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Página Principal (en inglés)
4.19.15 Discretionary Programs
Esta página no está traducida al español porque no hay traducción disponible en el idioma que ha elegido.
4.19.15.1 Program Scope and Objectives
4.19.15.1.1 Background
4.19.15.1.2 Authority
4.19.15.1.3 Roles and Responsibilities
4.19.15.1.4 Program Management and Review
4.19.15.1.5 Program Controls
4.19.15.1.6 Terms/Definitions/Acronyms
4.19.15.1.7 References
4.19.15.2 Child and Dependent Care Credit
4.19.15.3 Education Tax Benefits - General Requirements and Exam Programs
4.19.15.3.1 American Opportunity Tax Credit (AOTC) and Lifetime Learning Credit
4.19.15.3.1.1 Education Tax Credits - Evaluating Taxpayer Responses
4.19.15.3.2 Tuition and Fees Deduction
4.19.15.4 Mortgage Interest Credit
4.19.15.4.1 Initial Contact
4.19.15.4.2 Conducting the Examination
4.19.15.4.3 Evaluating Taxpayer Responses
4.19.15.4.4 Form 886-A Explanations and Tax Resources
4.19.15.5 Adoption Credit and Qualified Adoption Expenses (QAE)
4.19.15.5.1 Eligible Child – Claiming the Credit or Exclusion
4.19.15.5.1.1 Determining the Year a Foreign Adoption Becomes Final
4.19.15.5.1.2 Non-Hague Adoptions
4.19.15.5.1.3 Hague Adoption Convention, Adoptions
4.19.15.5.1.4 Custodial Agreements Followed by Adoption in the United States
4.19.15.5.2 Research and Initial Contact
4.19.15.5.3 Evaluating Responses
4.19.15.5.4 Special Needs Adoptions
4.19.15.5.5 Carry Forwards
4.19.15.5.6 Credit Limitations
4.19.15.6 Tax Benefits for Kidnapped Children
4.19.15.7 Questionable Refund Cases
4.19.15.8 Alternative Minimum Tax
4.19.15.8.1 Alternative Minimum Tax Procedures
4.19.15.9 Estate and Gift Tax
4.19.15.10 Math/Clerical Error
4.19.15.11 Non-Earned Income Tax Credit Duplicate TIN (Non-EITC DUP TIN)
4.19.15.11.1 Initial Contact
4.19.15.11.2 Processing Taxpayer Replies
4.19.15.11.3 Related Taxpayer(s)
4.19.15.12 Self-Employment Tax (SET)
4.19.15.12.1 Self-Employment Tax Procedures
4.19.15.13 SS-8 Determination of Worker Status
4.19.15.14 Partnership-level Proceedings
4.19.15.14.1 Form 8082, Notice of Inconsistent Treatment and Administrative Adjustment Request (AAR)
4.19.15.15 Unallowable Code (UA) Program
4.19.15.15.1 Unallowable Code Assignment and AIMS Opening
4.19.15.15.2 Identifying Unallowable Inventory to be Classified
4.19.15.15.3 Reviewing and Classifying Unallowable Inventory
4.19.15.15.4 Initial Taxpayer Contact
4.19.15.15.5 Processing Reply/No Reply Unallowable Cases
4.19.15.15.6 Transcripts
4.19.15.15.6.1 Resolving the -Q Freeze
4.19.15.15.7 Unallowable Program and Alternative Motor Vehicle, Electric Plug In Credit or Electric Drive Motor Vehicle Credit
4.19.15.15.8 Unallowable Program and First Time Homebuyer Credit
4.19.15.15.9 Unallowable Program and Health Coverage Tax Credit
4.19.15.15.10 Unallowable Program and the District of Columbia First-Time Homebuyer Credit Carryforward
4.19.15.16 Fuel Tax Credit Claimed on Form 4136
4.19.15.17 Erroneous Refunds
4.19.15.18 Alimony
4.19.15.18.1 Initial Contact and General Processing
4.19.15.18.2 No Reply
4.19.15.18.4 Workpapers
4.19.15.18.5 Research
4.19.15.18.6 Documentation
4.19.15.18.7 Legal Terminology
4.19.15.18.8 Death Contingency
4.19.15.18.9 Pension Income
4.19.15.19 What is DIF CORR (Source Code 06)
4.19.15.19.1 Procedures for DIF CORR (Source Code 06)
4.19.15.20 Schedule A
4.19.15.20.1 Nondeductible Medical Expenses
4.19.15.20.2 Taxes Paid
4.19.15.20.3 Home Mortgage Interest Deductions
4.19.15.20.3.1 General Requirements
4.19.15.20.3.2 Evaluating Taxpayer Responses
4.19.15.20.3.3 Limits on the Home Mortgage Interest Deduction
4.19.15.20.3.4 Excess Mortgage Interest Deduction – IRC 163
4.19.15.20.3.4.1 Computing the Limit on the Mortgage Interest Deduction
4.19.15.20.3.4.2 Evaluating Excess Mortgage Interest - Taxpayer Responses
4.19.15.21 Charitable Contributions
4.19.15.21.1 Qualifying Payments
4.19.15.21.2 Qualifying Organizations
4.19.15.21.3 Cash and Non-cash Contributions
4.19.15.21.4 Amount of Contribution Deduction
4.19.15.21.4.1 Acceptable Documentation for Charitable Contributions
4.19.15.21.4.2 Limitations on Contributions
4.19.15.21.4.3 Additional Research Material
4.19.15.21.4.4 Charitable Contribution Rules - Project Code 0391, Project Code 0392 and Project Code 0629
4.19.15.21.4.4.1 Initial Contact
4.19.15.21.4.4.2 No Response Cases
4.19.15.21.4.4.3 Processing Taxpayer Replies to Letter 566-S/566-T for TDC cases
4.19.15.21.4.4.4 Closing Actions
4.19.15.22 Casualty and Theft Losses
4.19.15.23 Employee Business Expense (EBE) Cases
4.19.15.23.1 Evaluating EBE Taxpayer Responses
4.19.15.23.2 Additional Information
4.19.15.24 Miscellaneous Deductions - IRC 67
4.19.15.25 Return Preparer Referrals
4.19.15.25.1 Role of the Exam RPP Coordinator
4.19.15.25.2 Referral Process and AIMS Opening
4.19.15.25.3 Controlling RPP Returns
4.19.15.25.4 Procedures for Examining RPP Cases
4.19.15.25.5 Examining the Schedule A on Preparer Referrals
4.19.15.25.6 Examining the Schedule C on Preparer Referrals
4.19.15.26 Correspondence Exam Tip Program
4.19.15.26.1 Commonly Used Terms
4.19.15.26.2 Contents of Case File
4.19.15.26.3 Case Processing –General Information
4.19.15.26.3.1 Filed Returns – Initial Contact
4.19.15.26.3.2 Non-Filers
4.19.15.26.4 Case Processing – Revised Reports and Responses to 90-day Letters
4.19.15.26.5 Case Processing – Closing Actions and Other Information
4.19.15.27 10 Percent Additional Tax on Early Distributions – IRC 72(t) & IRC 72(q)
4.19.15.27.1 Procedural Instructions
4.19.15.28 Gambling Issues (Income and Losses) - General Casual Gamblers
4.19.15.28.1 Initial Contact for Gambling Income
4.19.15.28.2 Evaluating Gambling Issue Responses
4.19.15.28.2.1 Gambling Losses – IRC 165(d)
4.19.15.28.2.2 Gambling Income
4.19.15.28.2.3 Replies – General Processing
4.19.15.28.2.4 No Response Cases
4.19.15.28.3 Special Gambling Closing Procedures
4.19.15.29 Health Coverage Tax Credit – IRC 35
4.19.15.29.1 HCTC Case Selection & Classification
4.19.15.29.2 Research for HCTC Cases
4.19.15.29.3 Initial Contact & No Response Procedures
4.19.15.29.4 HCTC Responses
4.19.15.29.5 Case Closure
4.19.15.30 Self-Employed Health Insurance Deduction – IRC 162(l)
4.19.15.30.1 Self-Employed Health Insurance Deduction
4.19.15.30.2 Initial Contact Letter
4.19.15.30.3 Evaluating Responses
4.19.15.30.4 Potential Documentation
4.19.15.30.5 Resources To Assist In Technical Determination
4.19.15.30.6 Replies – General Processing
4.19.15.31 Form 1040, Schedule C - Correspondence Examination
4.19.15.31.1 Sharing Economy Tax Center
4.19.15.31.2 Schedule C - Car and Truck Expenses
4.19.15.31.3 Schedule C - Travel Expenses
4.19.15.31.3.1 Schedule C - Meals and Entertainment Expenses for TY 2018-2025
4.19.15.31.4 Schedule C - Mortgage Interest
4.19.15.31.5 Schedule C - Legal and Professional Fees
4.19.15.31.6 Schedule C - Repairs and Maintenance
4.19.15.31.7 Excess Business Losses for TY 2018 - TY 2025
4.19.15.31.8 Schedule C Referrals from the Social Security Administration
4.19.15.31.9 Project Code 0288, Questionable Schedule C with EITC
4.19.15.32 Return Preparer Analysis Tool (RPAT) Program
4.19.15.33 CI Education Credit Program
4.19.15.34 Child Tax Credit (CTC), Additional Child Tax Credit (ACTC), Refundable Child Tax Credit, and Credit for Other Dependents (ODC)
4.19.15.34.1 Programs and Initial Contacts
4.19.15.34.1.1 Individual Taxpayer Identification Number (ITIN) ACTC
4.19.15.34.1.1.1 ITIN ACTC - Acceptable Documentation
4.19.15.34.2 ITIN and Employment-Related Identity Theft
4.19.15.35 Conversion of Invalid Form 1120S Cases - Background
4.19.15.35.1 Identifying the Form 1120S Return to be Examined
4.19.15.35.2 Examining the Converted Form 1120S Return and Adjusting the Shareholders Returns
4.19.15.36 Moving Expenses – IRC 217
4.19.15.36.2.1 Distance Test
4.19.15.36.2.2 Time Test
4.19.15.37 Multiple Filers
4.19.15.37.1 Scenarios and Contact Procedures
4.19.15.37.2 Non-Joint Return is Valid or Considered the Return of Record - Remove Secondary from Joint Return
4.19.15.37.3 Joint Return is valid or Considered the Return of Record - Combine Non-Joint to the Joint Return
4.19.15.38 Qualified Plug-In Electric Drive Motor Vehicle Credit
4.19.15.38.1 Special Situations and Replies
4.19.15.38.2 Taxpayer Explanations for Form 886-A
4.19.15.39 Residential Energy Credits
4.19.15.39.1 Nonbusiness Energy Property Credit
4.19.15.39.2 Residential Energy Efficient Property Credit
4.19.15.39.4 Taxpayer Replies
4.19.15.40 Premium Tax Credit - IRC 36B
4.19.15.40.1 Premium Tax Credit Eligibility
4.19.15.40.2 Common Terms
4.19.15.40.3 PTC Project Codes
4.19.15.40.4 Case Selection
4.19.15.40.5 Research and Initial Report Writing
4.19.15.40.6 Creating the PTC Issue(s)
4.19.15.40.8 Closing Procedures
4.19.15.41 Campus Employment Tax Non-Filer Program
4.19.15.41.1 Employment Tax Non-Filer Initial Contact Letter
4.19.15.41.2 Employment Tax Non-Filer Responses
4.19.15.41.3 Second Contacts
4.19.15.41.4 Complete Form 13496-A Certification
4.19.15.41.5 Undeliverable Mail
4.19.15.41.6 Closures
4.19.15.41.7 Penalties
4.19.15.41.8 Failure to Deposit Penalty (TC180)
4.19.15.41.9 Failure to File Penalty (TC 160)
4.19.15.41.10 Request for Penalty Relief
4.19.15.41.11 FUTA Certification
4.19.15.41.12 Signatures
4.19.15.41.13 Case Assembly
4.19.15.41.14 Identity Theft - BMF Accounts
4.19.15.41.15 Partials
4.19.15.41.16 General Information for Reconsiderations
4.19.15.41.16.1 Taxpayer Advocate Service (TAS) Cases
4.19.15.41.16.1.1 Form 3870 Request for Adjustment
4.19.15.41.16.2 Controlling the Case
4.19.15.41.16.3 Examiner Procedures
4.19.15.41.16.3.1 Unsigned Return
4.19.15.41.16.3.2 Signed Return
4.19.15.41.16.4 Closing Procedures
4.19.15.41.16.5 Telephone Contact
4.19.15.41.16.6 Replies to Disallowance Letters (105C, 106C and 916C)
4.19.15.41.16.7 Statute of Limitations
4.19.15.41.16.8 RSED on Original Return
4.19.15.42 General Business Credit
Part 4. Examining Process
Chapter 19. Liability Determination
Section 15. Discretionary Programs
Manual Transmittal
(1) This transmits revised IRM 4.19.15, Liability Determination, Discretionary Programs.
Material Changes
(1) IRM 4.19.15.1, Program Scope and Objectives - Editorial changes and Paragraph 1 moved to IRM 4.19.15.1.1 Background.
(2) IRM 4.19.15.1.3, Roles and Responsibilities - Updated employee responsibility to act in accordance with Taxpayer Bill of Rights.
(3) IRM 4.19.15.1.6, Terms/Definitions/Acronyms - Added Taxpayer Digital Communication (TDC) Acronym to chart.
(4) IRM 4.19.15.2, Child and Dependent Care Credit - Updated "A Qualifying Person" "Verifying Information" chart with 2020 and 2021 gross income amounts for a disabled dependent. Added note to explain the American Rescue Plan Act revision for tax year 2021.
(5) IRM 4.19.15.3, Education Tax Benefits - General Requirements and Exam Programs - Added to Note in paragraph 1, third bullet, the Tuition and Fees Deduction was extended for tax years 2018, 2019, and 2020. Updated link to international school listings websites.
(6) IRM 4.19.15.3.1, Lifetime Learning Credit and American Opportunity Tax Credit (AOTC) - Updated the Lifetime Learning Credit Only chart with Modified Adjusted Gross Income phase out amounts for tax year 2020, between $59,000 and $69,000 (joint return: $118,000 and $138,000).
(7) IRM 4.19.15.3.2, Tuition and Fees Deduction - Paragraph 1 changed AGI to MAGI limitations to claim a Tuition and Fee Deduction. Paragraph 10, added link to revision of Form 8917 allowing taxpayers to retroactively deduct for 2018.
(8) IRM 4.19.15.4.1, Initial Contact - Removed 4549 and 4549EZ from paragraph 1.
(9) IRM 4.19.15.5, Adoption Credit and Qualified Adoption Expenses (QAE) - Updated links. Paragraph 7, note added that the TC766 with CRN 261 is only applicable to tax years 2010 and 2011, when it was refundable.
(10) IRM 4.19.15.5.2, Research and Initial Contact - Added Taxpayer Digital Communications (TDC) letter 566-T reference for future use.
(11) IRM 4.19.15.5.5, Carry Forwards - Corrected paragraph 1, third bullet, last sentence 'adoption credit first allowable in 2014, not 2104.
(12) IRM 4.19.15.5.6, Credit Limitations - Updated Current and Prior Year Credit Limitation chart; Maximum Tax Credit amount for tax year 2020, $14,300, and updated MAGI Phaseout amount for 2020, $214,250-$254,520. Some editorial changes made.
(13) IRM 4.19.15.8.1, Alternative Minimum Tax Procedures - Updated references to 692SC/CG to reflect revised letter 692-M and include TDC letter 692-T.
(14) IRM 4.19.15.10, Math/Clerical Error - Removed paragraph 2, reference to First-time Homebuyer Credit and Long Time Resident Credit since this inventory is no longer received.
(15) IRM 4.19.15.11.1, Initial Contact - Updated link and added reference to TDC combo letter 566-J.
(16) IRM 4.19.15.12.1, Self-Employment Tax Procedures - Updated links and added references to TDC letter 525-T.
(17) IRM 4.19.15.13, Determination of Worker Status - Editorial changes made and updated link in paragraph 2.
(18) IRM 4.19.15.14, Partnership-level Proceedings - Changed title from TEFRA (Tax Equity and Fiscal Responsibility Act). Added reference to the Centralized Partnership Audit Regime (BBA) Filed Examination Procedures regarding partnerships subject to TEFRA for tax years beginning before January 1, 2018 and to the Bipartisan Budget Act of 2015 (BBA) for tax years after January 1, 2018.
(19) IRM 4.19.15.14.1, Form 8082, Notice of Inconsistent Treatment and Administrative Adjustment Request (AAR) - Added clarification IRC 6241, prior to amendment by the BBA.
(20) IRM 4.19.15.15.1, Unallowable Code Assignment and AIMS Opening - Removed UA code 83 from the table in paragraph 3, updated IRM links in paragraph 4 Note.
(21) IRM 4.19.15.15.4, Initial Taxpayer Contact - Changed paragraph 4 to suspend the case 30 days instead of 45 days.
(22) IRM 4.19.15.15.5, Processing Reply/No Reply Unallowable Cases - Added reference to the TDC letter 525T in the If Then chart.
(23) IRM 4.19.15.15.11, Unallowable Program and a Personal Casualty or Theft Loss - Entire section removed since no longer coded on tax returns.
(24) IRM 4.19.15.18, Alimony - Changed title from Separate Maintenance. Paragraph 1 revised to provide a clear overview and definition of the program. Note from (3)b deleted and moved to (1).
(25) IRM 4.19.15.18.1, Initial Contact and General Processing - Deleted divorce or separation from sentence.
(26) IRM 4.19.15.18.4, Workpapers - Added reference links for additional information regarding payment instruments Paragraph 2, 4th bullet.
(27) IRM 4.19.15.18.5, Research - Added reference link to IRC 71 to define payment requirements.
(28) IRM 4.19.15.18.8, Death Contingency - Added reference links to IRC 71 and Publication 504 to clarify termination requirements of qualifying alimony payments upon death of the payee.
(29) IRM 4.19.15.18.9, Pension Income - Revised (1) to provide a detailed explanation of how to consider and treat a Qualified Domestic Relations Order (QDRO). Removed OPM Reporting and revised (2) to provide a detailed explanation of how to consider and treat a military pension paid by the Defense Finance and Accounting Services(DFAS). Revised (4) Disability Pensions to provide a detailed explanation how to consider and treat a disability pension.
(30) IRM 4.19.15.20.2, Taxes Paid - Added clarification to (6) for tax years 2018 through 2025, a taxpayer's total deduction of either state and local general sales taxes and state and local income taxes deduction is limited.
(31) IRM 4.19.15.20.3.2, Evaluating Taxpayer Responses - Updated links in paragraph 4 and corrected beginning in 2018, the Mortgage Interest Credit from Form 8396 is reported on Form 1040, Schedule 3, not Schedule 1.
(32) IRM 4.19.15.20.3.4, Excess Mortgage Interest Deduction - IRC 163 - Updated (3) with reference to initial contact letter, 566-T for TDC cases.
(33) IRM 4.19.15.21, Charitable Contributions - Added two new paragraphs to provide guidance on deducting contributions when an individual does not itemize for tax years 2020 and 2021.
(34) IRM 4.19.15.21.4.1, Acceptable Documentation for Charitable Contributions - Added clarification to the table in (1) regarding contributions of motor vehicles, clothing, household items, and Easements in Registered Historic Districts.
(35) IRM 4.19.15.21.4.2, Limitations on Contributions - Added limitations to (1) for tax years 2018 through 2025.
(36) IRM 4.19.15.21.4.4.1, Initial Contact - Added in (1), in the table, column labeled "Issue Letter " , that 566-T should be issued on TDC cases.
(37) IRM 4.19.15.21.4.4.2, No Response Cases - Added in (1), in the table, column labeled "Latest Letter issued" and column labeled "Action" , that 566-T, 525-T, and 692-T letters should be issued on TDC cases.
(38) IRM 4.19.15.21.4.4.3, Processing Taxpayer Replies to Letter 566-S/566-T for TDC cases - Changed title to include TDC letters for TDC cases." If And Then" chart updated throughout to include references to TDC letters on TDC cases.
(39) IRM 4.19.15.21.4.4.4(1), Closing Actions - Updated table, "If the Taxpayer Then" throughout to include references to TDC letters on TDC cases.
(40) IRM 4.19.15.22(1), Casualty and Theft Losses - Added new bullet that includes a table to show dollar requirements for deduction by tax year. Added a note to provide guidance on losses attributable to the California wildfires. Added new paragraph to define the three types of casualty losses that refer to federally declared disasters; Federal Casualty Loss, Disaster Loss, and Qualified Disaster Loss.
(41) IRM 4.19.15.23, Employee Business Expense (EBE) Cases - Added clarification beginning after December 31, 2017, Armed Forces reservists, qualified performing artists, fee-basis state or local government officials, or employees with impairment-related work expenses, are the only employees that can use Form 2106.
(42) IRM 4.19.15.23.1, Evaluating EBE Taxpayer Responses - Added note to (1) amounts paid or incurred after December 31, 2020 and before January 1, 2023, for food and beverages provided by a restaurant are 100 percent deductible. Added a link to (9) to Notice 2021-25 pertaining to food or beverage provided by a restaurant limitations.
(43) IRM 4.19.15.23.2, Additional Information - Updated (1) Notice 2018-76 reference to Notice 2021-25. Added a bullet item for Treasury Regs regarding sporting events.
(44) IRM 4.19.15.26(3), Correspondence Exam Tip Program - Clarification added to define the different case types.
(45) IRM 4.19.15.26.1, Commonly Used Terms - Added clarification in (1), throughout the Definition/Description column of the table to describe the Terms used in the Tip Income Program.
(46) IRM 4.19.15.26.2, Contents of Case File - Added clarification that data collected for examination selection includes data for non-participating employees of a tip agreement and rarely a non-filer.
(47) IRM 4.19.15.26.3.1, Filed Returns – Initial Contact - Separated Paragraph 14 to make information clear and concise. Created new paragraph 15. Removed If and Then chart for processing cases with imminent statutes.
(48) IRM 4.19.15.26.3.2(5), Non-Filers - Added IRM link to provide procedural guidance when asserting penalties. Added a new paragraph (7), to provide an IRM link for partial and closing procedures.
(49) IRM 4.19.15.26.4, Case Processing - Revised Reports and Responses to 90-Day Letters - Updated to include new letter revision numbers and TDC letters.
(50) IRM 4.19.15.26.5(2), Case Processing – Closing Actions and Other Information - Updated If/Then chart to complete a partial prior to the issuance of the 90 day letter when the taxpayer does not respond to the 15/30 day letter and to use a Posting Delay Code 1 when taxpayer agrees to the 90 day letter or the case defaults.
(51) IRM 4.19.15.27, 10 Percent Additional Tax on Early Distributions - IRC 72(t) & IRC 72(q) - Added to third paragraph the payer will not know if a taxpayer is using a distribution for a qualified birth or adoption.
(52) IRM 4.19.15.27.1(3), Procedural Instructions - Added information to the 'If' box of the first row 'or 55 or older and meets exception per Tables A and B
(53) IRM 4.19.15.27.1(7), Procedural Instructions - Added a bullet to the chart (Form 886-A Standard Explanation for Qualified Retirement Plans) labeled Additional tax of 10 percent due to the early distribution made from your qualified retirement plan, to include qualified birth or adoption distribution.
(54) IRM 4.19.15.27.1(7)(a)(under the note), Procedural Instructions - Added a bullet to the chart (Form 886-A Explanation for Individual Retirement Account (IRA)), labeled 'Additional tax of 10 percent due to the early distribution made from your Individual Retirement Account(IRA)', to include qualified birth or adoption distribution.
(55) IRM 4.19.15.27.1(10), Procedural Instructions - Added the exception, qualified birth or adoption, to Table A.
(56) IRM 4.19.15.27.1(12), Procedural Instructions - Added the exception qualified birth or adoption and the acceptable documentation needed to verify to Table B.
(57) IRM 4.19.15.28, Gambling Issues (Income and Losses) - General Casual Gamblers - Updated for tax years 2019 and subsequent, gambling income is reported on Form 1040 Schedule 1, line 8.
(58) IRM 4.19.15.28.1, Initial Contact for Gambling Income - Updated to include TDC initial contact letter.
(59) IRM 4.19.15.28.2.3(1)Table, Replies - General Processing - Added TDC Letters to the If/Then chart, Processing Taxpayer Replies and added information for tax year 2019 and subsequent.
(60) IRM 4.19.15.28.2.4, No Response Cases - Updated chart with TDC letter and revised 692-M references.
(61) IRM 4.19.15.29(5), Health Coverage Tax Credit - IRC 35 - Added paragraph (d), with information to define an eligible month.
(62) 4.19.15.30.1, Self-Employed Health Insurance Deduction - Updated (2)a with TDC letter reference.
(63) 4.19.15.30.2, Initial Contact Letter - Updated chart to include TDC letter reference.
(64) IRM 4.19.15.30.6, Replies - General Processing - Updated the chart, Processing Taxpayer Replies to Letter 566-S/Letter 566-T for TDC cases and Subsequent Letters with TDC letters and revised 692-M references throughout.
(65) IRM 4.19.15.31, Form 1040, Schedule C - Correspondence Examination - Updated paragraph 8 with TDC letter reference.
(66) IRM 4.19.15.31.3.1, Schedule C - Meals and Entertainment Expenses for TY 2018-2025 - Added clarification to (1) Note of how TCJA impacted substantiation requirements regarding meals and entertainment. Paragraph 2, a Note was added to define the deductible percentage allowed for tax years 2021 and 2022 is 100 percent.
(67) IRM 4.19.15.31.5, Schedule C - Legal and Professional Fees - Added clarification to paragraph 1 that costs of defending an action in criminal court are not deductible unless the charges are attributable to the taxpayer's trade or business.
(68) IRM 4.19.15.31.6, Schedule C - Repairs and Maintenance - Added reference to TDC letter in paragraph 3.
(69) IRM 4.19.15.31.7, Excess Business Losses for TY2018 - TY 2025 - Updated Paragraph 1 with the applicable tax years 2018-2026, that taxpayers cannot deduct an excess business loss in the current year. Added Note the limitation of the TCJA of 2017 was extended through TY 2026 by the American Rescue Plan Act of 2021.
(70) IRM 4.19.15.31.9, Project Code 0288, Questionable Schedule C with EITC - Added section to provide guidance on project code 288.
(71) IRM 4.19.15.32, Return Preparer Analysis Tool (RPAT) Program - Editorial changes and reference to TDC letter in paragraph 5.
(72) IRM 4.19.15.34, Child Tax Credit (CTC) - Additional Child Tax Credit (ACTC), Refundable Child Tax Credit, and Credit for Other Dependents (ODC) - Updated title name include Refundable Child Tax Credit.
(73) IRM 4.19.15.34.1, Programs and Initial Contacts - Updated to provide guidance when working programs related to CTC, ACTC, Refundable Child Tax Credit, and ODC.
(74) IRM 4.19.15.34.1.1, Individual Taxpayer Identification Number (ITIN) ACTC - Updated to reference TDC letters.
(75) IRM 4.19.15.34.1.1.1, ITIN ACTC - Acceptable Documentation - Updated income amount threshold amounts in the chart for tax year 2020.
(76) IRM 4.19.15.36, Moving Expenses - IRC 217 - Renumbered from 4.19.15.37.
(77) IRM 4.19.15.37, Multiple Filers - Renumbered from 4.19.15.39. Added clarification to background and procedures.
(78) IRM 4.19.15.37.1, Scenarios and Contact Procedures - Changed title from Initial Contact General. Added If And Then chart to further clarify actions to take based on case facts and circumstances.
(79) IRM 4.19.15.37.2, Non-Joint Return is Valid or Considered the Return of Record - Remove Secondary from Joint Return - Changed title from Responses. Provide guidance on case resolution.
(80) IRM 4.19.15.37.3, Joint Return is valid or Considered the Return of Record - Combine Non-Joint to the Joint Return - Changed title from Additional Closing Actions. Added instructions for reconsiderations when a secondary return should not have been backed out and the ASED is now expired.
(81) IRM 4.19.15.39, Residential Energy Credits - Updated to include Section 148 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 extended the Nonbusiness Property Energy Credit through December 31,2021. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 later extended this same treatment to qualified biomass fuel property expenditures through 2023
(82) IRM 4.19.15.39.1, Nonbusiness Energy Property Credit - Removed notes. Added Section 148 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 extended the Nonbusiness Property Energy Credit through December 31,2021.
(83) IRM 4.19.15.39.2, Residential Energy Efficient Property Credit - Added biomass fuel to list.
(84) IRM 4.19.15.40.1, Premium Tax Credit Eligibility - Added a note that contains references and clarification to better assist examiners in determining eligibility so MFS taxpayers who claim checkbox exception are not inadvertently denied the credit.
(85) IRM 4.19.15.41.1, Employment Tax Non-Filer Initial Contact Letter - Removed paragraph 2 to attach Form 886-A and added paragraph to identify required contact information that must be included on the letter.
(86) IRM 4.19.15.41.2, Employment Tax Non-Filer Responses - Revised paragraph 2 and added note for letter contact information required. Added paragraph for taxpayer telephone contact to request additional information and updated table to clarify information and procedure.
(87) IRM 4.19.15.41.3, Second Contacts - Added information for "No Changes" and Form 13863, Expeditor Label - LG Check. Added paragraph to identify required contact information that must be included on the second contact letters.
(88) IRM 4.19.15.41.4, Complete Form 13496 Certification - Changed all references to Form 13496 to Form 13496-A. Clarified Form 13496-A is used with substitute for return Employment Tax examinations. Added information for "No Changes". Added information for delinquent returns received. Changed "No Change" and delinquent returns received information from a bullet to a note. Reference link updated in paragraph 5.
(89) IRM 4.19.15.41.5, Undeliverable Mail - Updated instruction to send Letter 4108 and Form 8822-B with Letter 4107. Clarified what to send to taxpayer based on undeliverables received.
(90) IRM 4.19.15.41.6, Closures - Added paragraph for TC 971 input on secondary tax periods and for when return is received.
(91) IRM 4.19.15.41.7, Penalties - Updated reference link.
(92) IRM 4.19.15.41.8, Failure to Deposit Penalty (TC180) - Changed title Request for Penalty Relief. Added guidance to address specific failure to deposit penalty procedures.
(93) IRM 4.19.15.41.9, Failure to File Penalty (TC 160) - Changed title from FUTA Certification. Added guidance to address specific failure to file penalty procedures.
(94) IRM 4.19.15.41.10, Request for Penalty Relief - Changed title from Return Posted as TC 976/977. Guidance for Return Posted as TC 976/977 has been removed from this IRM.
(95) IRM 4.19.15.41.11, FUTA Certification - Renumbered from 4.19.15.43.9. Added If Then chart in paragraph 2 for state credit on Form 940. Removed paragraphs 3, 4 and the note.
(96) IRM 4.19.15.41.12, Signatures - Changed title from Identity Theft - BMF Accounts to Signatures. Updated paragraph for authorized signatures. Added paragraph for alternative signature methods.
(97) IRM 4.19.15.41.13, Case Assembly - Changed titlefrom General Information to Case Assembly. The information in this subsection was previously in 4.19.15.43.13.9 .
(98) IRM 4.19.15.41.14, Identity Theft - BMF Accounts - Renumbered to new subsection from 4.19.15.43.12. All links updated.
(99) IRM 4.19.15.41.15, Partials - Added a new subsection to provide guidance on when to complete the partial and associated actions to take.
(100) IRM 4.19.15.41.16, General Information for Reconsiderations- Added a new subsection that provides guidance from previous IRM 4.19.15.43.13 - General Information and addresses all reconsideration procedures.
(101) IRM 4.19.15.42, General Business Credit - Added new subsection to provide guidance regarding qualifications to claim the credit.
(102) IRM 4.19.15.42.1, Evaluating Responses - Added a new section to provide guidance in evaluating taxpayer responses regarding the General Business Credit.
(103) Updated all references in the IRM where a Taxpayer Digital Communication (TDC) letter may be used if the taxpayer was selected to participate in the TDC program.
(104) Replaced reference to Letter 692 with current Letter 692-M revision throughout.
(105) IRM renumbered - Schedule F Expenses section, previously in IRM 4.19.15.32 and First Time Homebuyer Credit - IRC 36 sections previously in IRM 4.19.15.38 have been removed since programs are obsolete.
(106) All IRM citations and hyperlinks have been updated in all sections. Various editorial changes also implemented throughout.
Effect on Other Documents
This IRM supersedes IRM 4.19.15, Liability Determination, Discretionary Programs, dated November 4, 2019. The following IRM Procedural Updates have been incorporated into this IRM: 20U0130, 20U0304, 20U0354, 20U0429, 20U0489, 20U0556, 20U0580, 20U0637, 20U0794, 20U01003, 20U1271, and 21U0453, issued from January 22, 2020 - March 23, 2021.
This IRM is intended for the use of SB/SE (Small Business/Self-Employed) and W&I (Wage and Investment) Campus Examination.
Lori L. Caskey
Director, Examination - Field and Campus Policy
Small Business/Self-Employed
4.19.15.1 (02-01-2022)
Program Scope and Objectives
Purpose: This IRM contains procedural steps for Campus Exam employees when reviewing taxpayer's correspondence in response to examination notices or letters. It provides instructions to help examiners accurately review individual income tax returns and to ensure taxpayers are in full compliance with all tax laws and regulations in regard to: reporting all income, claiming legitimate dependents, claiming allowable deductions and valid credits.
Audience: IRS employees who are responsible for processing Campus Exam responses in SB/SE and W&I Campus Exam.
Policy Owner: SB/SE Director, Examination - Field and Campus Policy..
Program Owner: SB/SE Campus Exam and Field Support (CEFS).
Primary Stakeholders:
SB/SE Campus Examination
W&I Campus Examination
Contact Information: To recommend changes or make any other suggestions to this IRM section, see IRM 1.11.6.6, Providing Feedback About an IRM Section - Outside of Clearance.
4.19.15.1.1 (02-01-2022)
This section is used by Small Business/Self Employed (SB/SE) and Wage and Investment (W&I) Campus Examination to review and process taxpayers' correspondence received in response to examination notices. Other IRM chapters will be referenced throughout this IRM to provide specific guidance for individual topics. Examination employees are responsible for researching and utilizing information contained in all reference materials. Legal citations, form and letter references, and IRM references are reviewed and updated as necessary.
IRM 4.19.15, Liability Determination, Discretionary Programs, contains information on examination procedures relative to the Exam Discretionary Programs. It provides a reference for common issues and related items that might be found on tax returns that are not compliant with the current tax laws and regulations for individual income tax returns and their related schedules.
By law, the Service has the authority to conduct examinations under Title 26, Internal Revenue Code, Subtitle F - Procedure and Administration, Chapter 78, Discovery of Liability and Enforcement of Title, Subchapter A, Examination and Inspection, which includes, but is not limited to, the following IRC sections:
IRC 7602, Examination of books and witnesses
IRC 7605, Time and place of examination
Additional information related to conducting examinations is contained in the 26 CFR 601.105, Statement of Procedural Regulations.
Liability Determination - Discretionary Programs is used in Campus Examination Operations by managers, coordinators, examiners, and clerical staff to work, control, and monitor inventory for discretionary tax issues in both SB/SE and W&I.
The Taxpayer Bill of Rights (TBOR) lists rights that already existed in the tax code, putting them in simple language and grouping them into 10 fundamental rights. Employees are responsible for being familiar with and acting in accord with taxpayer rights. See IRC 7803(a)(3), Execution of Duties in Accord with Taxpayer Rights. For additional information about the TBOR, see the Taxpayer Bill of Rights.
Program Management and Review
Program Reviews:
Campus program reviews are conducted to ensure case actions are in accordance with IRM procedures.
Examination quality reviews are conducted using IRM 21.10.1, Embedded Quality (EQ) Campus Compliance
AIMS Centralized Information System (ACIS) reports are used by Headquarters Policy to review closure statistics and determine the effectiveness of each program.
Program Reports:
See IRM 4.4.27, Reports.
Embedded Quality Review System (EQRS) Reports, are used by managers and program analysts to identify error trends.
National Quality Review System (NQRS) Reports, are used by managers and program analysts to identify error trends.
Program Controls
IRM 4.19.20, Automated Correspondence Exam (ACE) Processing Guidelines, is used for Campus Exam's automated case creation, monitoring, and closure. Cases set up in ACE generate taxpayers's correspondence. Procedures in this IRM are used to process these replies.
Report Generation Software (RGS), is used for Campus Exam's: open case control, monitoring incoming taxpayer's correspondence, and manual review of case files.
The Audit Information Management System (AIMS), under IDRS command code AMDIS is used to display taxpayer's account information.
