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#21 Red Flags for an IRS Audit + 2022 Tax Changes

#21 Red Flags for an IRS Audit + 2022 Tax Changes

May 12, 2023

The 2022 Tax Year has a number of major changes that could radically alter the refunds you expect to receive ... or the amount you expect to pay in federal income taxes.

In this episode, we cover these changes in detail, along with 5 red flags from your tax return that could increase your chances of an IRS audit!


CNBC Red Flags Article

2022 Form 1040


Brenton: It's almost time to file your 2022 taxes, and there have been some changes that could impact the amount of refund you're due to receive or the amount you owe in federal taxes. In this episode, we tell you about some of those changes and some of the red flags on your tax return that could put you at risk of a IRS audit.
Let's get started.
Hello, my name is Brenton Harrison of New Money, new Problems, and your host for the New Money New Problems podcast. I hope you joined us for the previous episode where we did a primer on federal income tax returns and gave you an idea of some of the tax terminology that you need to know to be informed so that when you read about tax changes, you're not left in the dark.
And in this episode, we're gonna take those lessons further and put some of them into practice as we talk about some things that could be a red flag on a tax return.
To me, the reason this is important is because in my opinion, when you reach a certain income, the juice is worth the squeeze to use a professional tax preparer.
If you're following along [00:01:00] with us on screen on our YouTube channel, we have up on the page a blank 1040, which is almost like the summary of a federal income tax return.
The very last thing you see on a federal 10 40 is a section where you have to identify whether you prepared this yourself, in which case it would say self prepared in this section, or if you used a paid preparer, an enrolled agent, a cpa, and if you did in this section, They have to list their business information, their contact information, all of the things the IRS can use to first look at the tax return. Then look and verify the credentials of the preparer in their efforts to decide whether or not a return should be audited. So to me, maybe it's just my opinion, but I think this is the IRS signaling that if you are a high income earner, if you are claiming a lot of complex things on your return and you prepared this yourself, they're going to go above and beyond to say, did this person do this, return [00:02:00] the right way? And if not, we're gonna put them higher at a risk of a potential audit. .
I brought this up before we share an article that we're gonna go back and forth from in the first part of this episode. And this article was actually written by a friend of mine, a person named Kate Dore, who's a writer, uh, for CNBC, and it's entitled, 'don't Risk a Tax Audit. Here are four reasons the IRS may flag your return.'
So consider my reason, the official fifth reason, even though it's not a part of this. But I wanted to start with that before sharing some of the red flags that they shared in this article. The first red flag that they identified are excessive credits or deductions as compared to your taxable income.
They give an example of a person who makes a hundred thousand dollars but claims $70,000 in charitable deductions.
We talked about the fact that when you file your tax return, you can take what's called the standard deduction, which is a certain amount that they give to any taxpayer. In 2022 [00:03:00] for an individual, it's $12,950.
For a couple that's married, falling jointly, it's $25,900 and you can claim that amount to reduce your taxable income no matter what. But there are some people who believe that they have deductions that exceed those numbers and to further their taxable income reduction even more, they decide to itemize their deductions and list out all of the things for which they believe they're eligible.
So if the IRS looks and you are claiming substantial itemized deductions, it's not always about whether those deductions are misleading or deception. Sometimes it's just about whether or not you did it accurately or inaccurately.
And when you claim substantial deductions and credits, it puts you higher on the list of people that they want to verify.
The next red flag is missing income, and this is all about the income that you claim as part of your gross income on your tax return versus the corresponding tax documents that [00:04:00] those entities submit to the irs. Here's what I mean by corresponding documents. If the only income that you received in a given year is a w2, you receive a W2 from your employer that says how much money you make.
and they also send a report of that income to the irs. So if you decided to not claim that W two income, there is a corresponding entity that has told the IRS that you made that money. For a person who's a 1099 contractor who might do business with various entities throughout the year, like myself, in any given year, I might have 10 to 12 different 1099s that are given to me as an independent contractor. And if I file my taxes before I verify whether or not I received all my 1099s, I could have two or three that are missing where I am not paying taxes on that income, but the IRS knows that they've received documentation saying that I did earn it.
In the article, they talk about specific tax documents for not just things like [00:05:00] independent contractors where you might receive something like a Form 1099 N E C. They also talk about things like 1099 B for investment earnings. If you have a taxable investment account, you at the end of the year get a tax document that says how much investment income you receive.
If you're divorced, depending on the year in which you became divorced, if you receive alimony, even alimony can be considered in some cases taxable income. So you need to make sure that for everything you received, you have documentation you file to say that you are paying taxes on it, cuz even if you don't send in that documentation, somebody or some other company is doing so on your behalf.
The next red flag refundable tax credits. In the episode where we talked about credits, we shared that some credits are refundable and some are non-refundable. A refundable credit is one that will allow you to go beyond zero, even if you don't owe taxes at all.
As an [00:06:00] example, let's say that I owed $5,000 in taxes and I had $10,000 in tax credits to take against that amount. Well, I technically am owed $5,000, and if those are refundable credits, I might receive all or a portion of those $5,000. In this article, the reason they talk about refundable credits is because, as I shared, they're very valuable. After the break.
