taxes are not on everybody’s mind, forgetting is not an excuse that the IRS will tolerate.  Most taxpayers report all the income they receive on W-2s and 1099-Rs forms, but some taxpayers who are not familiar with the 1099-MISC or 1099-NEC payments for nonemployees377 fail to include them when they file. I have worked with taxpayers that were surprised they received form 1099-MISC or 1099-NEC for a small project, for which they were paid cash. The taxpayers agreed with the employer that their earnings would not be reported, which is a fraud according to the IRS. 

Prior to tax year 2020, non-employee income used to be reported on Form 1099-MISC box 7. Starting that year, the IRS created a new form 1099-NEC to report the non-employee income separately from other income that can be listed on Form 1099-MISC. 377











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Frequently, the employer did not honestly communicate that they will be reporting the income as they were trying to receive a discount from the worker for paying them cash. If the workers had known that the employer would have been reporting that information to the IRS, they would have priced the job differently (TM 8I).  It is crucial to realize that all cash income is reportable and taxable income according to the IRS, so the worker should report any income they receive on their tax returns. Some taxpayers fail to report gambling winnings on Form W-2G and unemployment payments on Form 1099-G. When the taxpayers receive gambling winnings, they may not believe that the IRS will find out about it. While taxpayers who receive unemployment income don’t realize it is taxable. Taxpayers who receive unemployment income for the first time, as many did during the 2020 Covid-19 pandemic, don’t believe that the unemployment income to help them survive is taxable.  All gambling and unemployment income is taxable, except under the 2020 CARES Act, Congress approved an exclusion of $10,200 of unemployment income per taxpayer from the 2020 taxes.378 Any unemployment income up to $10,200 was not taxes, and everything over the amount was. This was very helpful to taxpayers who found themselves on unemployment first time in their lives and didn’t withhold taxes.

378

https://www.taxpayeradvocate.irs.gov/covid-19-home/coronavirus-covid-19-tax-relief/









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Table 47. Taxable & Non-Taxable Income Taxable Income

Non-taxable Income

• Alimony (for divorce before 12/31/2018) • Business income • Canceled debts • Cash income • Compensation for personal services • Director’s fees • Disability bene ts (employerfunded) • Dividends • Estate and trust income • Farm income • Gains from sale of property or securities • Gambling winnings • Hobby income Interest • Interest • Jury duty fees • Military pay (not exempt from taxation) • Military pension • Non-employee compensation • Partnership, Estate and SCorporation income (Schedule K-1s, Taxpayer’s share) • Pensions • Prizes • Punitive damage award • Railroad retirement • Refunds of State and local income tax (if reportable) • Rent income • Rewards • Royalties • Self-employment income • Severance pay • Social security bene ts - portion may be taxable • Taxable scholarships and grants • Tips and gratuities • Unemployment compensation • Wages, salaries, bonuses, commissions

• Aid to Families with Dependent Children (AFDC) • Alimony received for court orders after 12/31/2018 • Child support • Civil damages, restitution for wrongful incarceration • Damages for physical injury (other than punitive) • Death payments • Dividends on life insurance • Economic Impact Payment (EIPs), Stimulus Payments • Employee education assistance from an employer up to $5,250 • Employer reimbursements for ordinary or necessary expenses • Federal income tax refunds • Foreign earned income up to $108,500 (2021) • Gifts • Home sale exclusion on primary residence up to $250,000 per ler • Inheritance  or bequest • Insurance proceeds (Accident, Casualty, Health, Life) • Interest on EE/I bonds redeemed for quali ed higher education expenses • Interest on tax-free securities • Meals and lodging for the convenience of employer • Olympic & Paralympic medals and prizes • Payments to the bene ciary of a deceased employee • Quali ed Medicaid waiver payments • Relocation payments • Rental allowance of clergyman • Rental income for less than 15 days • Repayments of excess Advanced Premium Tax Credit for marketplace insurance subsidies  suspended (Tax Year 2020 only) • Reverse mortgages • Sickness and injury payments • Social security bene ts - portion may not be taxable • Supplemental Security Income (SSI) • Temporary Assistance for Needy Families (TANF) • Unemployment compensation up to $10,200 per ler (Tax Year 2020 only) • Veterans’ bene ts • Welfare payments & food stamps • Worker’s compensation













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Audit Triggers

According to IRS, the majority of income is taxable.379 Very few items are not taxable, mainly welfare, worker’s compensation, death payments, EIPs, reimbursements, child support, and interest on tax-free securities. Taxpayers who don’t include all their income earned during the year when they file have an increased probability for an audit. Occasionally you may be lucky, and if you are missing something minor, IRS will make a correction for you and send you a CP2000 adjustment letter.380 However, if you fail to report more than 25% of your income, you can pay a 20% penalty of the net understatement of tax or more. B. RETIREES NOT TAKING RMD S Until 2020, taxpayers had to be 70 1/2 when they started taking the Required Minimum Distribution (RMD). However, the SECURE Act from early 2020 changed the age to 72. At 72, taxpayers are required to begin drawing income from their retirement plans; otherwise, they will owe 50% tax on the amount not withdrawn.  Under the CARES Act from 2020, for the tax year 2020, RMDs were waived. However, for the tax year 2021, they are back. 

https://apps.irs.gov/app/vita/content/globalmedia/teacher/ examples_of_taxable_nontaxable_income.pdf 380 https://www.irs.gov/taxtopics/tc652 379











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Which accounts have RMDs? Almost all accounts have RMDs except Roth IRAs since you paid taxes on the contributions upfront. All the accounts listed below have RMDs: • • • • •

Traditional IRA SEP IRA SIMPLE IRA Traditional & Roth 401(k), 403(b), 457(b) Profit-sharing plans

The IRS knows how old each taxpayer is and can easily estimate when RMD withdrawals should start. RMDs are required to be taken by the end of each year. However, the agency offers a grace period for taxpayers turning 72. They can delay the payout until April 1 of the following year.  Additionally, there is a specific exclusion for taxpayers who are 72 or older and still working. They are allowed to delay taking their RMDs from the current employer's 401(k) until after they retire. This only applies to 401(k)s and not IRAs.  How are RMDs calculated? RMDs are calculated based on balances in each retirement account as of December 31 and the life expectancy factor in the IRS Publication 590-B.381 If a taxpayer has several IRAs, an RMD has to be calculated for each account, but the taxpayers could take the entire amount from one IRA. However, for each 401(k) there has to be a separate withdrawal,382 which can be confusing for the taxpayers. 

https://www.irs.gov/pub/irs-pdf/p590b.pdf https://www.irs.gov/retirement-plans/rmd-comparison-chart-iras-vs-defined-contributionplans 381 382























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The custodians who administer your retirement accounts have to report your RMDs and send a report to you and the IRS. At that point, the IRS knows what you should have taken in RMDs vs. what you actually did. For example, an unmarried taxpayer age 72 in the tax year 2021 had two retirement accounts, one traditional IRA with a balance of $60,000 on December 31, 2020, and a 401(k) with a balance of $100,000. Per Table III Uniform Lifetime in IRS Publication 590-B, her life expectancy is 25.6 years. Therefore, the amount of each account divided by that number calculates the total RMD of $6,250 for the year (see Example 13). RMD Penalty Taxpayers who don't take out their required RMD can receive 50% penalty. However, the IRS can waive part or all of the penalty if you can show that any shortfall in distributions was due to reasonable cause and that you're taking steps to remedy the situation.  The way to do that, the taxpayer would have to: • Take corrective action asap by taking the RMD missed and avoid withholding tax from the RMD to make it match as best as possible to the requirement amount.383 • File form Form 5329, "Additional Taxes on Qualified Plans," and attach a statement of explanation for each year missed. To request the waive of the penalty, the taxpayer has to write "$0" next to line 54, and on the dotted line, write "RC" for 'reasonable cause' followed by the amount of the RMD shortfall.

https://www.kitces.com/blog/fix-rmd-missed-forgotten-miscalculated-corrective-actionform-5329-penalty/ 383















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To continue on our example, since the taxpayer had an obligation taking $6,250 and failed, the penalty would be $3,125 ($6,250 x 50%). Example 13. RMD Calculation & Penalty Plan Balance on 12/31/20 Life Expectancy RMD

Trad. IRA $60,000

Penalty 50%

$1,172

$2,344

401(k) $100,000 25.6 $3,906

Total

$1,953

$3,125

$6,250

The hefty penalty for not taking RMD doesn't seem to scare some taxpayers. The Treasury Inspector General for Tax Administration (TIGTA) audit identified 639,000 taxpayers with IRAs worth over $40 billion who may have failed to take the RMDs from IRAs in the tax year 2012.384 Only 6,500 of these taxpayers submitted Form 5329 to self-report failing to take their RMDs and to pay the 50% penalty. However, the IRS is on the lookout for these accounts because the Treasury loses revenue when taxpayers keep their assets sheltered.

https://www.cuinsight.com/treasury-audit-identifies-significant-noncompliance-with-rmdrules.html 384





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Ruth’s Story When Ruth came to a VITA site to get her taxes done, she was close to her early retirement age of 62. She was single, worked part-time and lived with her older brother. Regardless of age, there can be a power dynamic at play when it comes to siblings, which I saw with Ruth and her brother.  Ruth’s brother insisted that she start taking her social security benefits as soon as she became eligible at 62. Ruth felt pressured by her brother but was unsure whether she should wait until her full retirement age of 66 or even until 70. She thought she could wait a bit longer and receive larger benefits, while her brother wanted Ruth to start collecting social security earlier for a more extended period.  There is no right or wrong answer as it comes to when a taxpayer should start taking their social security benefits because there are several variables that need to be considered.  What is the life expectancy for Ruth and her family? If she expects to live few more decades, waiting to get higher benefits may make sense.  Will Ruth plan on working until at least 70? How much were Ruth’s earning? If Ruth made over $18,960 (2021) between her 62nd and full retirement, her social security benefits would be reduced by $1 for every $2 that she would make over that amount. Was Ruth going to receive any other income while drawing her social security, such as pension benefits?













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Depending on her other income, up to 85% of her social security could become taxable.  If Ruth stopped working and decided to start taking her SS benefits, would she have health insurance before she turned 65 and started receiving Medicare? Some seniors prefer working until they turn 65 and receive Medicare, as otherwise, they may find themselves without health care coverage.  No one variable triumphs another; it depends on each taxpayer's preferences and circumstances. The unfortunate part was that Ruth felt pressured by her brother to select an option that she knew very little about. Ruth has to look at all the pros and cons and select the make best decision for herself. C. LARGE CASH TRANSACTIONS IRS has found that many cash-heavy businesses don’t declare all cash income, and therefore, this is a good indicator that an audit would result in additional tax assessment. Large cash transactions are suspicious because, in this digital world, they have become a thing of the past. Most transactions between individuals and businesses operate with bank payments and credit card charges.  Banks are required to report transactions over $10,000 to the IRS. If a notice is triggered, the agency can request information about where and how the money was earned and used.  Certain businesses that operate cash, such as restaurants, beauty salons, or gig services, have more opportunities to













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hide income, considering that most transactions are not documented. That increases the likelihood of an audit, especially if there are additional red flags such as operating losses or substantial deductions, etc.  D. FLUCTUATING INCOME Fluctuating income is a part of life. College students getting their first job will experience a large income bump. People who retire or transition to a new industry or get laid off may experience significant income drop. However, if taxpayers' income fluctuates from year to year, the IRS may suspect some underreporting of income. Audit teams track historical data on taxpayers and account for the main life changes, such as first job, retirement, filing status change. If there are unexplained and out-of-the-norm trends, the agency can request more information or audit the tax return. E. MOST INCOME WIPED OUT

BY

D EDUCTIONS

Taxpayers whose most income gets wiped out by deductions and credits are more likely to be audited. Taxpayers should take advantage of all tax deductions they qualify for. However, they should also notice whether that could increase their audit exposure. The IRS has a lot of data on taxpayers in different professions, filing statuses, and historical data on each taxpayer. If deductions seem out of the norm for the taxpayer, the agency is more likely to want to examine the tax return.















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If you had a challenging year and have contemporaneous support for all credit and deductions, file your tax return, including them all. Many audits and correspondence examinations result in no adjustments; therefore, as long as you have supporting information, you are protected. F. EARNING

A

LOT

OF

MONEY

Although the audit rate has been dropping overall, the likelihood that you get audited goes up as your income increases. Those making over $1 million are audited the most.385 IRS doesn’t want to waste its time and resources auditing taxpayers that won’t be able to pay or where there are not many irregular items to examine.  More high-income earners take more deductions and credits, and their tax returns are much more complex, which leaves more room for misinterpretation. That also means a greater prospect of significant tax revenue recovery. Those taxpayers that make over $1 million in income AND file Schedule C have an even higher audit rate. Having a higher income does trigger a higher rater of an audit than making below $200,000, except for those who report no adjusted gross income or their income is wiped out by deductions and credits (AT 3E) These taxpayers also have to be cautious.

