What to Do When the IRS Questions a Deduction?

You’ve received a letter from the IRS requesting supporting documentation on one of your deductions. Does this mean the agency will disallow the item and you’ll owe additional taxes, penalties, or interest? Not necessarily. 

Each year, the IRS chooses returns for examination, including those with deductions classified as red flags or that fall outside the norms for your income level. When you receive a letter notifying you that deductions on your return have been chosen for verification or further examination, it’s important to respond to the IRS and not ignore the correspondence. Even if you need more time than the typical 30 days to answer, you should contact the agency at the number on your notice and explain. 

Note, the IRS will always contact you by mail. The agency will not initiate contact in an email, text, or phone call. If you receive such a message, it is likely fraud.  

Here are some commonly questioned deductions and issues to be aware of: 

  • Charitable contributions – if you report a large increase in charitable contributions over the prior tax year or your total contributions are significantly higher than most taxpayers in your tax bracket, you might be flagged for an examination. Taxpayers are required by the IRS to keep bank records or written documentation of any donation. This documentation must show the date the contribution was paid, name of the charity, and amount given. For donations over $250, taxpayers are also required to obtain and keep written documentation of the donation from the charity. 

In addition to ensuring taxpayers report true contributions, the IRS is concerned about the validity of the charitable organizations themselves. During the COVID-19 pandemic, scams related to fake charities increased. The IRS encourages taxpayers to use its tax-exempt organization search tool to verify a charity’s validity before writing a check or donating with a credit card payment. 

  • Schedule C Profit or Loss from Business – business owners or independent contractors who file a Schedule C are permitted to deduct legitimate expenses from their business income. These can include legal fees that are ordinary and necessary for running a business, such as drafting contracts, fees related to defending a lawsuit, and business incorporation and planning expenses. Personal legal expenses, such as those related to divorce or drafting a will, are not deductible. It’s important for small business owners to keep personal and business legal expenses separate, and to make sure any documentation such as an invoice that includes fees for both specify which charges are related to the business and which for personal issues. 

Home office deductions and those related to business use of a vehicle can be IRS audit red flags if they fall outside norms. You’re entitled to deduct a portion of your utilities, mortgage interest, and other expenses if you use a room in your home exclusively for work. The rules are detailed, complex, and subjective, however, which makes them ripe for questioning by the IRS. One-hundred percent use of a vehicle for business purposes also draws the agency’s attention.  

It’s important to keep records of all business expenses, such as cancelled checks, invoices, cash register tapes, credit card sales slips, mileage logs, rental contracts, and bank and credit card statements that show the date and expenses paid. If the IRS asks for proof of any of your Schedule C deductions, it will ask that you send copies of all business expense records along with a completed Form 11652 Questionnaire and Supporting Documentation Form 1040 Schedule C. 

  • Splitting deductions with a spouse or partner – mismatched information between your return and documents sent to the IRs by a third party may trigger a request for further documentation of a deduction. For example, if you own a house with a spouse (and file separate tax returns) or partner but only one name is on the mortgage, only the person who owns the mortgage and receives the Form 1098 Mortgage Interest Statement can deduct the mortgage interest. This is true even if you use a joint checking account to make the payment or send two checks to the bank. The same rule applies for deducting property taxes if the tax statement only has one name on it. 

Have Questions? Call the Experienced Tax Attorneys at Wiggam Law  

If the IRS has requested further deduction support and sent you notice of an examination, the experienced attorneys at Wiggam Law can evaluate your situation and recommend a course of action. Contact metro Atlanta’s top tax attorneys by clicking here or give us a call at (404) 233-9800