Terms/Definitions/Acronyms
Acronyms used within IRM 4.19.15 are shown in the table below:
AAR Administrative Adjustment Request
ACA Affordable Care Act
ACE Automated Correspondence Examination
AGI Adjusted Gross Income
AIMS Audit Information Management System
AM Accounts Management
AMT Alternative Minimum Tax
AOTC American Opportunity Tax Credit
APTC Advance Premium Tax Credit
ARC Aging Reason Code
ARRA American Rebate Recovery Act
ASED Assessment Statute Expiration Date
ATAA Alternative Trade Adjustment Assistance
ATTI Abusive Transactions and Technical Issues
AVS ACA Verification System
BMF Business Master File
BOD Business Operating Division
CAS Customer Accounts Service
CDR Coverage Data Repository
CEAS Correspondence Examination Automation Support
CFC Campus Fraud Coordinator
CHIP Children's Health Insurance Program
CI Criminal Investigation
CIS Correspondence Imaging System
COBRA Consolidated Omnibus Budget Reconciliation Act
CRN Credit Reference Number
CSED Collection Statute Expiration Date
CSEO Compliance Services Examination Operations
DC Disposal Code
DDb Dependent Database
DEBR Discretionary Examination Business Rules
DFAS Defense Finance and Accounting Services
DIF Discriminant Information Function
DOL Department of Labor
EBE Employee Business Expenses
EC Error Code
ECID Examination Closing Input Document
EGC Employee Group Code
EIN Employer Identification Number
EITC Earned Income Tax Credit
ERS Error Resolution System
ERSED Erroneous Refund Statute Expiration Date
ETNF Employment Tax Non-Filer
EUP Employee User Portal
FCR Federal Case Registry
FEHBP Federal Employees Health Benefits Program
FICA Federal Insurance Contributions Act
FITW Federal Income Tax Withholding
FMV Fair market Value
FPL Federal Poverty Line
FAFSA Free Application Federal Student Aid
FSA Flexible Spending Account
FTC Fuel Tax Credit
FTD Failure to Deposit
FTF Failure to File
FTHBC First-Time Home Buyer Credit
FTP Failure to Pay
FUTA Federal Unemployment Tax Act
HSA Health Savings Account
HCTC Health Coverage Tax Credit
HHS Health and Human Services
HOH Head of Household
HQ Headquarters
ICL Initial Contact Letter
ICM Inventory Control Manager
IDT Identity Theft
IMF Individual Master File
ITIN Individual Taxpayer Identification Number
LB&I Large Business & International
LDC Lead Development Center
LUQ Large Unusual Questionable
MAGI Modified Adjusted Gross Income
MCC Mortgage Credit Certificate
MeF Modernized Electronically Filed
NRA Non-Resident Alien
OASDI Old Age, Survivors, and Disability Insurance
OPM Office of Personnel Management
OPR Office of Professional Responsibility
PBC Primary Business Code
PBGC Pension Benefit Guaranty Corporation
PC Project Code
PCS Partnership Control System
PTC Premium Tax Credit
QAE Qualified Adoption Expenses
QDRO Qualified Domestic Relations Order
QFM Qualifying Family Member
QRP Questionable Refund Program
RA Revenue Agent
RC Reasonable Cause
RGS Report Generation Software
RO Revenue Officer
RPAT Return Preparer Analysis Tool
RPP Return Preparer Program
RRTA Railroad Retirement Tax Act
RURT Railroad Unemployment Repayment Tax
SB/SE Small Business/Self Employed
SC Source Code
SCHIP State Children's Health Insurance Program
SDC Scheme Development Center
SE-DPR Self-Employment Determination Posting Record
SEHID Self-Employment Health Insurance Deduction
SFR Substitute For Return
SLCSP Second Lowest Cost Silver Plan
SNOD Statutory Notice of Deficiency
SP Submission Processing
SPC Special Processing Code
SQPs State-Qualified Plans
SSA Social Security Administration
SSIVL Statistical Sampling Inventory Validation
SSN Social Security Number
TAA Trade Adjustment Assistance
TAS Taxpayer Advocate Service
TC Tracking Code
TCJA Tax Cuts and Jobs Act of 2017
TCO Tax Compliance Officer
TDC Taxpayer Digital Communication
TEFRA Tax Equity and Fiscal Responsibility Act
TETR Telephone Excise Tax Refund
TIN Taxpayer Identification Number
TPA Third party Administrator
UA Unallowable Code
VEBA Voluntary Employees' Beneficiary Association
W&I Wage and Investment
WHBAA Worker Homeownership and Business Assistance Act
WSD Workload Selection and Delivery
Other IRMs referenced within IRM 4.19.15 are:
IRM 1.2.1, Policy Statements for the Examining Process
IRM 1.2.2, Delegations of Authority for the Examining Process
IRM 4.4.29, Social Security Administration Adjustments
IRM 4.10, Examination of Returns
IRM 4.19.6, SSA Correspondence, Minister/Religious Waivers, and Information Return Penalties (IRP)
IRM 4.19.10, Examination General Overview
IRM 4.19.11, Examination Classification of Work
IRM 4.19.13, General Case Development and Resolution
IRM 4.19.14, EITC/Revenue Protection Strategy
IRM 4.19.16, Claims
IRM 4.19.17, Non-Filer Program
IRM 4.23.7, Employment Tax on Tip Income
IRM 4.25, Estate and Gift Tax
IRM 21.1.3, Operational Guidelines Overview
IRM 21.4.5, Erroneous Refunds
IRM 21.6.3, Credits
IRM 25.6.1, Statute of Limitations Processes and Procedures
Helpful information can be found on the Exam Research Portal, located on SERP at: http://serp.enterprise.irs.gov/databases/portals/compliance/exam/exam.html
Child and Dependent Care Credit
The following guidelines are used for tax years 2020 and prior to determine if the taxpayer qualifies for the Child and Dependent Care Credit:
The limit on the amount of qualifying expenses that can be taken into account in computing the credit is $3,000 for one qualifying person or $6,000 for two or more qualifying persons. The amount of qualifying expenses after applying the limit is reduced by the aggregate amount of dependent care assistance excludable from gross income for the tax year.
The credit can be as much as 35 percent of qualifying expenses. Refer to Form 2441, Child and Dependent Care Expenses, for computation.
The American Rescue Plan Act revised the Child and Dependent Care credit rules for tax year 2021. For tax year 2021, the limit on the amount of qualifying expenses that can be taken into account in computing the credit is $8,000 for one qualifying person or $16,000 for two or more qualifying persons, and the credit can be as much as 50 percent of qualifying expenses. The amount of qualifying expenses must still be reduced by the aggregate amount of dependent care assistance excludable from gross income for the tax year. Refer to the 2021 Form 2441 and instructions for computation.
A standard Exam letter will be issued requesting verification of items claimed on the return. Cases will be assigned the following project codes (PC): PC 0393, Child Care Credit and the taxpayer is filing Married Filing Separately; PC 0394, Child turned age 13 during the first half of the year; PC 0400, Child Care Credit/Dependent age greater than 12 years, and PC 0628, duplicate dependent for child tax credit, child and dependent care credit or education credit. See IRM 4.19.15.11, Non-Earned Income Tax Credit Duplicate Taxpayer Identification Number (Non-EITC DUP TIN), for additional guidance on PC 0628, duplicate dependent cases.
The charts below will be helpful in determining what can be accepted to verify amounts claimed for the Child and Dependent Care Credit.
The Tax Cuts and Job Act amended Section 151, effective for Tax Years 2018 through 2025, suspended the deduction for personal exemptions by reducing the amount of the deduction to zero. The rules for claiming the dependent on the tax return for a credit remains the same.
A Qualifying Person is:
Verifying Information:
The taxpayer's dependent qualifying child who was under age 13 when the care was provided. Generally, the taxpayer must claim a dependency exemption for the child to claim the credit. However, if a non-custodial parent claims a dependency exemption for the child under the special rule regarding a child of divorced or separated parents or parents who live apart at all times during the last six months of the year, the child is treated as a qualifying person of the custodial parent, not the non-custodial parent for purposes of the credit. The custodial parent must meet the other requirements for claiming the credit. Age verification - Birth certificate, school records, or baptismal certificate. Qualifying Child Verification – See IRM 4.19.14.6.5, Personal Exemptions and Dependents.
The taxpayer's spouse who was physically or mentally not able to care for himself/herself and who lived with the taxpayer for more than half of the year except for temporary absences. Marriage certificate (proof of spouse). Proof of disability: doctor's statement or state certification.
The taxpayer's dependent (1) who was physically or mentally not able to care for himself/herself, (2) who lived with the taxpayer for more than half of the year except for temporary absences, and (3) for whom the taxpayer can claim an exemption; (or a person who satisfies 91) and (2) and for whom the taxpayer could claim an exemption except that:
The person had gross income of, $3,650 or more for 2010, $3,700 or more for 2011, $3,800 or more for 2012, $3,900 for 2013, $3,950 or more for 2014, $4,000 or more for 2015, $4,050 or more for both 2016 and 2017, $4,150 or more for 2018, or $4,200 or more for 2019, or $4,300 or more for 2020 and 2021.
The person filed a joint return with the person's spouse, or
The taxpayer, or the taxpayer's spouse if married filing jointly, was a dependent of another taxpayer).
Proof of the person's residence: school records, official mail, or local library card.
If disabled, doctor's statement or state certification to verify the individual's disability.
The Filing Status of the taxpayer must be Single, Head of Household, Qualifying Widow(er) With Dependent Child, or Married Filing Jointly. If married, a joint return must be filed unless the taxpayer meets the rules to be considered unmarried head of household. Information is on the return and IMFOL.
Eligibility Requirements Test:
The taxpayer and the taxpayer's spouse, if the taxpayer is married, must have earned income during the year. However, a special rule applies to a spouse who is a full-time student or who is unable to care for himself/herself. Form W-2, Wage and Tax Statement, or Form 1099. Schedule C, E, or F, if no Form 1099 income.
The taxpayer must pay child and dependent care expenses so that the taxpayer and the taxpayer's spouse, if the taxpayer is married, can work or look for work.
Proof of payment includes receipts or cancelled checks. If the expenses claimed were incurred while looking for work, examine interview sheets, job placement letters/statements, calendar/log/statements showing interview appointments and dates, or places applied to for work.
If the expenses claimed were for any month in which the taxpayer or the taxpayer's spouse was a full-time student, examine letters/ transcripts from the school showing full-time course load and the specific number of months of enrollment.
Verifying Information
The identity of the care provider must be reported on the tax return. The return must include the name, address, and Taxpayer Identification Number (TIN) of the care provider. If the care provider is an individual, the return must include a Social Security Number (SSN) or an ITIN. If the care provider is an organization/corporation, the return must includes an Employer Identification Number (EIN). The EIN/TIN does not have to be provided if the care provider is a tax-exempt organization (such as a church or school). If the care provider information given is incorrect or incomplete, the credit may still be allowed if the taxpayer demonstrates due diligence in trying to supply the information.
The taxpayer must pay child and dependent care expenses to a provider the taxpayer or spouse cannot claim as a dependent. If payments are made to a child of the taxpayer, the child cannot be the taxpayer's dependent and must be age 19 years or older by the end of the year. In addition, payments to the taxpayer's spouse or the parent of the taxpayer's qualifying person if that person is the taxpayer's child and under age 13 do not qualify for the credit. Name on the receipts or cancelled checks. If the taxpayer and the care provider have the same surname, determine if the taxpayer claimed the care provider as a dependent. If the taxpayer did not claim the care provider as a dependent, verify the age of the care provider using INOLE.
Adjustment must be made for any dependent care assistance (payments or benefits) provided by the employers. Form W-2 or letter from employer.
If the above conditions are met, compute the allowable credit.
Expenses for a child to attend kindergarten or a higher grade do not qualify for the Child and Dependent Care Credit. Expenses for before-school or after-school care of a child in kindergarten or a higher grade may qualify for the credit.
Cases that are not initiated through ACE (Automated Correspondence Examination) must be worked as follows:
Issue Letter 566-B/ Letter 566-J with Form 4549, Income Tax Examination Changes, if during initial research (DUPOL, DDBKD), it appears that a duplicate dependent was used to obtain a dependent care expense, or
Issue Letter 566-B/ Letter 566-Jfor TDC cases, if initial research indicates: 1) The credit is for a child who is over 12 years, or 2) The Filing Status is Married Filing Separately
If neither of the two conditions mentioned in (a) or (b) are met, issue Letter 566-S/Letter 566-Tfor TDC cases.
Request applicable documentation.
Follow normal procedures to work the case.
If taxpayer is allowed the credit and a duplicate dependent exists, you must open the other duplicate dependent case and disallow the credit.
Additional information regarding the Child and Dependent Care Credit is found in:
Publication 503, Child and Dependent Care Expenses
Publication 17, Your Federal Income Tax (For Individuals)
Instructions for Form 2441, Child and Dependent Care Expenses
Education Tax Benefits - General Requirements and Exam Programs
The law offers a number of tax incentives for taxpayers pursuing post-secondary (after high school) education:
The Hope Credit was a non-refundable tax credit available for the first two years of post-secondary education only. The Hope Credit was replaced in the 2009 tax year by the American Opportunity Tax Credit (AOTC).
The AOTC is available for the first four years of post-secondary education only. Forty percent of the AOTC is refundable. The remainder is a non-refundable credit against the taxpayer's tax liability.
Bona Fide residents of Puerto Rico cannot claim AOTC, after 2018, on Form 1040. It must be claimed on their Hacienda tax return filed in Puerto Rico. Erroneous Refund issues for this will be worked in LB&I.
Congress extended the Tuition and Fees Deduction for 2017 in section 40203 of the Bipartisan Budget Act of 2018, Pub. L. 115–123, div. D, title I, Section 40203(a), Feb. 9, 2018, 132 Stat. 145. Congress again extended the Tuition and Fees Deduction for tax years 2018, 2019, and 2020 in section 104 of the Taxpayer Certainty and Disaster Relief Act of 2019. Congress finally repealed, as part of the Taxpayer Certainty and Disaster Relief Act of 2020 (section 104(b)), the deduction for all tax years after 2020.
The Lifetime Learning Credit is a non-refundable tax credit available for any year of post-secondary education.
The Tuition & Fees Deduction reduces the taxpayer's adjusted gross income (AGI). It is available for any year of post-secondary education.
A taxpayer cannot claim the Lifetime Learning Credit, the Hope Credit/AOTC or the Tuition & Fees Deduction if any of the following apply:
The taxpayer's filing status is married filing separately
The taxpayer is listed as a dependent on another taxpayer's return. (The taxpayer is ineligible for the Tuition & Fees Deduction if the taxpayer can be claimed as a dependent on someone else's return, regardless of whether the taxpayer is actually claimed as a dependent.)
The taxpayer (or the taxpayer's spouse) was a nonresident alien for any part of the tax year unless the taxpayer elected to be treated as a resident alien for tax purposes or a treaty applies. More information on nonresident aliens can be found in Publication 519, U.S. Tax Guide for Aliens.
Restrictions specific to each credit/deduction are addressed in the appropriate section.
Eligible educational institution,
an eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions.
Certain educational institutions located outside the United States. See if the school is listed on the U,S. Department of Education's Federal Student Loan Program list, or the Free Application for Federal Student Aid (FAFSA) international school list.
The following table provides an overview of the Education Credit/Deduction Programs currently worked in Exam:
Initial Contact Letter
0351 Hope Credit or AOTC: Taxpayers must demonstrate that they are eligible for the credit. Letter 566-S/566-T for TDC cases Form 886 H-AOC
0402 Duplicate Education Credit & Tuition Deduction Letter 566-S/566-T for TDC cases Form 14803
0405 Education Credit – Age Related: Taxpayers must demonstrate they are eligible for the credit. Letter 566-S/566-T for TDC cases Form 886 H-AOC or Form 14807
0406 Hope/AOTC claimed for more than 4 years Letter 566-S/566-T for TDC cases Form 886 H-AOTC-MAX and Form 14807
Additional resources include:
Pub 970, Tax Benefits for Education
"What is an Eligible Educational Institution" irs.gov page which includes a link to the Department of Education's list of accredited schools.
Form 8863, Education Credits (American Opportunity and Lifetime Learning Credits)
Form 8917, Tuition and Fees Deduction, available 2020 and prior, it cannot be used if credit is taken on Form 8863.
IRM 21.6.3.4.1.5, Form 8863 Education Credits
American Opportunity Tax Credit (AOTC) and Lifetime Learning Credit
Overview of the Education Tax Credits:
Lifetime Learning Credit
Maximum Credit For Tax Years 2009 and forward: Up to $2,500 credit per eligible student (Calculated as 100 percent of first $2,000 of qualified expenses and 25 percent on next $2,000 of qualified expenses, per student). Up to $2,000 credit per return (Calculated as 20 percent of qualified expenses up to $10,000) (For tax years 2008 & 2009, the maximum credit was $4,000 per return if a student in a Midwestern disaster area –calculated as 40 percent of qualified expenses up to $10,000).
Refundable or nonrefundable 40 percent of credit is refundable (limited to $1,000 per student). The rest is nonrefundable. Nonrefundable-credit limited to the amount of tax liability.
Number of years of postsecondary education Available ONLY for the first 4 years of postsecondary education. Student must not have completed first 4 years of postsecondary education before the beginning of the tax year. Student does not need to be pursuing a program leading to a degree or other recognized education credential if the course(s) is taken to acquire or improve job skills.
Number of years credit available Available starting in 2009, ONLY for 4 tax years per eligible student (including an year(s) Hope Credit was claimed). Available for unlimited number of years.
Type of program required Student must be pursuing a program leading to a degree or other recognized education credential. Student does not need to be pursuing a program leading to a degree or other recognized education credential.
Number of courses Student must be enrolled at least half time for at least one academic period that begins during the tax year. Available for one or more courses.
Felony drug conviction No felony drug convictions on student's records. N/A
Qualified Expenses Tuition, required enrollment fees, and course materials that the student needs for a course of study whether or not the materials were bought at the educational institution as a condition of enrollment or attendance. Tuition and fees required for enrollment attendance (including amounts required to be paid to the institution for course-related books, supplies, and equipment). Additional expenses allowed for students in Midwestern disaster areas.
For additional information on tax years prior to 2008, refer to Publication 970, Tax Benefits for Education, for the appropriate year.
The Hope Credit was available for tax years 2003 through 2008. The American Opportunity Tax Credit (AOTC) replaced the Hope Credit for most taxpayers starting with the 2009 tax year. However, a larger Hope Credit ($3,600 maximum) was available in 2009 for taxpayers meeting the special rules for the Midwestern disaster areas. In order to claim the Hope credit for 2009 a taxpayer had to:
Claim the Hope Credit for at least one student attending an eligible institution in a Midwestern disaster area, and
Choose not to claim the AOTC for any student in 2009.
The American Opportunity Tax Credit (AOTC) was first available during the 2009 tax year.
The PATH Act made the AOTC permanent.
The Hope Credit, AOTC, and the Lifetime Learning credit are phased out (gradually reduced) if the taxpayer's Modified Adjusted Gross Income (MAGI), refer to Pub 970, Tax Benefits for Education, is as follows:
Hope Credit and Lifetime Learning Credit
2008 Between $48,000 and $58,000 (joint return: $96,000 and $116,000)
2009 Between $50,000 and $60,000 (joint return: $100,000 and $120,000)
Lifetime Learning Credit ONLY
MAGI See Rev. Proc. 2018-57
2018 Between $57,000 and $67,000 (joint return: $114,000 and $134.000)
2019 Between $58,000 and $68,000 (joint return: $116,000 and $136,000.
AOTC ONLY
2009 forward Between $80,000 and $90,000 (joint return: $160,000 and $180,000)
4.19.15.3.1.1 (11-04-2019)
Education Tax Credits - Evaluating Taxpayer Responses
The two different education credits (the AOTC and the Lifetime Learning Credit) cannot be taken in the same year for the same student. In contrast, more than one credit may be taken on the same return if they are for different students. For instance, a taxpayer may claim the AOTC for an eligible student for whom they claim a dependency exemption, and also claim the Lifetime Learning Credit for themselves.
Expenses are considered paid by the taxpayer who claims the dependency exemption for the student. If a taxpayer claims the dependency exemption for an eligible student, any expenses paid by the student or a third party are considered paid by the taxpayer. If a taxpayer does not claim a dependency exemption for an eligible student, then the student can claim the education credit on the student's return.
Taxpayers may not take a double benefit for expenses paid. For instance, a taxpayer cannot take a credit for an expense that is allowed as a deduction to the taxpayer.
AOTC cases selected for exceeding the 4 year rule for claiming AOTC/Hope Credit should NOT be allowed even if the taxpayer verifies the expenses paid. AOTC is available ONLY for 4 tax years per eligible student including any year(s) that the Hope credit was claimed. When processing these cases, please also check the current year to see if the same SSN is being used to claim the credit again. If so, and the credit decrease would result in a deficiency over tolerance, open the current year, using Tracking Code 9219. Use IDRS command code DLITE with definer E to determine if a student has been claimed for the American Opportunity Credit.
AOTC cases selected for this issue include:
≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡
≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡
Acceptable documentation of qualified expenses:
Qualified Expenses
Accepted Proof for: AOTC, HOPE, and Lifetime Learning
Qualified tuition and related expenses paid to the academic institution. Tuition receipts and transcripts to verify enrollment; proof of payment of expenditures via cancelled check or electronic funds payment confirmation, credit card statement, or paid receipt from the institution. Form 1098-T, Tuition Statement, is also acceptable proof if the issuer completes Box 1 of that form. (Note: The educational institution is not required to complete Box 1. A different proof of payment is required if there is no amount in Box 1. See above.)
Fees for course-related books, supplies, and equipment. For AOTC: Receipts and documentation to support the need for the course of study. For instance: class outline, school program guide, and/or letter from institution. Fees do NOT have to be paid to the institution.
For HOPE and Lifetime Learning: Receipts and documentation to support the requirement for enrollment in attendance. For instance: class outline, school program guide, and/or letter from institution -- only if the fees must be paid to the institution as a condition of enrollment or attendance
Prepaid expenses paid in the prior year for an academic period that begins in the first three months of the next year are allowed as a part of the prior year's credit. Tuition receipts and receipts for qualifying expenses as listed above.
Payments made with borrowed funds are allowed in the year that the expenses are paid, not in the year the loan is repaid. Receipts and transcripts to determine the year applied.
Following are expenses that generally do not qualify for an education credit. Note that textbooks and supplies are qualifying expenses for the AOTC, even if they are not purchased from the institution as a requirement for enrollment:
Expenses which generally do not qualify for the credit include:
Accepted proof when allowable
Cost of insurance, medical expenses (including student health fees), room and board, transportation or similar personal, living or family expenses, even if the fee or expenses must be paid to the institution as a condition of enrollment or attendance. N/A
Expenses related to any course of instruction or other education that involves sports, games or hobbies, or any noncredit course. However, if the instruction or other education is part of the student's degree program or is taken by the student to acquire or improve job skills, these expenses can qualify. School transcripts and curriculum or catalog demonstrating courses required for the degree program.
For Hope and Lifetime Learning: Textbooks and supplies, even though purchased at the school bookstore, are generally not allowable, unless they are paid to the institution as a requirement for enrollment or attendance. For AOTC: Textbooks and supplies qualify as expenses for the AOTC even if they are NOT required to be purchased from the institution as a condition or enrollment or attendance. For AOTC: Receipts, cancelled checks, or other proof of payment. To qualify as expenses for the AOTC, textbooks and supplies do NOT have to be purchased from the institution as a condition of enrollment or attendance.
For Hope and Lifetime Learning: In addition to proof of payment, documentation to support that textbooks and supplies are required as a condition of enrollment or attendance.
Expenses paid with the tax-free portion of a distribution from a Coverdell educational savings account or qualified tuition program or with tax-free educational assistance, such as a scholarship, grant, or assistance provided by an employer, cannot be used to figure the credit.
Additional qualifications and conditions for AOTC and Hope Credit (these restrictions do not apply to the Lifetime Learning credit):
Qualifications and conditions for AOTC and Hope credit
Accepted Proof
For AOTC: The taxpayer did not claim an AOTC and/or Hope credit for 4 earlier tax years for the AOTC. For Hope Credit: The taxpayer did not claim a Hope Credit for two earlier tax years for this student. For AOTC: All prior years' returns for tax years during which the first four academic years of post-secondary studies were not completed.
For Hope Credit: All prior years' returns for tax years during which the first two academic years of post-secondary studies were not completed.
The student has not completed the first two years of postsecondary education if claiming a Hope Credit or the first four years of postsecondary education if claiming the AOTC. School academic transcripts.
The student was enrolled at least half time in a program that leads to a degree, certificate, or other recognized educational credential, for at least one academic period that begins during the taxable year. School transcripts or Form 1098-T, Tuition Statement
The student was free of any federal or state felony conviction for possessing or distributing a controlled substance as of the end of the tax year in which the credit is claimed. If any documentation indicates that this has occurred, the credit is not allowable.
Effective for tax years after 2015, if the taxpayer's claim for AOTC is due to reckless or intentional disregard of rules and regulations, a 2-year ban may apply. If the claim is fraudulent, a 10-year ban may apply. The 2 and 10-year bans do not apply to the Lifetime Learning Credit or the tuition and fees deduction. See IRC section 25A(b)(4)(A), and IRM 4.19.14.7.1, 2/10 Year Ban - Correspondence Guidelines for Examination Technicians (CET).
Tuition and Fees Deduction
Taxpayers may claim a Tuition and Fees Deduction as an adjustment to income on Form 1040. Beginning in TY 2004 through 2020 certain Tuition and Fees deductions can reduce income, depending on the amount of the taxpayer's modified adjusted gross income (MAGI) – if it does not exceed $65,000 ($130,000 for a joint return), $4000. In the case of a taxpayer whose MAGI is up to $80,000 ($160,000 for a joint return), $2000. In all other cases, the reduction amount is 0. See Pub 970 , Tax Benefits for Education, for an explanation of the term, MAGI.
Generally, taxpayers can claim a deduction if all three of the following requirements are met:
Payments were for qualified education expenses for higher education.
Education expenses are for an eligible student.
The eligible student is the taxpayer, the taxpayer's spouse, or a dependent for whom the taxpayer may claim the exemption.
An eligible educational institution is any college, university, vocational or other post-secondary educational institution.
Generally qualifying expenses are limited to tuition and fees.
The taxpayer may not file married filing separately.
The deduction is phased out between $65,000 and $80,000 ($130,000 - $160,000 for joint returns).
No double benefit is allowed:
The taxpayer cannot claim a Tuition and Fee expense for a student if he or anyone else claimed the Hope or Lifetime Learning Credit for that same student in the same tax year.
Taxpayer cannot use the following expenses to claim the Tuition and Fee expense: expenses paid by tax-free portion of distribution from a Coverdell Educational Savings Account or a qualified tuition program, or expenses paid with tax-free interest on U.S. Savings Bonds, or expenses which have been paid by a tax-free scholarship, grant, or employer-provided educational assistance.
For additional information, refer to Publication 970, Tax Benefits for Education.
Acceptable Documentation:
Transcripts showing name and identifying information of student and period of enrollment
Proof of payment for tuition and fees, i.e., cancelled check and invoices from education institution
Form 1098-T, Tuition Statement, is also acceptable as proof of payment if the issuer completes Box 1 of the form. (The educational institution is not required to complete Box 1. A different proof of payment is required if there is not an amount in Box 1. See above.)
Evaluating Taxpayer Responses:
Review the name and SSN on transcripts and payment vouchers to ensure they are the same as those on the tax return.
Ensure payments were made by taxpayer.
In contrast to the Education Credits, expenses used for claiming the Tuition & Fees Deduction must have been paid by the person claiming the deduction. Payments made by the student or on their behalf by a third party are not considered to have been paid by the person who claims an exemption for the student. Compare to IRM 4.19.15.3.1.1, Education Tax Credits - Evaluating Taxpayer Responses. So, for instance, if a student pays their own expenses but can be claimed as a dependent on their parent's tax return, then neither the student nor their parent may claim the Tuition & Fees Deduction.
Ensure fees are for post-secondary courses.
Review return to ensure the same expenses for the same student are not used to claim additional educational benefits such as the Hope/AOTC or Lifetime Learning Credit; with managerial approval to expand audit to apparent duplicated expenses if needed.
Disallow all other expenses other than tuition and fees.
Effective for tax years after 2017, Taxpayers may no longer claim a Tuition and Fees Deduction as an adjustment for income on Form 1040. However, Form 8917, Tuition and Fees Deduction, was revised January of 2020 and taxpayers can now retroactively claim the deduction for 2018.
Mortgage Interest Credit
The Mortgage Interest Credit helps lower-income taxpayers afford home ownership. The taxpayer must have received a qualified Mortgage Credit Certificate (MCC) from a state or local government unit or agency.
Certificates issued by the Federal Housing Administration, Department of Veterans Affairs, Farmers Home Administration and Homestead Staff Exemption Certificates do not qualify for the credit.
For the initial contact, send Letter 566-S/Letter 566-T for TDC cases, and Form 14809, Interest you Paid, to the taxpayer.
The Form 14809 contains the following language: We need to verify that you are eligible to claim the deduction for Interest You Paid taken on Schedule A-Itemized Deductions. Please provide the following information to support the amounts claimed.
Send copies of mortgage interest statements, equity credit lines/loans, land and mortgage contracts, and amortization schedules for loan outstanding. Send copies of cancelled checks, receipts or other evidence of payments made for the year under examination.
Send copies of closing statement verifying points paid.
Send copies of statements from financial institutions, investment brokerages or persons to verify your total investment interest deductions.
Conducting the Examination
If qualified, the taxpayer may claim the credit each year for part of the home mortgage interest paid. Form 8396, Mortgage Interest Credit, is used to compute the amount of the credit. If the certified indebtedness amount (loan) shown on the Mortgage Credit Certificate (MCC) is less than the total mortgage loan, the credit is figured on only the part of the interest paid that is applicable to the MCC loan.
The credit is an amount equal to the product of:
The certificate credit rate (which may not be less than 10 percent or more than 50 percent), and
The interest paid or accrued by the taxpayer for the year on the remaining principal of the certified indebtedness (plus a limited carry forward, if any).
If the credit rate exceeds 20 percent, the tax credit for any year may not exceed $2,000 (IRC 25(a)(2)(A)).
A three-year carry forward is provided IRC 25(e)(1)(A), for the unused portion of such credit caused by the limitation imposed by IRC 26(a), and IRC 25(a)(2)(A), as amended by Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L.107-16). In essence, the credit and carryover are limited to the tax less the following credits: Foreign Tax Credit, Credit for Child and Dependent Care, Credit for the Elderly or Disabled, Education Credits, Retirement Savings Contributions Credit, Child Tax Credit and the Adoption Credit. Form 8396, Mortgage Interest Credit, should be used to assist in the calculation of the allowable credit amount.
If the taxpayer itemized on Schedule A, he must reduce his home mortgage interest deduction by the amount of the Mortgage Interest Credit shown on Line 3 of Form 8396. He must do this even if part of that amount must be carried forward.
If the taxpayer sells the home during the first nine years after the closing date, he may be required to recapture all or part of the benefit received from the program. See Publication 523, Selling Your Home, for more information.
Evaluating Taxpayer Responses
Use the following to evaluate taxpayer responses:
Determine that the taxpayer owns the home and is making the payments by reviewing the Mortgage Interest Statement from the lender on Form 1098, Mortgage Interest Statement, obtained from the taxpayer or through IRPTRL.
Review addresses, etc., to ensure the credit is taken on the taxpayer's primary residence.
Request and review the Mortgage Credit Certificate to ensure it was issued by the state or local government.
Review the certificate credit rate on the Mortgage Credit Certificate to ensure this is the rate applied in the computation and not the rate of interest listed on the mortgage statement from the lender.
Review the Schedule A and/or C to ensure the taxpayer has not duplicated the interest and that he has properly reduced the interest claimed there by the amount of mortgage interest credit.
Review originating year information if the credit is a carryover.
Review carryover amounts in subsequent years to ensure accuracy and requisition those returns if errors exist which are significant.
Review the computation to ensure the taxpayer is taking the correct amount of credit each year and that applicable credits are not carried over for more than 3 years.
If the taxpayer has actually claimed the District of Columbia First-Time Home buyer Credit as a Mortgage Interest Credit, see Form 8859, District of Columbia First-Time Homebuyer Credit, for proper application of that credit and disallow the Mortgage Interest Credit.
Form 886-A Explanations and Tax Resources
RGS Standard Paragraphs 6306 - 6309 should be used as applicable on Form 886-A, Explanations of Items.
Tax Resources:
Reference items (Publications, Regulations, existing training materials, existing IRM references, etc.)
IRC 25, Interest on Certain Home Mortgages
Publication 530, Tax Information for Homeowners
Publication 936, Home Mortgage Interest Deduction
Publication 17, Your Federal Income Tax (For Individuals), Instructions to the Form 8396, Mortgage Interest Credit
Publication 523, Selling Your Home
Adoption Credit and Qualified Adoption Expenses (QAE)
The Adoption Credit is nonrefundable for most years but was refundable in 2010 and 2011. Regardless of the year involved, the rules for the Adoption Credit are generally the same. However, the income and dollar limitations change year to year based on inflation. Also, taxpayers who claim a refundable credit for 2010 or 2011 were required to file their returns on paper and to include substantiation when filing their returns.
For more information on the income and dollar limitations, see IRM 4.19.15.5.6, Credit Limitations, and IRM 4.19.15.5, Adoption Credit and Qualified Adoption Expenses (QAE). For more information on substantiation, see IRM 4.19.15.5.3, Evaluating Responses.
The Adoption Credit was nonrefundable for all taxable years which began on or after January 1, 1997 and ended before January 1, 2010. The Adoption Credit also is nonrefundable for taxable years which begin after December 31, 2011.
The Adoption Credit was refundable for taxable years which began after December 31, 2009 and ended before January 1, 2012. See the Patient Protection and Affordable Care Act (PL 111-148).
Adoption Credit carryforwards from taxable years 2005 - 2009 were also refundable in 2010. See Notice 2010–66, 2010–42 I.R.B. 437.
The credit is subject to an income limitation based on the taxpayer's modified adjusted gross income (MAGI). See IRM 4.19.15.5.6, Credit Limitations, for more information.
The credit is also subject to a dollar limitation. See IRM 4.19.15.5.6, Credit Limitations, for more information.
The Adoption Credit and any employer-provided adoption benefits that can be excluded from income are computed on Form 8839, Qualified Adoption Expenses. The credit then is entered on Form 1040; for tax year 2018 and forward, the credit is entered on Schedule 3 of Form 1040.
For refundable years, the Form 8839 instructions advise the taxpayer that he or she must include documentation, attached to the return, to substantiate the Adoption Credit. Because of the documentation requirement for refundable years, taxpayers must file a paper return when claiming an Adoption Credit for 2010 or 2011.
The credit will post to Master File as a Transaction Code (TC) 766 with a Credit Reference Number (CRN) 261.
The (TC) 766 with a (CRN) 261 will only be applicable to tax years 2010 and 2011 in which the credit was refundable.
Command Code (CC) DLITE identifies filters fired through Dependent DataBase (DDB) used in selecting the case for examination. Not all filters are shown, and the fact that a filter has been fired does not mean that the credit is unallowable. Examiners should use this information in evaluating the information submitted by the taxpayer. IRM 4.19.15.5.2, Research and Initial Contact, for more information on CC DLITE.
The Adoption Credit in SB/SE Campus Exam is worked under Project Code (PC) 0355.
For further details regarding the Adoption Credit, see Publication 17, Your Federal Income Tax (For Individuals), and the instructions for Form 8839. Additional information about the credit can also be found on http://www.irs.gov, and entering adoption credit in the search window.
Eligible Child – Claiming the Credit or Exclusion
An eligible child for the purposes of claiming Adoption credit is an individual who:
Has not attained age 18, or
Is a disabled individual physically or mentally, unable to take care of him/herself
Taxpayers may claim the credit for as many children as qualify.
The proper year for claiming the adoption credit or exclusion depends on whether the eligible child is a citizen or resident of the United States (including U.S. possessions) at the time the adoption effort begins and whether the adoption is final or in process. See the following tables.
If the eligible child is a U.S. citizen or resident, you can take the credit or exclusion even if the adoption never becomes final. See the following tables.
Child who is a U.S. Citizen or Resident
IF the qualified expenses are paid in:
THEN the credit is taken in:
Any year before the year the adoption becomes final The year after the year of the payment
The year the adoption becomes final The year the adoption becomes final
Any year after the year the adoption becomes final The year of the payment
IF the employer paid for qualifying expenses under an adoption assistance program in:
THEN the exclusion is taken in:
Any year The year of the payment
NOTE: If the eligible child is not a U.S. citizen or resident, you cannot take the adoption credit or exclusion unless the adoption becomes final. See the following tables. Generally, foreign adoptions are either non-Hague adoptions or Hague adoptions. IRM 4.19.15.5.1, Eligible Child - claiming the Credit or Exclusion, See the instructions for Form 8839, Qualified Adoption Expenses, for more information regarding foreign adoptions.
Foreign Child
Any year before the year the adoption becomes final The year the adoption becomes final
Determining the Year a Foreign Adoption Becomes Final
In general, the year of finality of a foreign adoption is determined either under Rev. Proc. 2005-31 (non-Hague Adoptions), or under Rev. Proc. 2010-31 (Hague Adoptions).
Non-Hague Adoptions
In most non-Hague adoptions, there is an adoption proceeding in the foreign country (and the country is one that is not a party to the Hague Adoption Convention, discussed later) before the child is permitted to come to the United States. There may also be a re-adoption proceeding in the United States, either in the same year as the foreign adoption or in a later year.
Rev. Proc. 2005-31 generally allows taxpayers to choose as the year of finality:
the year of the foreign-sending country adoption proceeding; or
the year of the re-adoption, if the re-adoption occurs in either the first or second year following the year of the foreign-country proceeding.
The expenses of re-adoption are qualified adoption expenses in the year in which the expenses are paid, subject to the dollar limitation.