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G. CLAIMING CHILD SUPPORT

AS

ALIMONY

Until the Tax Cuts and Jobs Act (TCJA) enactment, alimony payments were deducted from income on the taxpayer’s return, while the taxpayers that received them had to claim them as income. That is still true for all divorce or separation agreements executed before 12/31/2018.386 However, any alimony agreements entered after this date don’t treat the alimony as taxable income.  The biggest red flag with alimony is when it is unmatched. If the alimony payer deducts it from their income, the alimony receiver must include it in their income. Thus, the payer has an incentive to list it on their tax return as it reduces their taxable income, while the receiver may try to omit it, thus producing unmatched alimony in the IRS system. When taxpayers report alimony payments, they list the ex-spouse’s SSN on the tax return so that the IRS can match the payments as income for the ex. If an alimony agreement was executed in 2010 for the payment of $12,000, the payer would deduct that amount on the tax return as payment. On the other hand, the receiver would list it as an income on her/his tax return. If the receiver omits the alimony as income, it will trigger an IRS examination letter. The change in the tax law adds to the confusion as some taxpayers are not aware that the change doesn’t apply to agreements executed before 12/31/2018. For example, taxpayers may have learned that alimony is no longer taxable income starting with the tax year 2019. However, they

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may not realize that it only applies to agreements executed before 12/31/2018. The second transgression with alimony payments occurs when taxpayers try to claim child support payments as alimony payments. Child support payments are not deductible by the payer, nor are they taxable to the recipient.387 However, some taxpayers deduct them from their income, triggering an audit. H. FOREIGN B ANK ACCOUNTS Under the Foreign Account Tax Compliance Act (FATCA), strict rules require foreign financial institutions and certain nonfinancial foreign entities to report information on assets held by US citizens. By using the International Data Exchange Service (IDES), countries transmit and exchange data with the United States.  If the cumulative foreign account balance is more than $10,000, the taxpayer has to file FinCen Form 114 (FBAR),388 and if it is more than $50,000, they have to file Form 8938. The forms require information on the foreign financial institution and the amount held.  The IRS knows that some taxpayers try to conceal their assets in foreign jurisdictions, believing it won’t be discovered. The penalties for not disclosing foreign bank account information and filing the required forms are very steep. They can be as high as 50% of the account balance or up to $100,000. https://www.irs.gov/faqs/interest-dividends-other-types-of-income/alimony-child-supportcourt-awards-damages 388 https://bsaefiling.fincen.treas.gov/NoRegFBARFiler.html 387













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Additional confusion is that the FBAR is not filed with the IRS but rather with the Financial Crimes Enforcement Network (FinCEN),389 a bureau of the Treasury Department, while Form 8938 is filed with the IRS. Taxpayers may have a requirement to file one or both.  Indicating that you have a foreign bank account could increase your chance of an audit as taxpayers often don’t disclose all information or fail to file the required FBAR form. Meanwhile, the IRS receives taxpayer information from foreign jurisdictions. Foreign account compliance is complex, so make sure you are clear on what is required to avoid an examination. I. V IRTUAL CURRENCY TRANSACTIONS There is no data as of yet about how often do taxpayers with virtual currency transactions are audited. IRS is in its infancy trying to figure out how to audit all the taxpayers that trade or mine cryptocurrency and don’t report it. The agency does know that very few people comply with reporting virtual transactions and paying capital gains tax.  Starting with the tax year 2019, IRS added a question on Form 1040, asking taxpayers whether they have received, sold, or exchanged virtual currency during the tax year. For the tax year 2020, the question has been moved to the top of the form. Since you sign 1040 under penalties of perjury confirming that everything is true, you commit tax fraud if you don’t disclose virtual currency transactions. 

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IRS has been gathering information on taxpayers and marketplaces where virtual currency is traded to figure out who is not reporting it as income. The IRS treats virtual currency as property. Taxpayers need to report any gains on virtual currency transactions, similar to reporting stock sales.  In 2018, Coinbase, a company handling virtual currency, was forced under subpoena to release 14,000 user data to the IRS. 10,000 of these users received letters from the IRS inquiring why they failed to report the transactions on their tax returns.390   Since there is no audit trail on crypto-currency transactions, such as issuance of 1099 forms, in the eyes of the IRS, nonreporting of virtual currency is noncompliance. Until there are changes in reporting requirements, IRS will search for taxpayers who don’t report virtual currency transactions by accessing and requesting information from the most prominent market players. On May 12, 2021, IRS sent a statement of work request to companies specializing in cryptocurrency transactions to identify and pursue cases where taxpayers fail to report their cryptocurrency. 

https://www.forbes.com/sites/irswatch/2020/05/29/got-cryptocurrency--get-ready-for-anirs-audit/?sh=40e5c7e11231 390









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Virtual currency transactions are a red flag on any tax return. Because of the increase in virtual currency trading volume, it is only going to receive more scrutiny. For example, in the Coinbase case, there were 6 million customers of the exchange, while less than 1,000 reported cryptocurrency transactions. The IRS knows that the gap between taxpayers who disclose all cryptocurrency transactions and what is being traded is massive. Therefore it is a perfect area to investigate.  Tax compliance for cryptocurrency is complex, especially if you are executing many trades across different exchanges. Companies are entering the market that will prepare IRS forms for taxes. CryptoTrader.Tax391 is a company specializing in summarizing and e-filing crypto gains and losses with tax returns. If you are involved with many cryptocurrency transactions, hiring a specialized service to comply with the tax law may be worth investment. J. ZERO OFFICER S ALARY

FOR AN

S-C ORP

Many small businesses organize as an S-Corp to avoid being treated as sole proprietors who need to file Schedule C and pay self-employment tax.392 Business income from Form 1120-S filing for an S-Corp flows to each shareholder’s tax return. It is often referred to as flow-through income because it is not taxed on 1120-S at the federal level but instead flows to Form 1040 and is taxed at the shareholder’s individual tax rate. 

391 392

https://cryptotrader.tax/ https://tri-merit.com/small-business-tax-audit-triggers/









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When an S-Corp is making money, IRS expects its shareholders who work as employees to be reasonably compensated on W-2 and pay all required social security and medicare taxes. If the compensation for an officer’s salary is zero or very low, that is an audit trigger.  The IRS compares the tax returns of the shareholders and employees of S-Corporations across and historically to check for consistency in salary payments. Per WCG Inc, a reasonable officer salary for an S-Corp shareholder and employee hovers around 50% of S-Corp income.393 If your officer salary payments are much lower as an S-Corp business owner, you may consider increasing them in the future to avoid receiving an examination letter.

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Trigger 4: Deductions A. V ERY LARGE ITEMIZED D EDUCTIONS The IRS compares the information that it has for taxpayers in similar tax brackets to identify ordinary expenses. The agency wants to identify tax returns with large deductions out of the norm for taxpayers with a certain income level.394  For example, a taxpayer that makes $50,000 and claims mortgage interest of $20,000 on Schedule A as an itemized deduction may look like someone who is not living within their means or indicate a fraud. The IRS will question how the taxpayer could receive such a large mortgage with that level of income.  If itemized deductions on Schedule A wipe out the taxpayer’s entire income, it raises a red flag. It is possible to have medical expenses one year out of the norm due to an accident or operation. However, large charity donations or substantial personal property taxes are bigger red flags. The taxpayers could have more income than earnings due to inheritance, savings, or job change. Nevertheless, in the eyes of the IRS, that is a less likely explanation than the taxpayers underreporting their income or over-inflating their expenses. The system identifies returns with substantial itemized deductions and can trigger an audit, especially if they are significant.

394

https://www.thebalance.com/top-audit-triggers-that-catch-irs-attention-4153034













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B. LARGE CHARITY D ONATIONS As discussed in the point above, the IRS has data on typical charity donations for each income bracket. Therefore if a taxpayer claims overly generous charitable contributions, it can be a red flag. The agency knows that people who make certain wages are not giving away most of their income. Up until the 2020 and 2021 tax filings, all charity donations went on Schedule A, when taxpayers itemized. For 2020, up to $300 per return could be deducted by taxpayers who didn’t itemize. For 2021, that amount changed to $300 per taxpayer so MFJ can deduct up to $600 on their tax return without itemizing.395 Taxpayers with larger charity contributions can only deduct them on Schedule A when they itemize and overly large ones can be red flags. Large property donations are even more closely scrutinized by the IRS. The issue is that it is up to the taxpayer to value some of the donated property, which can be subjective. Taxpayers aren’t aware that the IRS expects them not to value things like clothing, furniture, toys, etc., for more than 1% to 30% of the original purchase price.396  For property donations over $500, Form 8283397 must be attached with information on the donated property. For property donations that are above $5,000, an appraisal is required. If these forms are missing and the givings are not substantiated, that can be an audit trigger.

https://www.taxwarriors.com/blog/consolidated-appropriations-act-of-2021-individualprovisions 396 https://www.investopedia.com/articles/pf/07/avoid_audits.asp 397 https://www.irs.gov/taxtopics/tc506 395











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Ed’s Story Taxpayer Ed rushed in to get his taxes done. The only thing he was interested in was the bottom line - how much he would owe. He was 56 years old, married but came in alone. To file MFJ, both taxpayers have to be present, but many tax preparation places allow one spouse to come in for the initial appointment.  Most IRS VITA in-person tax sites are more strict and require both taxpayers to be present during the initial interview. On the other hand, taxpayers who use tax preparation software and file themselves online often have one spouse finalize the tax return. Both taxpayers' signatures are also required when filing online using DIY software, but the tax software cannot confirm that.  From the get-go, Ed wanted to itemize his tax return. He did own a home, but most of Ed’s mortgage was paid off, so he and his wife didn't have much mortgage interest deduction to claim. Ed kept asking about how much he owed before we were even halfway done. He suggested that he had charity donations and large out-of-pocket medical expenses. At first, Ed wanted to claim around $5,000 in charity donations and $10,000 in medical expenses. I asked for receipts or summary calculations for these amounts that he wanted to claim. He said he forgot to bring them. A standard deduction of $24,400 in 2019 was still better than itemizing for Ed and his wife.  So Ed said that the charity donations were ‘actually closer to $14,000, and I should use that.' However, he still didn't











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have any receipts or summary calculations to comply with due diligence on my part. I told Ed a second time that he needed receipts for the deductions, and the IRS could send him a letter requesting just that.  I would not sign the tax return in such a state but could put it on hold until Ed could provide documentation and bring his wife to the appointment to sign. However, Ed insisted on finalizing the return, so I asked my manager to talk to him. My manager agreed that we would need more documentation. Ed left unhappy, saying he would file it himself.  I don't doubt that Ed could file the tax return online and claim the cited numbers. I also don't doubt that Ed would receive a letter from Uncle Sam requesting receipts and support for the deductions claimed. The IRS has data on how much taxpayers in different tax brackets donate to charities. Ed’s return would trigger a red flag since he claimed to donate 30% of his gross income to charity. C. CLAIMING H OME OFFICE D EDUCTION If you are using part of your home exclusively and regularly for your trade or business, you are allowed to deduct some cost of that space on your tax return as a home office deduction. Sitting on your couch and answering few emails on your work laptop does not substantiate such a requirement. 











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Taxpayers that abuse the deduction by claiming overly large home office expenses have a greater chance of an audit. If you are an employee and receive a W-2 for a job, you can’t claim a home office deduction.398 There used to be an itemized unreimbursed job expenses deductible on Schedule A limited to 2% of AGI limit until the passing of TCJA in 2017 that eliminated the provision.  Even if you qualify for a home office deduction, you have to be aware that the number of expenses may be limited. You may not be able to take the deduction if you don’t make a profit during the year (although you can carry it forward). With the Covid-19 pandemic in 2020, many taxpayers found themselves working from home for the first time. Some taxpayers will try to take advantage of this deduction without carefully reviewing the requirements. The taxpayer can’t be a W-2 worker, and the home office space can’t be used for anything else but business. That means that a kitchen table or a living room won’t qualify as a home office space. Unfortunately, IRS knows that many taxpayers may not know that. Therefore some taxpayers may be surprised to receive a letter from the IRS asking for supporting information (TM 5A).

https://www.irs.gov/newsroom/heres-what-taxpayers-need-to-know-about-the-homeoffice-deduction 398







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If you do claim a home office deduction, there are two methods to calculate the deduction: The Simplified Method - involves multiplying the square foot of your home used for business, up to a maximum of 300 square feet, by $5 per square. The maximum deduction is $1,500. This is a more conservative method to use. The Regular Method - involves multiplying the percentage of your home used for business by all the indirect expenses, which includes mortgage, real estate taxes, utilities, etc. You can also deduct direct expenses in full, including costs that relate to the home office only. This is a more aggressive method to use and more likely to trigger an audit.







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Trigger 5: Claiming EITC Your overall chances of being audited are 1 in 166 (0.6%);399 however, certain items can dramatically increase the possibility of an audit. Per the IRS data, for the tax year 2017, the audit rate for taxpayers with Earned Income Tax Credit (EITC) was 1.2%, which is twice the rate as it is for everyone else.400  The National Research Program (NRP) estimated that almost 50% of EITC claims had errors related to improper child qualification or misreporting income. Just claiming EITC on the tax return automatically moves you to a higher audit rate. If you qualify and have all the supporting documentation, you should always claim the credit. About 5 million taxpayers each year are eligible for the credit and fail to claim it. It is important to realize that the credit may trigger an examination, but that should not stop taxpayers from claiming it when they qualify for it (TM 5C). EITC is a very valuable credit. For the tax year 2021, it ranges from $1,502 for a single taxpayer without children to $6,728 for taxpayers with 3 children or more. To prevent fraudulent filings and identity thefts for EITC and ACTC, under the PATH Act from 2015, IRS delays the processing of these credits to no earlier than February 15 each tax season. This gives extra time for the agency to review the legitimate claims and gives taxpayers more time to file their taxes before criminals claim the credit.