When we talk about refundable credits, you'll see why. But if the IRS sees that you are claiming multiple or complex refundable credits, they're going to want to verify that you are actually eligible for those credits.
And then lastly, round numbers. When you talk about things like below the line deductions, things like a charitable contribution, things like a home office deduction if you are a person who is a business owner and is trying to claim that on your tax return. If you say that you had advertising expenses that were exactly $2,000. In the [00:07:00] article, they gave the example of someone who paid exactly $3,000 for legal expenses. That looks fishy and it's something that they might want to substantiate. So you want make sure if you are claiming something, that you're claiming it honestly, but you also have the receipt and the documentation to back it up.
After the break, we'll go back to the subject of refundable versus non-refundable credits. And we'll give you the example of a tax change in 2022 as compared to 2021 that will have a monumental impact on some filers with dependent children.
Before the break, I teased that there could be some big changes coming to the tax returns of people who have dependents living in their household. Well, the changes that I was alluding to are reflected in the child tax credit and the child and dependent care tax credit.
These are two different tax credits, both of which were modified as a result of pandemic related relief, but those modifications expired in the tax year 2022. And I want to make [00:08:00] sure you're aware of what they were in 2021 versus what they will be in 2022.
First, let's explain what the child tax credit is. This is a tax credit that's available to anyone who has eligible dependent in their care, regardless of the expense.
The child tax credit is a very forgiving credit in the sense that you have to make a significant amount of money before the amount of credit you can claim is actually reduced.
Now in terms of whether this is a refundable or a non-refundable credit, this is a partially refundable credit. So it is something that is very important because you can, in this credit, go beyond zero in terms of what you owe in taxes and what you're eligible for in credits. In 2021, they expanded the child tax credit and they allowed you to claim up to $3,600 per child who was under the age of six.
And if your child was over the age of six, but under the age of 18, you could claim $3,000 for [00:09:00] that dependent. So let's use the example of a person who has two children that are dependents under the age of six. In 2021, they could have claimed $3,600 per child for $7,200 of total partially refundable tax credits.
In 2022, however, they have drastically reduced the amount that you can file and gone from either 3,600 or 3000 down to $2,000 of flat credits per dependent, no matter their age. If they're under 17, the above six or below six no longer matters.
It's $2,000. So right off the bat, if you're looking at the example of a person who had two children under six that qualified, they have gone from $7,200 in potential credits, which they could receive a portion of that in the amount of a refund down more than $3,000 to $4,000 worth of credits.
That is significant, but it pales in comparison to the changes they made to another tax credit called the [00:10:00] Child and Dependent Care Credit.
The child and Dependent care Credit is something that's meant to benefit people who have to pay childcare expenses so that they can work. Now I say so that you can work. So you understand that not everybody gets to claim these expenses, even if you have them. As an example, if you are not working, you cannot claim this credit. You can't just send your kids and pay for daycare and stay at home. If you are married filing jointly even if you are working, if your spouse is not working, you can't claim the credit unless you can prove that your spouse is not working because they're something like a full-time student.
Now, in a typical year, this was not a refundable tax credit, so you could claim it, but you could not take it beyond zero. Additionally, in typical years, the amount of income past which point they reduced what you can claim was pretty low. As a matter of fact, if you earned more than like $15,000, the amount of your expenses that you could claim went down [00:11:00] precipitously as your income continued to increase. In 2021, however, they expanded the child and dependent care tax credit pretty significantly. The first thing they did is they increased the cap to which point you could earn money without seeing that percentage of expenses you could claim be reduced. But the other thing that they did was they increased the credit itself and they made it refundable. If you're looking at what they increased it to in 2021, if you had one dependent that was receiving care as a function of you being able to work, you could claim up to $4,000 of eligible expenses, and if you had two or more, you could claim a total of $8,000 of eligible expenses as a refundable credit. In 2022, they have dropped that income limit back down, where once you have earned above $15,000, the portion of your expenses you can claim starts to reduce, but they have also reduced the credit substantially.
Instead of you being able [00:12:00] to claim $4,000 for one child, $8,000 for two or more. You can claim $1,050 for one child and $2,100 total for two or more.
So in our example of a person who has two children under six, we've already covered how with the child tax credit, they went from over $7,000 of eligible partially refundable tax credits down to around 4,000. In this case, we've gone from $8,000 of potentially refundable tax credits down to a little over $2,000 of non-refundable tax credits. These two things alone could upend your expectation of the return, the refund, or the amount you owe from 2021 as it relates to 2022.
And I'm hoping that it not only illustrates the need for a tax professional, but also illustrates the need for you to be informed as to things like how taxes work, so that when you see articles like this fly across your desk, you know that they're relevant to you and you [00:13:00] have a better leg up of understanding what they're discussing.
So we're gonna continue these tax conversations as we lead up to the April 15th deadline.
And if you want to hear more about this topic or submit a request for another episode, we might cover, you can do so by not only joining our email list, but sending an email to info new money new We'll see you next time.