Hague Adoption Convention, Adoptions
The Hague Convention on Protection of Children and Cooperation in Respect of Inter-country Adoption (Hague Adoption Convention) entered into force for the United States on April 1, 2008. The Hague Adoption Convention applies to a taxpayer who adopted a child from a country that is party to the Hague Adoption Convention and who filed his or her application and petition (Forms I-800A and I-800) with the U.S. Citizenship and Immigration Service after March 31, 2008.
See https://travel.state.gov/content/travel/en/Intercountry-Adoption.html, for more information on the Hague Adoption Convention, the application and petition, and a complete list of countries that are parties to the Convention.
In Hague adoptions, there is usually an adoption proceeding in the sending country (and the country is one that is a party to the Hague Adoption Convention, discussed later) before the child is permitted to come to the United States. Rev. Proc. 2010-31 generally allows taxpayers to choose as the year of finality:
the year in which the sending country enters a final decree of adoption; or
the year in which the U.S. Secretary of State issues a certificate under section 301(a) of the Intercountry Adoption Act of 2000, 42 U.S.C sections 14901-14954.
Custodial Agreements Followed by Adoption in the United States
In a few cases, the sending country may permit the child to come to the United States under a custodial agreement. If so, the child will be adopted later in a state court in the United States. Both Rev. Proc. 2005-31 and Rev. Proc. 2010-31 allow the adoptive parent(s) to treat the year of the state-court adoption as the year of finality.
Research and Initial Contact
IDRS CC DLITE, using the primary SSN, may provide information and identify filters fired. Examiners should research CC DLITE to assist in identifying the selection criteria. Examiners should refer to the tracking codes displayed on DLITE as guidance in evaluating the taxpayer's documentation. Holding cursor over the rule, then hitting XMIT, will display the list of Adoption Credit rules. The tracking codes identifying the filters fired are:
0379 - The Federal Case Registry (FCR) file indicates the taxpayer is the custodial parent, non-custodial parent, or putative father.
0381 - 5 year look back period where the credit claimed and carried over to subsequent years exceeded the maximum allowable.
0383 - The primary and/or secondary taxpayer is the father or mother of the child, the date of birth of the child listed on the Form 8839 is less than a year after the update date on the Data Master(DM1)/Kidlink.
Send Letter 566-S/Letter 566-T for TDC cases, as the initial contact letter (ICL) with a fill-in issue box for Adoption Credit.
Form 14806, Adoption Credit Documentation Requirements, is sent with the ICL requesting Adoption Credit documentation.
Evaluating Responses
Taxpayers being audited must verify that a legal adoption has either been finalized or is in process. In addition, taxpayers must provide verification either of their expenses or of any special needs determination. If part of the credit claimed is a carryforward from a prior year, the taxpayer must provide a worksheet explaining how the carryforward was computed. As the credit was refundable for tax years 2010 and 2011, no carryforward is allowable for tax years 2011 and 2012.
See IRM 4.19.15.5.5, Carry Forwards, for additional carry forward information.
Proper documentation must be provided for each child claimed. Follow the guidelines below for acceptable documentation:
Final Adoption
THEN acceptable documentation is:
Domestic or Foreign adoption finalized in the United States
Adoption certificate, report or final decree signed by a representative of the State Court, showing the names of the adoptive child and parent, or
Hague Adoption Certificate (Immigrating Child), or
IH 3 Visa
Foreign adoption from a country that is not party to the Hague Convention
Translated decree of adoption from a foreign court or other document, issued by the competent authority establishing that a parent-child relationship has been created, or
IR 2 or IR 3 Visa
Special Needs Adoption See IRM 4.19.15.5.4, Special Needs Adoptions.
In-Process Adoption
In-Process Adoption (Applicable to the attempted or not-yet-finalized adoption of an eligible child who is a U.S. citizen or resident.) Taxpayers will provide one or more of the following:
A copy of, or a receipt from, a home study completed by an authorized placement agency
A placement agreement with an authorized placement agency
A document signed by a hospital official authorizing the release of a newborn child from the hospital for legal adoption
A court document ordering or approving the placement of the child with the taxpayer for legal adoption
An affidavit or notarized statement signed under penalties of perjury from an adoption attorney, government official, or other authorized person. The documents must state that the signor either placed or is placing a child with you for legal adoption, or is facilitating the adoption process in an official capacity, with a description of the actions taken to facilitate the process.
Tax law requires the taxpayer to claim QAE that they pay for an In-Process adoption for the year after the expense is paid. Examiners need to be aware of the timing of the expense and that the documentation the taxpayer provides may be for a prior year.
Qualifying adoption expenses include:
Travel expenses (including amounts spent for meals and lodging) while away from home
Other expenses directly related to, and whose principal purpose is for, the legal adoption of an eligible child
An expense may be a qualified adoption expense even if the expense is paid before an eligible child has been identified. For example, prospective adoptive parents who pay for a home study at the outset of an adoption effort may treat the fees as qualified adoption expenses.
Acceptable proof of expenses include checks and receipts showing proof of payment.
The following expenses are not allowable and do not qualify for the Adoption Credit:
That violate state or federal law
For the purpose of carrying out any surrogate parenting arrangement
For the adoption of a spouse's child
Paid using funds received from any federal, state, or local program
Allowed as a credit or deduction under any other provision of federal income tax law
Reimbursed by an employer
Any other expense that is not directly related to, and whose principal purpose is not for, the legal adoption of an eligible child
Special Needs Adoptions
If the adoption is domestic and final, and is of a special needs child (as determined by the state where the adoption occurs), the taxpayer is entitled to claim the maximum amount of the credit (minus any amounts claimed for that child in a previous year) even if the taxpayer paid no qualified adoption expenses.
A child meets the definition of special needs if all of the following statements are true:
The child was a citizen or resident of the United States or its possessions at the time the adoption process began and
A state (including the District of Columbia) has determined that the child cannot or should not be returned to his or her parents' home and
The state has determined that the child is unlikely to be adopted unless assistance is provided to the adoptive parents
The taxpayer must provide both of the following documents when substantiating the credit for a special needs child. Do not request verification of any expenses:
Adoption certificate, report or final decree signed by a representative of the State Court showing the names of the adoptive child and parent and,
The state's determination of special need designation. See (4) for acceptable documentation of the state's determination of special needs.
The following are acceptable documentation of the state's determination of special needs (this list not all inclusive)
A signed adoption assistance or subsidy agreement issued by the state or county
Certification from the state or county welfare agency verifying that the child is approved to receive adoption assistance
Certification from the state or county welfare agency verifying that the child has special needs
For these purposes, an order or decree must include information establishing that the taxpayer's adoption of the eligible child has been finalized and the date it was finalized. A special needs determination must include information establishing that the state has made a determination of special needs for the eligible child.
Don't confuse "children with special needs" for purposes of the adoption credit with the definitions of "children with special needs" for other purposes. Foreign children aren't considered to have special needs for purposes of the adoption credit. Even U.S. children who have disabilities may not have special needs for purposes of the adoption credit. Generally, "special needs adoptions" are the adoptions of children whom the state's child welfare agency considers difficult to place for adoption.
Carry Forwards
The nonrefundable adoption credit allows any unused adoption credit to be carried forward for up to five years.
For taxable year 2010, a refund was allowed for all adoption credit properly carried forward from 2005 through 2009. However, no adoption credit carried forward from 2010 into 2011.
Adoption credit properly allowable for the first time in taxable year 2011 was refundable for that year. However, no adoption credit carried forward from 2011 to 2012.
In 2012, the adoption credit reverted to being nonrefundable. Adoption credit properly allowable for the first time in 2012 will be allowed if the taxpayer has enough tax liability to use the credit. Any remaining allowable adoption credit will be carried forward to 2013 (the first year of the five-year carryforward period). Similarly, adoption credit first allowable in 2013 will be carried forward into 2014 if the taxpayer does not have enough tax liability to use all the allowable adoption credit in 2013. The same rule applies to later years. For example, adoption credit first allowable in 2014 will be carried forward into 2015 if the taxpayer does not have enough tax liability to use all the allowable adoption credit in 2014.
Taxpayers claiming a credit carryforward must provide the same documentation for the carryforward years as a current year adoption. In addition to an explanation or worksheet showing how the carryforward credit was calculated, verification of the adoption and verification of qualified adoption expenses for all years is required.
The year in which adoption expenses are first eligible to be claimed is the determining year for the maximum credit amount as well as the income limitation restriction. If the taxpayer qualifies for the full credit one year, they cannot increase that amount by carrying it forward to another year. Likewise, if they are limited or disqualified from taking the credit based on their MAGI, they cannot change that restriction, by moving the credit into another year. However, if the taxpayer pays additional adoption credit in a subsequent year, the allowable credit for those expenses is subject to the limitations for the year in which they are eligible to be claimed. Any allowable credit must always be reduced by prior credits taken for the same child.
Most individuals use the cash method of accounting. Therefore, the relevant date for determining whether adoption credit is allowable is the date the adoption credit is paid, rather than the date the adoption credit is incurred. The date adoption credit is incurred is relevant only if the taxpayer uses the accrual method of accounting.
Adoption credit is allowable only if paid in connection with the adoption of an eligible child. Generally, an eligible child is an individual under the age of 18. The relevant date for determining a child's eligibility is when the adoption credit is paid. For example, suppose that adoption credit is paid in year 1, when the child is 16, and the adoption credit becomes allowable in year 2, when the child is 17. Suppose further that the adoptive parent has too little tax liability to use the credit in year 2 and that the credit carries forward into years 3 and 4. In year 5, the adoptive parent has enough tax liability to use the full carried-forward credit. The entire carried-forward credit will be allowable in year 5, even though the child who was adopted is now 20 years old.
In order to claim adoption credit in the year it is first allowable, individuals must file as single, married filing jointly, head of household, or as qualifying widow(er). If the individual's filing status is married filing separately in the year that particular adoption credit first become allowable, the individual will never be eligible to claim a credit or exclusion for that adoption credit unless he or she files an amended return, using married filing jointly status, within the period of the statute of limitations. However, an individual who is married filing separately may claim an adoption credit carryforward from a prior year or years, provided that, if the individual was married in the year in which the adoption credit first became allowable, the individual filed a joint return for that year. For more information, see Topic 607, Adoption Credit and Adoption Assistance Programs, available at https://www.irs.gov/businesses/small-businesses-self-employed/adoption-credit-glance.
Credit Limitations
Adoption credit current and prior year limitations:
Current and Prior Year Credit Limitations
Maximum Tax Credit (Dollar Limitation)
MAGI Phaseout See Rev. Proc. 2018-57
2020 $14,300 $214,520 - $254,520
2019 $14,080 $211,160 - $251.160
Tax Benefits for Kidnapped Children
Following are guidelines to determine the allowance of tax benefits for kidnapped children for tax years ending after December 21, 2000.
Guidelines for Determining Allowance of Kidnapped Children Tax Benefits
Then, for all tax years during which the kidnapped child is missing and the treatment has not terminated
The child is presumed by law enforcement authorities to have been kidnapped by someone who is not a member of the family of the taxpayer or the child The child was the taxpayer's qualifying relative for the part of the year before the kidnapping or Treat the child as the taxpayer's qualifying relative or
The child is presumed by law enforcement authorities to have been kidnapped by someone who is not a member of the family of the taxpayer or the child The child had the same principal place of abode as the taxpayer for more than one half of the part of the year before the date of kidnapping Treat the child as meeting the residency test in the definition of qualifying child.
Termination of treatment shall apply if there is a determination that the child is deceased, or that the child would have reached the age of 18.
The treatment applies for purposes of (1) the Dependency Exemption, (2) the Child Tax Credit, (3) head of Household filing status, (4) Qualifying widow(er) filing status, and (5) the Earned Income Tax Credit.
Questionable Refund Cases
See IRM 4.19.14.9, Questionable Refund Program (QRP), for program procedures on Questionable Refund cases.
The Alternative Minimum Tax (AMT) program cases are identified by Submission Processing as taxpayers who are liable for the AMT but have not completed or attached Form 6251, Alternative Minimum Tax - Individuals.
Submission Processing will notify the taxpayers that they appear to be liable for the AMT by issuing Letter 12C. The case is suspended for a response. If the taxpayer does not respond timely, the return is coded as an Audit Code P, generating the AIMS (Audit Information Management System) opening in Source Code 26.
AIMS will open in the Andover Campus (W&I) or Philadelphia Campus (SB/SE) based on the Master File Business Operating Division (BOD) Code for the return.
For W&I, the AMT cases are worked under Project Code 0631.
Alternative Minimum Tax Procedures
Prepare Letter 2194, Alternative Minimum Tax Proposal, and Form 4549/Form 4549-EZ, Examination Report, and issue to the taxpayer for the initial contact.
Based on the information reported on the return, the Examination Report (Form 4549/Form 4549-EZ) should include the largest determinable amount(s) as adjustments and tax preference items when computing the AMT on Form 6251, Alternative Minimum Tax-Individuals.
Taxpayer responds agreeing to the AMT by signing exam report Process assessment and close case agreed.
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30 day letter - after the suspense time has expired, issue Letter 3219, Notice of Deficiency.
90 day letter - after the suspense time has expired, process assessment and close case as a default.
See IRM 4.19.10.1.5.2, Standard Suspense Periods for Correspondence Examination, for suspension periods for the various letters and time frames to issue letters/notices.
Estate and Gift Tax
Refer to IRM 4.25, Estate and Gift Tax, for information on estate and gift tax audits and procedures.
4.19.15.10 (02-01-2022)
Math/Clerical Error
General procedures for the establishment and processing of unsubstantiated math/clerical error cases are presented in IRM 4.19.14.10, Math/Clerical Error Program.
Unsubstantiated math/clerical error protest cases for which the original adjustment did not include a TC 764 will set up on AIMS under Project Code 0125. Campuses must review the cases to determine whether or not the math/clerical error protest involves potential examination issues.
All domestic math/clerical error cases can be referred to Exam.
When initiating Non-EITC math/clerical error cases they should be started using Letter 566-B, ICL/30-Day Combo Letter and the cases are updated to Status 22 on AIMS.
Non-Earned Income Tax Credit Duplicate TIN (Non-EITC DUP TIN)
The Non-EITC DUP TIN program includes a population of taxpayers who have claimed a dependent who has been claimed on another taxpayer's tax return. Generally these cases involve two or more uses of a TIN to claim a dependent.
Duplication of TIN
Duplicate TIN 2 - 3 times None
Multi-Duplicate TIN 4 - 10 times 7669
Ten-plus Duplicate TIN > 10 times 6450
Duplicate Dependent Used for CTC, CCC, Education Credit 1 or more times 6545
There are two types of the Non-EITC DUP TIN cases, the Dependent/Dependent and Dependent/Primary. For the Dependent/Dependent cases, the same individual is claimed as a dependent by two or more taxpayers. Dependent/ Primary cases involve an individual who claimed a personal exemption for himself or herself and another person who also claimed a dependency exemption for that same individual.
Definitions for the DUPTIN Program are as follows:
Non-entitled taxpayer - the taxpayer who is not entitled to claim the dependent or the personal exemption.
Entitled taxpayer - the taxpayer who is entitled to claim the dependent or the personal exemption.
Abused SSN - the SSN of the person who has been claimed as a dependent by more than one taxpayer in the same tax year or who has claimed a personal exemption and has been claimed as a dependent.
The Dependent/Dependent cases are assigned Project Code 0097 or 0628 and the Dependent/Primary cases are assigned Project Code 0098 on AIMS.
Whipsaw cases are established on AIMS under Project Code 0059.
4.19.15.11.1 (02-01-2022)
Cases in Project Code 0097 and Project Code 0098 are systemically processed using Automated Correspondence Exam (ACE) processing. For the initial contact, Letter 566-S/Letter 566-T for TDC cases, is issued to the taxpayers and the cases are updated to Status 10 on AIMS. For guidance on initiating PC 0628 cases that are not initiated using ACE, refer to IRM 4.19.15.2 , Child and Dependent Care Credit, paragraph (6).
Whipsaw cases in Project Code 0059 are manually processed by preparing Letter 566-B/Letter 566-J for TDC cases, Form 4549 / Form 4549 EZ, Examination Report, and Form 886-H-DEP. The package is issued to taxpayers and the cases are updated to Status 22 on AIMS. The adjustments in the Examination Report include the disallowance of all duplicated dependents claimed on the returns and any other tax benefits claimed attributable to the dependency exemption such as Child Care Credit, Child Tax Credit, Education Credit or Filing Status. Refer to IRM 4.19.15.11.3, Related Taxpayer, before issuing the Examination Report.
Refer to IRM 4.19.14.6.5, EITC - Personal Exemptions and Dependents, for rules on claiming a personal exemption or dependency exemption and for recommended supporting documentation.
Processing Taxpayer Replies
Refer to IRM 4.19.13.10, Taxpayer Replies, for procedures for processing replies from the taxpayer
For a child of divorced or separated parents or parents who live apart at all times during the last 6 months of the calendar year, a noncustodial parent claiming a child as a dependent must file a Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, or substantially similar statement with his or her return, if the special rule for divorced or separated parents or parents who live apart applies. See Residency Test - Children of divorced or separated parents (or parents who live apart), in Pub 501, Standard Deduction and Filing Information.
Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, is a written declaration signed by the custodial parent releasing a claim to an exemption for the child to the noncustodial parent for a single year, a specified number of years, or all future years. The noncustodial parent must attach a copy of the signed Form 8332 or similar statement to his/her return for each year that the non-custodial parent is claiming an exemption for the child.
A copy of this form or similar statement must be requested during the audit since the return is not included in the examination case file. A Form 8332 executed after the return has been filed should be considered in the overall context of the examination when determining which parent is entitled to the exemption.
The filing requirements for attaching Form 8332 or similar statement to the noncustodial parent's return are based upon the year in which the divorce decree or separation agreement went into effect:
DECREE or AGREEMENT YEAR
Post-1984 but pre-2009 decree or agreement. The decree/agreement:
States that the noncustodial parent can claim the child as a dependent without regard to any condition, such as the payment of support, and
Specifies the year or years in which the noncustodial parent can claim the child as a dependent, and
Is otherwise substantially similar to Form 8832, and
Is signed by the custodial parent to indicate that the custodial parent agrees not to claim the child as a dependent for the year.
If submitted in lieu of Form 8332, the noncustodial parent must attach certain pages of the decree or agreement to the tax return.
For additional information, see Custodial parent and noncustodial parent in the chapter on Personal Exemptions and Dependents in Pub 17.
Post-2008 decree or agreement. The decree/agreement:
The noncustodial parent cannot attach pages from decree/agreement, in lieu of Form 8332.
The noncustodial parent must attach a Form 8332 or similar statement to his or her return.
The custodial parent must sign either Form 8332 or a similar statement whose only purpose is to release the custodial parent's claim to the dependency exemption for the child without any conditions.
Effective for tax years after 2015, if the taxpayer's claim for ACTC or AOTC is due to reckless or intentional disregard of rules and regulations, a 2-year ban may apply. If the claim is fraudulent, a 10-year ban may apply. The 2- and 10-year bans do not apply to the Lifetime Learning Credit or the tuition and fees deduction. See IRC section 24(g)(1), section 25A(b)(4)(A), and IRM 4.19.14.7.1, 2/10 Year Ban - Correspondence Guidelines for Examination Technicians (CET).
Related Taxpayer(s)
The scope of the examination must be expanded to include returns for taxpayers who, from previous audits, have been determined not to be entitled to the dependency deduction. Consideration must also be given to expanding the examination to returns of taxpayers who, based on analysis of internal information, may not be entitled to the dependency exemption. These cases should be likely to ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ and must be established on the Audit Information Management System (AIMS) under Project Code 0059 and started within 30 days from the closure of the previous audit. For related returns claiming EITC, refer to IRM 4.19.14.8.1.2, DUPTIN Related Taxpayers.
The workpapers on the initial audit must document the reasons the examination was expanded or why it was not expanded.
If opening the custodial TIN per Federal Case Registry (FCR) or the TIN of one of the child's parents per Kidlink, the initial audit must be closed as a "No Change" to tax.
Self-Employment Tax (SET)
IRC 1401 establishes the legal authority for assessing Self-Employment Tax (SET), as defined in IRC 1402.
Refer to IRM 4.4.29, AIMS Procedures and Processing Instructions, Social Security Administration (SSA) Adjustments. Also see IRM 25.6.1.9.11, Self-Employment Contributions Act (SECA), for special case situations.
SET is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners. The SET program identifies income that might be subject to SET. The income may be reported on Schedules C, C-EZ or F.
SET is required when:
Net earnings from self-employment (excluding church employee income) is $400 or more, or
Church employee income is $108.28 or more. (Income from services performed as a minister, member of a religious order, or Christian Science practitioner isn't church employee income.)
The SET rate on net earnings is 15.3 percent (12.4 percent Social Security Tax plus 2.9 percent Medicare Tax). See IRM 4.19.15.26, Correspondence Exam Tip Program, for information regarding Additional Medicare Tax on self-employment income.
For 2011 and 2012, the SET rate was reduced to 13.3 percent (10.4 percent Social- Security Tax plus 2.9 percent Medicare Tax).
Taxpayers may deduct half of the self-employment tax amount when determining their adjusted gross income.
For 2011 and 2012, taxpayers may deduct the employer-equivalent portion of the self-employment tax amount when determining their adjusted gross income. The amount that may be deducted varies based upon the amount of self-employment tax the individual paid. See Form 1040 (Schedule SE) for tax year 2012. For tax years beginning after 2012, the deduction for one-half of self-employment tax will be computed without regard to the 0.9 percent Additional Medicare Tax on self-employment income.
Self-Employment Tax Procedures
Pull IDRS cc IRPTR (Information Returns Processing Transcript Requests) if available.
These cases will start in AIMS Status 10 through the Automated Correspondence Exam (ACE) system.
Letter 718 will be the initial contact letter and will include Form 9549, Explanation of Other Income, which the taxpayer is asked to complete.
If the case needs to be pulled from ACE due to a reject/filtering condition, prepare Form 3198, Special Handling Notice for Examination Case Processing, for the case file, along with the examination report. Show the applicable Reference Codes to adjust the self-employment income and tax.
This information is required for closing so that the Social Security Administration (SSA) records are updated accordingly.
Case processing:
No response is received in 45 days to Letter 718 Prepare Letter 525/Letter 525-T for TDC cases, and report Form 4549.
No response is received to Letter 525/Letter 525-T for TDC cases Prepare Statutory Notice of Deficiency (SNOD) from the information available.
Taxpayer responds to initial contact and income is determined to be self-employment income Prepare Letter 525/Letter 525-T for TDC cases, Exam report and propose correct self-employment tax.
Taxpayer responds to initial contact letter with a Form 1040X agreeing that the income is from Self Employment Close Case agreed. See IRM 4.19.13.10, Taxpayer Replies
Taxpayer substantiates the income is not from self-employment or the taxpayer is not liable for the employee share of FICA (Federal Insurance Contributions Act) tax Close the case no change and issue Letter 590
Taxpayer claims an employee-employer relationship existed, but the employer did not withhold FICA tax Request further information to show employee status. Consider referral to SB/SE Compliance Area Office if warranted. IRM 4.19.13 , SS-8 Determination of Worker Status.
Taxpayer claims to be exempt from self-employment tax due to a previous filing of Form 4361, Application for Exemption From Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners, or Form 4029, Application for Exemption From Social Security and Medicare Taxes and Waiver of Benefits Research Master File to verify if indicator is on file. For a list of indicators, see IRM 4.19.6.4(2 ), Minister/Religious Waivers Overview. If no indicator, request approved copy of Form 4361, or Form 4029 from taxpayer.
Taxpayer has not retained approved copy of Form 4361 or Form 4029 and there is
No indicator on Master File
No verification of approval is available
For a list of indicators, see IRM 4.19.6.4(2) , Minister/Religious Waiver Overview. Determine tax year form was filed. Research Master File entity information to verify indicator is on file.
Pull return from files to see if exemption form is attached
Continue with the proposed self-employment tax and issue appropriate letter per IRM 4.19.13.10.1, Taxpayer Responses - Additional Information Needed.
Reply is a copy of an approved Form 4361 but the MIN-SE-TX-EXEMP-CD field on IDRS cc ENMOD displays a value other than "1" , the Form 4361 has NOT been approved. Route Form 4361 to Philadelphia Campus Mail Stop 4-G08.151 for processing. For general information about Form 4361 see IRM 4.19.6.5.1, General Guidelines for Form 4361.
Reply is a copy of an approved Form 4029 but the MIN-SE-TX-EXEMP-CD field on IDRS cc ENMOD displays a value other than "4" , the Form 4029 has NOT been approved. Route Form 4029 to Philadelphia Campus, Mail Stop 4-G08.151 for processing. For general information about Form 4029 see IRM 4.19.6.6.1 , Form 4029-Procedures.
No response. After the suspension period has expired, process the assessment and close case as a default.
SS-8 Determination of Worker Status
The Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, is used to request a determination or ruling letter regarding a worker's federal employment tax status. If a letter is received requesting a worker status determination, a Form SS-8 is sent to the taxpayer advising them to resubmit their request for determination to the appropriate office.
The SS-8 Program has been centralized at Brookhaven Campus, except for Form SS-8 requests involving agencies and instrumentalities of the Federal government. See IRM 7.50.1, Form SS-8 Processing Handbook. Form SS-8 requests involving agencies and instrumentalities of the Federal government are handled by the Associate Chief Counsel (CC:EEE) at the address provided in IRM 7.50.1.1.1(2), Overview, paragraph (2).
Procedures for issuing rulings, determination letters, and information letters are found in the first revenue procedure of the calendar year. The procedure is updated each year.
If a determination is made that the worker involved is an employee, correct returns may be solicited from the business. If the business does not respond, an employment tax examination may be initiated depending on the criteria of the applicable Area Office where the business is located.
Any information related to other areas of employment tax noncompliance can be provided by Area Office management.
Partnership-level Proceedings
Refer to IRM 4.29, Pass-through Control System (PCS), IRM 4.31, Pass-Through Entity Handbook, and IRM 4.13.9 Centralized Partnership Audit Regime (BBA) Field Examination Procedures, for additional information for partnerships subject to TEFRA (Tax Equity and Fiscal Responsibility Act of 1982) for tax years beginning before January 1, 2018 or the centralized partnership audit regime enacted by the Bipartisan Budget Act of 2015 (BBA) for tax years beginning on or after January 1, 2018."
Form 8082, Notice of Inconsistent Treatment and Administrative Adjustment Request (AAR)
The Form 8082, Notice of Inconsistent Treatment and Administrative Adjustment Request, is filed by taxpayers for two different purposes. It is used by taxpayers to report when they are taking a position on their return that is inconsistent with the way the partnership or S- Corporation treated and reported the same item on its return. It is also used by a TEFRA partnership or one of its partners to reflect changes to partnership items. It is also used by BBA partnerships when correcting a previously filed return.
Notice of Inconsistent Treatment.
TEFRA and BBA Partners, under IRC 6222 and S corporation shareholders, under IRC 6037(c), are generally required to file their returns consistently with the partnership or S- Corporation return. However, there may be reasons why a member wishes to report items differently. Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), is used for this purpose. (For tax periods prior to 201812 a partner in an electing large partnership must also file in a manner consist with the partnership, per IRC 6241.)
TEFRA was repealed as part of the BBA of 2015 and replaced with a new centralized partnership audit regime. The repeal of TEFRA became effective for partnership tax years beginning after December 31, 2017.
Refer to IRM 4.31, Pass-Through Entity Handbook, for additional information.
Administrative Adjustment Request (AAR).
An AAR is filed to correct items on the original partnership return, or may be filed by a partner to correct partnership items that have passed through to their return. Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), is used for this purpose.
The BBA regime also allows BBA partnerships to file AARs.
Refer to IRM 4.31.4, Pass-Through Entity Handbook, for additional information on TEFRA AARs and BBA AARs.
Unallowable Code (UA) Program
The Unallowable Code (UA) Program is a pre-refund program that identifies items for potential audit during return processing. It is a Compliance initiative used to prevent the issuance of erroneous tax refunds on both Individual Master File (IMF) and Business Master File (BMF) tax returns. The program requires coordination between headquarters analysts in W&I Campus Examination, SB/SE Campus Examination, Large Business & International (LB&I) and Submission Processing (SP) to ensure the correct types of Unallowable Conditions are being identified.
During processing, returns are reviewed for unallowable issues. If there is an unallowable issue present on the return, the appropriate code is assigned to the return. The cases are systemically opened on Audit Information Management System (AIMS) to the appropriate campus based upon back-end state mapping.
For a complete listing of unallowable codes reference Document 6209, IRS Processing Codes and Information.
Unallowable Code Assignment and AIMS Opening
Submission Processing (SP) Headquarters (HQ) analysts are the primary owners of any work request that activates and establishes the programming for an Unallowable Code.
Examination HQ analysts contact SP with any changes that need to be made in the Unallowable Program.
SP employees in Code & Edit and Error Resolution System (ERS)/Rejects) identify unallowable issues during return processing. Unallowable Code tolerances are as follows:
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For additional information regarding SP processing, refer to the following IRMs:
IRM 3.11.3.3.7.6, Unallowable Code (UAC).
IRM 3.11.3.18, Schedule A, Itemized Deductions.
IRM 3.12.2.5.9, Unallowables,.
IRM Exhibit 3.12.2-5, Audit Codes.
IRM Exhibit 3.12.2-6, Unallowable Codes.
During return processing a TC 576 will generate for a TC 150 with a credit balance and unallowable tax hold, holding the unallowable tax to the extent of the credit balance in suspense. The TC 576 will set a -Q Freeze, which prevents the amount of the TC 576 from refund or offset.
The cases will be systemically opened on AIMS to the campuses under Project Code (PC) 0000, Source Code (SC) 03, and Employee Group Code (EGC) 5000. The Primary Business Code (PBC) will be based on back-end mapping.
Identifying Unallowable Inventory to be Classified
Most of the cases opened in the unallowable program are opened under PC 0000 and SC 03. They have frozen refunds and should be started within 30 days of full AIMS creation.
Other cases selected using an Audit Code open in PC 0000 and SC 02. These cases should also be classified to determine if the return should be selected for examination.
One of the data sources available to identify new UA inventory is the SSIVL (Statistical Sampling Inventory Validation).
Reviewing and Classifying Unallowable Inventory
When new Unallowable returns are opened to campus examination inventory, Exam Tax Compliance Officers (TCOs) should classify them. See IRM 4.19.11.2, Examination Classification of Work,IRM 4.19.13, General Case Development and Resolution, and IRM 4.8.4.2, Cases Subject to Mandatory Review.
TCOs should review the return using Command Codes RTVUE, BRTVU, or TRDBV. The Employee User Portal (EUP) can be used to view Modernized Electronically Filed (MeF) returns. (Detailed return information and attachments are often available on EUP). SP employees are not trained on all tax law issues, and it is possible that the unallowable condition was incorrectly identified or coded. Classifiers should verify the unallowable conditions on the return and look for any other large, unusual and questionable items.
Refer to Document 6209, IRS Processing Codes and Information, for a list of unallowable codes and explanations to ensure the unallowable code(s) was properly coded. Referrals should be made to the appropriate area when potentially-abusive preparers and/or fraud are identified.
Unallowable Codes and amounts are shown on the last page of RTVUE and on the Code and Edit Values section on EUP. RTVUE will also show if there is a change to adjusted gross income, itemized deductions, or a tax adjustment. If RTVUE "Per Return" side and "Per Computer" side are different, a math error notice should have been sent. If the math error resolved the unallowable issue, close the case per local procedures.
Process cases as follows:
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If the taxpayer is in an active combat zone Refer to IRM 4.19.13.21, Combat Zone, for instructions.
The unallowable code was coded incorrectly and no other unallowable issue is present on the return Survey case with Disposal Code 20
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No additional issues are identified for the return and the UA issue does not need additional clarification Form 6754, Examination Classification Checksheet, is not required. Case is ready for initial contact letter.
No additional issues are identified for the return and the UA issue needs additional clarification (i.e. UA code is incorrect or EUP provides a description of the UA item) Use Form 6754, Examination Classification Checksheet, to identify the unallowable items(s).
Additional issues are identified for the return Use Form 6754, Examination Classification Checksheet, to identify the unallowable and additional issue(s). Change to Source Code 20. The Project Code will remain the same.
Initial Taxpayer Contact
Workpapers should be updated to include the specific issue(s) being audited (including UA code and description) along with any research conducted. See IRM 4.19.13.6, Workpapers for All Cases, for additional requirements.
Issue Letter 566-S, Initial Contact Letter (ICL), to notify taxpayer of issue(s) being examined on unallowable cases.
For UA 89, PC 0505 cases, see IRM 4.19.15.29, Health Coverage Tax Credit - IRC 35, for examination instructions.
Initial contact must include Form 886-A, Explanation of Items, to explain the issue(s) being examined.
Update AIMS to Status 10 and suspend the case for 30 days.
Processing Reply/No Reply Unallowable Cases
When processing replies or no reply cases, refer to IRM 4.19.13, General Case Development and Resolution. See below for additional requirements relating to the unallowable program that are not shown in the referenced IRM.
Sending Letter Letter 525/Letter 525-T for TDC cases, General 30 Day Letter, or Letter 3219, Notice of Deficiency In addition to the attachments noted in IRM 4.19.13, General Case Development and Resolution, include:
Form 2297 , Waiver of Statutory Notification of Claim Disallowance OR
Include the following paragraph on Form 4549, Income Tax Examination Changes: I waive the requirement that a notice of claim disallowance be sent to me by certified mail to disallow the refund claimed on my income tax return as described above. I understand that waiving this requirement is irrevocable and it will begin the 2-year period for filing suit with the United States District Court or the United States Court of Federal Claims for refund of the disallowed claim as if the notice of disallowance had been sent by certified or registered mail.
Case is closed as unagreed Issue Letter 105C , Claim Disallowed, or Letter 106C, Claim Partially Disallowed, as appropriate.
Transcripts titled, – QFRZALERT, will be sent to the responsible campus when an un-released TC 576 remains on a module longer than 6 months without open AIMS or 18 months for a module with open AIMS.
The transcript should be resolved within 15 days of receipt.
4.19.15.15.6.1 (01-01-2017)
Resolving the -Q Freeze
The -Q freeze is set by a TC 576. The TC 576 freezes an amount claimed on a return that appears to be unallowable by tax law.
The amount will remain frozen until the exam is closed/surveyed, or the refund is manually released.
To resolve the -Q freeze, the campus will need to identify the reason the unallowable was coded and take one of the following actions:
There is no TC 420 The unallowable was identified correctly in processing Establish AIMS using SC 06, PC 0000. Once the AIMS base is established, convert to SC 03. Refer to IRM 4.19.13.21, Combat Zone, for Combat Zone procedures.
There is no TC 420 The unallowable was identified incorrectly in processing Release the TC 576 through a manual online adjustment using a TC 572. This will generate a TC 577, restoring the TC 576 Unallowable Tax into the tax module, releasing the TC 576 hold.
There is no TC 420 There is a TC 971/522 on ENMOD indicating ID Theft for the tax year Refer to IRM 4.19.13.26, Campus Exam Identity Theft .
There is a TC 420 The examination has not started Follow IRM 4.19.15.15.3, Reviewing and Classifying Unallowable Inventory, to see if it should be examined or surveyed.
There is a TC 420 The examination has started See where the examination stalled and promptly take the appropriate actions to get the case into the next stage of the examination process.
There is a TC 420 There is a TC 300 or TC 421 Make sure that the correct blocking series and Disposal Code were used at closure. Doc Code 47 is to be used with Disposal Code 20-25, 27, 29, 31-33, 35 or 36. If the incorrect Doc Code was used, then please correct or manually input the TC 572 to release the TC 576.
Unallowable Program and Alternative Motor Vehicle, Electric Plug In Credit or Electric Drive Motor Vehicle Credit
UA 79 is used when a taxpayer claims the same vehicle more than once on a combination of Form 8834, Qualified Electric Vehicle Credit, Form 8910, Alternative Motor Vehicle Credit, and/or Form 8936, Qualified Plug-In Electric Drive Motor Vehicle Credit.
These cases open in Source Code 03 and PC 0000.
See IRM 4.19.15.38 , Alternative Motor Vehicle Credit, Qualified Plug-in Electric Drive Motor Vehicle Credit, or Qualified Electric Vehicle Credit, for appropriate Form 886-A, Explanation of Items, paragraphs and substantiation requirements.
Unallowable Program and First Time Homebuyer Credit
UA 84 is used when the taxpayer could not have transferred the home, which was claimed for the FTHBC, as part of a divorce settlement.
Refer to IRM 3.12.3.13.7, Error Code 126 (EC) Unallowable First-Time Homebuyer Credit (UA84), for the specific unallowable information.
Refer to IRM 4.19.15.38, First-Time Homebuyer Credit IRC 36, for appropriate Form 886-A, Explanation of Items, paragraphs and substantiations requirements.
Unallowable Program and Health Coverage Tax Credit
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These cases will open in SC 03 and PC 0505
Refer to IRM 4.19.15.29, Health Coverage Tax Credit - IRC 35, for specific unallowable conditions and examination procedures.
4.19.15.15.10 (03-11-2019)
Unallowable Program and the District of Columbia First-Time Homebuyer Credit Carryforward
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The DC First-Time Homebuyer Credit was available for the purchase or construction of a principal residence beginning August 5, 1997 through December 31, 2011. Any unused portion of the credit can be used to claim a carryforward until the maximum $5,000 ($2,500 MFS) has been used.