Depending which year you review it can be between 1 in 200 (2017) to 1 in 166 (2018) or less. https://www.nolo.com/legal-encyclopedia/what-are-the-odds-being-audited.html 400 https://www.irs.gov/newsroom/irs-update-on-audits 399











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There are a few scenarios that taxpayers that claim EITC and file Schedule C401 should be cautious with: • • • •

Filing Sch C without any expenses; Filing Sch C with only cash income; Filing Sch C with overstated or understated costs; Filing Sch C with expenses that have round numbers.

https://www.eitc.irs.gov/tax-preparer-toolkit/schedule-c-and-record-reconstructiontraining/eitc-schedule-c-and-record 401











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Trigger 6: Math Errors The error rate for paper returns is more than 20%, whereas it is around 1% for electronic filings. The IRS may fix some minor and straightforward math calculation errors; however, it can trigger a full-blown audit if the mistake leads to significant adjustments.  Simple blunders such as transposing a number, entering 3 instead of 8, can significantly impact tax liability. If there is a “substantial understatement” or “negligence,” the penalty is 20% of the net understatement of tax. There are additional penalties for more significant mistakes.  The best defense against math errors is using tax software with e-filing options. Tax software performs most of the calculations for taxpayers. It also flags typical errors and helps taxpayers find credits and deductions for which they may qualify.  When the tax return is sent to the IRS e-filing system, IRS computers check it for easy-to-fix mistakes, like math errors or incorrect SSNs. If the system finds a quickly identifiable error, it rejects the return (ER) and sends it back to taxpayers. The rejection code explains the error, and once it is corrected, the taxpayers can e-file it again. That can take a couple of days, and a fixed tax return is processed. Any errors on paper returns have much longer processing time and refund delays. It may take weeks and a couple of letters from the IRS to finalize the return. In simple terms, electronic filing is the way to go.












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Trigger 7: Business Related A. S CHEDULE C FILERS Taxpayers who file Schedule C are audited at higher rates than taxpayers who don’t. Schedule C filers with income close to $1million and who claimed EITC get a letter from Uncle Sam at higher rates. A tax return where the Schedule C maximizes EITC is most likely to trigger an audit.  IRS audits sole proprietors more than other business entities as there is less separation between business and personal income and expenses.  Several audit triggers that we already discussed fall as separate items on Schedule C. It is an all-encompassing form that can cause many red flags for different items, such as: • • • • • • • • •

hobby expenses (AT 7G),  lots of deductions (AT 4A),  day trading losses (AT 9B),  mixing personal and business expenses (AT 7B),  reporting only round numbers (AT 7C). overly lavish meal expenses (AT 7D),  claiming 100% business use of a vehicle (AT 7F),  unreported income (AT 3A),  multi-year business losses (AT 8A). 

Several areas of Schedule C can be red flag by themselves. Therefore, the IRS knows that by selecting it for review, there is a higher probability of identifying noncompliance and assessing additional tax. 































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Of course, many Schedule C filers don’t get audited. The only way to be in that group is by keeping meticulous records, separating business and personal expenses, and operating as a legitimate business. Any expenses deducted for business should be ordinary and necessary to the operation. Finally, showing a profit in 3 out of 5 years will make your Schedule C less likely to be selected for review. B. MIXING B USINESS

AND

P ERSONAL EXPENSES

As we previously discussed, Schedule C’s are audited more frequently than other tax returns because there is less of a separation between business and personal expenses. Any mixing between business and personal expenses is a red flag for the IRS.  Taxpayers are allowed to have assets that are used both for business and personal purposes. However, they have to keep meticulous records and perform reasonable calculations of how they allocate expenses between both. Taxpayers should always keep business finances separate from personal.  Don’t: • Use a business credit card for personal expenses; • Mix vacations with business trips, and if you do, make sure you keep clear records of days spend on each; • Label personal purchases (e.g., computers, furniture, household items, etc.) as business expenses. For any business expense that you deduct, keep a receipt and record of it. Items such as travel and meals need additional contemporary information on the business



















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purpose for the event. If most of your work is during the week and most meal expenses fall on the weekend, it could be hard to justify business purpose. If you put personal expenses on Schedule C, and the IRS reviews and disallows it during a correspondence examination, it can trigger an in-person audit. If the IRS realizes you mixed personal with business expenses at least once, they can assume you did it before and ask to review prior tax returns. Such an audit can lead to back taxes, interest, and penalties for false deductions.402  Additionally, remember that in 2017 the TCJA eliminated business-related entertainment deductions such as expenses related to sports, games, or concerts. Therefore if a taxpayer tries to claim such items on their tax return, it is an automatic red flag of personal deductions being claimed as business.403 C. ALL E XPENSES H AVE R OUND NUMBERS When was the last time you paid for something in a store exactly $10.00, $50.00, or $100.00? When it occurs, we are surprised as it is so rare. IRS knows that legitimate business expenses rarely have round numbers. When the agency sees all costs having exact round numbers such as $100, $300, $500, it looks too neat as if the taxpayer is trying very hard to have everything nicely add up.  Many new Schedule C gig-workers or newly self-employed don’t track their costs very well. Some don’t bring any calculations or summary of what they spent during the year https://www.taxdefensenetwork.com/blog/the-dangers-of-mixing-business-and-personalexpenses/ 403 https://www.irs.gov/newsroom/irs-issues-guidance-on-tax-cuts-and-jobs-act-changes-onbusiness-expense-deductions-for-meals-entertainment 402











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to tax appointment. Once asked about their expenses, they try to either make them up on the spot or adjust them as they see the bottom line. The only costs that the IRS will allow to deduct are ones with contemporaneous documentation.  Tax software rounds off cents to whole dollars, which is not the same as rounding amounts to the nearest hundred. One is a legitimate simplification, and the other is a dishonest practice. D. OVERLY LAVISH MEAL E XPENSES Taxpayers may continue to deduct 50% of the cost of business meals if they can show business purpose. However, business meals can’t be overly lavish. Steak dinners in five-star restaurants with drinks afterward will rarely be seen as an ordinary and necessary business expense.  The IRS uses information for different professions, such as standard deduction-to-income ratio and standard net profit margins, to determine which Schedule C has overly lavish deductions and expenses. For every business meal, IRS can ask for detailed records such as receipt, place, people attending, business purpose, nature of the discussion, or business conducted for each meal deduction. The agency knows that meal deductions are often overused and abused business expenses. Anytime they review it, it is likely that the taxpayer won’t have all the supporting documentation. IRS tries to gauge which audits will result in the most efficient use of their resources, so they try to audit those returns that will produce the most in back taxes, interest, and penalties. Overly lavish meal expenses are an excellent target for that.













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E. CLAIMING B OTH S TANDARD MILES & A CTUAL CAR E XPENSES When you use your vehicle for business, you can deduct the expenses on Schedule C. The IRS allows taxpayers to select between standard mileage rate or actual expenses method to calculate the costs. However, taxpayers can’t use both methods concurrently; otherwise, it can be an automatic audit trigger.  Each of the two methods has its advantages: Standard Miles - taxpayers have to track mileage used for business but don’t need to keep track of actual expenses. The total miles used for business are multiplied by the millage rate of 56 cents per mile (rate for 2021).  Actual Expenses - taxpayers have to track all the expenses and save receipts for each expense claimed. The taxpayers also have to track miles if the car is used for both business and personal use. The percentage of business use is applied to allocate the amount of expenses that can be deducted for depreciation, gasoline, insurance, repairs, etc.  Regardless of which method the taxpayers use to claim business car expenses, they must track mileage for business, personal, and commute purposes. The mileage percentage used for business is used to allocate actual expenses and multiply the standard mileage rate.













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Table 48. Car Vehicle Deduction Methods Actual (% for business) Depreciation Gasoline Insurance Lease payments Maintenance (oil, breaks, tire rotation) Repairs Title and registration fees Tires Washes Can’t switch to standard Need receipts & business % use based on miles

Both Parking Tolls

Standard Miles 2021 @ 56 cents per mile 2020 @ 57.5 cents per mile

Can switch to actual Need miles for business

When taxpayers complete Schedule C on their own, sometimes they feel that they have to complete all the expense categories listed, which is a red flag. Only parking and tolls can be deducted when taxpayers use either of the methods. No other expenses cross the methods, so you can’t deduct auto repairs if you use standard mile deduction. If you use the actual method, you can’t also deduct miles driven. Taxpayers should use the method that benefits them most if they have supporting documentation. However, not all taxpayers know that they can switch from the standard mile method to the actual but not the other way around.404 Therefore, if taxpayers claimed actual expenses in one year, they can’t switch to standard miles. That will trigger an IRS review.

https://www.hrblock.com/tax-center/filing/adjustments-and-deductions/mileagededuction-rules 404







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It is not always better to use the actual expenses. I have worked with many taxpayers that immediately think the actual method would be better for them. Sometimes it is, but especially when the business owner drove many miles for business and didn’t have many actual expenses, the standard mile method is more beneficial. Moreover, the benefit of the standard mile method is that no actual costs have to be tracked, and the taxpayer can switch to the actual method in the future.  Example 14. Vehicle Deduction Expense Depreciation Gasoline Insurance Maintenance (oil, breaks) Repairs Washes

Actual

Standard

(50% for business)

(2021 @$0.56 per mile)

$1,000 $750 $800 $200 $1,000 $100 $3,850

Miles Business 5,000 Personal 5,000 Total 10,000 Business Use 50% Standard Rate

$0.56 per mile

Total Deduction $1,925

$2,800

Parking $120 Tolls $40 $160

$120 $40 $160





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Audit Triggers

F. CLAIMING 100% B USINESS U SE

OF

V EHICLE

Taxpayers can deduct the use of a vehicle for business on their taxes and Schedule C. If you have a second car and the business vehicle is a truck or a van, the IRS can anticipate it primarily utilized for business. However, the IRS will not believe you used your vehicle 100% for business if you have a sedan and only one car. Especially if you have a family with kids, some personal use is expected. For any vehicle expenses, you need to keep track of your mileage. If you are using your vehicle for both business and personal purposes, you have to keep track of mileage used for: • • •

Business Personal Commute 

To keep track of your business vs. personal vs. commuting miles, taxpayers have to understand how to differentiate between them. IRS knows that many taxpayers incorrectly count commuting miles as business miles, so reviewing taxpayers' vehicle expenses can often result in additional tax. Reducing the percentage of business use to a more precise amount can reduce audit exposure.















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If you use your vehicle for business and commute, how do you know which miles count for business? For employees and self-employed people, the first trip from home to the first work location is considered a commute unless it is a temporary work location.405 One exception is for taxpayers who have an office at home. Their first trip counts for a business purpose also. 

Figure 16. Business Miles Rules (Source: IRS)

If you work in multiple locations or as a rideshare driver, you have to have good mileage and trip information that will support your deductions if requested by the IRS. Many phone applications on the market can help business owners keep an accurate record of miles used for work. Here is a list of the best mileage trackers in 2021.406 

405 406

Pub 463 page 12: https://www.irs.gov/pub/irs-pdf/p463.pdf https://bench.co/blog/operations/mileage-trackers/

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Audit Triggers

G. CLAIMING H OBBY

AS

B USINESS

Very few businesses can become successful overnight, and if you are starting, it can take a couple of years before you can make a profit. However, some taxpayers try to disguise their hobby as a business and deduct expenses on Schedule C. This is a common tax mistake that taxpayers make (TM 8G) and a big red flag for the IRS.  If you have not made a profit in at least 3 out of 5 years, the IRS can question whether your venture is truly a business. The agency developed 9 factors407 that help determine whether a business should be identified as a hobby.  If you are not carrying out the activity in a businesslike manner, have a profit motive, and put an honest effort into making it successful, IRS will determine that your business is a hobby. You won’t be able to deduct any of your expenses on Schedule C. The income, though, will still need to be reported on the tax return.  For some taxpayers, they may start with a hobby that turns into business. Even if the activity is not yet a business, any income it generates must be included on the tax return. The IRS can audit the return if the taxpayer receives 1099 forms with earnings from the activity and fails to include them when filing.

https://www.irs.gov/faqs/small-business-self-employed-other-business/income-expenses/ income-expenses 407











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Trigger 8: Reporting Losses A. NET OPERATING LOSSES (NOL S ) Taxpayers start businesses to make money and sustain their livelihood. It is common for a startup to lose money in the first or two years of operations. However, if a business, especially Schedule C sole proprietors, continuously loses money, the IRS will want to take a closer look.  If a business losses money 3 out of 5 years, it is a likely audit trigger. As discussed in AT 7G, the IRS will investigate if a venture is truly a business or, more likely, a hobby. The question the agency will want to answer is why is the business not making a profit? • Do you carry on the activity in a business-like manner? • Do you maintain accurate books and records? • Do you know what you are doing? • What are your motives for starting this business? • Do you depend on the income to support yourself and your family? • Do you expect to make a profit soon? • What are the variables that affect and cause your business to lose money each year? If the IRS reviews your business financials and notices that the reason why your business is making net operating losses (NOLs) is that you are taking too many deductions to avoid paying taxes.408 In that case, the deductions will be disallowed. 

