DO CASUALTY LOSSES TRIGGER AN IRS AUDIT?
(A question asked recently
of this blog)
The short answer: No one
can tell you one way or another. There are people inside the IRS who can tell
you an accurate answer, but they will not tell anyone.
Let me tell you a story –
it is an old story and therefore not necessarily relevant to today, but it does
say something about how the agency sometimes reacts to situations.
A client was being audited
by the IRS. It was a field audit, meaning the auditor came to my office and
went over the client’s records in great detail. The audit took several days. As
a result of the extended time that the auditor was in my office, I had the
opportunity to engage him in conversation of a nature that did not always relate
to the specifics of the case he was examining. It was several years after the
Northridge Earthquake of January 17, 1994.
During one of our
conversations the IRS auditor told me that he had recently had a short time
period where he was basically unassigned to a case. During this time he was
sent downtown to the main local office where he was given the task of reviewing
tax returns for audit. The computer had made selections based on a proprietary scoring
of the returns. His job was to use his human experience and knowledge that had
still not been computerized and determine if the returns should be audited or
sent back without further scrutiny. So there would be two piles, “audit” or
“don’t audit.” But wait, it turns out there was a third pile. Apparently the
computer would score a tax return with a casualty loss deduction for further
analysis by a human such as this experienced IRS auditor. He told me that if
any of the returns had deductions related to the Northridge Earthquake he was
to put those in a third pile. Now he did not know what would be done with those
Northridge Earthquake casualty loss returns, but he assumed they would be sent
back to the file room, never to be seen again.
Then there was another time
that was in the local IRS office on an office audit. In this office the
examiners have cubicles which are only semi-private. I could not tell who was
in the next cubicle, but I could hear generalities of the conversation. The examination
was of a Northridge Earthquake loss. So apparently some returns were being audited.
Finally, in my ongoing
review of tax cases that taxpayers take to the courts when they disagree with
the IRS audit results, there are many that involve disasters and the proper
reporting of losses and insurance proceeds.
My personal experience is
that providing proper disclosure in a tax return always reduces the chances of
examination. The computer makes overall evaluations, but when that human looks
over the return and is able to see that all looks fairly reasonable on its
face, I believe that reduces the possibility of the auditor placing the return
in the “audit” pile.
I want to believe that the
IRS has gotten more sophisticated and may now look at returns in a different
way. For instance, do they look at all the returns from a specific Zip code and
look for the deductions that are likely to be out of the ordinary. The
extraordinary casualty loss does not necessarily mean that it is incorrect, but
it might garner additional attention. When preparing the return for filing,
there is no way of knowing what the neighbors reported on their returns.
One thing that I am certain
of is that a taxpayer who has a loss that is properly supported and documented
should not be intimidated by the possibility of an IRS audit. If the loss is
not claimed on the correct tax return where it should be claimed can be a problem.
Using the appraisal method and not including the appraisals is a problem. If
the appraisals do not meet the standards required by the IRs, that will be a
problem.
This is certainly one of
the situations where you go cheap on the preparation, it is likely that you are
risking an expensive audit. Your specific situation should be discussed with a
knowledgeable tax professional before taking on the responsibility of filing a
return for a disaster loss.
This blog,
“AccountantForDisasterRecovery.com” has been addressing taxpayer income tax
issues related to catastrophic losses for more than five years.
All rights to reproduce or quote
any part of the chapter in any other publication are reserved by the author.
Republication rights limited by the publisher of the book in which this chapter
appears also apply.
JOHN
TRAPANI
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Certified
Public Accountant
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2975
E. Hillcrest Drive #403
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Thousand
Oaks, CA 91362
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(805)
497-4411
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Contact us through our website at:
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Blog:
www.AccountantForDisasteRrecovery.com
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It All Adds Up For You
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This material was contributed by John
Trapani. A Certified Public Accountant who has assisted taxpayers since 1976,
in analyzing and reporting transactions of the type covered in this material.
Internal Revenue Service Circular 230 Disclosure
This
is a general discussion of tax law. The application of the law to specific
facts may involve aspects that are not identical to the situations presented in
this material. Relying on this material does not qualify as tax advice for
purpose of mounting a defense of a tax position with the taxing authorities
The
analysis of the tax consequences of any event is based on tax laws in effect at
the time of the event.
This
material was completed on the date of the posting
© 2013, John Trapani, CPA,
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