When a new UA 61 opens to the campus, Exam TCOs should research the taxpayer's account to determine if one or more of the following unallowable conditions are present:
the taxpayer has taken a cumulative amount greater than the maximum credit of $5,000 ($2,500 MFS)
the taxpayer does not appear to have resided in Washington DC
other questionable conditions identified by the TCO
If there are no unallowable conditions present, survey the case with DC 20.
Fuel Tax Credit Claimed on Form 4136
Form 4136, Credit for Federal Tax Paid on Fuels, is used to claim an income tax credit for certain nontaxable uses (or sales) of fuel during the tax year. Ultimate purchasers, credit card issuers, and in some cases, ultimate vendors of certain types of fuels may be able to claim a fuel tax credit (FTC). A claim cannot be made for personal use of any fuel on Form 4136, Line 1.
Form 4136 is often used to claim a credit for fuel used in an off-highway business. Off-highway business use is fuel used in a trade or business or in an income-producing activity described in IRC 212 otherwise than as a fuel in a highway vehicle (i) that is registered or required to be registered for highway use with a state department of motor vehicles, or (ii) in the case of a highway vehicle owned by the United States, is used on the highway. The fuel tax credit for off-highway business use of gasoline does not apply to passenger cars or, generally, to other vehicles that are registered or required to be registered to drive on public highways. It also does not include non-business, off-highway use of fuel, such as use by minibikes, snowmobiles, power lawn mowers, chain saws and other yard equipment. The credit is available for fuel used in a separate, non-propulsion motor of a highway vehicle to power auxiliary equipment, if certain requirements are met.
The taxpayer owns a landscaping business and uses power lawn mowers and chain saws in his business. The gasoline used in the power lawn mower and chain saws qualifies as fuel used in an off-highway business use. The gasoline used in the taxpayer's personal lawn mower at home does not qualify.
FTC returns are filtered and selected by Dependent Database (DDb) rules. Cases are opened pre-refund in PC 1505 with assigned tracking codes (TC):
TC 6560 - FTC cases (previously selected under PC 0000)
TC 6561 - cases with FTC and the American Opportunity Tax Credit
TC 6562 - cases with FTC and no Schedule C, E or F attached
TC 6563 - cases with FTC with specific NAICS codes present on Schedule C
The corresponding Credit Reference Number (CRN) applicable to the type of fuel tax paid is shown in column (e) of the Form 4136. Review the Form 4136 using Command Code (CC) TRDBV or view the Modernized Electronically Filed (MeF) return through the Employee User Portal (EUP).
Some of the most common documents the taxpayer can submit to verify their FTC claim are listed on Form 14811, Substantiation for Fuel Tax Credit (FTC), and include:
A list of vehicles and equipment used, including proof of ownership
Copies of invoices or receipts for the fuel purchases that include: The purpose for which the fuel was used; The number of gallons used for each purpose; The dates of purchase, and the names and addresses of suppliers and amounts bought from each.
Additional documentation may be required for certain fuels and Form 14811 can be modified to request this documentation if needed. See available resources below for additional requirements.
Start cases with Letter 566-S, Initial Contact Letter, and Form 14811, Substantiation for Fuel Tax Credit (FTC). If other issues are selected for examination, additional forms my be used to request needed documentation.
Generally, cases should be researched and worked following the procedures in IRM 4.19.13, General Case Development and Resolution. There are additional considerations related to the FTC that should be included in the examiner's research. Some of them are highlighted below.
Ensure there is a business activity reported on the return.
Review the credit to see if it appears to be unallowable or excessive based on the type of business shown on the return.
Check to see if the taxpayer claimed any amounts on Form 4136 that were claimed on; Form 8849, Claim for Refund of Excise Taxes, and/or Form 720, Quarterly Federal Excise Tax Return.
Other available resources which provide more detail on each type of fuel and the requirements to claim the credit are:
The instructions for Form 4136, Credit for Federal Tax Paid on Fuels
Pub 510, Excise Taxes
Pub 225, Farmer's Tax Guide
Erroneous Refunds
The Erroneous Refund Program in Correspondence Examination involves cases that had incorrect refunds issued to taxpayers due to variety of reasons. The potential for erroneous refunds may occur in the following situations: misapplied payments, incorrect tax adjustments/assessments, incorrect credit refunds, taxpayers filing fraudulent returns, or taxpayers using incorrect TINs. For more information on Erroneous Refunds and causes refer to IRM 21.4.5, Erroneous Refunds, and IRM 5.1.8.7.1, Recovery of Unassessable Erroneous Refunds.
Erroneous refunds cases are processed according to categories based on characteristics on the tax module. Erroneous refunds are generally classified as either:
Assessable – Requires a recalculation of tax liability.
Unassessable – No Requirement for a recalculation of tax liability.
The Correspondence Examination program involves assessable erroneous refunds. These errors arise when the Service made a downward recomputation of the taxpayer's tax liability based on a substantive determination and later discovers that the determination was incorrect. The adjustment to the tax liability or recapture of a refundable credit will require Statutory Notice of Deficiency processing.
The assessable erroneous refunds generally are referred to Examination as Category A1 or A2 referrals. There are situations in which Examination closes a case incorrectly and thereby creates an erroneous refund. If the case was closed with an erroneous refund, the case reopening criteria in Rev. Proc. 2005-32, and in IRM 1.2.1.5.1 , Policy Statement 4-3, must be followed. Also, see IRM 1.2.2.5.7, Delegation Order 4-7.
Before examination contact with the taxpayer and initiation of the Statutory Notice of Deficiency processing, each case will be screened to determine if the erroneous refund was correctly classified as assessable or non-assessable. Refer to IRM 21.4.5.5, Erroneous Refund Categories and Procedures, for more information on the categorizing of erroneous refunds.
Examination will determine if the statutory period for assessment has expired. Since Examination accepts only assessable erroneous refunds with tax liability changes, the ASED becomes the statute of limitations for the erroneous refund and is used in the selection criteria. For informational purposes, the following are the statute of limitations issues involved with erroneous refunds:
ASED – Assessment Statute Expiration Date
CSED – Collection Statute Expiration Date
ERSED – Erroneous Refund Statute Expiration Date
If the taxpayer did not cause the erroneous refund, and the amount of the erroneous refund is $50,000 or less, under IRC 6404(e)(2), the Service must abate interest accruing from the date of the refund to date of notice and demand. If the amount of the erroneous refund is more than $50,000, the Service may abate the interest accruing before the date of notice and demand in its discretion, see IRM 20.2.7.7, IRC 6404(e)(2), Erroneous Refunds. The classifier or examiner must determine whether the taxpayer in any way caused the erroneous refund and the workpapers must document this determination.
The following procedures should be used in erroneous refunds:
Non-assessable erroneous refund or assessment statute period has expired
Return transcripts back to initiator.
Non-assessable erroneous refunds are not worked by Examination.
Assessable and statute period of assessment has not expired
Classification will submit Form 5345-B, Examination Request Non-ERCS Users, or Form 5345-D, Examination Request-ERCS (Examination Returns Control System) Users, to obtain the examination assembly.
The cases should be opened with the following AIMS information:
Source Code: 20
Status Code: 08
Project Code: 0044 for Non-EITC Related or 0045 for EITC Related (EITC is the subject of the erroneous refund)
Employee Group Code: 5000
Assessable Erroneous Refunds on Individual Income Tax Returns
The initial contact letter should be issued as follows:
Non-EITC Discretionary PC 0044 cases, issue Letter 566-B with examination report.
EITC PC 0045 cases, issue Letter 566-S.
On Letter 566–B for discretionary or Letter 566-S for EITC, include the following explanation "Erroneous Refund" and "See Form 886-A." Enclose Form 886-A with the following explanation titled Erroneous Refund: "The refund check we mailed to you for your (tax year) overpayment was incorrect."
EITC case must follow the three letter exam process; i.e. ICL, 30 Day Letter, and Statutory Notice of Deficiency.
When preparing Examination Report, Form 4549, Income Tax Examination Report , use the following suggested explanation:
"We are sorry but the refund we sent you is incorrect because we overpaid you by the amount shown in the attached report. We regret the error and thank you for helping us correct it. Since the erroneous overpayment was due to IRS error, no interest will be charged if you pay the amount refunded in error within 21 days from the date of this letter. If the amount due is not received within 21 days, interest will be assessed from the date of this letter demanding repayment."
Include in the explanation to the taxpayer, on what line of the tax return or on what schedule the error occurred.
Update case to the appropriate AIMS status following general examination procedures.
Assessable Erroneous Refunds on other Federal Tax Returns
Business Master File (BMF) or Residual Master File (RMF) for deficiency procedures may be sent to recover an assessable erroneous refund.
General examination procedures will be followed.
Refer to IRM 4.10, Examination of Returns, and IRM 4.2, General Examining Procedures.
Erroneous Refunds to individuals who are Bona Fide residents of Puerto Rico Contact: LB&I WIIC Planning & Special Programs
Complete Form 3198, Special Handling Notice for Examination Case Processing, identifying the Erroneous Refund. Special handling is required to abate all interest charges if erroneous refund is repaid with 21 days (when the unpaid amount is between $50,001 and $99,999) or within 10 days (when the unpaid amount is $100,000 or more) of the request for repayment.
Alimony or separate maintenance is a payment to or for a spouse or former spouse that satisfies the requirements of IRC 71 . The term payer refers to the taxpayer who claims the alimony deduction. The term recipient refers to the spouse or ex-spouse whom the payer states received the alimony. Alimony or separate maintenance must be paid under a divorce or separation instrument. The term, "instrument," means a (i) a decree of divorce or separate maintenance, (ii) a written separation agreement, or (iii) a decree not described in (i) requiring a spouse to make payments of support or maintenance to the other spouse. Different alimony rules apply based upon the date an instrument was executed or modified. The Tax Cuts and Jobs Act of 2017 repealed IRC 71 and IRC 215 , removing both the responsibility of including alimony received as income and the ability to declare alimony paid as a deduction to income for any agreement executed after December 31, 2018. The law also applies to agreements executed on or before that date which modified alimony after that date to provide that the alimony is not includable in, or deductible from, income. Beginning with 2019, Form 1040, Schedule 1 requires a payer claiming a deduction for alimony paid to provide the date of the original divorce or separation agreement. See Pub 504 , Divorced or Separated Individuals, for additional information.
The correspondence examiner should resolve discrepancies between the amount deducted as alimony by one taxpayer (the payer) and the amount reported as income by the other taxpayer (the recipient). Beginning tax year 2018, receipts and payments of alimonies are reportable on Schedule 1 of Form 1040.
Two of the current Alimony Programs are referenced below.
Inventory for the Alimony SSN Program involves cases where the recipient of the alimony, as identified by the payer's return, apparently has an invalid SSN. The Project Code for the payer is 0141, and the Project Code for the recipient is 0142.
Inventory for the Alimony Matching Program involves cases where there is a substantial difference between the alimony deduction claimed by the payer and alimony income reported by the payee. The Project Code for the payer is 0231, and the Project Code for the recipient is 0232.
Initial Contact and General Processing
Payers - Payer cases are initiated through ACE (Automated Correspondence Exam) processing.
Payer cases are started in Status 10 with Letter 3541-A/Letter 3541-E for TDC cases, Initial Letter Asking For Verification on Alimony Deduction.
Letter 3541-A/Letter 3541-E for TDC cases, solicits records supporting the deduction claimed by the payer including proof of alimony payment and a copy of the instrument(s) authorizing payment. It also requests identification of the alimony recipient(s).
Cases will be suspended for 45 days in Status 10.
When the case moves into Status 22 or when a tax examiner is responding to a reply to the Letter 3541-A/Letter 3541-E for TDC cases, the Letter 3541/Letter 3541-D for TDC cases along with the Form 4549 will be mailed.
ACE generated reports include a substantial understatement penalty when applicable. Examiners should consider the application of accuracy penalties and information return penalties when processing responses.
Recipients - Open recipient cases on AIMS and initiate manually only upon verification by a payer of unreported alimony or pension income which would generate a deficiency for the recipient ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡. Refer to AIMS Processing IRM 4.4.23.2.1.1, Input Forms, and the IDRS Command Code AM424 Job Aid.
Create the recipient case on AIMS no later than 30 days after closure of the related payer case.
Initiate recipient cases in Status 10 with Letter 3540-A/Letter 3540-E for TDC cases, Initial letter Inquiring about Unreported Alimony Income.
Letter 3540-A/Letter 3540-E for TDC cases, requests a copy of instruments if income is disputed as well as identification of any payers.
Cases will be suspended for 45 days.
After the suspense period, the case will be manually updated to Status 22 and Letter 3540/Letter 3540-D for TDC cases along with the Form 4549 will be mailed manually by the campus. The case can be introduced into ACE after the Status 22 action is completed.
Recipient workpapers must detail the supporting information for the unreported income provided by the payer and include the payer's name and SSN from initial contact. Include both the ex-spouse's (or spouse's) SSN and the primary TIN of a joint payer return if the ex-spouse filed as the secondary taxpayer.
Include a copy of all relevant supporting documents provided by the payer in the recipient's case file.
Examiners should consider the application of accuracy penalties from initial contact.
Complete appropriately the Related Return Information Section of Form 5344, Examination Closing Record.
Form 5344 field:
Form 5344 entry should be:
Overwrite the default entries.
405 Payer's SSN
406 Payer's MFT (Master File Tax)
407 Payer's tax period
All - Suspend all cases after initial contact for 45 days awaiting taxpayer response.
Recipient Return Not Filed - If the recipient has not filed a return, initiate manually only upon verification by a payer of unreported alimony or pension income which would generate a deficiency for the recipient ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡. No later than 30 days after closure of the related payer case, open on AIMS per IRM 4.19.17.3.4, Non-Filer Source and Project Codes, and follow examination procedures per IRM 4.19.17, Non-Filer Program.
If the taxpayer does not respond to the letter, prepare the case for issuance of a Statutory Notice of Deficiency.
Close the case as a default if no response is received to the Statutory Notice of Deficiency after 105 days from its mail date.
Use the following table when reviewing a taxpayer's reply.
The taxpayer signs the report or, prior to the mailing of a Statutory Notice of Deficiency, pays the full amount Close the case agreed using normal procedures.
The taxpayer submits documentation and you need additional information Follow procedures in IRM 4.19.13.10.1, Taxpayer Response – Additional Information Needed.
Treat Letter 3540/Letter 3540-D for TDC cases, and Letter 3541/Letter 3541-D for TDC cases the same as Letter 525/Letter 525-T for TDC cases.
The taxpayer appeals the determination Follow relevant procedures in IRM 4.19.13.12, No Response and Unagreed Cases and IRM 4.19.13.15, Transfers to Area Office Examination or Appeals.
The taxpayer submits sufficient verification that the return is substantially correct. Close using "no change" procedures.
If at any time during the examination of a Payer it is discovered that the Payer listed an incorrect Recipient TIN on their tax return, inform the taxpayer of this. Notification can be given at any time before closing and may be accomplished through correspondence or a phone call. Examiners must document on the workpapers that this has been done. Notifying the taxpayer of their TIN reporting error will help prevent them from making the same error year-to-year, and potentially triggering audit selection rules unnecessarily.
Open a recipient case under the conditions noted in IRM 4.19.15.18.1, Initial Contact and General Processing, paragraph (2). The related payer case need not be closed first. For example, alimony payments may be resolved with respect to one recipient and not another, or the payer case remains open for expanded issues only. Monitor a payer case through default if necessary when the conditions to open a recipient case have been met but additional supporting records are required to resolve the remainder of payments purported to be made to the same recipient. Copy all pertinent documents provided by the payer for inclusion in the recipient's file in case the latter files an appeal.
The burden of proof is on the Service for disputed income.
Workpapers
While thorough workpaper documentation is important regardless of the issue, it is particularly critical for alimony deductions/income because the outcome of one taxpayer's case may impact one or more other taxpayers.
Examiners should note the following when applicable on Form 4700, Examination Workpapers (not all inclusive):
The type of each document received (e.g., divorce decree or, separate maintenance agreement or , written separation agreement, QDRO (Qualified Domestic Relations Order), cancelled check, pay statement, etc.).
The date of an instrument, the state in which it was executed, and the parties who signed it.
The name and SSN of the other party affected by an instrument or QDRO. (Also if the other party filed as the secondary taxpayer on a joint return, note the primary TIN of that return.)
The nature of the payments ordered by an instrument (e.g., pension, periodic alimony (in general, applicable for instruments executed on or before December 31, 1985),lump-sum alimony(see IRC § 71(f) recharacterizing deductible alimony as a nondeductible property settlement), unallocated family support(in general, for instruments executed after December 31, 1984, see IRC 1.71-1T, Q/As 15 through 18, describing the circumstances in which an amount of unallocated family support is fixed as child support and not alimony), etc.) and the amounts specified by type.
It is not necessary to detail a property settlement unless the payer deducted it or to note any other type of payment if the payer only claimed a pension split.
The presence or absence of a child support order (not applicable for pension splits). If child support is ordered, it must be verified as paid before allowing a deduction for any direct payments for alimony.
The presence or absence of a death contingency (not applicable for pension splits). If there's a death contingency, explain whether it is specifically stated in an instrument or it applies by operation of state law.
The presence or absence of a child-related contingency if unallocated support was ordered in an instrument.
Taxpayers often deduct payments made to more than one spouse/former spouse. Record documentation received concerning each recipient separately in the payer's workpapers.
Copy/paste can be used when creating the recipient's workpapers to transfer information from the payer's workpapers.
If the payer audit results in a no-change, audit consideration of the recipient taxpayer(s) must be documented in the payer's workpapers. The workpapers must indicate whether the audit was or was not expanded to the recipient taxpayer(s) and why.
Refer to IRM 4.19.13.3.3, Standard 3 - Workpapers Support Conclusions and IRM 4.19.13.6, Workpapers for All Cases for more information concerning workpapers.
Payers - Since payer cases are initiated systemically, it's important to thoroughly research IDRS when processing the first response.
Screen each recipient's RTVUE/TRDBV and IRPTR to determine if alimony income was substantially reported on any income line of a recipient's return.
Review each recipient's account to determine if an amended return was filed to report the alimony income.
After verification of payments made, meet IRC 71 requirements, close the payer case as a "no change" if alimony income reported by the recipient(s) substantially matches the alimony deduction claimed by the payer.
Screen the payer's RTVUE/TRDBV and IRPTR to determine if there are large, unusual or questionable items (LUQs) other than the alimony deduction and revise the report if warranted. Do not introduce new deficiency issues when sending Letter 555.
Recipients - Perform IDRS research prior to establishing a recipient case on AIMS.
Review the recipient's account to determine if an amended return was filed. It is common for payers to inform recipients of their examinations, often prompting recipients to amend their returns.
Screen the recipient's RTVUE/TRDBV and IRPTR to determine if there are any LUQs other than the alimony income and expand the scope of the audit if warranted.
All - Review all related CEAS records including any for prior and subsequent years and for the cross-reference taxpayer(s) to determine if they contain pertinent information. However, do not "no change" a case solely because the same issue was examined for another tax year and not adjusted. Each year stands on its own merits.
Documentation must include the instrument that orders the payment of alimony with all amendments and proof of payment in the form of:
Copies of cancelled checks identifying who received the funds, the dollar amount and the date the payment cleared the bank, the front and back of money orders, or proof of direct deposit that specifically identifies the recipient by name;
Court receipts or statements from state or county agencies to which payments were made; or
Pay statements showing the name of the recipient or court document docket number.
The instrument may require payments to third parties that could qualify as alimony. Documentation can include, but is not limited to:
Copy of a deed to verify home ownership for mortgage, real estate taxes and home insurance payments;
Receipts, utility statements, lease agreement, etc., for living expenses;
Registration and receipts for education expenses;
Proof of recipient's ownership for life insurance premiums;
Bills and receipts for medical and dental expenses;
Statements for health insurance premiums;
Proof of ownership of other property such as car, boat, recreational vehicle, etc. The recipient must be the sole owner of said property.
Payments designated as not alimony on or before December 31, 2018, can only be excluded from income if the recipient attaches a copy of the instrument designating the payments as not alimony, on instruments executed to his/her return. The instrument must be attached to the return for each tax year for which the designation applies.
Unacceptable documentation includes but is not limited to:
Unsigned (by either a judge or both affected parties), undated, or incomplete instruments,
Letters unexecuted testifying to verbal agreements,
Retroactive instruments unless a judge indicates the correction was due to a clerical error made by the court or there is a nunc pro tunc order revising the original decree to conform to the intent of the court at the time of entry.
Legal Terminology
Instruments of divorce or separation often contain legal terminology. Some frequently used terms relevant to alimony include:
Decree nisi - a provisional decree that will become final unless cause is shown why it should not.
Some states grant divorces using decrees nisi. The decree nisi creates a time period (such as three months) allowing for possible reconciliation or for completion of various arrangements (such as custody).
Separation a mensa et thoro - a separation of spouses which does not involve a dissolution of the marriage but in which certain arrangements (such as for maintenance and custody) are ordered by the court (also called legal separation, judicial separation).
Divorce a vinculo matrimonii - a divorce that completely and permanently dissolves the marital relationship and terminates marital rights (such as property rights) and obligations (such as fidelity); absolute divorce.
Ex parte - on behalf of or involving only one party to a legal matter and in the absence of and usually without notice to the other party.
an ex parte motion;
relief granted ex parte (used in citations to indicate the party seeking judicial relief in a case).
Nunc pro tunc - now for then (used in reference to a judicial or procedural act that corrects an omission in the record, has effect as of an earlier date, or takes place after a deadline has expired).
a nunc pro tunc order;
permitted to file the petition nunc pro tunc.
Pendente lite - during the suit: while litigation continues.
awarded joint legal custody of the child pendente lite;
pendente lite child support.
Interlocutory - not final or definitive.
an interlocutory order.
Joint tenancy - a tenancy in which two or more parties hold equal and simultaneously created interests in the same property and in which title to the entire property is to remain with the survivors upon the death of one of them (such as a spouse) and so on to the last survivor.
a right to sever the joint tenancy.
Tenants in common - a tenancy in which two or more parties share ownership of property but have no right to each other's interest (such as upon the death of another tenant).
Tenants by the entirety - a tenancy that is shared by spouses who are considered one person in law and have the rights of survivorship inherent in joint tenancy and that become a tenancy in common in the event of divorce.
Property subject to a tenancy by the entirety cannot be encumbered by one tenant acting alone.
Death Contingency
Prior to the repeal of IRC 71 by TCJA, IRC 71 required, in part, that for a payment to qualify as alimony, the payment must immediately cease upon the death of the payee. The termination requirement was satisfied if set forth in the applicable instrument or occurred by operation of state law or, in certain cases, federal law. Typically, the state, in which the instrument was executed, applies to determine whether alimony immediately ceases upon the death of the payee. In general, this requirement is applicable only to instruments executed on or before December 31, 2018. See Pub 504 .
Pension Income
Qualified Domestic Relations Order (QDRO) - If pension income is paid from a qualified retirement plan that is a private industry plan, an instrument can provide for the division of the retirement benefit or distribution between the plan participant and a non-participant spouse (or former spouse). This instrument is referred to as a qualified domestic relations order (QDRO), and transfers the applicable percentage of distributions or other amounts from the plan to an alternate payee who may be the non-participant spouse (or former spouse) or a child or other dependent. Although pension income paid to a non-participant spouse (or former spouse) is not alimony, it is frequently deducted as such.A distribution that is paid under a QDRO to an alternate payee who is a spouse (or former spouse), the distribution is taxed to the spouse (or former spouse). A distribution that is paid under a QDRO to an alternate payee who is a child or other dependent is taxed to the plan participant. However, the participant may be ordered to pay the required percentage directly to a non-participant spouse after distribution. Under a QDRO, separate Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., should be issued to each individual, the plan participant and non-participant spouse, showing only the amount of their respective distributions. If the QDRO is to a non-spouse, such as a child, only one Form 1099-R is issued to the participant showing the entire distribution. Unlike other property settlements, pension distributions are taxable to the recipients because those distributions were based on amounts previously contributed on a tax-deferred basis.
A QDRO is not a divorce decree. It is the document used to authorize a qualified retirement plan to distribute funds to an alternate payee. However, the participant may be ordered to pay the required percentage directly to a non-participant spouse (or former spouse) after distribution. Unlike other property settlements, pension distributions from a qualified retirement plan generally are taxable to the recipients because those distributions were based on amounts previously contributed to the plan on a tax-deferred basis (unless the participant made after-tax employee contributions). If a plan distributes a portion of a participant's pension to a participant spouse and, under a QDRO, a portion of the participant's pension to the non-participant spouse (or former spouse), separate Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., should be issued to each individual, the plan participant and non-participant spouse (or former spouse), showing only the amount of their respective distributions. If the distribution of the pension income under the QDRO is to a non-spouse, such as a child, only one Form 1099-R is issued to the participant showing the entire distribution. Retirement plans that are maintained by governments or churches can also divide a retirement benefit or distribution between the plan participant and non-participant spouse under a domestic relations order as if the document were a QDRO. In such a case, the tax treatment described above applies to distributions from the plan made under the domestic relations order.
Defense Finance and Accounting Services (DFAS) Reporting - A portion of a military pension can be paid by the Defense Finance and Accounting Services (DFAS) directly to a former spouse under a domestic relations order for child support, alimony, or as a division of the retired pay as property. Under these circumstances, DFAS will issue a Form 1099-R to each individual reflecting their shares of the retirement and taxes withheld. If the domestic relations order instead requires a portion of the military retirement pay to be paid to a non-spouse, such as a child, that portion is included in the participant's taxable income and only one Form 1099-R is issued to the participant showing the entire distribution. A copy of both the front and back of the Retiree Account Statement (DFAS-CL) must be received to verify the taxpayer claimed the entire pension amount. The plan participant can obtain the copies from MyPay at HTTP://MYPAY.DFAS.MIL
State and Local Government/Private Industry Pensions - Total distributions from the plan must be verified to ensure the taxpayer claimed the full amount received by all parties.
Disability Pensions - Disability pensions paid from any retirement plan other than a military plan are taxable. Certain military disability retirement payments are nontaxable to the participant. However, the non-taxable nature of a disability pension paid from a military plan does not transfer to the non-participant spouse (or former spouse). The disabled participant spouse cannot take a deduction for a non-taxable distribution transferred to a non-participant spouse (or former spouse) unless it is first reported in taxable income. The non-participant spouse (or former spouse) is required to report the income on his/her tax return.
Do not use alimony language when adjusting pension income.
What is DIF CORR (Source Code 06)
Discriminant Information Function (DIF) examines non-complex credits, deductions and/or expenses on Nonbusiness returns. Some examples are:
Simple miscellaneous expenses such as union dues, work clothes, and small tools
DIF order could be utilized to select high income taxpayers with high DIF score for audit.
DIF returns require classification.
Procedures for DIF CORR (Source Code 06)
Use Initial Contact Letter 566-S to notify taxpayer of review.
Check off the issues on the back of Letter 566-S using classification check sheet.
Adjustment is required after information is submitted by the taxpayer Send Letter 525 (SC), Form 4549 / Form 4549-EZ, and appropriate attachments, and retain copy of letter and report in the RGS case file.
Case is a single issue information return Send Letter 525 (SC) and Form 4549/Form 4549-EZ, and with adjustment and standard explanation(s).
Evaluating Taxpayer Replies/No Replies/Closing Procedures etc. Refer to IRM 4.19.13, General Case Development and Resolution, for guidelines. IRM 4.19.15.20, Schedule A, for Schedule A issues.
For all examined Schedule A items, the examiner should check for:
Altered photocopies of paid bills.
Bank statements or cancelled checks coinciding with the amount claimed as paid.
An altered document is an indicator of fraud and a fraud referral or civil fraud penalty should be considered. Refer to IRM 4.19.10.4, Fraud Referrals.
Medical and Dental Expenses: The examiner should have the taxpayer send in the following documentation (Form 14808, Schedule A - Medical and Dental Expenses):
Copies of bank statements or cancelled checks, receipts or statements for all medical savings accounts, medical and dental expenses (including medical insurance) showing the person for whom each expense was incurred, the name and address of each person to whom payment was made, and the amount and date of payment in each case.
Any insurance or employer reimbursement records, and
Verification of medical and dental insurance premiums paid.
The Archer Medical Savings Account program expired on December 31, 2007.
When the requested documentation is received, the examiner should:
Ensure that insurance reimbursements are excluded from deductions. Ensure medical or dental insurance premiums were not paid pre-tax. Ensure the expenses are for the taxpayer, spouse, dependent, adopted child, child of divorced or separated parents, or a decedent who, when living, was the taxpayer, spouse, dependent, adopted child, or child of divorced or separated parents.
Ensure that the medical expenses are for a person.
Costs of a guide dog or other animal to be used by a visually impaired or hearing impaired person are allowable. Also allowable are expenses to care for an animal trained to assist persons with any other physical disabilities.
If there is a multiple support agreement, the taxpayer may be able to claim medical expenses even if the taxpayer cannot claim that person as a dependent (IRC 152 and IRC 213).
Nondeductible Medical Expenses
This list is not all inclusive.
Nondeductible Purchases
Baby-sitting, child care, and nursing services for a normal, healthy baby Personal expenses are not allowable, even if the expenses enable the taxpayer to get medical treatment.
Controlled substances Purchase of any substance in violation of federal law is not deductible, e.g., marijuana, laetrile, etc.
Cosmetic surgery, electrolysis or hair removal, hair transplant Medical expenses paid for cosmetic surgery are deductible only if they are necessary to improve a deformity arising from, or directly related to, a congenital abnormality, or a personal injury resulting from an accident, trauma, or a disfiguring disease
Dancing lessons or swimming lessons Not allowed, even if recommended by a doctor for the improvement of general health. These are deductible only if prescribed for a specific medical condition.
Diaper service Allowed only if needed to relieve the effects of a particular disease.
Health club dues A fee charged by a health club is deductible only if it is a fee for a specific service, such as a fee for a trainer service to treat a particular medical problem.
Household help Allowed only if paid for nursing-type services. Certain maintenance or personal care services provided for qualified long-term care can be included in medical expenses.
Illegal operations and treatments Not allowed, even if medically prescribed.
Insurance Premiums Not deductible if for the following insurance benefits:
Payments for loss of life, limb, sight, etc.
Payments for loss of earnings. Guaranteed payment for each day of hospitalization.
Pre-tax insurance premiums.
Maternity clothes Not allowable.
Medical Savings Accounts (MSA) Not allowed.
Any expense paid from a medical savings account is not deductible.
The taxpayer cannot deduct medical expenses as itemized deductions that are included in the tax-free amount of a distribution from a Health Savings Account (HSA). If taxpayer has deducted medical expenses or insurance premiums elsewhere on the return, these expenses cannot be used again as a deduction on Schedule A.
Nonprescription drugs and medicines Not allowed.
Nutritional supplements Allowed if they are recommended by a medical practitioner as treatment for a specific medical condition diagnosed by a physician. See Publication 502.
Personal use items Allowed only when an item is purchased in a special form primarily to relieve a physical defect. The excess of the cost of the special form over the cost of the normal form is a medical expense.
Weight-loss program Allowed only if the program is undertaken to treat an existing disease (such as obesity) diagnosed by a physician.
Taxpayers are allowed to deduct certain taxes when they itemize deductions on Schedule A (Form 1040). These taxes include:
State and local income taxes
General sales taxes
Personal property taxes
For tax years beginning in 2018 through 2025, the deductions is limited to $10,000 ($5,000 for married individual filing a separate return. See IRC 164(b)(6).
For additional information on deductible taxes refer to IRM 21.6.4.4.1.4, Taxes and Fees –Deductible and Nondeductible.
For taxes paid, the examiner should consider having the taxpayer send in the following documentation:
For State and Local Income Tax deductions:
Copies of state or local returns for the years involved.
Copies of cancelled checks and receipts for taxes paid during the year.
Form W-2 or other statement showing state and local income tax withheld during the year.
For State Sales Tax Deduction:
Sales receipts for the year involved, if actual state and local general sales taxes are claimed.
Statements from the payer for non-taxable income which includes: tax exempt interest, veterans' benefits, non-taxable combat pay, workers' compensation, non-taxable part of Social Security and Railroad Retirement Benefits if the taxpayer used the Optional State Sales Tax Table, and indicates he/she had non-taxable income and the non-taxable income was not shown on the return. The General Sales Tax Tables are in the Form 1040 Instructions.
Sales receipts for motor vehicles, mobile and prefabricated homes, or home building materials. The actual sales tax paid on these items can be added to the amount in the Optional State Sales Tax Tables, but only include the amount of tax paid at the general sales tax rate.
For State and Local General Sales Tax Deduction:
Documentation to support state and local sales taxes paid on a motor vehicle, aircraft, boat, home, or home building materials, if claimed in addition to table amount. This includes purchase contracts and bills of sale. If the taxpayer claimed actual sales taxes then the taxpayer needs to provide actual sales receipts and support for purchase of large items.
If the receipts are too numerous to photocopy, the taxpayer may provide an itemized list. The list should identify the item purchased, date, total cost, and the amount of sales tax paid.
For Taxes on Qualified Motor Vehicles-State or Local Sales or Excise
Documentation to support state and local sales and excise taxes paid on a qualified new motor vehicle, include purchase contracts and bills of sale.
This provision expired in 2009. The vehicle must have been purchased before the end of 2009. However, the vehicle sales taxes may still be deducted as a general sales tax if the taxpayer elects to deduct general sales taxes.
For Real Estate and Personal Property Taxes deduction (list is not all inclusive):
Verification of legal ownership of the property.
Copies of cancelled checks, mortgage statements or receipts for taxes paid.
Copy of property tax bill and documentation of any property tax rebates or refunds.
Copy of the settlement statement if real property was sold or purchased during the year.
Verification of any special assessments deducted as taxes and an explanation for their purpose.
See , Form 14810 – Schedule A - Taxes You Paid.
The following is a list of nondeductible taxes (not all inclusive):
Federal Income and Excise taxes.
Social Security Taxes .
Medicare.
Federal Unemployment Tax (FUTA).
Railroad Retirement Taxes (RRTA).
Customs duties.
Tax on gasoline.
Car inspection fees.
Assessments for sidewalks or other improvements to property.
Tax paid for another taxpayer.
License fees (marriage, driver's, dog, etc.).
Penalties or interest.
Homestead Exemption – this is not a tax, but is used to reduce state or local real property taxes for qualified homeowners.
For tax years beginning after 2017 through 2025, foreign real property taxes.
Taxpayers should not reduce their deduction by:
Any refund of, or credit for, prior year state and local income taxes received in the tax year of the return.
Tax refunds from prior year State returns, when the taxpayer has state and local taxes on the prior year Schedule A should be reported on the appropriate line of Form 1040 beginning in tax year 2018 use Form 1040 Schedule 1.
Refunds of real estate taxes deducted in prior years should be reported on the "Other Income" line of the Form 1040, beginning in tax year 2018 use Form 1040 Schedule 1.
For 2004 and subsequent tax years, taxpayers can elect to deduct either state and local general sales taxes, or state and local income taxes. The taxpayer cannot deduct both. For tax years beginning in 2018 through 2025, a taxpayer's total deduction of either type of tax is limited. See IRM 4.19.15.20.2(1).
If the taxpayer deducts state and local income taxes, the taxpayer reports the sales or excise taxes for a new motor vehicle on line 7 of the Schedule A.
If the taxpayer elects to claim a general sales tax deduction using the general sales tax table amount, the taxpayer can add the sales tax paid for a new motor vehicle to the general sales tax table amount, and report it on line 5(b) of Schedule A.
Ensure the taxpayer has not duplicated the deductions elsewhere on the return such as on Schedule E or C.
If taxpayer has a Schedule E, ensure taxes and interest related to that property have not been placed erroneously on Schedule A.
State and Local Sales Tax Deduction:
The state or locality imposes a general sales tax on the sale of a home, The "closing statement" from the sale of the home should show the amount of sales tax due from the seller.
The state or locality imposes sales tax due to a major/substantial renovation, The taxpayer should provide a statement from the state or locality for the sales tax paid.
A contractor was authorized by contract to act in the taxpayer's behalf to build or substantially improve the taxpayer's home, The taxpayer should provide a copy of the contract designating the contractor, a statement from the contractor indicating the items purchased and amount of sales tax paid.
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Home Mortgage Interest Deductions
Taxpayers are allowed to deduct mortgage interest paid for their main home and a second home. The deduction is reported on Schedule A of the Form 1040 as an itemized deduction. Personal interest, i.e., for credit cards, unsecured loans, car loans, mortgage interest on a third home, and excess mortgage interest is not deductible. During examinations, tax examiners will need to determine the correct amount of mortgage interest allowable as a deduction. In some instances the mortgage interest deduction including deductible points is limited, as discussed below.
See , Form 14809, Interest you Paid
Use IDRS CC IRPTR to search for Form(s) 1098, Mortgage Interest Statement(s), verifying that the taxpayer paid mortgage interest in the year under examination. If there is no data on IRPTR to indicate that mortgage interest was paid by the taxpayer, or if the taxpayer's name is not on Form 1098, or if the transcribed Form(s) 1098 do not verify the amount deducted, the examiner should request copies of:
mortgage interest statements for the year being examined
mortgage or loan contracts
equity line of credit agreements
amortization schedules for loans outstanding
cancelled checks, receipts, or other evidence of payments made for the year under examination
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Taxpayer Liable. There must be a true debtor-creditor relationship between the taxpayer and the lender, and the taxpayer must be legally liable for the loan. If the taxpayer is not liable for the debt, the interest is not deductible. It is not necessary that the taxpayer be the party making the payments, but if the taxpayer is not filing a joint return, and is a co-owner with a party other than a spouse, the taxpayer may need to verify the specific amount he/she paid. (See IRM 4.19.15.20.3.2, Evaluating Taxpayer Responses.)