408

https://tri-merit.com/small-business-tax-audit-triggers/

























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If most comparable businesses in your industry409 operate with a profit, then it can indicate underreporting of income, improper deductions, or both. If other ventures like yours take a 10% deduction for travel while you take 30%, the IRS will want to see contemporaneous receipts and support for travel purposes.  Schedule C businesses have higher audit rates than other business structures overall. That is even before you take into consideration NOLs. Schedule C ventures with NOLs are even more serious red flags. For the first couple of years, you may want to keep things simple and stay as a sole proprietor. However, there is less separation between personal and business transactions, and more likely that the IRS may want to examine your operations. After a couple of years as a sole proprietor, you should talk to a tax specialist and consider other business structures410 that may not only protect you from liability but also reduce your audit exposure. B. GAMBLING LOSSES Gambling winnings are considered taxable income on both federal and state income taxes (Table 47). Most wellestablished gambling venues will issue you Form W2-G411 detailing your winnings, withholdings and date of the win. If you don’t receive Form W2-G, you can directly report it on Form 1040 Schedule 1 as “other income.”

https://proconnect.intuit.com/articles/principal-business-activity-codes/ https://www.irs.gov/businesses/small-businesses-self-employed/business-structures 411 https://www.irs.gov/pub/irs-prior/fw2g--2021.pdf 409 410











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To offset your winnings, you can subtract your losses up to your winnings only if you itemize your deductions on Schedule A, which only 14% of taxpayers do post TCJA tax law change.412  The only way taxpayers can deduct their losses is to keep accurate records in a logbook or phone application. The information should include:413 The date and type of wager; The name and location of the gambling establishment; • The names of other people present with you at the gambling venue; • The amount(s) you won or lost. • •

The IRS knows that very few taxpayers keep good records of their losses. If the agency selects a tax return to examine gambling losses, it will likely lead to additional tax assessment because of a lack of documentation. Some taxpayers gamble and do keep good records. I worked with a couple that liked to gamble at a nearby casino regularly and kept a journal of all their gambling wagers. They had ample supporting information to deduct their losses on Schedule A.  There are numerous applications for taxpayers to assist them in keeping good gambling records. However, the apps seem to specialize in the type of betting taxpayers do (e.g., sports betting, casino, etc.); thus you should search for one that suits your gambling activity.

412 413

https://taxfoundation.org/standard-deduction-itemized-deductions-current-law-2019/ https://paladinilaw.com/irs-gambling-losses-audit/

















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Audit Triggers

Another gambling tax issue is that some taxpayers deduct the losses from their winning and only put net winning as other income on Form 1040. If Form W2-G has been issued with $5,000 winnings, but the taxpayer only claims $3,000 on Form 1040 because he/she lost $2,000 in the process, the IRS will want to examine the tax return. The IRS receives a copy of form W2-G, and thus they can verify that it should be $5,000 in winnings and not a net gambling income of $2,000. Finally, taxpayers have to understand that if their losses are more than their winnings, they can only deduct on Schedule A up to the amount of their winnings, and only if they have good records. If you won $5,000 at a casino but lost $7,000, if you itemize, you can only deduct $5,000. The other $2,000 is your personal loss that you won’t be able to carry forward. If you use the standard deduction, none of the $7,000 can be deducted. Example 15. Gambling Losses Deductions Gambling Income $5,000 Gambling Losses $7,000 If you take standard deduction Gambling Income $5,000 You can’t deduct gambling losses $0 If you use itemized deduction Gambling Income $5,000 Gambling losses are limited to your $5,000 gambling winnings Can't deduct & can't carry forward ($2,000)





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C. R ENTAL LOSSES According to the Government Accountability Office, 53% of taxpayers with rental real estate make inaccurate claims when filing their tax returns.414 Many rental losses are overestimated and can trigger an audit.  The challenge with rental properties is that even if properties show a loss for tax purposes, they could be making money. The loss, especially in the first years, is mainly caused by the deductibility of depreciation and other investment expenses. That is why high-income taxpayers often use rentals to offset their taxable income. The rules on deducting rental losses and carrying them forward are complicated and easily misinterpreted, giving the IRS an easy target to examine (TM 8H). Additionally, rental activity is subject to passive activity loss rules, which means that the amount of loss that can be deducted depends on the nature of the rental activity.  For example, suppose you actively participate in the management of your rental properties by actively managing all operations, screening tenants, managing the property, etc. In that case, you can be classified as an active participant and deduct up to $25,000 of losses per year if your MAGI is less than $100,000.  Sometimes taxpayers don’t understand the repercussion of selecting the active participation option for their rental activities. They see the benefit of deducting the loss but are not aware of the documentation requirements, which is a perfect situation to audit by the IRS. https://wealthpilgrim.com/rental-real-estate-tax-loss-how-to-avoid-an-irs-audit/











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Audit Triggers

In most cases, a rental loss is considered passive, which can only be deducted against other passive income. It can’t be deducted against ordinary or capital gains income. Additionally, If you use the rental property more than 14 days in a year or 10% of the days rented out, then the amount of deductions you can take is limited.415 This is not always welltracked by taxpayers. Lastly, if you are considered a real estate professional, the rental activity loss rules don’t apply as your rental activity is your business. In that case, you can deduct the entire rental loss in the current year. To qualify, you have to spend at least 751 hours working in real estate and actively participate in all your rental properties. Not many taxpayers can substantiate all that information to the IRS. The rental business rules can be complicated; therefore, it is essential to seek the advice of a reliable tax professional before you claim significant rental losses on your tax return. They may not be worth the exposure and audit trouble.  One seldom-known IRS rule is that if you rent your dwelling for fewer than 15 days, that income is not taxable. You can’t deduct the expenses, but you can keep the income taxfree.416

https://www.fool.com/millionacres/taxes/real-estate-tax-deductions/passive-activity-lossrules-what-real-estate-investors-need-know/ 416 https://www.irs.gov/taxtopics/tc415 415









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D. BAD D EBT LOSSES

AND

CANCELLATION

OF

D EBT

Generally, business debts are easier to deduct as long as they intimately relate to your business. However, for personal debts, the criteria is rigorous. Only totally worthless personal debts can be deducted under very stringent circumstances, which are challenging to document.417 Taxpayers can report nonbusiness bad debts on Form 8949.418  Reporting nonbusiness bad debts involves describing the debt, amount(s), dates, name of the debtor, description of a relationship between the parties, description of efforts taken to receive repayment, and the process of determining when the debt became worthless.  Because of the complexity of the matter, each of these items can be challenged and rejected by the IRS. Deducting personal debt is a fast way to receive a request for an examination by the IRS. Another matter that can trigger an audit is not reporting 1099-C, cancellation of debt as income. Taxpayers don’t realize that most cancellations of debt is taxable (Table 47). The discharged credit card debt that you received from your bank is considered taxable income. 

https://www.irs.gov/taxtopics/tc453 https://www.irs.gov/pub/irs-pdf/f8949.pdf







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418



417

Audit Triggers

Taxpayers have trouble understanding that debt that was forgiven because they could not pay is taxable. It doesn’t help is that the IRS treats different debts differently.  For example, debt canceled under Chapter 11 bankruptcy doesn’t have to be reported as income if the taxpayer was insolvent (unable to pay all debts owed). The IRS Publication 4681 specifies which obligations can be excluded from income.419 Taxpayers would have to show on Form 982420 how he/she made that determination. Writing off personal or business debts should be approached with extra caution as the audit exposure for these matters is high.

pg 4-5: https://www.irs.gov/pub/irs-pdf/p4681.pdf https://www.irs.gov/forms-pubs/about-form-982

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420




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Trigger 9: Misclassifications A. I MPROPER P AY

FOR

H OUSEHOLD H ELP

Only about 5% of Americans who employ domestic workers complete all the required paperwork and comply with the tax law.421 A big part for this significant non-compliance is the complexity of the IRS regulations and the considerable burden on the employer. As discussed in TM 9F, domestic workers are considered your employees because of the behavioral and financial nature of the relationship and control over the job performance. If you pay any of your household employees more than $2,300 for the tax year 2021, then you should withhold income, social security, medicare, and federal unemployment taxes from their pay.  In addition, you are obligated to have your employees fill out Form W-4 so you can issue them Form W-2 and file Schedule H with your taxes.422 We are not even discussing the fact that you should also:  • pay them overtime if they worked more than 40 hours in a week; • and ask them to fill out Form I-9 to check if they can legally work in the US.

https://www.wsj.com/articles/youre-not-the-only-one-whos-not-paying-your-nannytax-1539336600 422 https://www.thebalance.com/preparing-to-pay-the-nanny-tax-3544887 421















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Audit Triggers

If the IRS discovers that you employed domestic workers and paid them under the table, there are many noncompliance areas they can find to examine. It is like a goldmine for the agency because they know that 95% of taxpayers fail to comply with this IRS regulation correctly.  Domestic help non-compliance can usually come to light after the employer’s and the worker’s relationship goes sour. Sometimes it can be caused by a work injury or firing. When the employee files for unemployment or worker’s compensation, the respective agency can investigate how the worker was paid. Another big no-no is when taxpayers pay their household employees through their businesses.423 Since the household work is not related to the business and does not contribute to the business operations, it is an audit trigger. If your business operates in web design, any expenses related to landscaping will be a red flag. The IRS could close the compliance gap if it passed rules that average households could follow. One option for taxpayers is to hire a Nanny Payroll Service424 to take care of most of the compliance matters for the taxpayers. It is an excellent alternative to avoiding an audit that would likely lead to back taxes, interest, and penalties and can even lead to tax fraud charges.

https://www.fedortax.com/blog/household-help-tips-to-avoid-employment-tax-disputes 10 Best Nanny Payroll Services for 2021: https://www.business.org/finance/accounting/ best-nanny-payroll-service/ 423 424









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B. DAY TRADER MISCLASSIFICATION Claiming trader status has several advantages that average investors don’t get. Traders can deduct operating expenses and losses beyond the $3,000 limit against ordinary income for investors. However, by default, the IRS classifies all taxpayers as investors first. Only taxpayers that can pass stringent criteria and show that their activities are frequent and continuous can be classified as traders.  Unfortunately, many taxpayers who select the trader classification don’t come close to the recommendations based on tax court cases and IRS guidelines (see Table 38).425 If you trade less than 720 trades per year for fewer than 4 days a week and hold securities for longer than 31 days, you are an investor and can’t deduct any of your expenses on Schedule C.  Notably, with the growth of technology, trading platforms, low-commission trading, starting with 2020 during the Covid-19 pandemic, trading by average taxpayers skyrocket. For example, the Robinhood stock trading and investing application grew its user base to 18 million in 2021 from 10 million in 2019.426 Most of these users average 31 years of age with $3,500 account value. Unfortunately, few taxpayers understand their activity’s compliance and tax consequences (TM 8J), leading to incorrectly selecting the day trader status and triggering an audit.

https://www.forbes.com/sites/greatspeculations/2019/10/01/how-traders-get-enormoustax-deductions-and-investors-do-not/?sh=8a4c6bb48ab0 426 https://www.businessofapps.com/data/robinhood-statistics/ 425











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Note: Activity established to create opportunities for average taxpayers and investors is a plus in my book. But as with everything else, there are risks that some new investors may not be aware of. Unless companies are marked as nonprofits, all entities are in the business of making money and create incentives to make large gains for themselves. If you are a small investor trading on a margin with cash advancement, be especially careful.427 Many taxpayers can accumulate very large debts, lose all their money and even life. It is important to address this especially if you hear the story of a young University of Nebraska Robinhood investor, Alex Kearns,428 who committed suicide when he thought he lost over $700,000.429 If you find yourself in any kind of large debt, talk to someone. Call 1-800-273-8255 National Suicide Prevention Lifeline or text to 741741 with a HELLO.430

https://www.nytimes.com/2020/07/08/technology/robinhood-risky-trading.html https://www.npr.org/transcripts/895054084 429 https://www.cbsnews.com/news/alex-kearns-robinhood-trader-suicide-wrongful-deathsuit 430 https://suicidepreventionlifeline.org/ 427 428





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Trigger 10: Informant Complaint The majority of audit triggers are identified by the Discriminant Inventory Function System (DIF), which scans every tax return to detect anomalies, irregularities, and inconsistencies. Tax returns can also be randomly selected for an examination.  Finally, a tax audit can also be triggered manually by a whistleblower and a third-party complaint. An angry spouse, relative, co-worker, former employee, or even a neighbor can file Form 3949A and report fraudulent activity such as: False exemptions or deductions Kickbacks A forged or altered document Failure to pay tax Unreported income Organized crime Failure to withhold Failure to follow the tax laws

• • • • • • • •

The IRS informant program has an award system for information about tax fraud, which can be 15% to 30% of the amount collected on $2 million disputes. No small change. I wonder if that is taxable. ◕‿↼ 

























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Audit Triggers

Most tax fraud complaints have little merit and are made by disgruntled relatives or employees. However, 1 in 20 provides evidence of wrongdoing that the IRS can validate and pursue. In 2018, 61,890 people filed the whistleblower compliant Form 3949A to report tax fraud.431 That is an audit trigger you want to avoid. On the other side, taxpayers are not without power and can report fraud, waste and abuse committed by the IRS by reporting it to the Treasury Inspector General for Tax Administration (TIGTA).432 TIGTA was established in 1999 to provide independent oversight of the IRS activities.

https://www.irsmind.com/audits/can-someone-turn-me-in-to-the-irs/ https://www.treasury.gov/tigta/contact_report.shtml

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Boost Your Tax IQ

Key Takeaways • The tax penalty for not filing your taxes is higher than for not paying, so make sure you file even if you can’t pay. • Filing your taxes starts the statute of the limitation period.  • Intentionally not filing tax returns or deliberately not paying taxes is considered tax evasion.  • The IRS can recreate substitutes for returns (SFRs) based on forms from employers and other institutions. • Tax returns with consistent year-to-year dependent claims are less likely to be examined. • You can’t file Head of Household (HOH) if you are married and have lived with your spouse in the past 6 months of the year. • All cash income is reportable and taxable, according to the IRS. • Child support income is not taxable. • Alimony income for court orders before 12/31/2018 is taxable to the recipient and deductible to the payer. Alimony income for court orders after that date is no longer reportable on the tax returns. • Most canceled debts reported on 1099-C are taxable unless discharged due to bankruptcy. • Unemployment income is taxable (except the first $10,200 per filer in the tax year 2020). • Social security benefits can be taxable up to 85%. • If you don’t take your Required Minimum Distribution (RMD) from your retirement plans by 72, you will face a 50% penalty of the amount not withdrawn.





























