IRS Errors that Cost You Money
College tuition payments, interest income from U.S. savings bonds and health care expenditures from qualifying plans can all cause income tax reporting errors that cost you money.
Taxpayers generally view the Internal Revenue Service as one sided: If mistakes are found where the taxpayer owes more money they will pursue collection; if the IRS finds an error in the taxpayer’s favor they won’t tell them.
The IRS corrects significant errors found and sends notification to the taxpayer regardless of whether the taxpayer owes more money or a refund is due.
While the IRS verifies many of the items on a 1040, not all information is separately reported to them. Even more troubling are 1099s reporting income of the taxpayer but not the corresponding deduction.
Three 1099s taxpayers receive reporting income that the IRS won’t receive information for corresponding deductions are 1099-Q Payments From Qualified Tuition Programs, 1099-INT Interest Income, and 1099-SA Distributions From an HSA, Archer MSA, or Medicare Advantage MSA.
A taxpayer receiving one of these 1099s needs to be aware they may not result in taxable income.
The 1099-Q reports in box 1 gross distributions, box 2 earnings and box 3 basis. A taxpayer with a child in college that wisely invested in the Washington State GET program receiving a 1099-Q might mistakenly report the taxable income. If the child is in college, and qualifying expenses exceed the gross distribution, then not only is there no tax, nothing even has to be reported on the 1040. While the IRS should have received a 1098-T Tuition Statement from the college, it may not have all qualifying tuition and related expenses.
We have had clients receive letters from the IRS with a notice of tax due attributable to unreported income from the 1099-Q. The response – it wasn’t required to be reported (included with the response is evidence of the qualifying deductions) and no tax is due. I suspect many taxpayers receiving such a letter from the IRS write a check when they don’t need to.
Unless earnings from a qualified tuition program are taxable, the earnings are not entered in the tax return. For more information see IRS Publication 970.
If grandparents bought a US EE Savings Bond, the interest reported on 1099-INT may be excludable from income to the extent of qualified higher education expenses paid during the year by preparing Form 8815.
While at least the IRS receives a 1098-T reporting deductions that will offset revenue on a 1099-Q, the IRS only receives the revenue on a 1099-SA.
In the case of a taxpayer with a Health Savings Account, if a $2,000 normal distribution is requested for reimbursement of qualifying medical expenses, that amount is reported in the Taxpayer’s 1040 on Form 8889, Health Savings Accounts, line 14a. Unreimbursed qualifying medical expenses must also be reported separately on line 15. As always, retain receipts and supporting documents.
If you receive a letter from the IRS with a notice of amount due whether for these 1099s or any other items, carefully review the items identified and related documents you have. Often times the IRS does have all of the information to make a proper assessment, and in that case they very well may err in the government’s favor.
If you had your tax return prepared for you, always consult with the preparer before responding or writing a check.
Barry Warner is managing partner with Alegria & Company, PS. He can be reached at firstname.lastname@example.org