Secured Debt. The mortgage must be a secured debt, it usually is if reported on Form 1098. Generally, a secured debt is one for which an instrument is signed such as a mortgage, deed of trust, land contract, promissory note, security instrument, or home equity line of credit. The home must be collateral for the interest of the lender; if the loan is not repaid, the lender can foreclose on the mortgage and the home can then serve as payment for the debt.
Qualified Home. The taxpayer's debt must be secured by a main home or a second home. A home includes a house, condominium, cooperative, mobile home, house trailer, and boat, or similar property that has sleeping, cooking, and toilet facilities. The taxpayer can choose his second home, but special rules apply to rented homes, home offices, and homes under construction. (See Pub 936, Home Mortgage Interest Deduction.)
Points (also known as Loan Origination Fees, Loan Discount, Maximum Loan Charges, or Discount Points) are deductible as interest. Generally, points are deducted ratably over the life of the loan. Points are deductible in full in the year of payment if all of the criteria in the following table are met:
AND all of the following are met
The points are paid to acquire a main home in connection with a loan that is secured by that home.
Paying points is an established business practice in the area and the points were not more than points generally charged in the area,
The taxpayer uses the cash method of accounting,
The amount is clearly shown on the settlement statement (reported as points, loan origination fees, loan discount, discount points),
The points are not paid in place of amounts ordinarily stated separately on the settlement statement for items such as real estate taxes, inspection, appraisal fee,
The points are calculated as a percentage of the principal loan and,
The points are paid directly by the taxpayer and not derived from loan proceeds.
The points are deductible in full for the year paid. However, if mortgage interest is limited then points will also be limited. See Pub 936, Home Mortgage Interest Deduction and IRM 4.19.15.20.3.3, Limits on the Home Mortgage Interest Deduction below.
The documentation provided by the taxpayer must verify that all of the requirements listed under IRM 4.19.15.20.3.1, General Requirements, are met. Request additional documentation as needed using standard examination procedures.
The interest must have been paid in the year under examination. The taxpayer may not deduct prepaid interest. However, the allowable portion of interest deferred from a prior year may be deducted in the current year. Accept the amounts shown on Form(s) 1098, Mortgage Interest Statement(s) unless other documentation shows that all or part of the interest was prepaid.
The taxpayer may deduct interest only on a main home and a second home. If the taxpayer submits mortgage documentation for more than two residences, then the taxpayer must identify the principal residence (as defined under IRC 1.121-1(b)(2) of the Income Tax Regulations) and may select up to one other residence that the taxpayer uses as a residence. See IRC 163(h)(4)(A).
Ensure that the taxpayer did not deduct the same interest on other Schedules such as Schedule C, E, or F, or as a Mortgage Interest Credit on Form 8396 in the Tax and Credits section of Form 1040, beginning in tax year 2018 use Form 1040 Schedule 3 . If there is a duplicate deduction, then the interest should be adjusted to reflect the correct amount. Duplicate Mortgage Interest is worked under PC 0049, Form 886-H-MIE, Mortgage Interest Expense, is sent with the ICL.
Taxpayers are allowed to deduct interest paid on a qualifying foreign home. Interest paid in foreign currency must be converted to U. S. Dollars. Ask the taxpayer to provide this computation. You will have to calculate the conversion yourself if the taxpayer does not provide one.
If the taxpayer is deducting mortgage interest and is also a co-owner of a qualified property, then accept the taxpayer's statement for the amount of interest paid. However, if there is a discrepancy in deductions by co-owners resulting in a combined deduction exceeding the amount of interest actually paid, the taxpayer will need to verify the amount he or she paid.
Even if the taxpayer meets all the general requirements for deducting home mortgage interest, their deduction may be limited. Refer to the following sections if:
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The documentation provided by the taxpayer indicates that the deduction is subject to the limits described in IRM 4.19.15.20.3.3 , Limits on the Home Mortgage Interest Deduction, or
You are processing a Project Code 0417 case for Excess Mortgage Interest Deduction.
Limits on the Home Mortgage Interest Deduction
The following table describes when the taxpayer's home mortgage interest deduction is limited based on the type of mortgage debt as defined in IRC 163(h)(3)(F):
If ...
Then ...
It is Grandfathered Debt, which applies to mortgages taken out on or before October 13, 1987, Interest paid in that year is fully deductible.
It is Home Acquisition Debt, which applies to mortgages secured by a main or second home. The limit on the amount of debt eligible to be treated as Home Acquisition Debt depends, in part, on when the debt secured the home:
If the debt was incurred after October 13, 1987 but before December 16, 2017 to buy, build, or improve the home, but only if throughout the year, these mortgages plus any Grandfathered Debt totaled $1 million or less ($500,000 or less if married filing separately) ("Pre-2018 Limits").
For mortgages secured after December 15, 2017, the limit is $750,000 ($375,000 if married filing separately) reduced by: (1) Grandfathered Debt ("2018-2025 Limits"). The dollar limits apply to the combined mortgages on the taxpayer's main home and second home.
Exception: The higher Pre-2018 Limits applies to home acquisition debt that would otherwise be subject to the 2018-2025 Limits, if: (1) the taxpayer entered into a written binding contract before December 15, 2017, to close on the purchase of a home before January 1, 2018, and (2) the taxpayer, in fact, purchased such home before April 1, 2018. If the above conditions are satisfied, the debt is considered to be home acquisition that was incurred prior to December 16, 2017.
Interest paid in that year is fully deductible.
It is Home Equity Debt, which applies to mortgages secured by a main or second home taken out after October 13, 1987, and before January 1, 2018, but only if throughout the year these mortgages totaled $100,000 or less ($50,000 or less if married filing separately), and totaled no more than the fair market value of the home reduced by outstanding Grandfathered Debt and Home Acquisition Debt. (See IRM 4.19.15.20.3.4.2 , Evaluating Excess Mortgage Interest Taxpayer Responses, for a discussion of fair market value).
For tax years beginning in 2018 through 2025, interest paid on home equity debt is not deductible. However, home equity debt may be treated as home acquisition debt if it is used to buy, build, or substantially improve the home which secures the debt, but only to the extent that the amount of the home equity debt, along with any other home acquisition debt and grandfathered debt, do not exceed either the Pre-2018 Limits of the 2018-2025 Limits, whichever are applicable.
For tax years before 2018, in appropriate circumstances, the $100,000 limit for Home Equity Debt, can be utilized to increase the $1 million limit for Home Acquisition Debt to $1.1 million.
The mortgages do not fit into the above categories, Interest paid in that year is limited. Refer to Pub 936, Home Mortgage Interest Deduction and IRM 4.19.15.20.3.4, Excess Mortgage Interest Deduction – IRC 163 below.
In order to compute the limit on the home mortgage interest deduction, where applicable, obtain information on the average outstanding mortgage balance(s) for the year under examination.
Use the highest mortgage balance if it is more beneficial for the taxpayer, but generally the average balance provides the most benefit. This information is only available from taxpayer documents. Refer to IRM 4.19.15.20.3.4, Excessive Mortgage Interest Deduction – IRC 163, for detailed procedures.
Excess Mortgage Interest Deduction – IRC 163
Home Mortgage Interest reported on Schedule A can be limited in some circumstances and therefore the taxpayer will not be able to deduct the full amount reported on Form 1098. Points count as interest and can also be limited. A tax examiner may receive this issue (home mortgage interest deducted in excess of the allowable limits) because of Discretionary Examination Business Rules (DEBR) Project Code 0417 or because of other Schedule A projects.
If the taxpayer deducted mortgage interest in excess of allowable limits, or if initiating Project Code 0417 cases, the examiner should request copies of the following information:
a detailed year-end interest statement showing the beginning and ending principal balances or interest rates for each loan on which interest was deducted,
Form HUD-1 Settlement Statements, and
worksheet(s) used by the taxpayer to compute the mortgage interest deduction limitation.
Initiate Project Code 0417 cases by sending Letter 566-S /Letter 566-T for TDC cases, with Form 886-H-INT, Limited Home Mortgage Interest Deduction Supporting documents and, Form 14900 Worksheet for Qualified Loan Limit and Deductible Home Mortgage Interest for Tax Years Beginning after 2017.
Additional information can be found in the Exam Project Code Search Tool.
4.19.15.20.3.4.1 (11-29-2011)
Computing the Limit on the Mortgage Interest Deduction
Determine the Average Mortgage Balance of each loan for which the taxpayer is claiming a mortgage interest deduction using one of the following:
Average of first and last balance method
Interest paid divided by interest rate method
Provider statements
For part year loans, yearly average balance = (number of days loan held) x (average loan balance)/365.
Simplified Method - Determine the allowable mortgage interest deduction using the worksheet in Table 1 of Pub 936, Home Mortgage Interest Deduction. This worksheet uses a simplified method for computing the limit by totaling the average balances of all the qualified mortgages and then determining the percentage of the total mortgage interest which is deductible.
Exact Method - The limit may be computed using an exact method which determines the limit on each qualified mortgage separately, starting with the oldest outstanding mortgage. The taxpayer may have used an exact method when computing the limit on the mortgage interest deduction. Verify the worksheet or formula provided by the taxpayer.
Apply the limit on deductible mortgage interest to deductible points as well.
Evaluating Excess Mortgage Interest - Taxpayer Responses
The documentation provided by the taxpayer must verify that all of the requirements listed under IRM 4.19.15.20.3.1, General Requirements are met.
Process responses to the initial contact letter as follows:
No Reply, NA Disallow the entire mortgage interest deduction.
Taxpayer replies with insufficient information to determine average balance of at least one of the mortgages, NA Research IRPTR for the required information.
Taxpayer replies with sufficient information to determine average balance of mortgages, Worksheet determines the mortgage interest deduction should have been limited, Issue examination report disallowing the excess mortgage interest deduction.
Taxpayer replies with sufficient information to determine average balance of mortgages, The mortgage interest deduction is not limited or the tax reported on the taxpayer's return is substantially correct, Close the examination using No Change procedures.
Taxpayer used an exact method to determine the allowable mortgage interest deduction, You are able to verify the taxpayer's computation, or there is substantial agreement between the limit the taxpayer computed and the limit determined using the simplified method, Close the examination using No Change procedures.
Observe the following guidelines when determining the extent of an excess mortgage interest deduction:
If you do not have an Average Balance for a loan, do not use the interest for that loan in the worksheet. There must be information for an average balance on at least one loan in order to complete the worksheet.
Accept the taxpayer's explanation for how the loan proceeds were used, unless the documentation shows otherwise.
If two unmarried taxpayers are deducting mortgage interest on a loan for property jointly owned by them, use the average balance of the entire loan for all parties and multiply the limitation by the amount of interest the taxpayer actually paid (i.e., do not compute the limitation using only one taxpayer's share of the loan). Accept the taxpayer's statement for the amount of interest the taxpayer actually paid, unless it is not consistent with the deduction the other owner is claiming.
For tax years before 2018 if the acquisition debt exceeds $1,000,000, the taxpayer may treat up to $100,000 of the excess acquisition debt as Home Equity Debt, for an effective limit of $1,100,000 on the mortgage debt on which interest may be deducted. However, the taxpayer may not treat actual Home Equity Debt in excess of $100,000 as Home Acquisition Debt.
For tax year 2017 if the taxpayer has Home Equity Debt of $200,000 and Home Acquisition Debt of $800,000, only the interest on $900,000 of mortgage debt is deductible – i.e., $800,000 in Home Acquisition Debt + $100,000 in Home Equity Debt – even though the total mortgage debt is less than $1,100,000.
The taxpayer may be eligible to deduct the limited mortgage interest as an investment interest expense in certain circumstances. If the limited mortgage interest qualifies as investment interest expense, the amount that may be deducted is generally limited to the amount of the taxpayer's net investment income. The taxpayer should use Form 4952, Investment Interest Expense, to figure the deduction for investment interest. Investment interest disallowed for the year under examination may be carried forward to future years. Refer to Pub 550, Investment Income and Expenses, for information on determining net investment income and limits on investment interest.
The fair market value (FMV) of a home is the price at which the home would change hands between a seller and a buyer, neither having to sell or buy, and both having reasonable knowledge of all relevant facts. ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡≡ ≡ ≡ ≡ ≡ ≡≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡
Taxpayers may claim an itemized deduction for contributions or gifts made to or for the use of qualified charitable organizations and governments, other than foreign governments. Payments to qualified organizations are contributions if they are made without the taxpayer getting, or expecting to get, anything of equal value.
For 2020, individuals who do not itemize their deductions may deduct from gross income, up to $150 (for taxpayers whose filing status is married filing separately) or up to $300 (for taxpayers whose filing status is single, head of household, qualifying widow(er), or married filing jointly) of their qualified cash charitable contributions to public charities, private operating foundations, and federal, state, and local governments. Contributions to establish or maintain a donor advised fund and contributions to supporting organizations do not qualify for this above-the-line deduction. See Pub 526, Charitable Contributions, for additional details on what contributions qualify for the deductions for non-itemizers.
For 2021, individuals who do not itemize their deductions may deduct from gross income, up to $300 (for taxpayers whose filing status is either married filing separately, single, head of household, or qualifying widow(er), or up to $600 (for taxpayers whose filing status is married filing jointly) of their qualified cash charitable contributions to public charities, private operating foundations, and federal, state, and local governments. Contributions to establish or maintain a donor advised fund and contributions to supporting organizations do not qualify for this above-the-line deduction.
Qualifying Payments
The following table provides some examples of qualifying and non qualifying payments.
Non-qualifying payments
Out of pocket expenses paid when serving as a volunteer for a qualified organization Bingo, raffles, lottery tickets
Expenses paid for a student living with you, if the student was placed by a qualified organization Membership dues or fees paid to country clubs or fraternal lodges
Gifts that are to or for the use of a qualified organization for its religious, charitable, educational, scientific or literary purposes Tuition and registration fees, Temporary use of property
Gifts to or for the use of federal, state, and local governments The value of your volunteer services
Certain automobile and travel expenses incurred when doing volunteer work Personal living expenses incurred while performing services for a qualified organization
Cost and upkeep of uniforms required when doing volunteer work Amounts paid for the benefit of an individual selected by the taxpayer
N/A Under TD 9864, 2019-27 I.R.B. 6., certain donations made in exchange for state or local tax credits or deductions do not qualify for charitable contribution deductions.
N/A Amounts paid in exchange for college or university athletic event seating rights.
Qualifying Organizations
Some qualified organizations are listed in Pub 78, Cumulative List of Organizations. If an organization is not listed in Publication 78 and is not a church or government, the taxpayer should be able to obtain a copy of the letter issued to the organization by the IRS granting it "qualifying organization" status.
If an organization provided by the taxpayer is questionable, verification may be obtained using an on-line search tool for exempt organizations called Tax Exempt Organization Search (TEOS). This site identifies organizations eligible to receive tax-deductible charitable contributions.
Qualified and non-qualified organizations can include, but are not limited to:
Qualified Organizations
Non-qualified Organizations
Churches, synagogues and other religious organizations Civic leagues, sports clubs, labor unions, chambers of commerce
Federal, state and local governments Most foreign organizations
Organizations organized in the U.S. that are created and operated only for charitable or certain other purposes, public parks and recreation facilities Lobbying groups
Salvation Army, Red Cross, Goodwill, Boy Scouts, Girl Scouts Individuals, political groups or specific candidates for public office.
Volunteer fire departments NA
Cash and Non-cash Contributions
Contributions can be in the form of cash or non-cash. Examples of the types of contributions are:
Type of Contribution
Cash Cash, check, money order, credit card, payroll deductions such as for the Combined Federal Campaign (CFC), electronic funds transfers
Non-cash Clothes, automobiles, household goods, artwork, stock, real estate, conservation easements
Amount of Contribution Deduction
In general a taxpayer can deduct the full amount of a properly substantiated cash contribution, subject to percentage limitations.
If the taxpayer paid the qualified organization more than the fair market value of an item he received in return, such as merchandise or tickets to sporting events, the deduction is limited to the amount in excess of the fair market value.
For non-cash contributions, the deduction is usually equal to the fair market value of the non-cash contribution on the date of the donation.
For contributions of clothing and household goods, the items must be in good used condition or better. If an item is not in good used condition or better, then a deduction may be allowed if the amount claimed for the item is more than $500, and the taxpayer includes with the return a qualified appraisal.
For contributions of motor vehicles, including an automobile, boat, and airplane, the claimed value of which exceeds $500, the deduction is generally equal to the lesser of the gross proceeds from the sale of the vehicle, or the vehicle's fair market value on the date of the contribution. See the chart below for specific rules.
The taxpayer donates a motor vehicle and deducts more than $500 the qualified organization sells the vehicle without any significant intervening use or material improvement. the deduction is the smaller of
the fair market value on the date of the contribution, or
the gross proceeds from the sale of the vehicle by the organization. Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, will show the gross proceeds and must be attached to the return.
The deduction for the motor vehicle is more than $500 the vehicle is to be significantly used, or improved by the organization in general, the taxpayer can deduct the fair market value of the vehicle on the date of the contribution. Form 1098-C will show if the vehicle is to be significantly used or improved by the organization and must be attached to the return.
The deduction for the motor vehicle is more than $500 the vehicle is to be given to a needy individual by the organization, or sold to a needy individual by the organization for a price much lower than the vehicle's fair market value, in furtherance of the organization's charitable purpose. in general the taxpayer may deduct the fair market value of the vehicle on the date of the contribution. Form 1098-C will show if the vehicle is to be transferred to a needy individual.
Acceptable Documentation for Charitable Contributions
The following table lists examples of acceptable documentation for charitable contributions.
Types of Documentation
All cash contributions Cancelled checks, receipts, verification of electronic funds transfer, bank records, credit card statements or a statement from qualified charity. The documentation must show the name of the organization, the date, and the amount of the contribution. Refer to IRM 4.19.15.21.4.1, Acceptable Documentation for Charitable Contributions, paragraph (6) and (9) below for additional information about verifying contributions, if there is doubt regarding the authenticity of the statement provided.
Cash contribution of $250 or more in a single payment For each such donation -the taxpayer must obtain an acknowledgement/statement or receipt from the organization showing the date of the contribution, amount of the contribution, a description of any goods or services provided to the taxpayer by the organization, and an estimate of the value of the goods and services received, or if the goods and services provided are solely intangible religious benefits then a statement to that effect. The taxpayer must obtain the statement from the organization by the earlier of the filing of the return or the due date for the filing of the return (including extensions). Refer to IRM 4.19.15.21.4.1, Acceptable Documentation for Charitable Contributions, paragraph (6) and (9) below for additional information about verifying contributions, if there is doubt regarding the authenticity of the statement provided.
Expenses of less than $250 incurred while volunteering for a charitable organization Taxpayer's own records, showing the name of the donee, the date that services were performed, the amount of the expense, and the amount of reimbursement received, if any.
Expenses of $250 or more incurred while volunteering for a charitable organization. Taxpayer's own records, showing the name of the donee, the date that services were performed, the amount of the expense, and the amount of reimbursement received, if any, and a statement from the organization describing the services provided as well as providing a description of any goods or services provided by the organization in consideration and a good faith estimate of the value of those goods or services, or if the goods and services provided are solely intangible religious benefits then a statement to that effect.
Non-cash contribution less than $250 A receipt from the charity showing the name of the organization, the date and location of the contribution and a reasonably detailed description of the non-cash contribution. If a receipt was impracticable to obtain (such as clothing left at an unattended Goodwill dropbox), the taxpayer must maintain a reliable written record that includes:
the name and address of the donee,
the date of the contribution,
a description of the property,
the fair market value of the property at the time of the contribution,
the method using in determining the fair market value, and
in the case of a contribution of clothing or household items, the condition of that item.
Non-cash contributions of $250 or more. Taxpayer must obtain a written statement from the organization. Refer to IRM 4.19.15.21.4.1, Acceptable Documentation for Charitable Contributions paragraphs (6) through (8) below.
Non-cash contributions over $500 but not more than $5,000, and Contributions of certain readily valued property. Taxpayer must obtain a written statement from the organization showing all the information required for non-cash contributions of $250 or more. In addition, Form 8283, Noncash Charitable Contribution, Section A, must be completed and attached to the return. See Pub 526 and Pub 561 for a description of the types of readily valued property.
Non-cash contributions over $5,000, but not more than $500,000 (other than contributions of certain readily valued property). The taxpayer must obtain a written statement from the organization showing all the information required for non-cash contributions of $250 or more. In addition, Form 8283, Section B, must be completed and attached to the return. The taxpayer must also obtain a qualified appraisal. (See Publication 561, Determining the Value of Donated Property).
Non-cash contribution of property over $500,000 (other than contributions of readily valued property). Taxpayer must attach a qualified appraisal to return unless contribution meets the readily valued property exception. Form 8283, section B, must also be completed and attached to the return. The taxpayer must obtain a written statement from the organization showing all the information required for non-cash contributions of $250 or more.
Contributions of motor vehicles, including automobiles, boats and airplanes, whose claimed value is more than $500 and the deduction is limited to the gross proceeds from the vehicle's sale. Taxpayer must attach Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, or an equivalent statement from the charitable organization and a completed Form 8283 (Section A) to the taxpayer's return on which the deduction is claimed.
See special rule described below for certain contributions on motor vehicles.
If the taxpayer does not attach Form 1098-C, the taxpayer must include the vehicle identification number on Line 1, column(b) of Form 8283 Section A.
Special rule for contributions of motor vehicles, including automobiles, boats and airplanes, whose claimed value (a) is more than $5,000 and (b) whose deduction is not limited to the gross proceeds from its sale. If the claimed value of the donated motor vehicle is more than $5,000 and the deduction is not limited to the gross proceeds from its sale, the taxpayer must attach Form 1098-C and obtain a qualified appraisal and attach a completed Form 8283 (Section B) to the return on which the deduction is claimed. If the claimed value of the vehicle is more than $500,000, the taxpayer also must attach a copy of the qualified appraisal to the return on which the deduction is claimed.
A single item of clothing or a household item, not in good used condition or better, for which a deduction of more than $500 is claimed. (1) a written statement from the organization showing all the information required for non-cash contributions of $250 or more; (2) a completed Form 8283 (Section B); and (3) a copy of a qualified appraisal
Easements in Registered Historic Districts for claimed deductions greater than $10,000 A $500 filing fee, a qualified appraisal, photographs of the entire exterior of the building, and a description of all restrictions on the building must be included with the return. See IRC 170(f)(13)(B).
Form 14804, Schedule A - Gifts to Charity.
Taxpayers can provide information via mail, fax, e-mail or telephone.
Contributions are deductible only in the year they are made. Checks, receipts and other documentation provided by taxpayers should indicate a contribution made during the tax year in question. See IRM 4.19.15.21.4.2(2) for rules allowing the deduction of excess contributions in later tax years.
Written statements from charitable organizations must be received by the taxpayer on or before the earlier of:
the date the return is filed for the year contribution was made, or
the due date of the return, including extensions.
For contribution of cash, acceptable charitable organization statements are bank records, credit card statements, or written receipts from charitable organization and include:
Amount of the contribution
Date of the contribution
For all non-cash contributions of $250 or more each. In addition to the above listed requirements:
Description of any property contributed
Whether goods or services were provided by the organization in return for the contribution
Description and good faith estimate of the value of goods or services, if any, that the organization provided in return for the contribution
Statement that goods or services, if any, that organization provided in return for the contribution consisted entirely of intangible religious benefits, if that was the case
Unless you question the authenticity of the acknowledgement/statement, when above items are present, do not request any additional information from the organization (official letterhead, signature, etc.). See IRM 4.19.15.21.4.1, Acceptable Documentation For Charitable Contributions, paragraph (10) below.
There may be instances when you question the authenticity of the statement submitted by the taxpayer. In those instances it is appropriate to request additional documentation to substantiate the contribution has been made. Some examples of circumstances in which to request additional information are when:
the amount of the contribution is excessive in comparison to reported income;
documents appear altered;
unreadable receipts and/or statement, or
the statement or receipts does not include date, amount or the name of the organization.
Some religious organizations support the concept of tithing, or giving 10 percent of one's income. A taxpayer's deduction of 10 percent of income, alone, is not a basis to question documentation without considering other factors.
The workpapers must be documented to explain the reasons why additional documentation was requested and reasons that the statement appears questionable.
If you question the authenticity of the acknowledgement/statement:
Verification can be requested from the organization to ascertain it provided the acknowledgement/statement submitted by the taxpayer.
Many taxpayers make cash contributions for which they have no bank records, credit card statements or receipts. These contributions are not deductible. Taxpayers must maintain, as a record of a contribution, a bank statement, a canceled check, a scanned image of a canceled check, a credit card statement, an electronic funds transfer receipt, or a written communication from the donee showing the name of the donee organization, the date of the contribution, and the amount of the contribution.
Limitations on Contributions
For individuals:
100 percent limit: For the 2020 and 2021 tax years, a taxpayer may deduct up to 100 percent of cash contributions made to a public charity that is not a donor advised fund, a supporting organization, or a private foundation.
60 percent limit: For tax years beginning in 2018 through 2025, a taxpayer's deduction for cash contributions to public charities and certain other organizations is limited to 60 percent of the taxpayer's adjusted gross income (AGI).
50 percent limit: A taxpayer's total contribution deductions, for a taxable year, is limited to a maximum of 50 percent of the taxpayer's AGI for the year in which the deduction is claimed. The 50 percent limit generally applies to contributions of cash to public charities.
30 percent limit: Deductions are limited to 30 percent of AGI for contributions of cash to certain private foundations, contributions of capital gain property to public charities and certain foundations, and contributions "for the use of" charities.
20 percent limit: Deductions are limited to 20 percent of AGI for contributions of capital gain property to certain private foundations.
100 percent limit: Only for tax year 2018, a taxpayer's deduction for certain qualified contributions for California wildlife relief efforts is limited to 100 percent of a taxpayer's AGI minus deductions for all other charitable contributions. See Pub 526 and Pub 976 for additional details on what contributions qualify for the higher limitation.
Certain special limitations apply to contributions of conservation easements. Deductions for qualified conservation contributions are generally limited to 50 percent of AGI reduced by the amount of all other allowable contributions. However, if a taxpayer meets the definition of a qualified farmer or rancher and makes a qualified conservation contribution of property (1) used in agriculture or livestock production (or is available for such production), and (2) is subject to a restriction that the property remain available for such use, then the taxpayer's deduction is limited to 100 percent of AGI reduced by the amount of all other allowable contributions. The restriction on the property's use must be in place for qualified conservation contributions made in a tax year beginning after December 31, 2014. See Pub 526 for a description of a qualified farmer or rancher. Check IRC 170(b)(1)(E)(iv).
See Pub 526 for details on: (1) how the type of donee organization determines, in part, the limitation which applies, and (2) the order in which the various limitations apply.
Excess contributions can be carried over:
If the taxpayer's deduction exceeds the amount allowed by these limitations, the taxpayer can carry the excess forward to the next five taxable years until it has been deducted in full. In the case of excess qualified conservation contributions, the carryforward period is fifteen tax years.
If the taxpayer carries a deduction forward to another taxable year, the carried forward amount must be considered in computing the taxpayer's deduction for that year.
Any unused contribution that has not been deducted by the fifth succeeding year is lost.
If a taxpayer elects to claim the standard deduction (Does not file a Schedule A) in a tax year where the carryover may have been applied, the remaining carryover amount is reduced by any amount that may have been claimed during that year.
If a deduction is disallowed for the current year, and the examiner determines that it has been carried forward, the carryforward year should be opened if the carryover is substantial and the approval of the manager is obtained.
Taxpayers should keep records (such as copies of tax returns and worksheets) to verify any carryover deductions.
Certain deductions are limited to basis. In addition to percentage limitations, a deduction for certain non-cash contributions is limited to the taxpayer's adjusted basis in the property. These include contributions such as:
Contributions of ordinary income property (such as inventory or short-term capital gain property)
Contributions of property to charities that are not public charities
Contributions of tangible personal property that is not used by the charity in its charitable function (such as property that is sold by the charity).
Additional Research Material
For additional information on allowable deductions you may refer to Publication 526, Charitable Contributions, for the tax year you are examining.
Charitable Contribution Rules - Project Code 0391, Project Code 0392 and Project Code 0629
Project Code 0391 is Charitable contributions carryover with no prior year Schedule A.
Project Code 0392 is Charitable contributions carryover with prior year contributions of less than 50 percent of AGI.
Project Code 0629 is Charitable contributions and identifies returns with a deduction for cash contributions. PC 0629 cases are automated for ACE processing.
The examination of these cases will begin with case selection from the Dependent Database (DDb). The selected returns will have broken one of the contribution business rules indicated above. DDb should also provide Schedule A, Line 18 amounts claimed on the taxpayer's prior three tax returns. Each case will be established on AIMS in Source Code 06 with the appropriate Project Code.
The following table shows the Initial Contact Letter to send to the taxpayer.
Issue Letter
Amount to Disallow
PC 0392 Letter 566-S/Letter 566-T for TDC cases and Form 886-A with applicable explanation Schedule A, Line 13 - Carryover from prior year
PC 0629 Initial Contact Letter 566-S/Letter 566-T and Form 886-A Documents Request Schedule A, Line 11 - Gifts by Cash or Check.
No Response Cases
Take the following action if the taxpayer has not replied to the most recent letter by the normal purge date.
Latest Letter issued
Letter 566-S /Letter 566-T for TDC cases Issue Letter 525/Letter 525-T for TDC cases with Form 4549/Form 4549-EZ.
Letter 525/Letter 525-T for TDC cases, or Letter 692-M/Letter 692-T for TDC cases, and the Form 4549/Form 4549-EZ reflects a deficiency Follow normal procedures to have Statutory notice issued based on the adjustments shown on Form 4549 /Form 4549-EZ.
Processing Taxpayer Replies to Letter 566-S/566-T for TDC cases
The following describes the processing of taxpayer replies to Letter 566-S/Letter 566-T for TDC cases, for Project Codes 0391, 0392 and 0629 cases:
The taxpayer responds to Letter 566-S /Letter 566-T for TDC cases You are able to verify that the taxpayer is entitled to all of the amount as a contribution deduction. Follow procedures in IRM 4.19.13.28, Campus Closing Actions.
The taxpayer responds to Letter 566-S /Letter 566-T for TDC cases You are able to verify that the taxpayer is entitled to part of the amount as a contribution deduction. Issue Letter 525/Letter 525-T for TDC cases, with a Form 4549/Form 4549-EZ and an appropriate explanation to the taxpayer. Follow normal procedure for mail out and suspense.
The taxpayer responds to Letter 566-S /Letter 566-T for TDC cases You are unable to verify that the taxpayer is entitled to any part of the amount claimed as a contribution deduction. Issue Letter 525/Letter 525-T for TDC cases, with the Form 4549/Form 4549-EZ and an appropriate explanation to the taxpayer. Follow normal Letter 525/Letter 525-T for TDC cases, procedures for mail out and suspense.
The taxpayer replies to Letter 566-S/Letter 566-T for TDC cases, with information he is entitled to an additional deduction for contributions You are able to verify that the taxpayer is entitled to an additional deduction. Issue Letter 525/Letter 525-T for TDC cases, with a Form 4549/Form 4549-EZ and an appropriate explanation to the taxpayer. Follow normal Letter 525/Letter 525-T for TDC cases, procedures for mail out and suspense.
Closing Actions
Take the necessary action to close the case based on the chart below.
If the Taxpayer
Signs the Form 4549 /Form 4549-EZ, reflecting a deficiency or overpayment Follow normal procedures for Closed Agreed cases.
Does not reply to Letter 525/Letter 525-T for TDC cases, or Letter 692 -M/Letter 692-T for TDC cases, and Form 4549/Form 4549-EZ reflects an overpayment Follow normal procedure for Disposal Code 08 closings.
Does not reply to the 90 Day letter Follow normal procedures for defaulting cases.
Verifies that the contribution is allowable as a carryover deduction Follow normal procedures for No-Change cases.
Files a Form 1040X removing the contribution deduction and Accounts Management (AM) assesses the additional tax. Close the case using Disposal Code 08. In Field 35 of Form 5344, Examination Closing Record, show the entire amount of the assessment.
Casualty and Theft Losses
The examiner must keep in mind the following:
If the taxpayer's property was covered by insurance and the taxpayer fails to file a timely claim for reimbursement, the taxpayer cannot take a deduction.
For tax years 2018 through 2025, uninsured losses arising from personal casualties, such as primary residence or vacation property destroyed by fire not due to a federally declared disaster are no longer deductible. Theft losses must also be attributable to a federally declared disaster in order to be deductible. See Tax Relief in Disaster Situations for date-specific declarations associated with these disasters and for more information.
For disaster losses sustained in:
Dollar Requirements for Deduction
2010-2015, & 2018*, and all other years The amount of each separate casualty or theft loss exceeds $100 ($500 for tax year 2009) and the total amount of all losses during the year exceeds 10 percent of the adjusted gross income.
2016, 2017, 2019, and 2020 The net qualified disaster losses for the year exceed $500. The standard deduction for individuals is also increased by the amount of that particular individual's net qualified disaster losses.
*For tax year 2018, losses attributable to the California wildfires, the deduction limitation is $500 total. See Pub. L. No. 115-123, Section 20104(b).
The taxpayer may deduct Nonbusiness casualty or theft losses only to the extent that:
Simple disappearance of money or property (lost or mislaid) is not a theft. See Pub 547 for definitions of casualty and theft as it applies to Form 4684.
See Form 14814, Supportive Documents to Verify Personal Casualty or Theft Loss, Pub 976, Disaster Relief, and Pub 547, Casualties, Disasters, and Thefts for the particular year under audit, to determine special rules for claiming qualified disaster losses.
In order to deduct a casualty loss, the taxpayer must be able to show verification of the following:
The type of casualty (car accident, fire storm, etc.) and when it occurred.
That the loss was a direct result of the casualty.
That the taxpayer was the owner of the property, or if it was leased property that the taxpayer was contractually liable to the owner for the damage.
The amount of any insurance reimbursement.
Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.
In order to deduct a theft loss, the taxpayer must be able to show verification of the following:
When the property was discovered missing.
The property was stolen.
The property belonged to the taxpayer.
The following situations can result in casualty losses:
Car accidents.
Floods.
Fires.
Government-ordered demolition or relocation of a home that is unsafe to use because of a disaster.
Mine cave-ins.
Shipwrecks.
Sonic booms.
Storms.
Tornadoes.
Vandalism.
Volcanic eruptions.
The following are three types of casualty losses that refer to federally declared disasters:
Federal Casualty Loss is an individual's casualty and theft loss of personal-use property that is attributable to a disaster. The casualty loss must occur in a state receiving a federal disaster declaration.
Disaster Loss is attributable to a federally declared disaster and that occurs in an area eligible for assistance pursuant to the Presidential declaration. The loss must occur in a county eligible for public and individual assistance (or both). The loss is not limited to personal-use property. The loss may be claimed for individual business or income-producing property and by corporations, S-Corp and partnerships. The individual may claim the loss in the preceding tax year.
Qualified Disaster Loss is an individual's casualty or theft loss or personal-use property that is attributable to a major disaster declared by the President under Section 401 of the Stafford Act. For special rules, date specific declarations and expanded return procedures, see Form 4684 Instructions, Pub 976, Disaster Relief, or Pub 547.
Considerations when taxpayer qualifies for a Federally-Declared Disaster Loss:
A Federally Declared Disaster is a disaster that occurred in an area designated by the President to be eligible for federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. This includes a major disaster or an emergency declaration under the Act. If the casualty loss is attributable to a federally declared disaster and is sustained in a federally declared disaster area, the taxpayer can elect to deduct the disaster loss for the preceding year. Ensure that the taxpayer is not claiming the same loss for both years.
The taxpayer must reduce the casualty loss by funds received under any disaster provision and by any insurance reimbursement.
Employee Business Expense (EBE) Cases
These are cases with Form 2106, Employee Business Expenses, expenses included in Schedule A Miscellaneous Deductions, and where miscellaneous deductions do not appear consistent with the taxpayer's occupation or income. For any taxable year beginning after December 31, 2017, and before January 1, 2026, Form 2106 is for use by employees who are (1) Armed Forces reservists, (2) qualified performing artists, (3) fee-basis state or local government officials, or (4) employees with impairment-related work expenses. Due to the suspension of miscellaneous itemized deductions subject to the 2% floor under section 67(a), employees who do not fit into one of the listed categories may not use Form 2106. Because the Form 2106 and many lines on the 1040 Schedule A are not transcribed, you may see a combination of employee business expenses and miscellaneous expenses.
Returns may be requested for this issue.
Returns will be reviewed to determine if expenses appear in line with the occupation on the Form 2106.
Returns will be classified for other issues.
Initial Contact Letter 566-S/Letter 566-T for TDC cases (ICL), Form 13825, Employee Business Expense Questionnaire, and Form 886-I, Employee Business Expenses, explains the substantiation required to support the employee business expense, and will be issued to the taxpayer.
Follow normal suspense time frames. If there is no response to the ICL, issue a report disallowing the entire employee business expense amount and other questioned miscellaneous expenses.
The Tax Cuts and Jobs Act of 2017 (TCJA) removed the ability to deduct the cost of using your car as an employee due to the suspension of miscellaneous itemized deductions that are subject to the 2 percent floor under section 67. The suspension applies to tax years beginning after December 2017 and before January 2026. Deductions for expenses that are deductible in determining adjusted gross income are not suspended (Form 1040, Schedule 1, line 24).