395

Audit Triggers

• You don’t have to take RMD from a Roth IRA if you are the original owner. • Cash-heavy businesses such as restaurants or beauty salons are more likely to be examined. • Taxpayers with fluctuating income can be red-flagged by the IRS. • The tax return can be flagged if tax deductions seem out of the norm from other taxpayers in similar situations. • Taxpayers earning more than $1 million a year are audited the most. • Under FATCA, the IRS receives foreign account information from foreign jurisdictions. If you have more than $10,000 in a foreign account, you need to file an FBAR. • The IRS treats virtual currency as property and requires reporting of sale transactions. • A zero-dollar officer salary at a pass-through entity such as an S-Corp or partnership is a red flag. • Underreporting income or over-inflating expenses out of the norms for similar taxpayers can trigger an audit. • The IRS has a database of typical charity donations by each income bracket. Don’t claim you gave away 90% of your gross income unless you are Mother Theresa. • If you are an employee and receive a Form W-2 for a job, you can’t claim a home office deduction. • Almost 50% of EITC claims have errors, which increase the likelihood of an IRS examination. • 20% of paper returns have math and clerical errors compared to 1% on electronic filings.



























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Boost Your Tax IQ

• Self-employed taxpayers filing Schedule C and maximizing EITC are more likely to be audited. • For business expenses to be deductible, they have to be ordinary and necessary. • Keep good contemporaneous business records for the tax year in one envelope or a folder. • Estimated expenses with round numbers are a red flag. • Overly lavish meal expenses not typical for your industry are a red flag. • You can either claim standard miles or actual expenses for your vehicle, not both. However, both require business mileage information. • If you only have one compact vehicle, don’t claim it 100% for business and maintain that you never use it to go grocery shopping. • Commuting miles are not considered business miles. • If you didn’t profit at least 3 out of 5 years from your business, the IRS might see it as a hobby. • Consistent Net Operating Losses (NOLs) are red flags for any activity and may require additional substantiation. • Gambling winnings are considered taxable income. You can’t deduct gambling losses/expenses unless you itemize on Schedule A and only up to your winnings. • 53% of taxpayers with rental real estate make mistakes and are an easy target for examination. • You can only deduct more than $25,000 of real estate losses if you are a real estate professional and treat this activity as a business.



























397

Audit Triggers

• If you rent your dwelling for fewer than 15 days, that income is not taxable, but you can’t deduct any expenses either. • Personal debts can only be deducted if they are totally worthless under very stringent circumstances, so don’t try it unless you have an experienced professional working with you. • Domestic workers are considered employees, but only 5% of taxpayers who employ them complete all the required paperwork.  • Proper domestic worker paperwork requires issuing Form W-2s, medicare and social security withholdings, and filling Schedule H. Many third-party companies specialize in Nanny Payroll Services. • Your monthly or weekly trading on Robinhood doesn’t make you a trader. The IRS classifies most taxpayers as investors. Unless you trade more than 720 trades per year, 4 days a week, and don’t hold securities longer than 31 days, don’t mark that you are a trader on your tax return.  • A tax audit can be triggered manually by a whistleblower or a third-party complaint. The IRS has a reward system for the neighbors or co-workers who saw you drive up in a Bentley from a vacation in the Bahamas on a $25,000 salary.














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PART IV: RESOURCES

P

reparing taxes is an activity that requires many resources and references. In the process of writing this book, I must have referenced the IRS website a thousand times, if not more. I have done most of the work for you, and in this section, I share things that will make the tax preparation process easier for you.  The tax calendar summarizes the most relevant tax dates for individuals and businesses.  The legislative tax changes section lists the most significant tax laws in the past 50x years and the main adjustments made with each. It is interesting to discover when certain tax rules were enacted.







399





Resources

Mistakes, Rejections & Audit Triggers

Resources

The useful websites section lists places and organizations where you can learn more about taxes, share your voice and get help. In addition, this segment has a table with a list of secondary resources for additional tax help, based on how easy they are to understand (Table 50).  The software and tax preparation companies list will be added in the next version of this book. On the www.boostyourtaxiq.com website, I will post videos and reviews of big brand tax software.  Before starting the tax preparation process, you need to start with a good tax preparation checklist to make sure you don’t miss any documents and supporting information for deductions and credits. You can get a pdf version if you go to the www.boostyourtaxiq.com website and sign-up for the newsletter. Finally, in the sample forms section, you will find anatomy of most IRS tax forms. Each form contains detailed information on what is included in each box and what needs to be reported. These visual summaries of the forms will help you understand them better.









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TAX CALENDAR

Table 49. Federal Tax Due Dates Date 1/15/22 1/31/22 3/15/22

Type of Filer Individuals Issuers S Corp Partnerships

4/15/22

Individuals Individuals Corporations

4/30/22

Employers

6/15/22 9/15/22

Individuals Individuals S Corp Partnerships

10/15/22

Individuals Corporations

1/15/23

Individuals

Detail Pay 4th Q est. tax for 2021 on 1040-ES. Furnish Forms W-2 & 1099 to recipients. File Form 1120S & furnish copy of Sch K-1 to shareholders. File Form 7004 for extension. File Form 1065 & furnish copy of Sch K-1 to shareholders. File Form 7004 for extension. File Form 1040 or 1040SR or Form 4868 for extension. Pay 1st Q est. tax for 2022 on 1040-ES. File Form 1120 for calendar year or le Form 7004 for extension. Pay 1st Q federal payroll taxes for your employees on Form 941. Pay 2nd Q est. tax for 2022 on 1040-ES. Pay 3rd Q est. tax for 2022 on 1040-ES. File Form 1120S if you requested 6-mo extension. File Form 1065 if you requested 6-mo extension. File Form 1040 or 1040SR if you requested 6-mo extension. File Form 1120 if you requested 6-mo extension. Pay 4th Q est. tax for 2022 on 1040-ES.

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TAX B RACKETS

FOR

2021

Single (S) Rate

Income Bracket

Tax owed

10%

$0 to $9,950

10% of taxable income

12%

$9,951 to $40,525

$995 + (12% over $9,950)

22%

$40,526 to $86,375

$4,664 + (22% over $40,525)

24%

$86,376 to $164,925

$14,751 + (24% over $86,375)

32%

$164,926 to $209,425

$33,603 + (32% over $164,925)

35%

$209,426 to $523,600

$47,843 + (35% over $209,425)

37%

$523,601 or more

$157,804.25 + (37% over $523,600)

Married Filing Jointly (MFJ) or Qualifying Widow(er) Rate

Income Bracket

Tax owed

10%

$0 to $19,900

10% of taxable income

12%

$19,901 to $81,050

$1,990 + (12% over $19,900)

22%

$81,051 to $172,750

$9,328 + (22% over $81,050)

24%

$172,751 to $329,850

$29,502 + (24% over $172,750)

32%

$329,851 to $418,850

$67,206 + (32% over $329,850)

35%

$418,851 to $628,300

$95,686 + (35% over $418,850)

37%

$628,301 or more

$168,993.50 + (37% over $628,300)



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Mistakes, Rejections & Audit Triggers

Head of Household (HOH) Rate

Income Bracket

Tax owed

10%

$0 to $14,200

10% of taxable income

12%

$14,201 to $54,200

$1,420 + (12% over $14,200)

22%

$54,201 to $86,350

$6,220 + (22% over $54,200)

24%

$86,351 to $164,900

$13,293 + (24% over $86,350)

32%

$164,901 to $209,400

$32,145 + (32% over $164,900)

35%

$209,401 to $523,600

$46,385 + (35% over $209,400)

37%

$523,601 or more

$156,355 + (37% over $523,600)

Married Filing Separately (MFS) Rate

Income Bracket

Tax owed

10%

$0 to $9,950

10% of taxable income

12%

$9,951 to $40,525

$995 + (12% over $9,950)

22%

$40,526 to $86,375

$4,664 + (22% over $40,525)

24%

$86,376 to $164,925

$14,751 + (24% over $86,375)

32%

$164,926 to $209,425

$33,603 + (32% over $164,925)

35%

$209,426 to $314,150

$47,843 + (35% over $209,425)

37%

$314,151 or more

$84,496.75 + (37% over $314,150)

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Resources

LEGISLATIVE TAX CHANGES 433 Year

Acronym

2021

ARPA

2021

CAA

Main Changes

De nition American Rescue Plan Act of 2021

Consolidated Appropriations Act of 2021

• • • • • • • • • • • • • • •

2020

CARES

2020

FFCRA

2019

433

SECURE

Coronavirus Aid, Relief and Economic Security Act of 2020 Families First Coronavirus Response Act of 2020 Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019

https://en.wikipedia.org/











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• • • •

• • • •

expanded unemployment bene ts; stimulus payments to individuals; emergency paid leave; extended food stamp bene ts; expanded child tax credit; funding for housing; grants to small businesses; PPP loans for small employers; stimulus payments to individuals; expanded unemployment; halting evictions; school assistance; higher education deductions & exclusions; medical expenses deduction threshold made permanent; charitable contribution deduction without itemizing is increased; stimulus payments to individuals; expanded unemployment bene ts; provided student grants; suspended required minimum distributions; waived 10% early distribution penalty from IRAs; eviction protection. emergency paid sick & family medical leave pay; Covid-19 testing coverage; expansion of unemployment bene ts; supplemental appropriations to different US Departments; retirement plans overhaul; raising the minimum age for RMDs from 70.5 to 72; contributions to traditional IRAs until 70.5 use 529 plans money to pay student loans;

Year

Acronym

Main Changes

De nition

TCJA

Tax Cuts and Jobs Act of 2017

2015

PATH

Protecting Americans from Tax Hikes Act of 2015

2012

ATRA

American Taxpayer Relief Act of 2012

2010

ACA

Affordable Care Act of 2010

2017

2009

ARRA

American Recovery and Reinvestment Act of 2009

















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Mistakes, Rejections & Audit Triggers

• lowering tax brackets and increasing the standard deductions; • eliminating personal exemptions; • doubled child tax credit; • deduction for state and local taxes capped ; • alimony no longer deductible; • elimination of miscellaneous itemized deductions; • increased ATM exemptions; • at corporate tax rate of 21%; • protection against fraud by delaying refunds for AOTC & EITC until after Feb 15; • extended some deductions such as tuition deduction & charitable contributions; • renewal of ITIN numbers if not used in 3 prior years is required; • tax deduction and credit phase-outs; • increase in estate tax; changed ATM; • extension of EITC; • estate taxes set at 40% for $5 mil in value; • AMT indexed by in ation; • top marginal rate on dividends increased to 20%; • extension of corporate breaks; • US healthcare system's regulatory overhaul & expansion of coverage; • expansion of Medicaid eligibility; • insurance mandates for all tax ling taxpayers or pay a penalty; • disallowed rates based on preexisting conditions; • essential health bene ts are required; • four tiers of coverage established: bronze, silver, gold & platinum; • stimulus payments to individuals; • investments into infrastructure & healthcare; • education grants & aid; • spending for homeland security & law enforcement; • expanded EITC & CTC; • enacted Homebuyer credit & American Opportunity Tax Credit (AOTC) • Bonus depreciation; • unemployment bene ts up to $2,400 not taxable for 2009;

Resources

Year

Acronym

2008

2008

HERA

2003

JGTRRA

2001

EGTRRA

1998

Main Changes

De nition Economic Stimulus Act of 2008 The Housing and Economic Recovery Act of 2008 Jobs and Growth Tax Relief Reconciliation Act of 2003

Internal Revenue Service Restructuring and Reform Act of 1998

• exclusion from income of gain on the sale of principal residence ($250,000 for individual); • student loan deduction introduced; • taxpayers without TIN can't claim EITC; • Taxpayer Bill of Rights III passed;

Taxpayer Relief Act of 1997

1986

Tax Reform Act

















• increased ATM exemption amounts; • lowered taxes of income from dividends & capital gains;

Economic Growth and Tax Relief Reconciliation Act of 2001

1997















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• tax relief on forgiven mortgage debt due to foreclosure; • Increased the FHA loan limit from 95 percent to 110 percent of area median home price;

• lowered federal income tax rates - top rate from 39.6% to 35%; • reduced capital gain tax rates from 10% to 8% for taxpayers in 15% income tax bracket; • raised pre-tax contribution limits to IRAs; • removed limit on student loan deduction; • eliminated the estate tax; • tax rebates of $300 for single to $600 for MFJ;

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• stimulus payments to individuals of $300 per person & child;

• top capital gain tax rate fell from 28% to 20% with phase-in rules; • lowest capital gain tax rate dropped from 15% to 10%; • Roth IRA were established; • $400 child tax credit for children under 17; • estate tax exemption increased to $1mil; • Lifetime Learning Credits established; • Hope Scholarship Credit created; • lowered tax rates, • adopted sweeping expansions of international rules, • eliminated the lower individual tax rate for capital gains, • added signi cant inventory accounting rules,

Mistakes, Rejections & Audit Triggers

U SEFUL WEBSITES / P UBLICATIONS / ORGANIZATIONS United States Tax Court website, for Tax cases: https:// www.ustaxcourt.gov/ United States Tax Code - Title 26. Internal Revenue Code, tax code for individuals and businesses: https:// www.law.cornell.edu/uscode/text/26 Treasury Inspector General for Tax Administration, an agency overseeing IRS operations: https://www.treasury.gov/ tigta/oa_auditreports_fy21.shtml Oversight.Gov, all federal inspector general reports in one place: https://www.oversight.gov/investigative-press-releases Internal Revenue Service Advisory Council (IRSAC), public meeting about the improvement of IRS operations and improvement for taxpayer services: https://www.irs.gov/taxprofessionals/internal-revenue-service-advisory-council-irsac Taxpayer Advocate Panel, send your suggestions how you would like to improve the IRS or volunteer as a member: https://www.improveirs.org/ Tax Advocate Service, assists taxpayers in resolving matters with the IRS and providing clear information on all tax matters: https://www.taxpayeradvocate.irs.gov/ IRS Advisory Committees, lists and links to websites: https:// www.irs.gov/tax-professionals/irs-advisory-committeesgeneral-information



















