Are You Responsible for an Audit if You Prepared a Tax Return for Free?

If you prepared someone's tax return for free, will you need to be present if they are audited? Julian Block answers this question and addresses other topics in his latest post.

Feb 26th 2020
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Tax tidbits
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In twenty-three previous columns, I discussed my use of “tax tidbits” to enliven conversations when talking taxes with clients or speaking to groups like business owners, retirees, investors and home sellers. The tidbits discuss, among other things, IRS rulings and other announcements, law changes, court decisions and tactics that trim taxes for this year and even future ones.

I‘d like to share more of my favorites with you here.

“Income tax returns are the most imaginative fiction being written today.”—Herman Wouk, whose novels include Marjorie Morningstar and The Caine Mutiny.    

Profiles in courage: When Democrats and Republicans are able to reach across the aisle. However bitterly divided Congress continues to be on hot-button issues like immigration, voter registration and abortion, it’s a given that our lawmakers always unite in support of proposals to make it much easier to fill out 1040 forms and to simplify our Byzantine Internal Revenue Code. As you’d expect, hardly any of these proposals become law.

These efforts end up tangled up in politics. As for the ones that are enacted, most of them don’t reduce complexity. They tend to add to it. 

Plan ahead. Open a file now for this year and begin to save the information that you will need next year at 1040 time. 

The budget-strapped and under-funded IRS isn’t a paper tiger. The agency’s ever-vigilant computers bounced the return of an imaginative individual who claimed a theft-loss deduction for the cost of his unused dance lessons when it turned out the dance studio wouldn’t permit its instructors to date customers. An unsympathetic examiner refused to believe he’d been victimized by the studio and knocked out the entire deduction. So he tried to persuade the court. But it sided with the IRS. Merely because the studio had pretty instructors didn’t imply the girls would date customers.

Question. I did my neighbor a favor and filled out her 1040 for free. In case she’s audited, am I subject to those tough rules that penalize preparers who negligently or intentionally disregard IRS rules or regulations?

Answer. Fret not. The IRS applies those rules only to persons who prepare returns for compensation. For penalty purposes, the IRS doesn’t consider you to be “compensated” if she insisted on inviting you to dinner or mowed your lawn in return.

Losses on sales of year-round homes. While housing markets are buoyant in many parts of the country, they’re depressed in some places. Many people face the prospect of losing money when they unload their personal residences.

The tax code has never allowed write-offs for such losses. It treats them as nondeductible personal expenditures.

The IRS and the courts are adamant in their refusal to make any allowances for extenuating circumstances. For instance, an IRS ruling barred a deduction for a loss caused by a doctor-recommended move from a two-story to a one-story home to allow a child the maximum use of his wheelchair. 

The IRS is unmoved by the plight of a homeowner who is out of pocket because a job relocation triggered by a layoff, illness, death, divorce, or the like compelled a sudden sale before a home appreciated sufficiently to offset brokerage commissions, legal fees and other expenses involved in buying and selling.

Likewise, losses aren’t deductible when workers move to take new jobs or are transferred to new locations. But will tax relief become available if their employers reimburse them for the losses?

Here, too, an unyielding IRS says workers can’t offset otherwise nondeductible losses against the reimbursements, because they’re separate transactions. The losses stay nondeductible.

Will the IRS allow them to include reimbursements as part of the selling prices of their homes and avail themselves of profit exclusions of as much as $500,000? The reimbursements count as income, says the IRS.

Look for more tidbits in subsequent columns.

Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 300 and counting). 

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