Evaluating EBE Taxpayer Responses
TCJA removed the ability to deduct entertainment, amusement or recreational expenses paid or incurred after December 31, 2017. Business meal expenses remain deductible, generally subject to 50 percent disallowance. The deductibility of entertainment expenses in the remainder of this section 4.19.15.23.1 only applies to entertainment expenses paid or incurred prior to January 1, 2018.
Amounts paid or incurred after December 31, 2020, and before January 1, 2023, for food or beverages provided by a restaurant are 100% deductible. For more information, see Notice 2021-25.
All responses need to be evaluated using judgment considering what is known about the occupation.
The reimbursement policy of the employer is the starting point for all EBE audits and MUST be secured.
Employees and self-employed individuals claiming un-reimbursed travel expenses may claim the government per diem rate for the meals and incidental expenses (M&IE) portion of travel expenses, provided they have supported the travel. However, employees and self-employed individuals claiming un-reimbursed lodging expenses must provide receipts for lodging expenses and may not use the government per diem rates for lodging expenses.
An expenditure for travel, meals, or entertainment, to the extent it is lavish or extravagant, shall not be allowable as a deduction.
Unless the taxpayer is eligible to use and does use the government per diem rates, documentary evidence is required for:
Any expense for lodging while traveling away from home, and
Any other expenditure of $75 or more.
IRC 274(d) provides that no deduction shall be allowed for entertainment, gifts, listed property or travel unless the taxpayer substantiates the following elements of the expenditures:
Amount of each expenditure.
Time and place of the travel.(Prior to January 1, 2018, entertainment, amusement, recreation, or use of the facility or property.)
Date and description of the gift.
Business purpose for each expenditure.
Business relationship to the taxpayer of each person receiving the benefit.
Many expenses not listed in (5) above can be summarized or aggregated. See Publication 463, Travel, Gift, and Car Expenses, Section 5, Record Keeping, for a table that shows the substantiation requirement for specific expenses.
The deduction for business-related meal and entertainment expenses are generally subject to a 50 percent limit or 80 percent if taxpayer is subject to the Department of Transportation's "hours of service" limits. Caution: See Notice 2021-25 pertaining to food or beverage provided by a restaurant.
Travel expenses are deductible when taxpayers are temporarily away from their tax home. However, an indefinite assignment to another location is a change in tax home, thus travel expenses are not deductible.
Travel expenses for conventions, seminars, and similar meetings are deductible under IRC 162 if the taxpayer's attendance benefits or advances the taxpayer's trade or business. No deduction is allowable if a taxpayer is attending for social, political, or other purposes not related to the taxpayer's trade or business.
IRC 274(c)(1) states foreign travel must first be deductible under IRC 162 or IRC 212. The travel must be ordinary and necessary in the pursuit of a trade or business, or for the production of income. If the expense meets those requirements, then the business portion of the travel is deductible.
Travel outside of the United States generally must be allocated between business and personal. IRC 274(c)(2) provides two exceptions to the rule that travel expenses be allocated between business and personal. No allocation is made if foreign travel does not exceed one week, or if less than 25 percent of the trip is personal, then travel to and from the business destination is allowed in full.
Any issues beyond the expertise of the examiner assigned the case should be referred to the lead examiner to secure the appropriate technical guidance.
It is not necessary to fully allow or disallow any expenses. Expenses can be partially allowed when revising the report. Special care should be taken to explain these revisions to the taxpayer.
Additional Items to consider. Consider the following points when processing EBE cases.
Employee Business Expense Auditing Techniques
a - When examining employee business expenses, you must consider whether the employer has an expense allowance or reimbursement plan.
b - You must be able to determine if the plan is accountable or non-accountable. When examining expenses you believe are under a non-accountable plan (See Chapter 6 of Pub 463 , Travel, Gift, and Car Expenses), you may encounter nondeductible expenses that were reimbursed.
c - Always request a written statement explaining the requirements of the expense allowance or reimbursement plan from the employer. The written statement can be an excerpt from the employee handbook or a statement prepared for the purpose of the examination.
d - If the statement is prepared for the purpose of examination, be sure the author has sufficient knowledge of the expense allowance or reimbursement plan.
e - If the statement presented from the employer is vague, discuss with your manager or lead about the possibility of making a third party contact.
f - Be logical in organizing the examination. It may be better to structure the examination of these expenses into categories i.e., travel, entertainment, business meals, listed property, gifts, than by time periods (all of May's expenses or July's expenses). Examining by topic will allow you to see inconsistencies in the taxpayer's records. It will also allow you to determine the credibility of the taxpayer's record keeping.
g - Look for recurring names for entertainment and business meals, as well as recurring locations for travel. Recurring names may indicate a family member or a friend.
h-Be mindful of travel dates. Are the dates during holiday periods? If travel dates are during holiday seasons, this may indicate personal expenses.
i - Does the taxpayer use a travel agent on some occasions and not at other times? If he uses a travel agent regularly, this may be a source of documentation. A travel agent may or may not be used by his company. Does he use more than one travel agent? Most companies use one travel agent; if there are two or more, there may be some personal expenses intermingled with valid business travel.
j - Hotel receipts will often show how many people stayed in a room. If friends or family were staying with the taxpayer while they were away from home, you must determine if there was a business purpose for their stay and what, if any, additional charges were incurred.
k - Airline tickets and travel agency statements will show departure dates and who actually traveled. Compare the dates of the business meetings with the actual length of the trip. You could discover that the taxpayer extended his/her stay for a personal vacation. Request a detailed itinerary.
l - For employees on "accountable" plans, evaluate any reimbursement records. In most cases, the expenses reimbursed by the employer should be accepted up to the amount of reimbursement on face value since it is assumed that they were incurred for a business purpose. However, look to see if any changes were made to the employee's compensation structure (i.e., where the employee's wages reduced by the amount of the "reimbursement" ) to determine if the purported reimbursements were merely re-characterized wages. Special attention should be paid when they exceed the reimbursement policy. This may also be used to establish the business portion of the use of an automobile where the employee is taking an actual expense deduction vs. a mileage deduction.
m - Be alert for altered documents. Look for erasures of dates, times, places or amounts. Look for possible consecutive numbered receipts, especially for high entertainment costs.
n - Taxpayer should provide documentary evidence along with account book, diary and log to support each element of an expense.
o - A cancelled check by itself doesn't prove a business expense without other evidence to show that it was for a business purpose.
p - To verify total miles for the year, the taxpayer should provide repair receipts, inspection slips or any other records showing total mileage at the beginning of the year as well as at the end of the year.
The employer's letter regarding the company's reimbursement policy helps to establish:
the business expenses were ordinary and necessary, and
the taxpayer is deducting a legitimate "out of pocket" expense.
If the taxpayer does not provide the employer's letter regarding the reimbursement policy, the expenses should be disallowed.
There may be instances when the taxpayer is unable to provide an employer's reimbursement policy letter because the employer is out of business, or in receivership. In these instances, if the taxpayer has provided enough corroborating information which shows the expenses are: a) ordinary and necessary, and b) the taxpayer is "out of pocket" for the expenses, then allow the verified expenses.
Additional EBE information and materials should be referenced when processing EBE cases. These include:
Publication 463, Travel, Gift, and Car Expenses.
Training courses available: Training Doc 12266, Basic Income Tax Law for Correspondence Examination – Module D, Standard and Itemized Deductions (Lesson 7).
Publication 529, Miscellaneous Deductions.
Publication 17, Your Federal Income Tax (For Individuals).
Treasury Regulation 1.274-5T(c)(6)(i)(B) (Aggregation of Expenditures)
Notice 2021-25, (Temporary 100 Percent Deduction for Business Meal Expenses).
Treasury Regulations. 1.274-11,12 (Sporting Events).
Miscellaneous Deductions - IRC 67
The examiner should have the taxpayer send in the following documentation:
Copies of cancelled checks and paid bills of the expenses claimed.
A complete explanation of the purpose of the expense.
Form 14983, Schedule A - Other Miscellaneous Deductions.
Form 886-I, Employees Business Expense Explanation of Items.
Form 13825, Employee Business Expense Questionnaire.
For taxable years 2018 through 2025, miscellaneous deductions subject to the 2 percent AGI limitation are suspended. See IRC section 67(g).
The table below lists deductions subject to the two-percent AGI limitation, deductions not subject to the two-percent AGI limitation, and nondeductible expenses, for tax years prior to January 1, 2018.
Deductions Subject to the Two-percent of AGI Limitation
Deductions Not Subject to the Two-percent of AGI limitation
Nondeductible Expenses
Unreimbursed employee expenses (Line 21 of Schedule A): Deductible unreimbursed employee expenses must be ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade of business of being an employee. Deductible expenses not subject to the two-percent of AGI limitation are:
Casualty and theft losses from income-producing property.
See Pub 17, for an all-inclusive list of expenses. Examples of nondeductible expenses are:
Broker's commissions to buy investment property or to sell securities
Burial or funeral expenses
Campaign expenses
Capital expenses
Check writing fees
Club dues
Commuting expenses. If the taxpayer hauls tools, instruments, or other items in an auto to and from work, the taxpayer can deduct only the additional cost of hauling the items (such as the rent for a trailer to carry the items).
Business bad debt of an employee.
Expense of education that is work related if the education is not necessary to meet minimum requirements to qualify the taxpayer in the taxpayer's trade or business, and does not qualify the taxpayer for a new trade or business, and 1) it maintains or improves skills required in the taxpayer's present work, or 2) it is required by the employer or the law to keep the taxpayer's current salary, status, or job, and the requirement serves a business purpose of the employer.
Legal fees related to your job.
Licenses and regulatory fees.
Malpractice insurance premiums.
Medical examinations required by employer.
Occupational taxes.
Passport for a business trip.
Work-related subscriptions to professional journals and trade magazines.
Work-related travel, transportation, and entertainment.
Business liability Insurance premiums.
Damages paid to a former employer for breach of an employment contract.
Depreciation on computers if for the convenience of employer and required as a condition of employment.
Dues to a chamber of commerce and professional societies.
Educator expenses over the limit on the amount that may be taken as an adjustment to gross income.
Job search expenses for a job in the taxpayer's present occupation.
Repayment of income aid payment under an employer's plan.
Research expenses of a college professor directly related to your teaching duties.
Tools used in the taxpayer's work.
Union dues and expenses.
Work clothes and uniforms if required and not suitable for everyday use.
Impairment-related work expenses of persons with disabilities.
Losses from other activities from Schedule K-1, box 2
Repayments of more than $3,000 under a claim of right.
Unrecovered investment in an annuity.
Losses from Ponzi-type investment schemes
See Pub 17, for an all inclusive list of expenses.
Fees and licenses such as car or marriage licenses and dog tags.
Fines or penalties.
Health Spa expenses.
Hobby losses
Home repairs, insurance, and rent.
Home security system.
Illegal bribes and kickbacks.
Investment-related seminars.
Life insurance premiums.
Lobbying Expenses.
Losses from the sale of your personal home, personal furniture, or personal car.
Lost or mislaid items.
Lunches with coworkers
Meals while working late.
Personal disability insurance premiums.
Personal legal expenses.
Personal, living or family expenses.
Political contributions.
Professional accreditation fees.
Professional reputation.
Relief fund contributions.
Residential telephone service.
Stockholders meetings.
Tax-exempt income expenses.
Education expenses of a dependent (but see Education Tax Benefits).
The value of wages never received or lost vacation time.
Adoption expenses, but see Adoption Credit.
Personal accounts.
Travel expenses for another individual.
Voluntary unemployment benefit contributions.
Cost of a wristwatch.
Other expenses (Line 23 of Schedule A). A taxpayer can deduct certain other expenses as miscellaneous itemized deductions subject to the two-percent of AGI limitation. These other expenses are:
expenses to produce or collect income that must be included in the taxpayer's gross income,
expenses to manage, conserve or maintain property for producing gross income, and
expenses to determine, contest, pay, or claim a refund of tax. The expenses in (1) and (2) must be reasonable and closely related to these purposes.
Appraisal fees for a casualty loss or charitable contribution.
Clerical help and office rent to manage investments.
Depreciation on home computer.
Excess deductions allowed a beneficiary on termination of an estate or trust.
Fees to collect interest and dividends.
Hobby expenses limited, in part, by hobby income.
Indirect deductions from pass-through entities.
Investment fees and expenses.
Legal expenses to produce or collect taxable income or to obtain tax advice.
Repayments of $3,000 or less when the amount was included in income in the earlier year.
Repayments of social security benefits included in income in an earlier year.
Safe Deposit Box rent, but not for storing personal effects or tax-exempt securities.
Service charges on dividend reinvestment plans.
Trustee's administrative fees for IRA.
Tax preparation Fees are placed on Line 22 of Schedule A.
Hobby losses.
Investment related seminars.
Lunches with coworkers.
Value of loss of wages.
Return Preparer Referrals
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Role of the Exam RPP Coordinator
The Exam RPP Coordinator at each site will be the liaison between Campus Exam and the HQ and elevate any issues for resolution. RPP Coordinator can be any individual (manager, lead, TCO, P&A, TE) as designated by management.
RPP Coordinator's primary role is to provide technical assistance to Correspondence Exam in processing these cases.
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Referral Process and AIMS Opening
Cases will be opened on AIMS by SB/SE HQ Campus Workload Identification (CWI) team and controlled under Project Code 0133, Source Code 70. Any scheme that is related to EITC will be controlled under Project Code 0132. The AIMS will reflect the respective PBC for each site and an Employee Group Code (EGC) of 5000.
AIMS Tracking Codes may be assigned to identify the scheme.
Returns will be electronically forwarded and established through RGS.
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Controlling RPP Returns
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Procedures for Examining RPP Cases
Normal Exam procedures will apply to processing these cases.
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Consult RPP Coordinator, Classification TCO (Tax Compliance Officer) or manager and notate workpapers about the additional issues included in the audit.
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Letter 566-B/Letter 566-J for TDC cases, will be used to initiate the audit process for non-EITC cases. For EITC cases use Letter 566-S/Letter 566-T for TDC cases, as the initial contact letter (ICL). The cases will be started by Filer Bridge and BLP. The letter will be prepared by checking off the appropriate boxes for the issues being examined. Form 886-A with proper paragraphs and Form 4549/4549-EZ will be included, as well as the proper enclosures.
Follow normal deficiency processing from this point, allowing the normal time frames for purging and issuance of the Statutory Notice of Deficiency.
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The compliance employee or the manager should not obtain advice from CI for a specific case under examination. However, the campus can request clarification or additional information on a scheme, if necessary, via HQ.
Management must approve any short closing - DC 20, 32, or 33. If a determination is made to short close 25 or more cases from one scheme, then management must inform HQ timely the reason for survey.
Taxpayer/valid POA requests transfer of case(s) to Area Office Examination or Appeals Office, refer to IRM 4.19.13.15, Transfers to Area Office Examination or Appeals Office.
Examiners will ensure that procedures are followed for calculation of the interest suspension period as defined in IRC 6404(g). Please refer to IRM 4.19.13.6.1, IRC 6404(g) Suspension of Interest and Certain Penalties, for additional information.
Examining the Schedule A on Preparer Referrals
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The examiners are required to familiarize themselves with Schedule A See IRM 4.19.15.20, Schedule A. This IRM section will provide information related to the allowable and unallowable deductions on the Schedule A.
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Examining the Schedule C on Preparer Referrals
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Correspondence Exam Tip Program
Cases worked in the Tip Program are initiated based on information received from Area Offices. Revenue Agents (RAs) and or Revenue Officer Examiners (ROEs) gather data from the employers of tipped employees and use this information to determine each employee's correct tip income. If the employee did not report the correct amount of tips, Correspondence Exam will issue a report reflecting the increase in income tax and FICA taxes (which includes Social Security and Medicare) based on the unreported tip income. All other unreported income as identified on IRPTR should be addressed and included on the examination report per normal procedures.
The following conditions will apply:
The inventory will also include cases where the tipped employee has not filed a return.
In all cases, normal non-ACE case processing procedures will be used.
Penalties will be asserted as required or deemed appropriate. Refer to IRM 20.1, Penalty Handbook, and IRM 4.19.13.6.1.1, Managerial Approval of Bans.
The terms "taxpayer" and "employee" are used interchangeably in this section.
All correspondence to the taxpayer should contain the name and telephone number of the examiner who prepared the report.
If a taxpayer has reached the wage base limit for Social Security wages, he or she is still subject to Medicare tax on all wages (including tips) received. There is no wage base limit for Medicare wages.
All forms that are specific to the Tip Program and are not currently available through Report Generation Software (RGS) will be loaded onto workstations and attached to the taxpayer's file. These forms include Form 14980, Employee Tip Examinations Worksheet, Form 14980-C, For Information Purpose Only, and Form 14980-A, Unreported Tip Income. If the examination is based on the percentage of gross sales method, Form 14980-B, Computation of Tip Income, Using McQuatter's Formula, should be used to demonstrate how the unreported tip income was computed using the McQuatter's Formula. Form 14980-B, should be used for other Tipping Industries such as Food and Beverage cases, and Form 14980-A, Explanation of Tip Income, should be used for Gaming cases.
The program will consist of the following types of cases:
Tipped employees who do not participate in a tip agreement and have unreported tip income.
Tipped employees who do not participate in a tip agreement and are non-filers.
Tipped employees who participate in a tip agreement (GITCA/TRDA) and are non-filers.
Gaming Industry cases will be assigned Project Code 0360 if they are from Casino's other than Indian Tribal Casinos. If they are from Indian Tribal Casinos, they will be assigned Project Code 0916, Cosmetology Industry cases will be assigned Project Code 0672, and Food and Beverage Industry cases will be assigned Project Code 0364. Non-filer cases will be assigned the same Project Codes, however, Source Code 24 is used to identify these cases.
Original returns will not be ordered. RTVUE will be used unless it is necessary to review the original return during audit. If the taxpayer filed a Form 4137, Social Security and Medicare Tax on Unreported Tip Income, with his or her individual income tax return, follow the instructions in the table below to determine the unreported tip income. On joint returns where both taxpayers are tip earners and have unreported tips, make a separate calculation for each taxpayer.
The payer on the Employee Data Report matches a payer on IRPTR That employer is the only one on IRPTR where the taxpayer would have received tip income Consider the amount of tips reported on Form 4137 when determining the unreported tip income.
The payer on the Employee Data Report matches a payer on IRPTR There is more than one employer on IRPTR where the taxpayer would have received tip income Consider the amount of tips reported on Form 4137 when determining the unreported tip income.
Instruct the taxpayer to provide a copy of Form 4137 and a breakdown on tips reported for each employer with the response to the letter if the Form 4137 was incomplete because it did not identify the employers and the tips reported for each employer.
It cannot be determined that the employer on Form 4137 is the same employer on the Employee Data Report There is one or more than one employer on IRPTR where the taxpayer would have received tip income When determining the unreported tip income for each employer, do a pro- rata allocation of the tip income reported on Form 4137 and apply the ratios to each employer.
The Tip Extension database will contain the following:
Employees Participating in a Tip Agreement(GITCA/TRDA):
Conditions for Participating Employees
On joint returns where both taxpayers are tipped employees and their participant status is different, an Employee Data Report will only be generated for the employee who has unreported tip income regardless of participation status.
For taxpayers who worked for several employers and had different participation statuses with each employer, an Employee Data Report will only be generated for employers where the taxpayer under-reported tip income.
If the tipped employee is shown as participating but has reported tip income less than the amount on the agreement, the taxpayer will be treated as a non-participant.
Primary and Secondary SSNs will be identified.
Amounts reported on Form 4137 will be identified.
The Forms 14439 prepared by the field agents for the Food and Beverage Industry are computed by establishing a tip rate based on both charged and cash sales and assigned to each employee based on position and hours worked. A stiff factor and a tip out rate may also be factored into the computation.
Tip extension reports are no longer provided. These cases are delivered on Form 14439 , Employee Data Report. Forms 14439 will contain the percent of gross sales or an hourly rate, the venue, the position, hours worked, and shift. This information will be loaded onto the Form 14980, Employee Tip Income Examinations Worksheet, which will then be used as the allocation sheet.
Form 4137, Social Security and Medicare tax on Unreported Tip Income, is used by an employee to compute the social security and Medicare tax owed on tips not reported to the employer. Unreported tip income, reported on Form 4137, is carried over to Form 8959, Additional Medicare Tax, which is used by an employee to compute Additional Medicare Tax owed on tips not reported to the employer.
Additional Medicare Tax. A 0.9 percent Additional Medicare Tax (under IRC section 1401(b)(2)(B)) applies to Medicare wages, Railroad Retirement Tax Act (RRTA) compensation, and self-employment income that are more than:
$125,000 if married filing separately,
$250,000 if married filing jointly, or
$200,000 for any other filing status .
Tips are subject to Additional Medicare Tax, if, in combination with other wages and self-employment income, they exceed the individual's applicable threshold. RRTA compensation and tips are separately compared to the threshold.
Commonly Used Terms
The following table lists terms used in the Tip Income Program:
Definition/Description
(1) Tip Agreement Contract between an employer (of tipped employees) and the IRS.
There are various tip agreements between the IRS and the employer where employees and employers work together to improve tip reporting compliance. Under a TRDA or GITCA, the employer must secure written statements from at least 75 percent of its employees stating they agree to participate in either the TRDA or GITCA. There are 4 types of tip compliance agreements:
TRAC - Tip Reporting Alternative Commitment
TRDA - Tip Rate Determination Agreement
EmTRAC - Employer-designed TRAC
GITCA - Gaming Industry Tip Compliance Agreement
(2) Participating Employee A tipped employee who states in writing that they will report to their employer no less than the amount of tip income for his/her job classification, etc., as set forth in the Tip Agreement. This only applies to either a TRDA or GITCA. A Participating employee in a GITCA or TRDA who is compliant with the terms of their agreement will receive tip audit protection.
(3) Non-participating Employee A tipped employee who is not reporting tips at the rate specified in the employer's tip agreement and who declines to participate in the employer's tip agreement because they choose to instead report actual tips received to their employer.
(4) Venue Location where employee works, (i.e., Sunrise Cafe, Pool, Salon or Slots).
(5) Job Classification/Position Employee's job title i.e., food, server, maitre d', bellman, bartender, colorist, nail technician etc.
(6) Tip rate for all 1040 referrals Amount of tips per hour, shift, drink, car, etc., that is assigned to each employee, based on their job classification and venue.
The examiner reviews the information provided by the employer and determines this amount.
These rates may be related to a general tip examination or for non-participants associated with a tip agreement.
The tip rate is multiplied by the number of hours, etc., the employee worked to determine the minimum amount of tips the employee should have reported as income to their employer.
(7) Reported Tips The amount of tips an employee reports to the employer is included on their Form W-2.
(8) Unreported Tips In the case of a Non-Participating employee, Unreported Tips are the difference between the Reported Tips and the amount of tips determined based on the Tip Rate for 1040 Referrals. Additional tip income is shown on the employee's Form W-2.
(9) Allocated Tips Large food or beverage employees may be subject to tip allocation if the employee reports tips to their employer at a rate less than 8 percent of the employee's tipped sales. Allocated tips are included in box 8 of the employee's Form W-2 and must be included on the employee's tax return and Form 4137 unless the employee has adequate records to show that they received less tips in the year than the allocated amount. See Pub. 531, Reporting Tip Income. If an employee asserts that the allocated tips are already accounted for in their Form 1040, ask the employee to show where the tips were included for income tax and social security tax purposes.
Refer to Pub 531, Reporting Tip Income. If an employee's Form W-2 shows allocated tips, the employee is required to report the allocated tips on Form 4137, unless the employee has adequate records to show that the employee received less tips in the year than the allocated amount (see page 6 of Pub 531).
Therefore, if an employee does not include the allocated tips on Form 4137 the allocated tips should not be considered in a tip exam. (If an employee insists they already included the allocated tips on the Form 1040, ask the employee to show where the tips were included on the Form 1040 for income tax and social security tax purposes.)
(10) Form 4137 Form 4137, Social Security and Medicare Tax on Unreported Tip Income, is used by the employee to report tip income (and the related FICA/Medicare taxes) not reported to their employer(s) during the year.
This includes any allocated tips shown in box 8 of their Form(s) W-2. Use Form 4137 to figure the social security and Medicare tax owed on those tips.
(11) Employee Data Report Information from the Employee Data Report for each selected employee. Includes:
Employer's name
Employee's position
Tips reported
Tip rate
This information is used to determine the amount of unreported tip income. The report also indicates if they are the Primary or Secondary taxpayer and whether they are a participating employee.
(12) Form 2504 Form 2504, Agreement to Assessment and Collection of Additional Tax, provides the adjustment to the employee's share of FICA and Medicare taxes and the related penalties. This form is generated in RGS.
(13) Form 885-T Form 885-T, Adjustment of Social Security on Tip Income Not Reported to Employer, provides details of the computations for the taxes and penalties on Form 2504. This form is generated in RGS.
(14) Form 14980 Tracking Sheet
The examiner/clerk will photocopy the Form 14980, Employee tip Examination Worksheet, from the closing file and indicate the disposal code on the form. This form will be mailed to the tip program coordinator/analyst.
Form 8959 This form is used to compute and report Additional Medicare Tax on tips.
Contents of Case File
Tip Income Information – The Area Offices will accumulate employer and employee data, on non-participating employees of a tip agreement and rarely on a participating non-filer, to determine which employees will be selected for an examination. For employee audits, referred by the Area Offices, the data will be available on the Employee Data Report based on the Tip Agreement. The Employee Data Report and the list of selected employees will be provided to W&I headquarters/ Workload Development and Delivery team. The Food and Beverage and Cosmetology Industry tipped employee audits, referred from Area Offices, will contain a tip allocation worksheet or an Excel spreadsheet.
The following information will be provided for taxpayers selected for examination:
Employee's name and SSN.
Employee's position, venue and shift.
Number of hours worked or sales (if applicable).
Form 14980, Employee Tip Examinations Worksheet.
Employer's name.
Tip agreement date and RTVUE of tax return, if filed.
Tip rate for employee's position, venue and shift per the Tip Agreement.
Fact of filing.
Other Case File Information - Case files may also include the following information:
AMDISA for the selected year(s).
IMFOLT for the selected tax year(s).
IRPTR information for the selected year(s).
McQuatter's allocation sheet for the Food and Beverage cases.
Employee Data Report.
Tracking sheet. Form 14980, Employee Tip Examinations Worksheet. (Two copies are required: one copy is to be used as a tracking sheet and another copy as part of the administrative file).
Case Processing –General Information
The following information describes procedures specific to the Tip Income Program. Unless otherwise stated, normal case processing procedures should be followed.
Due to the specific procedures for assessing FICA taxes, all cases in the Tip Program should be filed separately from other cases or flagged for easy identification.
Adjustments to tip income involve both income tax and FICA taxes. Therefore, two sets of report forms are required:
Type of Tax
Agreement Form
Income tax Form 4549/Form 4549-EZ Form 4549/Form 4549-EZ
Social Security Calculated in RGS Form 2504
Medicare Calculated in RGS Form 2504
Additional Medicare Tax Form 885-T Form 2504
As the chart shows, report forms must be prepared and sent to the taxpayer (tipped employee): along with Form 2504, Agreement to Assessment and collection of Additional Tax and Acceptance of Over assessment. Form 886-A, Explanation of Items, and Form 14980, Employee Tip Examinations Worksheet, must also be sent. If the examination was based on the percentage of gross sales, a Form 14980-B will need to be completed and sent to the taxpayer. Form 14980-A, Explanation of Tip Income, shows how the tip income was computed using the McQuatter's Formula. This provides the taxpayer a detailed computation of the unreported tip income. Make sure your workpapers clearly explain how you arrived at your adjustments. This information will be extremely important if the taxpayer requests a transfer to an Area Office, requests an Appeals conference, or petitions the court.
Research AIMS to determine if another tax year is open for examination. If so, the cases should be worked by the same examiner.
Filed Returns – Initial Contact
Compare the tip income reported on Form 1040, including amounts reported on Form 4137, Social Security and Medicare Tax on Unreported tip Income, to the tip income identified by the Area Office.
The tip income identified by the Area Office exceeds the amount reported on the tax return, including Form 4137 NA Include the unreported amount in the examination report.
The taxpayer worked for more than one employer where tips were received The taxpayer participates in the tip agreement at one employer but does not participate at another Only the tip income reported by the employer for which the employee had unreported tip income should be included.
Both the taxpayer and the spouse on a joint return worked in a tipped occupation and a joint return was filed There is tip income information for one taxpayer but not the other Perform the necessary research to determine if there is unreported tip income for the other taxpayer and include all unreported tip income in the report.
Follow the instructions below when allocated tips are shown on the taxpayer's Form W-2:
The payer is the same payer as shown on the tip Employee Data Report or other source document The taxpayer included the allocated tip amount from Form W-2 as income on Form 1040 Give the taxpayer credit for the allocated tips reported on Form 1040 when determining the unreported tip amount.
The payer is the same payer as shown on the tip Employee Data Report or other source document The taxpayer did not include the allocated tip amount from Form W-2 as income on Form 1040 Disregard the allocated tip amount. Use the information from the Employee Data Report to determine the unreported tip income.
The payer is not the same payer as shown on the Employee Data Report or other source document The taxpayer did not include the allocated tip amount from Form W-2 as income on Form 1040 Include the allocated tips as a separate issue when determining the unreported tip income.
The payer is not the same payer as shown on the Employee Data Report or other source document The taxpayer included the allocated tip amount from Form W-2 as income on Form 1040 Assert the FICA penalty on the reported allocated tips.
Instructions for non-filers
If the payer is the same payer as shown on the tip Employee Data Report or other source document, disregard the allocated tip amount. Use the information from the Employee Data Report or other source document to determine the unreported tip income.
If the payer is not the same payer as shown on the Employee Data Report or other source document, include the allocated tips as a separate issue when identifying the unreported tip income.
Use the following table to determine other audit issues:
The information on IRPTR shows allocated tips from a different type of property than the one that generated the unreported tip income. That amount should be included in the unreported income with the appropriate explanation(s) on Form 886-A. For example – if the unreported tips are from a casino venue and IRPTR shows allocated tips from a restaurant, include the allocated tips from the restaurant as unreported tip income on the exam report.
Any other items on the return require examination Include them on the report with the appropriate explanation(s) on Form 886-A.
RGS categorization for unreported tip income is: AGI Adjustment/Taxable Earned or Personal Service Income/Unreported Tips from Form 4137. Choose "Primary Taxpayer" or "Secondary Taxpayer" as appropriate and answer "Yes" to the "Assert FICA Penalty" question. This categorization will generate the preparation of Form 2504 and the proper transaction codes on Form 5344.
Form 2504 will reflect a late filing penalty if it is applicable.
The taxpayer may be subject to a penalty equal to 50 percent of the FICA tax due on unreported tips reported on Form 4137 filed with the return. Write in and identify the applicable amount on the Form 2504 generated by RGS and recompute the total penalty amount shown on the Form 2504. Change the TC 310 amount on Form 5344 to reflect the correct amount.
Proper categorization of the tip income will generate Reference Codes 891, 892, 898 and 899 as necessary for the Primary or Secondary taxpayers on Form 5344 partial. Do not delete the Reference Codes as they are required entries for the partial assessment and may need to be adjusted.
Use the following standard explanations for the tip income issues in your initial contact with the taxpayer and in subsequent contacts as necessary.
1101 Tips are includible in income
8107 IRC 6652(b) penalty – 50 percent of the FICA taxes on the unreported tip income.
8201 IRC 3101 – Employee's share of the FICA taxes on the unreported tip income.
Custom Explanation Explanation of tip income examination, examination reports and options available to the taxpayer. This is not currently an RGS paragraph. It is attached to the RGS file through MS Word.
Prepare the Form 14980, Employee Tip Examinations Worksheet. Enter the name(s) of the employer, taxpayer's position, location worked, shift, hours, tip rate, amount of tips reported to the employer and amount of tips reported on Form 4137. The remaining calculations will be completed by the formulas built into the spreadsheet. The amount on the "Unreported Tips" line should be the same amount shown on Form 4549/Form 4549-EZ and Line 2 of Form 885-T, Adjustment of Social Security Tax on Tip Income Not Reported to Employer, as unreported tip income.
Taxpayers contacted in this program have been advised of their reporting requirements by their employers and were given the opportunity to participate in the tip compliance agreement program. Choosing not to participate in a tip agreement is a tipped employee's choice. If the tipped employee does not accurately report his or her tip income, the failure to report income may constitute intentional disregard of rules or regulations, or otherwise be subject to a civil penalty.
Consider asserting the IRC 6662(d) if requirements for the Substantial Understatement Penalty are met. If requirements for Substantial Understatement Penalty are not met, assert the Accuracy Related Penalty for Negligence, IRC 6662(b) (1), on the amount of unreported tip income, based on facts and circumstances surrounding the case.
Consider any fraudulent/altered documents provided by the taxpayer for fraud penalty referral. Refer to IRM 25.1, Fraud Handbook, and IRM 4.19.10.4, Fraud Referrals, for a list of indicators of fraud and the referral process.
Letter 525/Letter 525-T for TDC cases, is the initial contact letter for these cases. Prepare the mail-out package using normal procedures and include Form 14980-A, Explanation of Tip Income, (Unreported Tip Income) and the custom explanation.
RGS auto-populates the deficiency, penalty and interest from Form 4549/Form 4549-EZ as the balance due on Letter 525. Correct this amount to include the Form 4549/Form 4549-EZ amount plus the taxes and penalty shown on Form 2504.
Follow normal Letter 525/Letter 525-T for TDC cases, procedures for mail-out and suspense.
Prepare a Form 886-A1, Employee Tip Examinations Worksheet, for each employee. This form can hold up to 5 venues. Complete the form with Employer name, and Employer Identification Number. Leave a copy of each Form 14980, Employee Tip Examinations Worksheet, that has been completed loose in the case file to be used as a tracking sheet. If multiple tracking sheets are prepared, please staple them together so that they can be forwarded as one package.
On joint returns, enter the SSN of the taxpayer who received the tip income on the Form 14980, Employee Tip Examinations Worksheet.
If the unreported tip income, per the information provided by the Area Office, was included on Form 4137 filed with the return, you must still complete a tracking sheet for the tips and FICA taxes shown on Form 4137 so the corresponding employer's share of FICA taxes can be assessed. Attach the Form 4137 filed with the return to the tracking sheet. No other documents or reports should be attached to the tracking sheet.
When the case is ready to close, the tracking sheet Form 14980, Employee Tip Examinations Worksheet, should match the closing actions and determination on Form 5344. These tracking sheets will be sent to the originating Area Offices' Tip Coordinator monthly and quarterly to Indian Tribal Gaming (ITG) Tip Compliance Coordinator from TE/GE. Tracking sheets are generally not needed for PC 0364 and 0672 since the employer received their Notice and Demand, unless instructed by HQ.
If the taxpayer does not sign agreed before the 90-day letter (Statutory Notice of Deficiency) is ready to be sent, the case will include one Form 5344 for the FICA taxes, penalty, and reference codes, and one final Form 5344 for the income tax and related penalties and reference codes. If the taxpayer signs agreed before the Statutory Notice of Deficiency is ready to be sent, then only one Form 5344 is needed.
Disposal Code and Closure
Posting Delay Codes
DC 04 (agreed) before 90 day letter All transactions can be entered on one Form 5344. No PDC needed.
DC 04 but IRC 6404(g) applies Same as above but input PDC 1.
DC 08 (partial assessed) FICA taxes and related actions will have to be processed on the partial Form 5344, and then the Statutory Notice of Deficiency can be issued.
DC 09 (agreed) after 90 day letter Income tax and related actions will be processed on the closing Form 5344.
DC 09 (agreed) after 90 day letter and IRC 6404(g) applies Same as above but input PDC 1.
DC 10 (Default) and DC 13 (Undeliverable) Follow instructions for DC 09 above.
The FICA taxes and the related penalties cannot be included on the Statutory Notice of Deficiency. These assessments must be made prior to the issuance of the 90 day letter. Refer to IRM 25.6, Statute of Limitations, for assessment statute of limitations on unreported tips income and IRM 4.23.7.4, Form 4137 Requirements.
Ensure that the assessments are input timely and properly. Prepare Form 5344 and attach the Form 5344 partial to the outside of the case folder. Attach Form 5344 final closing document to the inside of the case folder. The Examiner may include Form 14980-C, FICA Tax and Penalty, (For Information Only) with the 90-day package. This will inform the taxpayer that the income tax and TICA are both due.
Non-Filers
Follow the procedures beginning at IRM 4.19.17.3, Non-Filer Processing.
The AIMS database should be created with the following information:
Status 06
Source Code 24
Project Code The Gaming Industry cases generating from non-Indian Tribal Casinos will have Project Code 0360. Indian Tribal Gaming cases will have Project Code 0916. Food and Industry Non-Gaming cases will have Project Code 0364 and Cosmetology Industry will have Project Code 0672.
Org Code 5XXX
Push Code 036
After you have verified that the "dummy" TC 150 and TC 420 have posted to Master File, prepare Form 4549/Form 4549-EZ based on all available IRP information and the tip income information in the case file.
RGS categorization for unreported tip income is: AGI Adjustment/Taxable Earned or Personal Service Income/Unreported Tips from Form 4137. Choose "Primary Taxpayer." The Filing Status on these cases will be either "Single" or "MFS" . Answer "Yes" to the "Assert FICA Penalty" question. This categorization will generate the preparation of Form 2504 and the proper Transaction Codes on Form 5344.