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Resources

The Office of the Federal Register (OFR), provides archival since 1994 of all the US government agencies publications and regulatory changes: https://www.federalregister.gov/ Tax Justice Now, helps people understand and participate in the tax debate and to see how each income group pays in taxes: https://taxjusticenow.org/#/ The Joint Committee on Taxation of US Congress, nonpartisan committee with experienced professional economists, attorneys, and accountants to assist Congress on tax legislation and publish papers: https://www.jct.gov/ The Board of Governors of the Federal Reserve System, data on consumer and taxpayer finances: https:// www.federalreserve.gov/data.htm Washington Center for Equitable Growth, non-profit research organization dedicated to advance equity across people: https://equitablegrowth.org/ PolitiFact, is a fact-checking nonpartisan group of journalists that rates information on a spectrum of six from true, half-true to false: https://www.politifact.com/ Tracker of US Economy including US Federal Debt, Social Security and Medicare Size, Mortgage loans, Home Sales, Auto Sales, Tax Revenue, State Revenue, etc., statistics as a running clock: https://usdebtclock.org/index.html IRS Website: https://www.irs.gov/

















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Mistakes, Rejections & Audit Triggers

IRS Contact Phone Numbers: https://www.irs.gov/help/ telephone-assistance • For Individuals: 1-800-829-1040 • For Businesses: 1-800-829-4933 • Non-Profit Taxes: 1-877-829-5500 • In-person local appointments: https://www.irs.gov/help/ contact-your-local-irs-office • Set-up IRS account online to access your payments, tax information, EIP payments statuses, address info, etc.: https://www.irs.gov/payments/view-your-tax-account Tax Justice Network, discloses, informs and works to repair the unjust tax system that benefits corporate giants and the super-rich: https://www.taxjustice.net/ Inequality.org, has been tracking inequality-related news and views around the world. A project of the Institute for Policy Studies since 2011: https://inequality.org/about/ Investor.gov by US Securities and Exchange Commission Office of Investor Education and Advocacy, to help taxpayers and investors make sound investment decisions and avoid fraud. It has number of financial calculators such as RMD calculator, college savings calculator, Social Security Retirement estimator, etc. Center on Budget and Policy Priorities is a nonpartisan research and policy institute that works to reduce inequality and poverty by reviewing different government programs and policies: https://www.cbpp.org/





















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Resources

Congressional Budget Office is a nonpartisan analysis for the US Congress, producing independent analyses of budgetary and economic issues: https://www.cbo.gov/ about/overview Opportunity Insights is a team of researchers and policy analysts at Harvard University, that identify barriers to economic opportunity and develop solutions for people to rise out of poverty: https://opportunityinsights.org/ U.S. Government Accountability Office is a provides Congress and the public with timely, fact-based, non-partisan information to improve performance of government and save taxpayers money: https://www.gao.gov/ National Taxpayers Union Foundation is a non-partisan research and educational organization that shows taxpayers how taxes, government spending and regulations affect them: https://www.ntu.org/foundation









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Table 50 below contains a list of tax resources,434 how helpful they are to taxpayers, whether their information is written in plain language and whether they are free from affiliations that try to sell you something. Table 50. Reliable Tax Sources Source The Balance Credit Karma Nerd Wallet Taxpayer Advocate Service (TAS) Tax Foundation Journal of Accountancy Tax Policy Center IRS

Plain Language 4.5 4

Helpfulness 4.5 4

Af liation Free Some

4

3.5

Some

4

3

Free

3.5

4.5

Free

3

4

Free

2.5

3.5

Free

2

4

Free

URL Addresses: 1) The Balance: https://www.thebalance.com/taxes-4073970; 2) Credit Karma: https://www.creditkarma.com/tax/i; 3) Nerd Wallet: https://www.nerdwallet.com/ hub/category/taxes; 4) TAS: https://www.taxpayeradvocate.irs.gov/taxpayer-resources/; 5) Tax Foundation: https://taxfoundation.org/; 6) Journal of Accountancy: https:// www.journalofaccountancy.com/topics/tax/individual-income-taxation.html; 7) Tax Policy Center: https://www.taxpolicycenter.org/taxvox; 8) IRS: https://www.irs.gov/individuals; 434



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Resources

TAX P REPARATION CHECKLIST

PERSONAL INFO

Names, birth dates, SS and/or TIN numbers

IRS security Identity Protection PIN (IP PIN)

Bank account and routing number

Copy of last year's tax return

Prior year's AGI (Adjusted Gross Income)

Any IRS tax letters received during the year

Any out of state work or property information

Foreign bank account info with peak value amount during the year

DEPENDENTS

If applicable, Form 8332 releasing the child’s custodial parent right to claim a child to the noncustodial parent

Income of dependents and of other adults in your home

PAYMENTS

Estimated tax payments made for federal and state, including amounts and dates

Amount of last year’s return over-payment applied to current year

INCOME

EMPLOYED

Wages, salaries, tips and bonuses (Form W-2)

Scholarship above education expenses

Foreign earned income

UNEMPLOYED

Unemployment compensation (Form 1099-G)

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Mistakes, Rejections & Audit Triggers

SELF-EMPLOYMENT

Non-employee compensation for self-employed (Form 1099-NEC)

Third-party transactions or drive-share payments such as Uber, Lyft (Form 1099-K)

Cash income

SAVINGS & INVESTMENTS

Interest income (Form 1099-INT)

Dividends income (Form 1099-DIV)

Sale of stock, land, etc. for capital gains, dates of acquisition, and records of your costs in property you sold (if basis not reported on Form 1099-B)

Installment sale information (Form 6252)

RETIREMENT INCOME

Retirement income from pensions, annuities, and IRAs (Form 1099-R)

Social Security and railroad retirement (Form SSA-1099)

OTHER INCOME

Miscellaneous income such as rent, prizes, and awards, royalty or other (Form 1099-MISC)

Last year's state refund (Form 1099-G)

Income from partnerships, trusts, and S-Corporations (Form K-1)

Gambling winnings, lottery and loss records (Form W-2G)

Sale of real estate property or home (Form 1099-S)

Jury duty pay

Hobby income (expenses are no longer deductible)

Cancellation of credit card or other debt (Form 1099-C)

Virtual currency trade information

Record of alimony paid/received with ex-spouse’s name and SSN for divorces finalized before or on December 31, 2018

Trust income (Schedule E)



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Resources

DEDUCTIONS

Student loan interest (Form 1098-E)

Retirement contributions (Form 5498)

Health Savings Account (HSA) contributions (Form8889)

Educator expenses for classroom supplies up to $250

Sale of home info, purchase and sale date and amounts, improvements (Form 1099-S)

Moving expenses for active military (Form 3903)

Scholarship or fellowship records

Nonbusiness bad debt in year it became worthless (Form 8479 on Schedule D)

Standard or itemized deduction (Schedule A)

ITEMIZED

MEDICAL

Medical expenses for you, your spouse & your dependents

Health insurance premium payments

Out of pocket doctor, dentist, hospital expenses not covered by insurance

Prescriptions and medicines

Travel expenses for medical purposes

Health Savings Account (HSA) or long-term care reimbursements (Form 1099-SA or 1099-LTC)

TAXES

State and local income taxes or general sales taxes

Real estate taxes and property PIN number

Personal property taxes

Vehicle sales tax paid

HOME

Mortgage interest & points paid on the first and second home, with limitations (Form 1098)

Mortgage insurance premiums



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Mistakes, Rejections & Audit Triggers

CHARITABLE DONATIONS

Cash donations (up to $300 per return for 2020; $300 per filer in 2021, without itemizing)

Fair market value of non-cash contributions; support for donations over $250; and (Form 8283) for non-cash contributions over $500

Miles driven for charitable purposes

Unreimbursed expenses related to volunteer work

OTHER

Gambling loses up to winning (only if itemizing)

FEMA assistance info, if your county has been declared a federal disaster area

Interest on property held for investment

CREDIT

Child care costs—provider or person's name, address, tax id, and amount paid (Form 2441)

Stimulus Payment confirmations (otherwise called Economic Impact Payments or EIP) or IRS Notices 1444

Health care insurance through Marketplace for Premium Tax Credit (Form 1095-A)

Adoption costs: SSN of the child; records of legal, medical and transportation costs

Foreign taxes paid

Receipts for any qualifying energy-efficient home improvements (solar, windows, etc.)

Education tuition & other qualified education expenses (Form 1098-T)

BUSINESS - SCHEDULE C

Tax or EIN number for your business

Business income



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BUSINESS EXPENSES

Records of all business expenses, including home office, if applicable

Business-use of asset information (cost, date placed inservice, etc.) for depreciation

Use of vehicle and tax deductible miles

Self-employed health insurance premium payments

Keogh, SEP, SIMPLE and other self-employed pension plans contributions

RENTAL - SCHEDULE E

Rental income and expenses

Rental asset information (cost, date placed inservice, etc.) for depreciation

Number of days used for personal vs. rental

FARM - SCHEDULE F

Farm income and expenses

Farm asset information (cost, date placed inservice, etc.) for depreciation



416

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TAX FORMS

417

Resources

418

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419

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421

Resources

422

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423

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424

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Resources

426

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427

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428

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APPENDIX

T

he appendix has supplemental information to everything covered in the book. It is an essential part of clarifying, locating and finding more information.

Here you will find a glossary of all the terms. Don't be afraid to use it regularly. Definitions clarify concepts and ensure that you have an accurate understanding. Under the bibliography, you will find a list of books referenced that I highly recommend. The archival links section lists permanent links to each web source used in the book. This is to avoid the links from breaking and rotting, as most internet information eventually does. Finally, the index gives you all the information covered and an easy way to locate it.












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Appendix

Boost Your Tax IQ

Appendix

GLOSSARY Term De nition

A

Ability to Pay

Basis of a progressive tax system, where taxpayers with higher income pay more in taxes than those with lower incomes.

Above-the-line Deduction

Also called adjustment to income. Deductions that tax breaks that taxpayers can take to reduce their gross income without having to itemize.

Accelerated Depreciation

Method of depreciation under which taxpayers can deduct more in the rst year(s) of the useful life of an asset.

Adjusted (Cost) Basis

Adjusted Gross Income (AGI)

It is used to determine the loss or gain on a sale of property. The formula used is: (original cost of property + value of improvements + any fees & expenses) - depreciation = adjusted basis. There are special rules for property that is inherited or received as gift, with the adjusted cost basis being calculated on the date of the event. It is your gross income from your wages, dividends, capital gains, business income, retirement distributions, and other income, less certain adjustments listed on Schedule 1 Part II, such as educator expenses, student loan interest or contributions to a retirement plan, plus other adjustments. AGI is an important item as it is often referenced in calculating deductions or credits and as an identity veri cation item in tax software.

Adjustment to income Affordable Care Act (ACA)

Alternative Minimum Tax (AMT)

Amended Return

See above-the-line deduction. The act included a variety of health-related provisions that extended health insurance coverage to taxpayers and imposed certain health insurance requirements. A special tax system that was originally intended to prevent wealthy taxpayers from taking advantage of so many tax-breaks that they ended up paying little or no taxes. A return that is led to make corrections on the originally led return.

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Term De nition American Opportunity Tax Credit (AOC)

It is a partially refundable tax credit available to taxpayers within the rst four years of postsecondary education to offset the cost of quali ed expenses. The maximum annual credit per student is $2,500. Either the student, or a taxpayer who claims the student as a dependent, may take the credit.

Amortization

Process of writing off the cost of an intangible asset over its useful life.

Amount Due

The amount taxpayer must pay to the government when the total tax due is greater than the total payments made for the year.

Annuity Audit

B

Bad Debt Brackets

C

It is a xed sum of money paid to a person annually, such as from a retirement plan. An IRS review or an examination of a tax return. It can be selected at random or be based on a number of red ags. It is a debt that tis unlikely to be paid. See Tax Brackets.

Cafeteria Plan

See Fringe Bene ts.

Calendar Year

12 consecutive months ending on the last day of December. Individuals must le using calendar year.

Cancelled Debt

Forgiven or discharged debts that are often taxable, although some can be non-taxable (e.g., bankruptcy debt, insolvency). See Table 47.

Capital Gain

The pro t made on the sale of property such as stocks, mutual funds and real estate. Gains on assets held less than 12 months are considered short-term capital gains and are taxed at the taxpayer’s top tax bracket as any ordinary income. Gains on assets held more than 12 months are considered long-term capital gains and are taxed at a preferential tax rate of either 0%, 15%, or 20%. There are some exceptions for things such as collectible assets such as precious metals and antiques, are taxed at 28%.

Carryover

A process by which a deduction or credit that can’t be taken during the year can be applied against a tax liability in subsequent years (Carryforward) or previous years (Carryback).

Cash Method

The accounting method which recognizes income and deductions when money is received or paid.

