Unreported income / IRS audit

[joanmcq]

Is this an audit or a CP2000 notice? Because of the year, I am supposing its an audit where they are looking at the huge amount of mortgage interest against the lack of income. How much interest was it? You only say they had a negative taxable income of 28K. Again, look at the refis and what was accquisition debt. The 1098s are accepted as proof of payment; what is probably being examined is what is accquisition debt, and how much is deductible. Then you get into the issue of unreported income. You say all the 1098s were for the primary residence? Or were they just reported as primary and/or secondary residence?

[JohnH]

Maybe Steve has figured this out by now, but just in case there's any doubt in his mind I'd like to suggest that he begin considering the real likelihood that there's probably MUCH more to this situation than just a little underrepoting of rental income.

[taxea]

And there is nothing better than a thorough questionaire/checklist or interview before the return is filed.taxea

[erchess]

Great Points Everyone

Steve I would like to hear whether you are really convinced that these people are honest and simply made a mistake however careless and or reckless it may have been.

The reason what you believe matters is that if they lied to you and are not ready to admit that to the IRS then I think that you risk your license by representing them. Also if they lied to you then I can't see a way around the conclusion that you prepared a fraudulent return because you did not do due diligence. I am sure no one would accuse you of intentional fraud but I believe you are exposed to penalties and perhaps you should seek representation for yourself. I trust that your E & O insurance is paid up.

On the other hand there may be facts that you have not listed that would make anyone see that the clients were at worst careless and reckless.

If you do decide they are honest, then you need to get a good Organizer (TTB has one that is free and I am sure AICPA and every other professional organization to which you belong has one whether free or not) and go through it with them making sure they answer all the relevant questions in their own handwriting and that includes any not on the organizer that may come up. It is safe to let them leave blank any questions for which the answers are deducible from something they gave or will give to you such as bank or brokerage statements, W2s etc. The point of the organizer is to document that you asked the questions. Now once you have asked and obtained a truthful written answer to every possible question about their financial lives including how they had the itemized deductions and other expenses they had on this income then you can prepare an amended return and either get it to the auditor before the interview or take it with you.

I thought I read that the IRS will not extend things beyond 1/9 because there has already been a ten day extension. As someone pointed out I believe that they have to give you 60 days. On the other hand you'll probably be more busy then than you are now so perhaps you don't want the extension or at least not that much of one.

By the way, I don't do a return without at least one real time conversation. That conversation can be on the phone or by Instant Messaging as long as they also get you the necessary papers. And I will willingly deal with only one member of a married couple as long as I get to speak briefly to the other member.

[FEDUKE404]

Careless or intentional ?

It's hard to tell, but my guess is the clients were giving you the "good" stuff (their perspective) such as the mortgage interest and ignoring the "bad" stuff such as the rental aspect. Whether they did so willingly, or as the result of a non-thorough interview, is unknown.

Several Forms 1098, especially if there was an indication of multiple addresses, should have been a very large and bright [color:red]red {/color}herring. If there was EITC involved, then my awareness level might have been even higher. With the new preparer penalties in place, I tend to ask a lot more questions these days than I ever did before, especially if I smell a potential tax-rat!

It's in the same category of employees who pay a lot of medical insurance.....they are programmed to think that is a deduction. After several questions, sometimes approaching "are you SURE?" levels, in virtually every instance the premiums are already pre-tax.

FE

[Kram BergGold]

Your options

I am assumning that 2006 was the first year for the rental income. If not then disregard this post.
Go to the audit with a corrected tax return and say the taxpayer's never told me there was rental income so here is a return with the necessary corrections. This may entice the examiner to call it a qucik day and not get into other stuff.

Go to the audit and provide info as it is requested. This may or may not be the better approach depending upon what else is problematic. A problem I see is if they refid after converting to rental and used proceeds for anything other than business or rental purposes the interest is non deductible. An arguement can be made that interest on any refi proceeds not used for the house or otehr business activity is non deductible as well.
Be prepared and keep us posted.

[joanmcq]

This is an audit; they don't have to give you an extension. And its too late to amend; you can't amend once the return is in audit. If they only got 10 days to provide the material, there is a good chance they were audited before. The only audit I've gotten from the IRS with only 10 days to provide info was when the client had been audited in the past and as the auditor said 'they should have good records after the last one'.

I think this is a big mess. Make sure you CYA if you prepared the return. But didn't the original post state all the mortgage interest was for one property?

[bonnieb]

It's been my experience that when you underreport, whatever the reason, if you disclose it at the beginning when you first meet with the auditor and let them know you just found it out, while it doesn't change the fact that tax is owed on it, they work with you better and seem to be more leinent on other items when they can. The mistake is there, and with that amount, they are going to find it, so I think it shows good faith if you just get it out there. Accidents do happen, but I agree with the person that said make sure where you are with this particular client before you go to the audit meeting. There may be some other things you don't know about. Document EVERYTHING.
Good luck!

[taxea]

In this case, it appears that not only does the income need to be reported but there may be several areas of the tax return that need to be corrected. I would do a 1040X to make all the corrections.

I agree that an audit for unreported income would not necessitate an amended return if it is a matter of just reporting the income and paying the liability it created. In this case the necessary adjustments may change the liability. The corrections will have to be detailed and what easier way to do that than to do an amended return and submit it to the auditor. taxea

[joanmcq]

This just in!

This just in from my tax update class; CA & the IRS are doing mortgage interest audits and are using 75K of mortgage interest as the trigger, since it is unlikely to pay that much and still be under the 1 million accquisition debt. I'd look over the whole return & 'fess up. In your case, they may end up doing a cash analysis too....and any deposits that can't be proven to be otherwise are considered income.

[S T]

More Info

Joan, can you start a new thread and share some of your information that you learned so we can be better prepared on what to look for as we are preparing 2008 returns.

Thanks,

Sandy