Follow the instructions in IRM 25.24.2.7.1 for asserting penalties and IRM 4.19.15.26.3.1 for preparation of Examination Closing, Form 14980-A, Explanation of Tip Income, (Unreported Tip Income) and the tracking sheet.
Send initial contact letter, Letter 1862, and follow normal procedures for preparation, mail-out and suspense.
Follow instructions in IRM 4.10.26.3.1(14)(15) for partial assessment and closing procedures.
Case Processing – Revised Reports and Responses to 90-day Letters
If the taxpayer replies to the Letter 525/Letter 525-T for TDC cases, or Letter 1862 and a revised report is prepared, issue Letter 692-M/Letter 692-T for TDC cases. Follow normal procedures for mail out and suspense of the letter.
And Enter These Amounts
You are issuing the report with Letter 692-M/Letter 692-T for TDC cases. Annotate the ECID or Form 3198:
Assess FICA taxes $ XX.XX (TC 300)
Assess FICA Penalty $XX.XX (TC 310)
Assess Delinquency Penalty $XX.XX (TC 160) (if applicable)
Enter Hold Code 4
Change the TC 300 shown on Form 5344
Annotate the ECID or Form 3198
If the case falls under the provision of IRC 6404, input TC 971 AC 064 with dollar amount On
Form 2504 – Total Amount of Tax
Form 2504 – IRC 6652(b) Penalty
Form 2504 – IRC 6651 Penalty
TC 300 entered by RGS less the total amount of tax on Form 2504. (Deficiency shown on Form 4549 )
TC 160 entered by RGS less the Delinquency Penalty shown on Form 2504
Ensure that the assessments for FICA tax and related penalties are made before the 90-day letter is issued. Refer to IRM 25.6, Statute of Limitation, on assessment statute of limitation on unreported tips income and IRM 4.23.7.4, Form 4137 Requirements. If you are evaluating a response to a 90 day letter and have reduced the amount of under-reported tip income, update a corrected Form 4549 and Form 2504 , as shown in the table after the next paragraph to ensure that the taxpayer is not over-assessed for FICA taxes and the penalty.
If a taxpayer requests Appeals rights during an examination, the FICA tax and penalty will be assessed prior to transferring to Fresno Appeals function. This is to ensure that the FICA tax and penalty statute are not barred. Any notices generated relating to FICA tax and penalty to the taxpayer should be suppressed. The Examiner/lead and the Clerical unit will review case file to ensure that it is followed and that the case file includes workpapers and Form 14980 with tip unreported income calculations for the taxpayer. The Fresno appeals function will adjust/abate the FICA tax and penalty, if necessary, at the conclusion of their appeals process.
Send Letter 555 and follow the normal procedures for mail-out and suspense. Keep in mind the restrictions on increasing the assessment and requesting documentation after the statutory notice has been issued. See IRM 4.19.13.13, Statutory Notices.
Transaction/Reference Code
Abate FICA taxes TC 301 Difference between the FICA taxes already assessed and the amount shown on the corrected Form 2504
Abate FICA Penalty TC 311 Difference between the FICA penalty already assessed and the amount shown on the corrected Form 2504.
Abate Delinquency Penalty (if applicable) TC 161 Difference between the delinquency penalty already assessed and the amount shown on the corrected Form 2504.
Input Reference Codes 891 and 898 (for Primary taxpayer) Difference between the Primary taxpayer's unreported tip income shown on Form 4549 that accompanied the 90 day letter and the Primary taxpayer's unreported tip income shown on your revised report. (Show this amount in brackets.)
Input Reference Codes 892 and 899 (for Secondary taxpayer) Difference between the Secondary taxpayer's unreported tip income shown on the Form 4549/Form 4549-EZ that accompanied the 90 day letter and the Secondary taxpayer's unreported tip income shown on your revised report. Show this amount in brackets.
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Case Processing – Closing Actions and Other Information
There are special rules for assessing FICA taxes. FICA tax and the associated penalties may have to be assessed prior to issuing the 90-day letter. Ensure that assessments are input timely and properly. Refer to IRM 4.19.15.26.3.1, Filed Returns – Initial Contact, and IRM 4.19.15.26.4, Case Processing - Revised Reports and Responses to 90-Day Letters.
Unless otherwise instructed, follow normal closing procedures. Refer to the table to determine the action to take and to IRM 4.4, AIMS Processing.
The taxpayer agrees to the 15/30 day letter. Input all transaction codes on Form 5344 as printed by RGS. Disregard handwritten notations, except for changes to the TC 310 amount.
The taxpayer does not respond to the 15/30 day letter. Do a partial assessment, prior to the issuance of the 90 day letter Use AMCLSF and input the following:
TC 300 per the examiner's instructions
TC 310 per the examiner's instructions.
TC 160 per the examiner's instructions. This will not occur on all cases.
Reference Codes 891, 892, 898 and 899 as shown on Form 5344.
If partial is input at closing use Posting Delay Code 1.
Hold Code 4
TC 470 with Closing Code 90 on IDRS using Command Codes REQ77/FRM77 if partial is input prior to 90 day.
Prepare the 90 day letter for the income tax deficiency and penalties shown on Form 4549/Form 4549-EZ.
The taxpayer agrees to the 90 day letter or the 90 day letter defaults. Using AMCLSE input:
TC 300, TC 350/ Ref. 680, TC 160 per the Form 4549/Form 4549-EZ issued with the 90 day letter.
Input all other transactions and references per Form 5344, if they have not been previously input.
Input Posting Delay Code 1 on the closing assessment.
A revised report and Letter 555 adjusting the tip income were issued after the 90 day letter and the taxpayer agrees or the case defaults. Do a partial abatement using AMCLSF and input the following:
Reference Codes 891, 892, 898 and 899 per the examiner's instructions.
A revised report and Letter 555 adjusting the tip income were issued after the 90 day letter and the taxpayer agrees or the case defaults. Using AMCLSE input:
TC 300, TC350 / Ref. 680, TC 160 per the revised Form 4549/Form 4549-EZ issued with the Letter 555.
Requests for Transfers to an Area Office and Statute Extensions. A case should not be transferred if there are less than 13 months remaining on the statute of limitations. Refer to IRM 4.19.13.15.1, Transfers to Area Office.
All Tip program cases that require transfer to Area Office should be routed to the clerical support unit. The support unit will update AIMS and RGS and route to the following address: Internal Revenue Service - Attn: PSP M/S 4031 - 600 17th Street - Denver, CO 80202.
HQ analyst should be informed of the transfer request to the Area Office.
Refer to IRM 4.19.17, Non-Filer Program, for information on the statute of limitations for non-filers and the returns they file in response to the initial contact letter or subsequent letter.
In cases where the time constraints do not allow for transferring the case, contact the taxpayer, explain the situation and ask the taxpayer to explain his or her concerns. Try to resolve the issues via correspondence. If the taxpayer insists on transferring the case, the Statutory Notice has not yet been issued, and there are less than 13 months remaining on the statute of limitations, the statute of limitations must be extended to transfer the case.
If the taxpayer filed Form 4137 with the tax return, prepare Form 872, Consent to Extend the Time to Assess Tax, and Form SS-10, Consent to Extend the Time to Assess Employment Tax, to extend the statute of limitations on both the income and the FICA taxes. Follow normal procedures for mail out and suspense of the request to extend the statutes. Refer to IRM 25.6.22.5, Preparation of Consent Forms - General Procedures.
If Form 4137 was not filed with the return, prepare Form 872, Consent to Extend the Time to Assess Tax, for the income tax only.
Other Processing Guidelines
If the taxpayer states that he or she disagrees with the report and you cannot clearly determine the basis of the disagreement, follow normal procedures for contacting the taxpayer to get clarification.
If necessary, the unreported tip income, as shown on the original report, can be adjusted. However, do not change the taxpayer's hours, shift, position, or venue unless the taxpayer has provided information from the employer.
Obtain as much information as possible from the taxpayer and document it in detail on your workpapers.
Access any additional information that is available from the Tip Match database and other employer driven resources.
If the taxpayer disagrees with an adjustment that is not related to the tip income use normal procedures to evaluate the information the taxpayer provides.
Tip diaries must meet specific requirements to be accepted. For information on the specific requirements for a tip diary, see Pub 531, Reporting Tip Income, or section 31.6053-4(a)(2) of the Employment Tax Regulations. Also refer to the SERP Job Aids, Compliance Tip Diary Evaluation.
If the taxpayer states he or she agrees with the adjustment to the tip income but provides information about employee business expenses, the taxpayer may be entitled to, evaluate that information and make the necessary determination based on the information provided.
If the taxpayer responds to the Letter 1862 with a tax return, review the return for accuracy and process the return as instructed in IRM 4.19.17.3, Non-Filer Processing.
If the taxpayer's response results in a revision to Form 4549 and Form 2504 make sure you make the corresponding changes to the tracking sheet.
If the taxpayer wishes to have a representative conduct the examination on his or her behalf, Form 2848 must give the representative authority to handle the income tax and the FICA tax issues.
If a request is made for printed documentation to be sent to Tax Court or Appeals, follow the instructions below (for clerical only):
Request the case file from the CORR team,
Case will be sent to Clerical to have all the requested case documents printed.
Clerical will send case file to Appeals or Tax Court with printed documentation enclosed.
A record should be kept by the Clerical manager.
10 Percent Additional Tax on Early Distributions – IRC 72(t) & IRC 72(q)
The 10 percent additional tax is an income tax which is assessed on the Individual Master File and taken into account when the total corrected income tax is determined by the tax examiner. Returns included in this program apply to taxable early distributions from qualified retirement plans, Individual Retirement Arrangements (IRAs), or annuity contracts.
To encourage taxpayers to save for retirement, Congress enacted an early distributions tax that requires taxpayers to pay an amount equal to 10 percent (or 25 percent of certain SIMPLE IRA distributions, if applicable) of the taxable amount distributed from a retirement plan before they reached the age of 591/1. The tax is 10 percent (or 25 percent if applicable) of the amount of early distributions includible in gross income and required to be reported on Line 4b (IRAs, pension and annuities) of Form 1040 for tax years 2018 forward. Lines 15b or 16b of Form 1040 will be used prior to tax year 2018.
For taxable year 2018, there are no lines 15b and 16b, this information will be reported on new line 4b of Form 1040.
The 25 percent additional tax applies to an early distribution from a SIMPLE IRA account that occurs within 2 years from the first contribution made by the employer. Distributions subject to the 25 percent additional tax are reported by the payer on Form 1099-R with a Distribution Code S in Box 7 and are required to be reported on Line 4b of the Form 1040.
There are a number of exceptions to these additional taxes. Tax examiners will be required to determine if the taxpayer meets one of the exceptions or if the taxpayer simply failed to report the proper amount. See Table A and B for details regarding exceptions. Generally, the payer (individual or entity who is responsible for preparing Form 1099-R ) will not know if a taxpayer is using the distribution for a first time home purchase, qualified medical expenses, qualified higher education expenses, or a qualified birth or adoption distribution. Therefore, the payer will code the Form 1099-R Box 7 as 1 (early distribution, no known exception.)
Procedural Instructions
Tax Examiners who work these cases should take the following Basic Income Tax Training lessons: IRA, Pensions, Annuities, and IRA Deductions.
For more information consult Pub 590-B, Distributions from Individual Retirement Arrangements (IRAs), Pub 575, Pension and Annuity Income, Instructions for Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts, and Instructions for Form 1099–R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
Tax examiners must conduct the following research before contacting the taxpayer to determine if the case should be surveyed and to ensure the audit report is correct.
IDRS Command Codes
INOLES to determine taxpayer's age. At time of distribution 59 1/1 or older Or55 or older and meets exception per TABLES A and B survey, close on AIMS using DC 31
TXMOD to verify if taxpayer amended Form 1040 and reported 10/25 percent additional tax reported survey case and close on AIMS using DC 31.
IRPTR
to verify if payer filed amended Form 1099-R for the distribution(s) that is (are) subject to the 10 percent or 25 percent additional tax,
to verify that all taxable pension, IRA distributions, or any other taxable income have been reported on the return. Include in income any unreported taxable income determined, and
to determine if pension or IRA distributions are substantially equal to distributions received in the prior or subsequent tax years. These should be surveyed and closed DC 31 if criteria is met.
Form 1099-R Box 7 Code is:
2 (early distribution, exception applies (under 59 1/1))
3 (Disability), or
4 (Death)
survey, close on AIMS using DC 31.
G (Direct Rollover of a distribution to a qualified plan, a Section 403(b) plan, a governmental Section 457(b) plan, or an IRA. This does not include the direct rollover of a designated Roth account distribution.)
H (Direct Rollover of a designated Roth account distribution to a Roth IRA.)
See the instructions to Form 1099-R for Codes G and H.
If the additional tax on early distribution does not apply, consider opening the examination if the amount of unreported income is material
10 percent additional tax cases are opened on AIMS in Project Code 0123, Source Code 06.
Cases selected using the UCP (Unattended Case Processing) Filter Create Discretionary tool will create in RGS Group B2, pending Status 10, with the Letter 566-S/Letter 566-T for TDC cases, and accompanying Form 886-A. A 100 percent review of these cases is required to identify cases that should be surveyed prior to contacting the taxpayers. Based on the required research shown above, if it is determined the taxpayer meets one of the exceptions and is not liable for the 10 percent additional tax, the case should be surveyed, and letter and forms not issued to the taxpayer. Also, the 10 percent additional tax issue should be reviewed to ensure the tax is only being assessed on applicable distributions and to include any unreported income. Cases which pass review, after any necessary corrections have been made, should be reintroduced to ACE (Automated Correspondence Exam) for subsequent automated processing.
The case will be suspended for 45 days.
The Letter 525/Letter 525-T for TDC cases, Form 886-A and Form 4549/Form 4549-EZ (audit report) will be prepared systemically during ACE Create 2 processing. Cases which fire one of the standard filters during Create 2 processing will reject to RGS Group B2. The audit reports must be randomly reviewed, per ACE procedures in IRM 4.19.20.2.9, Reviews. The standard explanation included in Form 886-A is determined by whether an amount is reported on Line 4b (IRAs, pensions, and annuities) of Form 1040 for tax years 2018 forward. Lines 15b and/or 16b on Form 1040 , or 11b and/or 12b on Form 1040A for tax years prior to 2018.
Additional tax of 10 percent due to the early distribution made from your qualified retirement plan.
We are proposing to adjust your tax by 10 percent of the taxable amount of the early distribution made from your qualified retirement plan because you received the distribution before you reached age 591/1, and the payment did not qualify for one of the following allowable exceptions:
Payments made from the Plan after you separate from service if you will be at least 55 during the year of payment
Payments made on account of total and permanent disability
Payments made in substantially equal periodic amounts over your life or life expectancy (or the joint lives or life expectancies of you and your beneficiary)
Payments made to a beneficiary after the death of the participant
Payments of Employee Stock Ownership Plan (ESOP) dividends
Payments paid directly to the government to satisfy a federal tax levy
Payments made to an alternate payee under a Qualified Domestic Relations Order (QDRO)
Payments for medical expenses that do not exceed the amount of your deductible medical expenses (whether or not you itemized deductions)
For distributions made before January 1, 2016 from a State or local governmental defined benefit pension plan to a qualified public safety employee who is at least age 50 at the time the public safety employee separates from service
For distributions made after December 31, 2015, payments from a governmental plan to a qualified public safety employee who is at least age 50 at the time the public safety employee separates from service.
Payments from CSRS and FERS made under a phased retirement annuity
Payments while you are on active duty, if you were called to duty after September 11, 2001, for more than 179 days.
Payments made to individuals who receive qualified reservist distributions.
In-plan Roth rollovers or eligible distributions contributed to another qualified retirement plan or IRA within 60 days.
Payments made for a qualified birth or adoption distribution.
If you believe you qualify for one of the exceptions, please provide us with documentation that shows you meet one of the above exceptions. Examples of acceptable documents include:
corrected Form 1099-R from the issuing entity, or
a statement from your plan administrator explaining why you meet the exception, or
a statement from your medical practitioner explaining your disability, or
copies of cancelled checks or receipts showing when and what qualified expenses were made, or
a copy of the QDRO (generally part of your divorce decree).
Additional tax of 10 percent due to the early distribution made from your annuity contract.
We are proposing to adjust your tax by 10 percent of the taxable amount of the early distribution made from your annuity contract because you received a distribution before you reached age 591/1, and the payment did not qualify for one of the following allowable exceptions:
Payments after the death of the annuity owner
Payment made on account of total and permanent disability
Payments made in substantially equal amounts over your life or life expectancy (or the joint lives or life expectancies of you and your beneficiary)
Payments allocable to an investment in the contract before August 14, 1982
Payments made under a qualified personal injury settlement
Payments made under an immediate annuity contract
Payments made under a deferred annuity contract purchased by your employer upon termination of a qualified plan that is held by your employer until you separate from service
If you believe you qualify for one of the exceptions, please provide us with documentation that shows you meet one of the above exceptions. Acceptable documents include:
a statement from your annuity holder explaining why you meet the exception, or
a statement from your medical practitioner explaining your disability
Use the following standard explanation if an entry is on Form 1040 Line 15b (IRA distribution taxable amount), but there is no entry on Line 16b (pensions and annuities taxable amount), or if an entry is on Line 11b (IRA distribution taxable amount), but there is no entry on Line 12b (pensions and annuities taxable amount) for Form 1040A.
For taxable year 2018, there is no line 15b or 16b. The information will be entered on new line 4b of the Form 1040. Also, for tax year 2018, there is no Form 1040A.
Additional tax of 10 percent due to the early distribution made from your Individual Retirement Account (IRA).
We are proposing to adjust your tax by 10 percent of the taxable amount of the early distribution made from your Individual Retirement Account (IRA) because you received the distribution before you reached age 591/1, and the payment did not qualify for one of the following allowable exceptions:
Payments made on account of the total and permanent disability
Payments made in substantially equal amounts over your life or life expectancy (or joint lives or life expectancies of you and your beneficiary)
Payments after the death of the IRA owner
Payments for qualified higher education expenses
Payments to buy, build, or rebuild a first home
Payments not exceeding the amount of your deductible medical expenses (whether or not you itemized deductions)
Payments to unemployed individuals for health insurance premiums
Payments while you are on active duty if you were called to duty after September 11, 2001, for more than 179 days
Payments made for a qualified birth or adoption distribution
corrected Form 1099-R from the issuing entity
a statement from your plan administrator explaining why you meet the exception
copies of cancelled checks or receipts showing when and what qualifying expenses were made
Use all of the standard explanations (per 7a and 7b above) on Form 886-A if there is an entry on Line 4b (IRAs, pensions, and annuities) of Form 1040 for tax years 2018 forward. For tax years prior to 2018 both Lines 15b (IRA distribution taxable amount) and 16b (pensions and annuities taxable amount) on Form 1040 [Lines 11b (IRA distribution taxable amount) and 12b (pensions and annuities taxable amount) on Form 1040A].
Suspend the case for 45 days waiting for taxpayer response to Letter 525/Letter 525-T for TDC cases. If no reply is received, follow the procedures in IRM 4.19.13.12, No Response and Unagreed Cases.
Use the following table when reviewing the taxpayer's reply.
The taxpayer signs the report or, prior to the mailing of a Statutory Notice of Deficiency, pays the full amount, Close the case using normal procedures.
The taxpayer submits documentation and you need additional information,
If the taxpayer provides a phone number, attempt to call the taxpayer and notate the phone call in your case file.
If the attempt to contact the taxpayer is unsuccessful, follow procedures in IRM 4.19.13.10.1, Taxpayer Response – Prior to Status 24 Additional Information Needed.
The taxpayer appeals the determination, Follow relevant procedures in IRM 4.19.13.12, No Response and Unagreed Cases and IRM 4.19.13.15, Transfers to Area Office Examination or Appeals Office.
The taxpayer submits sufficient documentation (refer to tables A and B below) to verify an exception was met, Close no change using normal procedures.
The IRS has released new and updated publications and forms for individuals who received qualified disaster distributions from retirement plans in 2016 or 2017. The Disaster Tax Relief and Airport and Airway Extension Act of 2017 offered tax-related and other relief to victims of Hurricane or Tropical Storm Harvey, Hurricane Irma, Hurricane Maria, and the California wildfires, that occurred in 2017. In the Tax Cuts and Jobs Act, Congress extended distribution relief to 2016 disasters. New Publication 976, Disaster Relief summarizes various types of tax relief available for individuals and businesses affected by qualifying disasters in 2016 and 2017, including qualified disaster distributions.
Table A provides the category of payer (IRA, qualified retirement plan, or annuity) and in what tax year the exception is available. Verify that the correct plan applies to the correct exception. For example, a distribution from a 401(k) Plan is not available for the first-time home buyer exception. The exception for distributions made after separation from service after age 55 is not available for an IRA distribution.
Table A
Exceptions to early distribution tax
Payments made on or after the date the plan participant or account holder reached 591/1. x x x ALL
Payment made to a beneficiary upon death of the plan participant or contract holder. x x x ALL
Payment made based on total and permanent disability of the recipient. x x x ALL
Distribution made as a part of a series of substantially equal payments. x x x ALL
Distribution used for certain higher education expenses. x n/a n/a Starting 1998
Distributions used for first-time home purchase (Up to $10,000). x n/a n/a Starting 1998
Distributions made after separation from service in or after the year the participant reached age 55. n/a x n/a Starting 1998
Distributions made to the extent of deductible medical expenses that can be claimed on Line 4 of Schedule AForm 1040. (Does not apply to annuity contracts or modified endowment contracts.) x x n/a After 1996
Distributions made to unemployed (at least 12 weeks) individuals for health insurance premiums. x n/a n/a After 1996
Payments to an alternate payee under a qualified domestic relations order QDRO. n/a x n/a ALL
Payments made if, as of March 1, 1986, the plan participant separated from service and began receiving benefits under a written election. n/a x n/a ALL
Payments made to correct excess deferrals, excess contributions, or excess aggregate contributions. n/a x n/a ALL
Payments allocable to investment in a deferred annuity contract before August 14, 1982. n/a n/a x ALL
Payments from an annuity contract under a qualified personal injury settlement. n/a n/a x ALL
Payments made under a deferred annuity contract purchased by the employer upon the termination of a qualified retirement plan or qualified annuity and that is held by the employer until the participant separates from service. n/a n/a x ALL
Payments made under an immediate annuity contract. n/a n/a x ALL
The distribution is due to an IRS levy under Section 6331 of the Internal Revenue Code. x x n/a Starting in 2000
Distributions to qualified reservists called to active duty for more than 179 days or for an indefinite period. x x n/a After September 11, 2001
Payments from a federal retirement plan made under a phased retirement annuity program n/a n/a n/a After 2014
Payments made after August 17, 2006 and before January 1, 2016, from a State or local governmental defined benefit pension plan to a qualified public safety employee who is at least age 50 at the time the public safety employee separates from service. n/a x n/a ALL
Payments made after December 31, 2015, from a governmental plan to a qualified public safety employee who is at least age 50 at the time the public safety employee separates from service. n/a x n/a ALL
Distributions for qualified birth or adoption expenses up to $5,000 paid during the 1-year period the individual was born or the legal adoption is finalized
While qualified birth or adoption distributions may be from a qualified retirement plan, such distributions are not permitted from a defined benefit plan
. x x n/a Starting 2020
The following bullets apply to Table A
A five percent rate may apply to certain annuity distributions – see IRM 4.19.3.15.3, 10 Percent Tax on Early Distributions From Qualified Retirement Plans/25 Percent Tax on Early Distributions from SIMPLE IRAs, for more information.
IRAs include: Traditional, Roth, and SIMPLE IRAs.
Qualified Retirement Plans include: 401(a) qualified pension, profit-sharing, and stock bonus plan, including 501(a) tax exempt trust plan, 403(a) qualified employee annuity plan, 403(b) employee annuity contract purchased by a public school or by a 501(c)(3) tax exempt organization, employee stock ownership plan (ESOP), 401(k) qualified cash or deferred arrangement plan, CSRS, FERS, the Federal Thrift Savings Plan, and any tax favored deferred compensation plan that is not an IRA, a SIMPLE IRA or an individual retirement annuity.
Table B details acceptable documentation for exceptions to the early distributions tax. The list is not all inclusive.
Always accept a corrected Form 1099-R. Do not accept Form 5329 submitted after filing as verification.
Table B
If the taxpayer claims one of the following exceptions:
Then acceptable verification is:
Payments made on or after the date the plan participant or account holder reached age 591/1, Taxpayer's age verified using IDRS CC INOLES or birth certificate.
Payment made to a beneficiary upon death of an IRA holder or pension plan participant (not applicable to modified endowment contracts), Date of death verified via IDRS CC INOLES or death certificate, plan beneficiary form or statement from plan administrator.
Payment made based on total and permanent disability, Letter from medical practitioner verifying the taxpayer's permanent and total disability.
Distribution made as a part of a series of substantially equal payments,
Review prior and subsequent year IRP documents, tax returns or RTVUE for amounts distributed and/or reported.
Confirm math is correct by method described in Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs), or Publication 575, Pension and Annuity Income.
Rev. Rul. 2002-62 will affect some distributions made after 2001 if there has been a modification to the series of periodic payments.
Distribution used for certain higher education expenses (tuition, fees, books, supplies and equipment required by the school for enrollment or attendance of a student). Eligible expenses should be reduced by scholarships and any other tax-free awards.
The distribution and payments must be within the same tax year.
Verified expenses from Form 1098-T using IDRS CC IRPTR, copies of cancelled checks/money orders and invoices, or statement from school showing dates and payment amounts of higher education expenses.
Do not accept direct payments from taxpayer to student.
Distributions used for a first-time home purchase, up to $ 10,000 (this is a lifetime limit). The distribution must be used for this purpose within 120 days after the distribution. Must be principal residence
Acceptable costs include expenses to acquire, construct or reconstruct a residence, reasonable settlement, financing, or other closing costs,
First time homebuyer defined as the taxpayer and, if married, the spouse, as well as any child, grandchild or ancestor of the taxpayer or spouse, who had no ownership interest in a principal residence in the two year period preceding the date of closing or preceding the date that construction/reconstruction commenced,
The 60-day rollover period (see below) for recontributing the distribution to an eligible retirement plan is extended to 120 days if the taxpayer does not close due to delay or cancellation of the purchase or construction of the residence.
To verify if first-time purchase, use IDRS and research prior years for mortgage interest or real estate tax payments for first time purchase:
Copies of cancelled checks or money orders, contracts, or closing (settlement) statements showing how the money was used.
Letter from financial institution or seller explaining reason for delay or cancellation of closing if applicable.
Distributions made after separation from service in or after the year the participant reached age 55.
Use IDRS CC INOLES to verify taxpayer's age
Check taxpayer's current and prior years Form W-2 to verify separation from service.
Distributions made to the extent of deductible medical expenses that can be claimed on Line 4 of Form 1040Schedule A, regardless of whether the taxpayer itemized deductions. (Does not apply to annuity contracts or modified endowment contracts.) IRM 4.19.15.20, Schedule A, for verification procedures.
Distributions made to individuals unemployed (for at least 12 weeks) for payment for health insurance premiums.
Verify unemployment from Form 1099-G or employee records
Copies of cancelled checks, money orders for insurance payments or statement of account from insurance agent/company
Paid to an alternate payee under a qualified domestic relations order, QDRO. Divorce decree or statement from plan administrator.
Payments from an employer plan made if, as of March 1, 1986, the plan participant separated from service and began receiving benefits under a written election. Statement from plan administrator.
Payments made from employer plans to correct excess wage deferrals, excess contributions, or excess aggregate contributions. Statement from plan administrator. See Employee Compensation, Retirement Plan Contributions in Pub 575 , Pensions and Annuity Income.
Payments from a deferred annuity contract to the extent allocable to investment in the deferred annuity contract before August 14, 1982. See Publication 575, Pensions and Annuity Income, for more information and accept statement from plan administrator.
Payments from an annuity contract under a qualified personal injury settlement. See Publication 575, Pensions and Annuity Income, for more information and accept statement from plan administrator.
Payments made under an immediate annuity contract. See Publication 575, Pensions and Annuity Income, for more information and accept statement from plan administrator.
Payments made under a deferred annuity contract, purchased by the employer upon the termination of a qualified retirement plan, or a qualified annuity that is held by the employer until the participant separates from service. See Publication 575, Pensions and Annuity Income, for more information and accept statement from plan administrator.
The distribution is due to an IRS levy of a qualified plan or on an IRA under Section 6331 of the Internal Revenue Code. Copy of IRS levy showing account levied.
Rollover – This is a tax-free distribution of assets from one eligible retirement plan that is reinvested in another eligible retirement plan or the same plan. The rollover must be completed within 60 days from the date of receipt of the distribution. The amount rolled over is not subject to either the 10 percent or 25 percent additional tax. See Publication 590-B, Distributions From Individual Retirement Arrangements (IRAS), for the frozen deposit exception to this rule. Statement from administrator of the new plan.
Transfer –If the taxpayer instructs the plan trustee to transfer funds directly to another plan, the transferred amount is not taxable or subject to the early distributions tax. Statement from plan administrator.
Payments from CSRS and FERS made under a phased retirement annuity program. Statement from plan administrator.
Permissible withdrawal made from an eligible automatic contribution arrangement (EACA) Statement from plan administrator.
Payment made by the taxpayer for a qualified birth or adoption distribution o Use IDRS CC TRDBV or RTVUE to verify the name, age and Taxpayer Identification Number of the eligible individual included on the taxpayer's tax return for the tax year in which the distribution is made. See IRC IRC 72(t)(H)(vi)(III) and Q&A, D-2 of Notice 2020-68 on page 567 of IRB 2020-38 , for further guidance on qualified birth or adoption distributions.
Payments made after August 17, 2006 and before January 1, 2016, from a State or local governmental defined benefit pension plan to a qualified public safety employee who is at least age 50 at the time the public safety employee separates from service.
Use IDRS CC INOLES to verify taxpayer's age.
Statement from plan administrator verifying that taxpayer is a public safety employee.
Payments made after December 31, 2015, from a governmental plan to a qualified public safety employee who is at least age 50 at the time the public safety employee separates from service.
The following bullets apply to Table B
The tax on early distributions does not apply to any part of the distribution that is tax free, such as amounts that represent a return of the taxpayer's cost or amounts rolled over/transferred (see above) to another retirement plan.
To avoid the 25 percent additional tax on an early distribution from a SIMPLE IRA Plan, the distribution must be rolled over/transferred into another SIMPLE IRA Plan.
Certain Roth IRA distributions are not subject to the 10 percent additional tax, see Instructions for Form 5329, Additional Taxes on Qualified Plans (Including IRAS) and Other Tax Favored Accounts, Page 2 and Publication 590-B, Distributions from Individual Retirement Arrangements (IRAS), for more information. Rev. Rul., 2002-62 allows certain taxpayers who began receiving fixed payments from their IRA or retirement plan based on the value of their account at the time they started receiving payments to switch – without penalty – to a method of determining the amount of their periodic payments based on the value of their account as it changes from year to year. If the taxpayer elects to do this, it may result in a lower periodic payment. See Rev. Rul. 2002-62 for more details.
Rev. Proc., 2003-16 provides guidance for applying to the IRS for a waiver of the 60-day rollover requirement. It also provides for an automatic waiver under certain circumstances. The Procedure is effective for distributions after December 31, 2001. See Rev. Proc., 2003-16 for more information.
Rev. Proc. 2016-47 provides guidance for waiver of the 60-day rollover requirement from one retirement plan or individual retirement arrangement (IRA) into another plan or IRA by providing a "self-certification procedure" for taxpayers to use in claiming rollover treatment. This revenue procedure is effective on August 24, 2016.
Gambling Issues (Income and Losses) - General Casual Gamblers
For tax years prior to 2018, taxpayers report gambling income on Form 1040, Line 21, and gambling losses on Form 1040 Schedule A Line 28. For tax years 2018, gambling income is reported on Form 1040 Schedule 1 Line 21, and gambling losses on Form 1040 Schedule A Line 16. For tax years 2019 and subsequent, gambling income is reported on Form 1040 Schedule 1, line 8.
The amount of total gambling losses may not exceed the amount of the total gambling income reported on Form 1040. Total gambling losses for a taxable year cannot be netted against total gambling income for a taxable year before the computation of the Adjusted Gross Income on Form 1040. Each item, income or loss, must be reported on the appropriate line or form.
This topic relates solely to casual gamblers. Gamblers in a trade or business of gambling use Schedule C.
Form W-2G, Certain Gambling Winnings, is a reporting requirement for certain gambling winnings. Gambling winnings are not the same as gambling income. A taxpayer recognizes gambling income (or a gambling loss) at the end of the taxpayer's gambling session (for example, when tokens are redeemed).
The following table shows examples of documentation taxpayers may provide to support their deduction for gambling losses. This is not an all-inclusive table. For returns with unreported IDRS cc IRPTR gambling winnings, the taxpayer may provide information of gambling losses that offset reportable gambling winnings from gambling income. For example, a taxpayer may show that after receiving the reportable gambling winnings he subsequently continued to gamble and lose the winnings, and ended his gambling session with no gambling income. Use good judgment when evaluating any information the taxpayer provides, including the possible inclusion of additional income.
Refer to http://www.irs.gov/pub/irs-utl/am2008011.pdf, for additional information on the concept of a gambling session, for residents of the U.S.. Courts have applied this concept to non-resident aliens as well. See Park v. Commissioner (722 F.3d 384, 406 U.S. App. D.C. 123).Note that the use of "session," in determining gambling winnings and losses has historically been limited to a slot machine play.
Gambling documentation - Examples
Documentation or wagering activity
Information provided
Diary of winnings and losses Date and type of wager or wagering activity
Name and address or location of the gambling establishment.
Names of other persons present at the gambling establishment.
Amount(s) won or lost.
Canceled checks, credit records, bank withdrawals; copies of casino credit records, copies of casino check cashing records Location of the gambling establishment; date of the wager.
Keno Date the keno tickets were validated by the gambling establishment.
Slot machines A record of the machine number and all winnings by date and time the machine was played.
Table games (twenty-one, blackjack, craps, poker, baccarat, roulette, wheel of fortune, etc.)
The number of the table at which the taxpayer was playing.
Casino credit data indicating whether the credit was issued in the pit or at the cashier's cage.
A record of the number of games played, cost of tickets purchased, and amounts collected on winning tickets.
Supplemental records include any receipts from the casino, parlor, etc.
Racing (horse, harness, dog, etc.)
A record of the races, amounts of wagers, amounts collected on winning tickets and amounts lost on losing tickets.
Supplemental records include unredeemed tickets and payment records from the racetrack.
A record of ticket purchases, dates, winnings and losses.
Supplemental records include unredeemed tickets, payment slips, and winnings statements.
Taxpayers with whom telephone contact is made should be encouraged to respond in writing with all documentation related to their gambling activities.
Initial Contact for Gambling Income
Issue Letter 566-S/Letter 566-T for TDC cases, as the initial contact letter to the taxpayer. Check "Schedule A Itemized Deductions" . Identify the issue by typing "Gambling Losses" . Identify income as an issue if there is unreported income.
Evaluating Gambling Issue Responses
Use the following guidelines when evaluating response to gambling issues.
Gambling Losses – IRC 165(d)
Carefully examine all documentation of losses for the year of the loss to ensure the losses are for the year related to the win. Notate the workpapers with the amount of losses and income from the documentation.
Receipts provided to support losses may also include gambling income not included on the return. Carefully review all documentation for income as well as losses. Subsequent reports (except for cases where the statutory notice has been issued) must include the income as well as the losses.
Examine unredeemed (losing) tickets carefully to ensure that they are for the correct year and that they had not been previously discarded prior to being acquired by the taxpayer.
Use sound judgment when considering taxpayer replies. Consider all aspects of the case, including the credibility of the taxpayer, additional burden, and the amount of tax when deciding whether to request more documentation.
Gambling Income
Form 5754, Statement by Person(s) Receiving Gambling Winnings, is completed by the taxpayer and given to the payer of the gambling winnings to ensure that the Form W-2G issued is correctly prepared when the taxpayer receives gambling winnings on behalf of another person or as a member of a group of winners on the same winning ticket.
A signature is required on Form 5754 only if federal income tax was withheld from the winnings.
Form 5754 should not be accepted as proof the income was distributed to other taxpayers. If the amount of disputed winnings exceeds $500, research the accounts of other taxpayers using Command Code IRPTR to determine if a Form W-2G was issued to that payee. If a Form W-2G was issued, then consider this an acceptable explanation.
If multiple Form W-2G were not issued, correspond with the taxpayer and explain that the gambling income is to be reported by the person to whom the Form W-2G is issued. Advise the taxpayer that a statement from the payer is required in order to accept the Form 5754.
Follow normal procedures for evaluating the information the taxpayer provides regarding the unreported gambling income. Make all necessary adjustments to gambling losses and income and issue a report, with the appropriate explanations and a cover letter. Refer to the table below for letter sequencing.
Replies – General Processing
Use the following table when processing replies.
Processing Taxpayer Replies to Letter 566-S/Letter 566-T for TDC cases and Subsequent Letters
The taxpayer replies to Letter 566-S/Letter 566-T for TDC cases, Letter 525/Letter 525-T for TDC cases, Letter 692-M/Letter 692-T for TDC cases. or the Statutory Notice of Deficiency (SNOD) with information to support gambling losses you are able to determine the taxpayer is entitled to the entire deduction, close the case "no change."