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Appendix

Term De nition Charitable Deduction Child Support

Credit

D

Decedent Deduction Dependents

Depreciation

Direct Deposit

Direct Tax Dividend

E

Deductions allowed for money or property gifts to charity. Payments made to an ex-spouse or legally separated spouse for the care of a child. Child support payments are neither taxable nor deductible. See Tax Credit. An IRS term for a person who has died. See Tax Deduction. Dependents is someone you support and you can claim on tax return. Generally, when you can claim a dependent you are eligible for additional deductions and credits such as CTC or credit for other dependents. Your ling status can change and your standard deduction is also higher. Having certain dependents under certain age, can also open some additional credits. An accounting technique in which the cost of an asset is allocated over its useful life and can be deducted as an expense. A method where a tax refund or payment is electronically deposited into a taxpayer’s bank account. It is often the fastest and most secure way to receive tax refund. A tax that is levied directly on the person, entity or property rather than transaction. Pro ts distributed by corporations to its shareholders in the form of cash, additional shares of stock or other property. All dividends are taxable but quali ed dividends are taxed at the lower capital gains tax rate.

Double Dipping

It is a term used to indicated using the same expense for two different deductions or credits, which is not allowed.

Double Taxation

A term indicating being taxed twice on the same income. Often it can happen between foreign and domestic jurisdictions.

Earned Income

Compensation earned through a paycheck, selfemployment, including wages, salaries and tips. It is derived for providing personal services in employment, trade or business. It requires taxpayer to actually do something for the money.

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Term De nition Effective Tax Rate

Electronic Filing (EFile)

Employee Employer Identi cation Number (EIN) Estate Tax

Estimated Tax

Examination

A rate at which taxpayers would be taxed if their tax liability was taxed at a constant rate rather than progressively. It is calculated by taking the total tax liability for the year and dividing it by total taxable income. The transmission of tax information directly to the IRS using a computer. It can be done via online software,, when using tax professionals or at a volunteer site. Works for an employer. Employers can control when, where, and how the employee performs the work. It is a 9 digit number to identify business entities. A tax targeted at the wealthy, on the total value of an estate if it exceeds a certain amount ($11,700,000 in 2021). Estimated Tax is the quarterly payment that a taxpayer may need to pay to the IRS in order to avoid the underpayment penalty if they owe more than $1,000 at the end of the tax year. If you have income not subject to withholdings, such as selfemployment or investments, you may need to make quarterly payments. The due dates for estimated payments are: April 15, June 15, September 15, and January 15 of the following year. See Audit.

Excise Tax

It is an indirect tax on speci c goods or services, such as alcohol or gasoline, which provides revenue to federal, state or local government.

Exclusions

Indicates income that is exempt, or not included, in the calculation of gross income for tax purposes.

Exempt

Exemption

A term used to describe a taxpayer that is free from withholding of federal income tax, if they meet certain income, tax liability and dependency criteria. See Tax Exemption.

Extenders

Temporary tax provisions that will expire if Congress does not act to extend them.

Extension

Taxpayers may request a 6-month extension to le their tax returns by submitting Form 4868, Application for Automatic Extension of Time to File US Individual Tax Return. It moves the typical April 15 ling deadline to October 15. The extension to le does not extend the amount of time to pay.

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Appendix

Term De nition

F

Fair Market Value Federal Income Tax

The price for which you could sell a piece of property on the open market to an unrelated party. The tax that the Federal government levies on people in order to provide defense, foreign affairs, law enforcement and interest on the national debt.

Federal Insurance Contribution Act (FICA) Tax

An employment tax required to fund Social Security and Medicare.

Federal Unemployment Tax Act (FUTA)

FUTA tax is the federal part the unemployment insurance program created by the Federal Unemployment Tax Act.

Fellowship

Fiduciary

A type of scholarship received in the form of a grant to help pay for educational or research pursuits. Generally it is not taxable when used for quali ed expenses. A person or a company holding assets in trust for a bene ciary.

Filing Status

One of ve tax ranks determined by your martial status, your dependents and how you le. Taxpayers can le as: Single (S), Married Filing Jointly (MFJ), Married Filing Separately (MFS), Head of Household (HOH), or Quali ed Widow(er) (QW). The tax rate used to tax taxpayer’s income is based on their ling status.

Fiscal Year

12 consecutive months ending on the last day of any month except December. Enterprises can le taxes based on their scal year.

Flat Tax

A tax based on the same percentage of income for all taxpayers, regardless of income level.

Flexible Spending Account (FSA)

An employer sponsored account which is used for approved medical expenses. Taxpayer contribution are taken pre-tax and can sometimes be matched by the employer. Funds contributed and not used by the end of the year may be lost.

Foster Child

A child other than a natural or adopted child who lived with the taxpayer for the entire year and whom the taxpayer treated as his or her own child.

Fringe Bene ts

A supplementary compensation given by employers to its employees in additional to regular pay. Common fringe bene ts include company cars, stock options, childcare, transportation, group term life insurance, expenses reimbursements, etc. Many fringe bene ts are taxable.

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Term De nition Full Retirement Age

Full retirement age, is the age a taxpayer can start receiving full social security bene ts. Every taxpayer can start receiving Social Security retirement bene ts when they turn 62, however, only by waiting until full retirement age can they receive the full amount.

Gift Tax

When a person transfers money or property to another person and receives nothing in return (or less than full value), a gift tax may be triggered. For 2021, there is a yearly exclusion of $15,000 per donor per recipient and a lifetime exemption of $11,700,000 per individual.

G

Good Faith

Goodwill

Gross Income

H

Head of Household (HOH)

Health Savings Account (HSA) Hobby

Hobby Loss Home Of ce

Household Employee

I

Identity Protection PIN (IP PIN) Income Taxes

Denotes a state of mind, whereby a person honestly and truly believes certain facts and circumstances are as they are. Value of intangible assets which consists of copyright, brand, client list, location, earning capacity, trader or business secrets, etc. Total income from taxable sources before any adjustments, exemptions, credits and deductions are subtracted. A ling status claimed by taxpayers who are single or married but can be considered unmarried and who had qualifying dependents, who lived with them and for whom they provided more than half the cost of keeping up the home. See AT 2B. A special tax-favored account for savings to cover current and future health care expenses. An activity pursued not primarily for nancial gain but for enjoyment, sport or entertainment. See AT 7G. A non-deductible loss from a hobby. A designated area or space within a taxpayer’s residence that is used primarily (or exclusively) for business purposes. A person that is paid to cook, clean, care for dependents of the taxpayer. It is a six-digit code assigned to taxpayers who have been victims of identity theft. Taxes paid by taxpayers and businesses base don earned and unearned income.

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Term De nition Independent Contractor

A self-employed or gig worker who performs services for others in exchange for compensation. They often have limited control how work is done and are often paid per project. See MT 8I.

Indirect Tax

A tax that is levied on transaction rather than person or entity, such as sales tax.

Individual Retirement Account (IRA)

A personal savings account that allows taxpayers to set aside money for retirement. There can be certain bene ts for making IRA contributions or distributions, depending on the type of IRA. See TM 5I.

Individual Taxpayer Identi cation Number (ITIN)

ITIN means Individual Taxpayer identi cation number. It is 9 digit long and start with 9. It is assigned to taxpayers who are ineligible to obtain SSN.

Information Return

Inheritance Tax

Declaration reporting to the IRS about certain transactions with taxpayers. The most frequent information returns are 1099 tax forms. A tax imposed on the bequests a taxpayer received from a person that dies. Currently there is no US Federal inheritance tax but few states do have it (MD, NE, KY, NJ, PA, and IA).

Injured Spouse Relief

A relief to taxpayers who had all or part of their tax refund offset to satisfy their spouse’s legally enforceable past-due taxes, child support payments or other federal non-tax debts. Taxpayers can le MJF and include Form 8379 to receive a their respective portion of the tax refund.

Innocent Spouse Relief

A petition led by a divorced taxpayer who led jointly in the past with the spouse to be relieved of responsibility for their ex-spouse’s unpaid tax bill because of false claims or omissions. Taxpayers have to be divorced and have to le Form 8857.

Insolvency

Installment Agreement Interest Income

Internal Revenue Service (IRS)

Inability to pay debts when they are due. The total assets such as cash, investment is less than what is owed in debt (liability). An IRS payment plan to pay taxes owed over an extended period of time. The income a taxpayer receives from lending their money or investments, such as savings accounts or CDs. A bureau of the Department of the Treasury, the IRS is the government agency responsible for collecting taxes and for enforcing the tax code.

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Term De nition

J

Investment Income

Income derived from the investment of capital, whether money or property, in income-producing assets or pro t-making venture, without active participation, such as interest, dividends, capital gains net income, certain rents and royalty, etc.

Itemized Deduction

It is the amount you can subtract from your gross income to calculate taxable income, that requires support and records for the items listed on Schedule A. It is an alternative to standard deduction for some taxpayers that have large mortgage interest, real estate taxes, state and local taxes or sales taxes, and other items.

Joint Return

One return lled jointly by two married taxpayers.

Jumbo Loan

A jumbo loan, also known as a jumbo mortgage, is a type of nancing that exceeds the limits set by the Federal Housing Finance Agency (FHFA). It is not eligible to be purchased, guaranteed, or securitized by Fannie Mae or Freddie Mac. As of 2019 it is more than $484,350.

K

Kiddie Tax

L

Levy Long-Term Capital Gains Loophole Losses

M

Marginal Tax Rate

Medicare Tax Modi ed Adjusted Gross Income (MAGI)

N

Nanny Tax

The tax paid by parents, at their tax rate, on the unearned income of a child which is in excess of a certain amount. To impose a tax. Gains on assets held more than 12 months are considered long-term capital gains and are taxed at a preferential tax rate of either 0%, 15%, or 20% Tax opportunities to minimize taxpayer’s tax burden. A term de ning expenses exceeding revenues. It is how much of each additional dollar of income that taxpayer makes, will be taxed. It is the top bracket for taxpayer’s income. For 2021, if you are single and your AGI is $45,000, you are in the 22% bracket so your marginal tax rate is 22%. Payroll tax collected from taxpayers to fund medical bene ts for people who retire and are over 65. Adjusted gross income with various items added back in. MAGI. It is used to determine certain tax bene ts such as IRA contributions or premium tax credit. Refers to taxes taxpayers must pay for, as well as withhold from, certain household employees. See TM 9F.

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Term De nition Negligence

A lack of due care or failure to do what is reasonable and ordinarily prudent given the circumstances.

Net Income

It is the amount a taxpayer earns after subtracting taxes and other deductions from their gross income.

Non-Recourse Debt

A debt for which an individual has no personal liability.

Non-Refundable Credit

Tax credits that can reduce your tax liability to zero amount due and any excess is lost.

Non-Resident

A taxpayer that did not live in particular state but worked or did business there and therefore must le a state income tax return.

Non-Taxable

O

Income which is not subject to tax.

Offer in Compromise

When a taxpayer who owes the IRS more money than they can pay, the IRS may agree to settle for less than the amount owed.

Of ce Audit

P

An examination at the tax authority’s of ce.

Part-Year Resident

A taxpayer that live in a particular state for only part of the year but must le a state income tax return.

Passive Income

Income received from an activity where the taxpayer doesn’t have to actively participate, such as dividends, interest, rental income, royalties, etc.

Passthrough Entities

Sometimes also called ow-though entities, are businesses whose income ows through onto the 1040 individual form and is taxed under the individual income tax.

Payment Plan

See Installment Agreement.

Payroll Tax

Also called Employment Tax. Refers to the Social Security and Medicare taxes that an employer withholds from an employee’s paycheck and pays to the government.

Pension

An employer-sponsored retirement plan that provides a speci ed payment amount when the taxpayer retires.

Personal Exemptions

See Tax Exemption.

Power of Attorney (POA)

Written authorization for a person to receive con dential information from the IRS, as well as perform certain actions, on behalf of a taxpayer. See TM 3E.

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Term De nition Pre-Tax Money

Principal Residence

Q

R

Money that is not subject to tax. Pre-tax money comes out of your paycheck before taxes are calculated. It is not considered part of your gross income.401(k) plans are examples of pre-tax accounts. The place where the taxpayer lives for majority of the year.

Progressive Taxation

Taxation that has a different tax rate for income in higher income ranges. Taxpayers at lower income levers are taxed at lower tax rate than taxpayers in higher income levels.

Property Tax

Taxes on property such as real estate, auto or boat.

Qualifying Child

To be a qualifying child, the dependent must meet eight tests: (1) relationship, (2) age, (3) residence, (4) support, (5) citizenship or residency, (6) joint return, (7) qualifying child of more than one person, and (8) dependent taxpayer.

Qualifying Widow(er)

A ling status that a taxpayer can claim for up to 2 years after passing of their spouse and if: (1) they led MFJ for the year of death; (2) taxpayer didn’t remarry; (3) taxpayer has a qualifying dependent; and (4) the taxpayer provides more than 50% of the cost to maintain the home for the year.

Recourse Debt

A debt for which an individual has personal liability.

Refund

The amount of money taxpayer receives back from the IRS if the person paid more in taxes than they owed.

Refundable (Tax) Credits

Tax credits that bring you up to a refund when you have no tax liability.

Required Minimum Distribution (RMD)

The amount of money taxpayers have to take out from their retirement plans at retirement age. IRS doesn’t allow taxpayers to leave retirement funds in their accounts inde nitely and avoid paying taxes. Starting with 2020, the RMD distribution age has been increased to 72. There is no RMD for Roth IRAs, unless they are inherited.

Resident

A taxpayer that lives in a particular state or country.

Resident Alien

A resident alien is a foreign person who legally lives and works in United States and is subject to U.S. income taxes.

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Appendix

Term De nition Rollover

S

A tax-free direct transfer of funds from one individual retirement account (IRA) to another, or from a company plan such as 401(k) to an IRA. The transaction has to take place within 60 days so as to avoid making it taxable.

Royalties

Payments received for the use of intellectual property such as copyright, patent, trademark, design, etc.

Schedules

IRS forms that are used to report and calculate various kind of income, deduction and credits.

Scholarship

Self-Employed

Sham Transaction Social Security Number (SSN)

Social Security Tax Sole Proprietorship

Money awarded for education use. If they are used for quali ed educational expenses, they are typically non-taxable. A taxpayer who works for themselves and are not employees. They can be independent contractors. See TM 8I. A transaction without substance, fraudulent in nature. It is a nine-digit number needed for employment and other government services. It helps us identify and accurately record wages or self-employment earnings. Payroll bene ts for retired and disabled taxpayers and their dependents. An unincorporated business entity, owned by one individual, who is personally liable for all debts of the business.

Standard Deduction

It is an amount of deduction that varies by ling status, age, blindness and dependency. It reduces taxpayers’ income that is subject to tax that does not require speci c support. See Table 6.

Statue of Limitations

A period within which a speci c legal action may take place such as collection of tax, audit, etc.

T

Tax Avoidance Tax Brackets

Tax Break

Legal methods used to minimize taxpayer’s tax liability and maximize their after-tax income. A range of income taxed at a speci c tax rate. There are different tax brackets for different lling statuses. For example, for 2021, the income below $9,950 is taxed at 10% for a single taxpayer and income between $9,950 to $40,525 is taxed at 12%. Use of deductions, credits and exemptions to legally reduce taxes.

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Term De nition Tax Compliance

A degree to which taxpayer complies with tax rules and regulations.

Tax Credits

It is an amount of money you can subtract, dollarfor-dollar, from the amount of tax you owe, granted that you qualify for the credit by meeting eligibility criteria. Tax credits are better than deductions as a $1,000 of tax credit, reduces your tax liability by exactly $1,000

Tax Cuts and Jobs Act (TCJA)

Tax law passed in 2017 and enacted in 2018. It changed deductions, tax rates, credits and other tax items that affect individuals and businesses.Main changes, included: (1) elimination of exemptions; (2) increase in standard deductions; (3) changed itemized deductions; (4) increase of child tax credit; plus number of other changes.

Tax Deduction

Tax Gap

Tax Evasion

It is an amount that can be subtracted from your income before you calculate taxable income and tax due. One of the largest tax deduction is the standard or itemized deduction. The difference between taxes paid and taxes owed by law. The IRS uses it to estimate of taxes that are not paid. It uctuates between 15% to 18%. Illegal action of a taxpayer or a business to deliberately underpay or refuse to pay taxes.

Tax Exemption

It is an amount that is available as a deduction for each qualifying taxpayer or dependent on the tax return. For Federal purposes, all tax exemption have been eliminated since the passing for TCJA law in 2018. Many state tax returns still use exemptions.

Tax Forms

IRS forms used to report nancial information to the agency.

Tax Liability Tax Rates

The amount of taxes a taxpayer must pay. The percentage rate that is used to tax income for taxpayers and businesses. For example, the federal tax rates on individuals for 2021 are: 10%, 12%, 22%, 24%, 32%, 37%. See Resources Part IV.

Tax Settlement

An IRS approved reduction or elimination of taxpayer’s debt.

Tax Worksheet

An IRS document that is used to make calculations or determine eligibility for deductions and credits. It is usually not led with tax returns.

Tax Year

The 12-month period covered on a tax return that runs from Jan 1 until Dec 31.

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Term De nition Tax-Exempt Interest Income Tax-Free Income

Any type of income that you don’t have to pay taxes on can, such as child support payments; combat pay; gifts; certain disability payments, etc. See Table 47.

Taxable Income

Amount of income used to calculate tax liability. It is AGI, minus deductions and exemptions.

Taxpayer Identi cation Number (TIN) The Protecting Americans from Tax Hikes (PATH Act) Tip Income

U

Underground Economy

Unearned Income

Use Tax

W

Interest income that is not subject to income tax, such as interest earned from municipal bonds.

Wage Garnishment

Wash Sale

A 9 digit long number that identi es business entities. Also refers to as EIN. The PATH ACT of 2015 enacted that the IRS can’t issue refunds that include EITC and ACTC until Feb 15 in order to stop fraudulent refunds being issued early in the tax season. Money and goods received for services performed that go beyond the stated amount of the bill. Money-making activities that people don't report to the government, including both illegal and legal activities. Income which is not earned by working, such as investment income, passive holdings, gifts or unemployment. It is a sales tax on purchases made outside of one’s state of residence. Money legally withheld from a person’s wages to satisfy a debt, such as delinquent child support payments, defaulted student loans, or unpaid taxes. A sale of security at a loss and repurchase of the same or almost identical security within 30 days.

Wealthfare

It is the government aid to the upper classes, the very wealthy and multi-millionaires often disguised in the form of tax breaks (e.g., a deduction small business stock, step-up basis for capital gains) or subsidized services (e.g., options for CEO performance pay ).

Withholdings

The amount of money that is taken out from each paycheck to pay your income, Social Security and Medicare tax. US has a pay-as-you-earn tax system, which means that taxpayers have to pay taxes through withholding with each paycheck.

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B IBLIOGRAPHY Administration, S. S. (2019). Social Security Handbook 2019: Overview of Social Security Programs (Social Security Handbook (Large Print)) (Large Print ed.). Bernan Press. Attorney, F. D. W., & Attorney, F. S. (2020). Stand Up to the IRS (Fourteenth Ediiton ed.). NOLO. Botkin, S. (2016). Lower Your Taxes - Big Time! 2016–2017: Wealth-Building, Tax Reduction Secrets from an IRS Insider (7th ed.). McGraw-Hill. J.K. Lasser Institute. (2020). J.K. Lasser’s Your Income Tax 2021: For Preparing Your 2020 Tax Return (2nd ed.). Wiley. Kennedy, D. (2004). Loopholes of the Rich: How the Rich Legally Make More Money and Pay Less Tax (Revised ed.). Wiley. Merino, N. (2011). Tax Reform (Opposing Viewpoints). Greenhaven Press. Murphy, R. (2017). Dirty Secrets: How Tax Havens Destroy the Economy. Verso. Obermaier, F., & Obermayer, B. (2016). The Panama Papers: Breaking the Story of How the Rich and Powerful Hide Their Money. Oneworld Publications. Saez, E., & Zucman, G. (2019). The Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay (1st ed.). W. W. Norton & Company.





















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Schnepper, J. (2019). How to Pay Zero Taxes, 2020–2021: Your Guide to Every Tax Break the IRS Allows (37th ed.). McGraw-Hill Education. Weltman, B. (2019). J.K. Lasser’s Guide to Self-Employment: Taxes, Strategies, and Money-Saving Tips for Schedule C Filers (2nd ed.). Wiley.

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ARCHIVAL LINKS Because of the sheer size of the links and footnotes (close to 500), it was more efficient and practical to put them online at www.boostyourtaxiq.com/resources). The below is an example of the information that will be added there over time.

Footnote 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Title

Archival Link

A Third of Americans Say They Like Doing Their Income Taxes PolitiFact | Tax code is so long that nobody's really sure of its length New York Times: How Economic Gobbledygook Divides Us The Top 0.5% Underpay $50 Billion a Year In Taxes and Crushed the IRS Plan to Stop Them ‚Äî ProPublica The Distribution of Tax Noncompliance DocumentCloud The shocking ways billionaires, highly pro table companies hide their money How the richest people on Earth avoid paying taxes Top tax frustrations for Americans: The feeling that some corporations, wealthy people don’t pay fair share Tax avoidance and tax evasion Are you part of the middle class? This calculator can tell you Bloomberg Wealth: Richest 1% of Americans Hide a Fifth of Their Income From the IRS J.K. Lasser's Your Income Tax 2022: For Preparing Your 2021 Tax Return Forbes: Why Infographics Rule Writing tip: Write 1, 2, 3. Numbers in plain language and legal prose | Contented Perma: Scoping and Addressing the Problem of Link and Reference Rot in Legal Citations Harvard Law Review IRS Behavioral Insight Toolkit Improving Notices Using Psychological, Cognitive, and Behavioral Science Insights Science is Essential to Public Policy | The Pew Charitable Trusts



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Appendix

INDEX adjusted gross income (AGI), 52, 85-90, 142, 179, 180, 199, 205, 264, 314, 316-320, 438 alternative minimum tax (AMT), 93-94, 438 amended return (amendment), 59, 105-111, 124,143, 145, 164-165, 195, 227, 323-324, 328, 438 American Opportunity Tax Credit (AOTC), 80, 83, 86, 110, 175-177, 187-191, 293, 326, 329-331, 341 capital gain, 19, 83, 86-87, 142, 147-149, 153, 171, 204, 215-216, 226, 256, 273-275, 285, 303, 358, 439 car expenses, 375-379 charity deduction, 90, 302, 362-365 child support, 87, 156, 163, 348, 356-357 cost basis, 147-149, 153, 214, 215, 438 dependents, 61, 78, 96, 110-111, 155, 157, 159-163, 173, 176, 187, 222, 304, 322-323, 343, 440 direct deposit, 135-137, 333, 440 domestic workers, 295-297, 389 earned income, 51, 87, 142, 186, 243, 247-248 Earned Income Tax Credit (EITC), 51, 57-59, 61, 63, 80, 83, 96, 110, 122, 142, 162-163, 174, 176-177, 184-187, 222, 243-244, 246-248, 278, 299, 324, 326, 329-331, 344, 368, 371 effective tax rate, 79, 93, 257, 441 electronic filing (e-file), 45, 108, 129, 228, 240, 313, 316, 370, 441 estimated tax, 59, 74, 80, 249-255 exemption, 162-163, 449 expired provisions, 181 filing status, 73, 78, 89, 91, 107, 111, 154-159, 160-165, 187,193, 322-323,  343-344, 442 filling requirement, 58, 61, 114, 192, 195, 202, 290, 324, 341-342

foreign bank accounts, 290, 302, 357-358 Form 1040, 68, 73, 77, 83-99, 105-111, 143, 150, 222-223, 226, 229-236, 249, 331, 342 Free File, 48, 58, 116-121, 128 head of household (HOH), 78, 154-159, 162-163, 184, 248, 322, 342, 344, 403, 443 health savings account (HSA), 88, 171, 443 hobby, 82, 242, 263-266, 380, 443 home office, 180, 215, 365-367 home sale exclusion, 214-216 homebuyer credit, 94, 201-202, 220, 332 identity protection pin (IP PIN), 304, 316, 319-320, 325, 327, 443 injured spouse relief, 163-165 investment income, 94, 184, 274 IRS Letters, 38, 64, 291-294 itemized deduction, 60, 89, 179-180, 264, 362-365, 384 marginal tax rate, 79, 92-93, 203, 258, 445 math errors, 58, 221, 225 non-refundable credit, 83, 95-97, 173-175 non-taxable, 81, 163, 207, 268, 347-348, 386 paper filing, 229, 327 passive income, 266, 386 penalties, 50, 54, 64, 103, 109, 111, 145, 146, 221, 268, 283, 287-288, 290, 301, 340, 357, 370, 374 premium tax credit, 93, 168, 175, 192-196, 329-330 progressive taxation, 91 qualified business income deduction (QBI), 85-86, 90, 171, 177, 255-259, 279 qualifying child, 70, 447 qualifying widow(er (QW), 78, 150, 158-159, 447


































































































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stimulus payment and rebate recovery credit (RRC), 58, 81, 196-200, 219, 221 tax brackets, 74, 79, 92-93, 204 tax credit, 57, 74, 80, 83, 95-97, 168, 173-177, 222, 329, 449 Tax Cuts and Jobs Act (TCJA), 82, 89, 178, 180-183, 192, 255, 263, 264, 356, 366, 373, 383, 405, 449 tax deduction, 74, 80, 168-172, 255 tax evasion, 300-306 tax rates, 79, 92-93, 203, 258, 445 taxable income, 74, 79, 80, 89-93, 224, 257, 347, 356, 382, 385, 402-403, 450 trader status, 273-276, 281, 391-392 unearned income, 87 virtual currency, 120, 285-286, 298, 302, 358-360 withholdings, 86, 102, 109, 114-115, 151, 165, 249-250, 321















































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Get the eBook Free! Every owner of a physical paperback or hardcopy of this book, can receive a digital copy for free. Since you paid more for a physical copy, I believe you should have a digital copy, which is more practical accessing the links and supporting information. To get a digital PDF version of the Boost Your Tax IQ book, go to www.boostyourtaxiq.com and follow the instructions to subscribe and receive an electronic version for free.









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About the Author

I love simplifying and clarifying complex tax information into accessible content. I have a BA in Economics, and I am an IRS Enrolled Agent.435 As an Enrolled Agent, I specialize in tax return preparation. I have worked at large tax preparation companies as Master Tax Advisor and Tax Expert.

Since 2016, I have also volunteered with two IRS Free Filing programs. With the IRS Volunteer Income Tax Assistance (VITA),436 through the Ladder-UP Tax Assistance Program (TAP),437 I have been preparing tax returns for taxpayers in disadvantaged communities,

With the Tax Counseling for the Elderly (TCE), I have been preparing tax returns for the elderly through the AARP Foundation Tax-Aide.438

Connect with me on social media @ https://linktr.ee/ akistepinska or at [email protected] or on my website www.akistepinska.com

https://www.irs.gov/tax-professionals/enrolled-agents/enrolled-agent-information https://www.irs.gov/individuals/free-tax-return-preparation-for-qualifying-taxpayers 437 https://www.goladderup.org/our-services/tax-assistance/ 438 https://www.aarp.org/money/taxes/aarp_taxaide/ 435 436

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