The taxpayer replies to Letter 566-S/Letter 566-T for TDC cases, or Letter 525/Letter 525-T for TDC cases, with information to support gambling losses you are able to verify that the taxpayer is entitled to part of the amount claimed, issue Letter 525/Letter 525-T for TDC cases, or Letter 692-M/Letter 692-T for TDC cases. with Form 4549, allowing the partial amount verified and an appropriate explanation.
The taxpayer replies to Letter 566-S or Letter 525/Letter 525-T for TDC cases, with information to support gambling losses you are able to determine that the taxpayer is not entitled to any part of the deduction, issue Letter 525/Letter 525-T for TDC cases, or Letter 692-M/Letter 692-T for TDC cases, with Form 4549 and an appropriate explanation.
The taxpayer replies to Letter 566-S/Letter 566-T for TDC cases, Letter 525/Letter 525-T for TDC cases, or Letter 692-M/Letter 692-T for TDC cases with information to support gambling losses you are able to determine that the amount on Form 1040 Schedule A Line 28 for tax years prior to 2018 or Line 21 for tax years 2018.- For tax years 2019 and subsequent, gambling income is reported on Schedule 1, line 8, issue Letter 525/Letter 525-T for TDC cases, with Form 4549 and an appropriate explanation.
The taxpayer replies to the SNOD with information to support gambling losses you are able to verify that the taxpayer is entitled to part of the amount claimed, issue Letter 555 with a revised Form 4549 and an appropriate explanation to the taxpayer.
The taxpayer replies to the SNOD with verification of his deduction you are able to determine that the taxpayer is not entitled to any part of the deduction, issue Letter 555 with the latest Form 4549.
The taxpayer replies to the SNOD with verification of his deduction you are able to determine that the amount on Form 1040 Schedule A Line 28 for tax years prior to 2018 or Line 21 for tax years 2018. For tax years 2019 and subsequent, gambling income is reported on Schedule 1, line 8, issue Letter 555 with a revised Form 4549 and an appropriate explanation to the taxpayer. Do not increase the deficiency as shown on the SNOD.
Take the following action if the taxpayer has not replied to the most recent letter by the normal purge date:
Letter 566-S/Letter 566-T for TDC cases, Prepare Letter 525/525-T for TDC cases, and Form 4549 disallowing the gambling losses and adding the unreported gambling winnings. Use Standard Explanations #1407 and/or #9412.
Letter 525/Letter 525-T for TDC cases, or Letter 692-M/Letter 692-T for TDC cases, and the Form 4549 reflects a deficiency Follow normal procedures to have SNOD issued based on the adjustments shown on Form 4549.
Letter 525/Letter 525-T for TDC cases, or Letter 692-M/Letter 692-T for TDC cases, and the Form 4549 reflects an overpayment Close the case DC 08.
SNOD Close the case DC 10.
Special Gambling Closing Procedures
When closing cases, consideration must be given to the disposition of receipts to the taxpayers. Receipts will not be returned to the taxpayer as a matter of practice. All verification of losses must be retained with the case file. If the verification is not substantial, for example a statement from a casino, it can be retained in the closed case file. If the documentation would be difficult to file, retain the records in a retrievable method for a period of nine months.
If the IRS and the taxpayer agree on the amount of the losses verified by the documentation, there is no reason to retain the receipts. If the taxpayer requests the return of the receipts, contact the taxpayer by telephone to confirm the taxpayer's request. Explain that there is no longer a tax requirement to retain the receipts. If the taxpayer insists, the tickets must be stamped before they are returned.
When making or receiving phone calls, an IRS employee must follow IRM 21.1.3.2.3, Required Taxpayer Authentication, to ensure that he or she is speaking to the appropriate taxpayer and to prevent the unauthorized disclosure of tax information.
If the taxpayer does not address the disposition of unredeemed tickets, retain them for a period of nine months after the case closes.
Health Coverage Tax Credit – IRC 35
Eligibility: A taxpayer may elect to take the Health Coverage Tax Credit (HCTC), a refundable credit, if the taxpayer is an eligible individual. An eligible individual is:
Workers who have been adversely impacted by foreign trade and who are recipients of Trade Adjustment Assistance (TAA), Alternative Trade Adjustment Assistance (ATAA) or Reemployment Trade Adjustment Assistance (RTAA), and
Pension Benefit Guaranty Corporation (PBGC) pension payees who are at least age 55.
A qualifying family member (spouses and dependents) can be considered recipients and are eligible to newly receive or continue to receive the HCTC in the event that a related TAA, ATTAA, or RTAA recipient or PBJC payee dies or finalizes a divorce with the recipient, if the recipient was a qualifying family member immediately before such event.
Qualifying family members can receive the HCTC for eligible coverage months up to 24 months from the death or divorce, or until the first coverage month that begins on or after January 1, 2020, whichever comes first.
Submission Processing (SP) and Accounts Management (AM) correspond with taxpayers claiming HCTC when accounts do not have eligibility coding (under either TIN if a joint return) and taxpayers did not provide proof of eligibility with U.S. Form 1040, Individual Income Tax Return, Form 8453, U.S. Individual Income Tax Transmittal for an IRS e-file Return, or Form 1040X, Amended U.S. Individual Income Tax Return. Examiners input TC 971 AC 172 when taxpayers respond with eligibility letters from State workforce agencies (SWAs) or PBGC.
Qualifying coverage: Eligible individuals must be covered by qualifying health care insurance to benefit from HCTC, which includes:
Consolidated Omnibus Budget Reconciliation Act (COBRA) continuation coverage,
Coverage under an employee benefit plan funded by a Voluntary Employees' Beneficiary Association (VEBA) established as a result of bankruptcy proceedings,
Group health plans available through the employment of the eligible individual's spouse,
State-based coverage, and
Individual health insurance which is defined as insurance for medical care offered to individuals other than in connection with a group health plan and does not include Federal or State-based coverage. For tax years prior to 2014, the eligible individual must have been covered under individual health insurance for the 30-day period ending on the date of separation from the employment which qualified the person for TAA/ATAA/RTAA or PBGC benefits. For tax years after 2015, coverage enrolled in through a Health Insurance Marketplace (Exchange) established under the Affordable Care Act (ACA) is not qualifying individual health insurance.
Qualifying coverage does not include; Flexible spending arrangements (FSAs) or similar arrangements; Insurance if substantially all the coverage is for excepted benefits described in IRC section 9832(c), such as dental or vision plans, policies covering only a specified disease or illness, and hospitalization insurance. (The examples are not all-inclusive.)
Taxpayers are required to attach proof of payment for health care insurance to HCTC claims. SP and AM correspond for missing documentation.
Other Specified Coverage: Eligible individuals must not have other specified coverage, defined as:
Subsidized coverage; Coverage under a health plan maintained by a current or former employer of the taxpayer or taxpayer's spouse if the employer pays or incurs at least 50 percent of the cost of the coverage; For ATAA and RTAA recipients only, eligibility for coverage meeting IRM 4.19.15.29, Health Coverage Tax Credit - IRC 35, paragraph (3)(a)(1) above, or enrollment in coverage under an employer-sponsored health plan if the employer pays any of the premiums; Coverage in lieu of a right to receive cash or other benefits under a cafeteria plan as described in IRC section 125(d)
Coverage under Medicare (entitlement under Part A, which generally occurs at age 65, or enrollment under Part B or Part C), Medicaid or the State Children's Health Insurance Program (SCHIP or CHIP), and
Coverage under the Federal Employees Health Benefits Program (FEHBP) or entitlement to coverage under the U.S. military's TRICARE program (formerly CHAMPUS).
Qualifying Family Members: If an eligible individual has qualifying coverage and does not have other specified coverage (refer to the exception in (c) below), the taxpayer may also claim HCTC for qualifying coverage of qualifying family members (QFMs).
A "qualifying family member" is a person who does not have other specified coverage and; Is the eligible individual's spouse or; Is claimed as a dependent on the tax return unless the taxpayer is the dependent's non-custodial parent or; Could be claimed as a dependent except the taxpayer is the custodial parent who released the right to claim the exemption to the non-custodial parent under the special support test for divorced or separated parents.
If spouses filing separate returns are both eligible individuals during the year, neither will be treated as a qualifying family member.
If HCTC would be allowed for qualifying coverage of the eligible individual but for Medicare coverage (entitlement under Part A or enrollment under Part B or Part C), the taxpayer may continue to claim HCTC for qualifying coverage of qualifying family members for the first 24 months after the recipient of PBGC or TAA/ATAA/RTAA benefits became covered by Medicare.
If a qualifying family member is treated as an eligible individual under the terms described in IRM 4.19.15.29, Health Coverage Tax Credit – IRC 35, paragraph (1)(d), then that person's qualifying family members are limited to those individuals who were qualifying family members immediately preceding the event that conferred provisional eligibility.
Other Rules: Additional considerations apply with respect to HCTC.
HCTC is not allowed if the eligible individual; Was imprisoned under Federal, State or local authority or; Could be claimed as a dependent on another taxpayer's return.
Persons receiving COBRA premium assistance under the American Recovery and Reinvestment Act of 2009 are not treated as eligible individuals or qualifying family members.
Premiums claimed for HCTC may not be used in determining medical and dental expenses on Schedule A or a self-employed health insurance deduction (SEHID).
An eligible coverage month is one that begins 90 days after the enactment of the Trade Act of 2002 and before January 1, 2022.
HCTC Claims: HCTC is determined on a month-by-month basis and is computed on Form 8885, Health Coverage Tax Credit
As of March 2011, HCTC is equal to 72.5 percent of the premiums paid by an eligible individual for qualifying health insurance covering that person and qualifying family members after reduction by any distributions from an Archer Medical Savings Account (MSA) or Health Savings Account (HSA). (The credit was 65 percent from December 2002 through April 2009 and 80 percent from May 2009 through February 2011.)
December 2002 was the first month that HCTC became available with enactment of the Trade Adjustment Assistance Reform Act. Subsequent legislation modified and extended HCTC to December 2013. The Trade Preferences Extension Act of 2015 reinstated the credit, made it retroactive to tax years 2014 and 2015 and extended HCTC through 2019.
To claim HCTC for tax year 2014, taxpayers must file an amended return with Form 8885 due to the timing of legislation.
Beginning with tax year 2014, taxpayers must make an irrevocable election to claim HCTC. Generally, the election must be made by the due date (including extensions) for the return. Refer to tax year 2014 - 2016 claims https://www.irs.gov/pub/irs-irbs/irb17-07.pdf
Once HCTC is elected, the Premium Tax Credit (PTC) may not be claimed for the same coverage for that month or any subsequent months that the taxpayer is HCTC eligible for the TY. 1- Taxpayers who previously claimed PTC or who received the benefit of advance PTC (APTC), must file Form 8962, Premium Tax Credit (PTC). No PTC should be claimed for Marketplace coverage subject to the HCTC election. All APTC should still be reported on Form 8962, even for months subject to the HCTC election. 2- The APTC repayment limitation on form 8962, line 28, may not apply when a taxpayer elects the HCTC for marketplace coverage.
Advance (Monthly) HCTC - IRC 7527: Advanced payments of HCTC became available for the first time in 2003.
The HCTC Processing Center forwarded payment of 100 percent of the cost of health insurance coverage for a person enrolled in the advance monthly payment option directly to the insurance provider or third-party administrator (TPA). The Center issued invoices to collect the taxpayer's portion. Refer to IRM 4.19.15.29, Health Coverage Tax Credit - IRC 35, paragraph (6)(a), for the percentage of premiums paid by Department of Treasury.
Advance HCTC was not available for tax years 2014 and 2015 due to the timing of extension legislation. It was reinstituted on a limited basis in July of 2016 with the assistance of certain TPAs. Advance monthly HCTC has been available to all qualified applicants since January 1, 2017. Participants will not receive monthly invoices but will remit premium monthly payments with coupons available at www.irs.gov/hctc.
Advance monthly HCTC is posted to the tax account of the enrolled participant with TC 971 AC 171. The amount received from the taxpayer for the remaining portion of the premiums is recorded with TC 971 AC 170.
Advance monthly HCTC payments are reported to the taxpayer on Form 1099-H, Health Coverage Tax Credit (HCTC) Advance Payments.
Resources: For more information about HCTC, refer to Publication 502, Medical and Dental Expenses (Including the Health Coverage Tax Credit), the instruction for Form 8885, Health Coverage Tax Credit, Notices 2005-50 and 2016-02, and http://www.irs.gov/hctc.
HCTC Case Selection & Classification
Procedures for HCTC audits are dependent on whether the credit has been posted to the taxpayer's account and the case selection method.
Returns are categorized as "processed claims" if HCTC is posted to the account. TXMOD of a processed claim should include TC 766 with CRN 250 in an amount equal to the HCTC claimed on Form 8885. (Processing errors can occur. Examples of improper HCTC adjustments include TC 291, TC 806 and TC 766 with CRN 336.) Processed claims are generally selected based on criteria established by W&I RICS Exam HQ.
For processing year 2016, processed claims for HCTC will be referred for examination using unallowable programming.
SP will post Unallowable (UA) code 89 to a return when one or more of the following conditions exist; There is no TC 971 AC 172, and the taxpayer did not respond to an error notice with proof of eligibility; The taxpayer did not provide proof of payment for health insurance, and/or the taxpayer claimed HCTC and Premium Tax Credit (PTC) for the same month(s).
Refunds are frozen up to the amount of HCTC claimed with TC 576.
Cases are created systemically in source code (SC) 03 and project code (PC) 0505.
Manual classification prior to initial contact is required. Change the source code to 20 when additional audit issues are identified. Do not change the project code.
General UA procedures in IRM 4.19.15.15, Unallowable Code (UA) Program, apply except where contradictory with the above.
Beginning with filing season 2017, Dependent Database (DDb) filters will be used to identify processed claims for potential audit of HCTC. (Exception: Returns meeting the criteria in 4.19.15.29.1(3)(a)(3) will continue to be coded with UA 89).
Returns selected via DDb filters will open in SC 06, PC 0505.
Taxpayers who receive advance monthly HCTC may erroneously claim the same coverage for the same months on Form 8885, Health Coverage Tax Credit, resulting in a duplicated or partially duplicated credit. ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ Tracking code 7560 is used for this compliance strategy.
Additional compliance strategies not involving advance monthly HCTC may include the use of tracking code 7559.
Returns are worked as " unprocessed claims" if HCTC is not posted to the account. Amended returns with increases to HCTC are CIS imaged and routed by AM to Exam classifiers if criteria per IRM 21.5.3-3, Examination Criteria (CAT-A) - Credits, is met. (For additional information refer to IRM 21.6.3.4.2.9.1, Eligibility Requirements / Claim Processing.)
Open AIMS with SC 30 and PC 0505 when an amended return is referred and selected for HCTC.
General claims procedures in IRM 4.19.16, Claims, apply.
For processed and unprocessed claims not selected as described above, update AIMS and CEAS/RGS with tracking code 7561 when the scope of an audit is expanded to include HCTC.
When classifying HCTC claims, pay particular attention to related issues on the return or reflected on the tax account, including PTC/APTC, Schedule A medical and dental expenses, a SEHID, and deductions for an Archer MSA and HSA. For more information about related medical issues, refer to:
Pub 974, Premium Tax Credit (PTC),
IRM 4.19.15.40, Premium Tax Credit - IRC 36B,
Pub 502, Medical and Dental Expenses (Including the Health Coverage Tax Credit),
IRM 4.19.15.20, Schedule A,
Pub 535, Business Expenses,
IRM 4.19.15.30, Self-Employed Health Insurance Deduction - IRC 162(l), and
Pub 969, Health Savings Account and Other Tax-Favored Health Plans.
Examiners must obtain managerial approval in the form of a non-action CEAS note prior to pursuing any large, unusual or questionable items (LUQs) not previously classified on a return.
Research for HCTC Cases
Complete research is required when technical employees, other than examiners resolving ACE reject conditions, must take actions to prepare letters and/or review responses. Follow general procedures in IRM 4.19.13.4, Researching Cases, including documenting workpapers for research performed and pertinent information found.
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Review MeF returns via EUP. Taxpayers may attach PDF files with supporting records. Note the entries on Form 8885, including the months checked.
Access CIS for documents received by AM. Consider a Form 8885 and any related records.
In IDRS, research the taxpayer's TIN, including a spouse's if applicable, for:
HCTC adjustments (TC 766/767 CRN 250),
HCTC eligibility indicator(s) (TC 971 AC 172),
Coding for advance monthly HCTC (TC 971 AC 170/171),
Age of the taxpayer(s) and qualifying family members,
PBGC-based eligibility per Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡"≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡" ,
Health insurance coverage and/or premium payment information per: Form 1095-A, Health Insurance Marketplace Statement; Form 1095-B, Health Coverage; Form 1095-C, Employer-Provided Health Insurance Offer and Coverage; Form 1099-H, Health Coverage Tax Credit (HCTC) Advance Payments; Form 1099-SA, Distributions From an HSA, Archer MSA, or Medicare Advantage MSA, and/or Form W-2, Wage and Tax Statement.
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Initial Contact & No Response Procedures
Unprocessed Claims - Source Code 30
Send Letter 566-D for initial taxpayer contact.
Include Form 14749, Health Coverage Tax Credit - Verification of Eligibility and Qualifying Insurance, to request information the taxpayer could provide to verify HCTC claimed and any Forms 886 applicable for HCTC or other classified issues.
Update to Status 10 and suspend the case for 45 days.
Follow IRM 4.19.16.2.4.1, Claims Contact Procedures, if the taxpayer does not respond to Letter 566-D and IRM 4.19.16.2.4.2, Claims Contact Responses, if there is no reply to subsequent letters.
Processed Claims - Source Codes 03, 06 and 20
Disallow HCTC on Form 4549, Income Tax Examination Changes, and send with Letter 525/525-T for TDC cases, for initial contact.
If there are error codes for the Premium Tax Credit (PTC) on the return, include the appropriate adjustments to the PTC and the Advance PTC repayment on Form 4549. Refer to IRM 4.19.15.40.6, Creating the PTC Issue(s), for error code specific instructions.
Include any Forms 886 applicable for HCTC or other classified issues and; Form 14749, Health Coverage Tax Credit - Verification of Eligibility and Qualifying Insurance, if TC 971 AC 172 is not present or, Form 14749-A, Health Coverage Tax Credit - Verification of Qualifying Insurance, when an eligibility indicator is posted.
When reviewing accounts for eligibility indicators, ensure TC 971 AC 172 has not been reversed by TC 972 AC 172.
For source codes 03 and 20, follow the additional procedure in IRM 4.19.15.15.5, Processing Reply/NoReply Unallowable Cases.
Follow the instructions in IRM 4.19.13.12, No Response and Unagreed Cases, and IRM 4.19.10.1.5.2, Standard Suspense Periods for Correspondence Examination, if the taxpayer does not reply to the initial contact or subsequent letters.
Closures: Refer to IRM 4.19.15.29.5, Case Closure, when a closure is appropriate after no response from the taxpayer. It details specific actions needed for HCTC and provides references for general closing procedures.
HCTC Responses
General Guidelines: Follow the steps in the table below to process replies (not all-inclusive).
TC 971 AC 172 is not present and the taxpayer did not establish eligibility, Do not allow HCTC. (Refer to IRM 4.19.15.29(1) for the definition of eligibility. Always ensure a TC 971 AC 172 is not reversed by TC 972 AC 172.)
TC 971 AC 172 is not present and the taxpayer established eligibility for one or more months during the tax year, Update TXMOD for the return with TC 971 AC 172. Include the TIN of the eligible individual. (For TAA/ATAA/RTAA, do not accept an application or enrollment form in lieu of an eligibility letter from an SWA dated after the eligible months for the year.)
The individual was a PBGC recipient under age 55 as of the first day of the month, Do not allow premiums paid for anyone's coverage for that month in the HCTC computation. (Age 55 does not apply for a person treated as an eligible individual under the terms in IRM 4.19.15.29(1)(d).)
The eligible individual or spouse treated as an eligible individual due to divorce did not have qualifying coverage as of the first day of the month, Do not allow premiums claimed for anyone's coverage for that month in the HCTC computation.
The eligible individual or spouse treated as an eligible individual due to divorce had other specified coverage as of the first day of the month, Do not allow premiums claimed for anyone's coverage for that month in the HCTC computation. (Refer to the Medicare exception in IRM 4.19.15.29(4)(c), which conditionally allows HCTC for coverage of qualifying family members.)
An otherwise qualifying family member, including one treated as an eligible individual due to death, had other specified coverage as of the first day of the month, Do not allow premiums claimed for coverage of the family member for that month in the computation of HCTC.
A qualifying family member, including one treated as an eligible individual due to death, did not have qualifying coverage as of the first day of the month, Do not allow premiums paid to cover the family member for that month in the HCTC computation.
The taxpayer is the non-custodial parent of a dependent on the return, Do not allow premiums covering the child of divorced or separated parents in the computation of HCTC for any month.
Health insurance premiums were paid to cover a family member (other than a spouse on the return) who was not claimed as a dependent, Do not allow premiums paid for the family member's coverage in the computation of HCTC unless the taxpayer is the custodial parent who unconditionally released the right to claim the exemption to the non-custodial parent with Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, or a divorce decree executed before 2009.
A distribution from an HSA or Archer MSA reported on Form 1099-SA , Distributions From an HSA, Archer MSA, or Medicare Advantage MSA, was not included on Form 8885 Subtract the distribution from allowable premiums and recompute the HCTC.
The eligible individual or qualifying family member received COBRA premium assistance under ARRA 2009 as of the first day of the month, Do not allow premiums paid for any health insurance covering that person for the same month in the HCTC computation. (A 65 percent subsidy was available to eligible workers who lost their jobs between Sept. 1, 2008, and May 31, 2010, for COBRA continuation premiums for themselves and their families for up to 15 months.)
The taxpayer submits cancelled checks remitted to "U.S. Treasury – HCTC" and/or Form 1099-H to support premium payments on Form 8885, Do not allow the payments for an end-of-year credit. Inform the taxpayer that the maximum monthly HCTC was allowed for the coverage associated with the advance payment program.
The taxpayer requests a case transfer or meeting with an Appeals Officer, Follow relevant procedures in IRM 4.19.13.14, Transfers to Area Office Examination or Appeals Office.
The taxpayer states that supporting records for HCTC were attached to Form 1040 or 8453 or were provided in response to an error notice, Inform the taxpayer that the information is not readily available and an attempt to obtain it would significantly delay resolution of the audit.
Verified payments for health insurance premiums are not allowable for HCTC but qualify as a Schedule A, Self-employed Health Insurance, HSA, or Archer MSA deduction, Advise the taxpayer to file an amended return to claim the disallowed premiums as a deduction from income unless a double tax benefit was previously claimed.
HCTC is not allowable, but the taxpayer qualifies for PTC not currently on the tax account, Allow PTC if the taxpayer previously claimed PTC/APTC and repaid it solely to claim HCTC. Otherwise, advise the taxpayer to file an amended return to claim PTC for the disallowed premiums.
For TYs 2014 thru 2015, HCTC is allowable, but the taxpayer claimed PTC based on the same Marketplace coverage, Disallow PTC claimed for any Marketplace coverage subject to the HCTC election starting with the first month for which the taxpayer elected to claim the HCTC:
Determine the total amount of PTC for which the taxpayer is eligible and create an issue for Total PTC net credit adjustment to reduce the total PTC claimed on the return.
Subtract the recomputed total PTC from the total Advance PTC received and create an Advance PTC repayment net tax adjustment if the result is a positive amount. Reduce the adjustment by any Advance PTC repayment already reported on the return.
HCTC and other classified issues are fully substantiated, Allow all issues and close the case. (Math verify Form 8885.)
Eligibility: Taxpayers may check too many months on Form 8885 when eligibility was for less than the full tax year. Do not allow premiums claimed for any month if, as of the first day of the month, the eligibility requirement was not met.
Taxpayers whose returns were selected for audit because eligibility indicator TC 971 AC 172 was not present must verify eligibility for all months claimed. Generally, an eligibility letter from an SWA or PBGC is required. If HCTC is claimed based on the special rules in IRM 4.19.15.29, Health Coverage Tax Credit - IRC 35, the taxpayer may need to establish the date of the qualifying event and eligibility of the original recipient of TAA/ATAA/RTAA benefits or PBGC pension payments at that time.
The eligibility months may be determined through internal means when an eligibility indicator is present, such as ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ and eligibility letters available in EUP or CIS. If the eligibility months cannot be determined and it appears the taxpayer may otherwise qualify for HCTC, correspond for an eligibility letter.
Pensions are generally paid to retirees for life. If PBGC issued a Form 1099-R for the tax year prior to the one under audit and the payee taxpayer is the retired employee who was at least age 55 at the start of the AIMS year, then the taxpayer was an eligible individual for the full year under audit or until the date of death, if applicable. (Retirees can be eligible individuals by virtue of PBGC pension payments and not receive distributions during the tax year. If the retiree elects a lump sum payment, PBGC should continue to transmit eligibility data until the person reaches age 65.)
Similar logic cannot determine TAA/ATAA/RTAA-based eligibility months. The maximum duration of assistance to affected workers varies between 104 and 156 weeks. Benefits may be terminated for lack of program participation, such as attendance for mandatory training, and then subsequently reinstated if the workers reapply. Participants may cease to qualify for assistance due to significant reemployment. (There is an additional grace month for HCTC eligibility after TAA/ATAA/RTAA benefits expire. SWAs include the grace month on HCTC eligibility letters.)
Qualifying Coverage: IRC 35 identifies some types of coverage as non-qualifying for HCTC. However, any coverage not specified in IRC 35 as qualifying is not qualifying. Refer to IRM 4.19.15.29, Health Coverage Tax Credit – IRC 35, paragraph (2), for the complete list of qualifying coverage.
Group health plans available through the eligible individual's current employer are not listed coverage and are generally not qualifying for HCTC. If the premiums claimed were for a group plan and the eligible individual was the primary insured, verify that the coverage was COBRA continuation, VEBA-funded due to bankruptcy or an SQP.
VEBAs may fund group coverage for retirees when the employer cannot meet COBRA continuation coverage requirements due to bankruptcy. When VEBAs fund individual health insurance, SQPs or work-related group plans with the spouse as the primary insured, bankruptcy is not a consideration because those coverage types are qualifying in their own right.
There are several types of coverage that a State may elect to designate as qualifying for HCTC, including some employee and retiree group plans. ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡
FSAs and similar arrangements are listed as non-qualifying coverage. Employee contributions to FSAs are made via pretax payroll deductions.
The tax treatment of employee health benefits may be determined by comparing the deductions on the employee's final leave and earnings statement for the year to the difference between the gross wages on the pay statement and taxable wages in box 1 of Form W-2.
The Office of Chief Counsel has advised that pretax treatment for employee contributions for health care insurance is an arrangement similar to flexible spending (if not actually an FSA) and is therefore not qualifying for HCTC.
Other Specified Coverage: Review IRM 4.19.15.29, Health Coverage Tax Credit – IRC 35, paragraph (3), for details about other specified coverage and the consequence for HCTC.
Employers are more likely to pay at least 50 percent of the health insurance costs of a current employee than a former one. The percentage of the amount of premiums paid by the employer may be determined from Form W-2. Employer contributions are identified with code DD in Box 12. The employee's cost of coverage (including dental, vision, and FSC payments) should be itemized in box 14.
If IRC 125 is indicated, verify that the employee's payroll deductions were taxed. If not taxed, the plan meets the condition for other specified coverage. Refer to (3)(b)(1) above to determine the tax treatment.
Qualifying Family Members: Occasionally, examiners must determine the premiums paid for coverage of a nonqualifying family member or beneficiary when one policy covers multiple persons. Counsel provided guidance for the allocation in IRS Notice 2005-50. If the shared policy was enrolled in through a Marketplace, use the guidance in Notice 2016-02 instead.
Workpapers: Follow the general procedures in IRM 4.19.13.6, Workpapers for All Cases, when documenting taxpayer responses. Notate any information still needed and record details about supporting records received, such as:
The name of the eligible individual, the eligibility type, the eligibility months, and
The type of coverage, the primary insured and other covered individuals, the dates of coverage, the covered benefits, the employer and/or TPA associated with a group plan, the group name and number if applicable, the insurance provider, the policy number, the cost of premiums by month, and the payment method.
Unprocessed Claims: Consult IRM 4.19.16.2.4.1, Claims Contact Procedures, and IRM 4.19.16.2.4.2, Claims Contact Responses, for the letters and forms to send the taxpayer when considering responses for unprocessed claims.
Processed Claims: Refer to IRM 4.19.13.10.1, Taxpayer Responses - Additional Information Needed, for the actions to take when all audit issues of a processed claim are not resolved.
Closures: Refer to the next section, IRM 4.19.15.29.5, Case Closure, when a closure is appropriate after considering a response. It details specific actions needed for HCTC and provides references for general closing procedures, including those pertaining to agreed cases.
Case Closure
Unprocessed Claims: Use the instructions in IRM 4.19.16.2.4, Claims Processing in Examination Operation, and IRM 4.19.16.2.4.2, Claims Contact Responses, when closing unprocessed claims if:
Allowing HCTC, use Credit Reference Number (CRN) 250 with the allowable amount in Block 15 of Form 5344. Send Letter 570 to the taxpayer.
Disallowing HCTC, and the taxpayer has not waived notification of claim disallowance, provide a detailed explanation on Letter 105C for a full disallowance or Letter 106C for a partial one.
When assessing additional tax to deny the HCTC, whether pre-refund or post-refund, deficiency procedures (including letter 3219) must be used.
Processed Claims: Follow procedures in IRM 4.19.13.28, Campus Exam Closing Actions, for processed claims. Also, follow the applicable steps below:
Allowing any HCTC TXMOD does not include an unreversed TC 971 AC 172,
Input TC 971 AC 172 with the TIN of the eligible individual unless eligibility coding is AP or PN.
Input "1" in Block 43 of Form 5344 for a posting delay of one cycle to avoid an unpostable condition.
Allowing all HCTC Form 5344 does not include changes to tax, income, or other credits,
Use DC 02 in Block 13 of Form 5344.
Input "no change" Issue Code 61065 in Block 41.
Disallowing some portion of HCTC TC 766 for HCTC does not include a CRN, Input CRN 767 with the disallowed amount and a minus sign (-) in Block 15 of Form 5344.
Disallowing some portion of HCTC TC 766 includes CRN 250, Input CRN 250 with the disallowed amount and a minus sign (–) in Block 15 of Form 5344.
Disallowing some portion of HCTC HCTC is posted to the account in any other manner (see above),
Consult the work leader for the appropriate reversal code.
Use Hold Code 3 in Block 7 of Form 5344 to prevent a notice.
Disallowing some portion of HCTC A refund is frozen with TC 576 and the taxpayer did not agree to waive statutory notification of claim disallowance, Issue Letter 105C. Refer to IRM 4.19.15.15.5, Processing Reply/No Reply Unallowable Cases, for more information.
Self-Employed Health Insurance Deduction – IRC 162(l)
A taxpayer may be able to deduct part or all of the amount paid for health insurance, if the taxpayer is one of the following:
A self-employed individual and has a net profit for the tax year from a Schedule C, Profit or Loss From Business (Sole Proprietorship), Schedule C-EZ, Net Profit From Business (Sole Proprietorship) or Schedule F, Profit or Loss From Farming
A shareholder owning more than two percent of the outstanding stock of an S Corporation (or is considered as owning more than two percent by reason of the attribution rules under IRC 318) with wages reported on Form W-2; or
A partner with net earnings from self-employment reported on Line 14a of Form 1065, U.S. Return of Partnership Income).
A self-employed individual's deduction of health insurance for income tax purposes does not reduce his net earnings from self-employment. (See Section 162(I)(4))
A taxpayer may be eligible for a section 162(l) deduction and the Premium Tax Credit (PTC) in the same taxable year. Under section 280C(g) of the Internal Revenue Code, a section 162(l) deduction is not allowed for the portion of the premium paid by the PTC. However, a taxpayer must know the section 162(l) deduction to compute the PTC and the PTC to compute the section 162(l) deduction. See Pub 974 and Rev. Proc. 2014-41 for more information on how taxpayers in this situation compute their section 162(l) deduction and PTC.
IRC 318 attribution rules include four situations that result in a shareholder's stock in an S corporation being constructively owned by another person:
An individual will be considered to own the S corporation stock owned by their spouse (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance), children (including legally adopted children), grandchildren and parents;
A beneficiary or owner of a trust (described in section 1361(c)(2)) will be considered to own the S corporation stock owned by the trust;
A beneficiary of an estate will be considered to own the S corporation stock owned by the estate; or
A person with an option to acquire S corporation stock will be considered to own the stock in which they hold the option.
A self-employed individual or employee-shareholder may claim 100 percent of the amount paid as an adjustment to income.
In calculating the deductible amount, taxpayers should use the Self-Employed Health Insurance Worksheet in the Instructions for Form 1040 which indicates the deduction is the lesser of
the amount paid for health insurance coverage, or
net profit or earned income from the business under which the insurance plan is established, minus any deductions claimed on the Form 1040 for one-half of the Self-Employment Tax and any contributions to Self-Employed Simplified Employee Pension Plan (SEP), SIMPLE IRA Plan, and Qualified Plans.
Taxpayers may receive a 1099-MISC, , Miscellaneous Income, for self-employed income. Generally, the taxpayer prepares a Schedule C to report this income; however, it may also appear on the "Other Income" line. Ensure the taxpayer has reduced this income by any expenses applicable to the earning of this income to arrive at net income. Taxpayers who are in business as a self-employed writer, inventor, artist, etc., should report their income on Schedule C, and apply appropriate expenses to obtain net income.
Constructive ownership of stock under IRC 318 applies to taxpayer's spouse, his children, grandchildren and parents.
For purposes of the deduction, a two percent-plus shareholder's wages from the S Corporation are treated as the shareholder's earned income. No deduction is allowed in excess of an individual's earned income derived from the trade or business with respect to which the plan providing the health insurance coverage is established.
For employee-shareholders, the health insurance premiums must be paid in the current year by the corporation and included in the wages (generally shown in Box 14 of the Form W-2) of the employee-shareholder. The amount may include payments for insurance covering the taxpayer, his/her spouse, and dependents. If the premiums were not included in the employee-shareholder's wages (in Box 1 of the Form W-2), the employee-shareholder may not deduct them.
The taxpayer may not claim the Health Coverage Tax Credit (for which additional qualifications apply) for the same expenses the taxpayer claimed for the Self-Employed Health Insurance Deduction.
A taxpayer may not take this deduction if the taxpayer participated, or is eligible to participate, in any subsidized health plan maintained by any employer of the taxpayer or of the spouse of , or any dependent, or individual described in subparagraph (d) of paragraph (1) of section 162(1) with respect to, the taxpayer.
Self-Employed Health Insurance Deduction
Cases are worked to determine if a taxpayer is:
Erroneously claiming health insurance payments in excess of earned income or net profits of the business,
Erroneously claiming health insurance payments because they are unable to itemize, or
Claiming the deduction when they have no self-employment or earned income.
Procedures are as follows:
The Initial Contact Letter 566-S/Letter 566-T for TDC cases, will be used to inquire about the income and/or deductions.
Normal suspense periods will be applied to all letters issued.
The following table shows the initial contact letter to be sent to the taxpayer:
Rule(s) Broken
Letter to Issue
914: Taxpayer claiming self-employed health insurance deduction with no apparent self-employment income. Letter 566-S/Letter 566-T for TDC cases, with the appropriate box checked None
Use the following guidelines when evaluating responses to Self-Employed Health Insurance Deduction:
Carefully examine all documentation to determine if all or some of the amounts were paid for qualifying insurance. If the taxpayer was eligible to participate in any subsidized health plan maintained by any employer of the taxpayer or of the spouse of, or any dependent, or individual described in subparagraph (D) of paragraph (1) of section 162(1) with respect to, the taxpayer he/she cannot deduct premiums for any month in which he/she was eligible.
Determine if the taxpayer had sufficient earned income for the claimed self-employed health insurance deduction. (Note: The deduction is limited to the profit from the business.) Review Form 1099-MISC or other documentation to ensure the taxpayer was self-employed. If the income is unreported, include the additional income in the report and compute self-employment tax, if appropriate.
If the taxpayer indicates income is from an S Corporation, review Schedule K-1, Partner's Share of Income, Deductions, Credits, etc. and/or other documentation (i.e., Form W-2) to establish if the income and/or wages received and reported were from an S Corporation in which the taxpayer was more than a two percent shareholder.
If IDRS information is used to link a taxpayer to a corporation, examiners may use judgment in accepting the taxpayer's statement as verification that he/she has more than two percent ownership. (The basis for the examiner's judgement must be fully documented on the workpapers.)
Ensure the taxpayer has reduced earned income by any deduction claimed for one-half of Self-Employment Tax and a deduction claimed for Self-Employed SEP, SIMPLE, and Qualified Plans (when applying lesser of earned income reduced by these deductions and amount paid).
If the taxpayer does not have a Form W-2 from a Subchapter S Corporation, a quick way to determine if the taxpayer is self-employed may be to review the taxpayer's Schedule SE, Self-Employment Tax. The amount of income on which he paid Self-employment tax can be used as the amount of income from net self-employment income.
Responses involving the concept of material participation generally relate to the allowance of a loss rather than income and are unlikely to be applicable here.
Since our taxpayers are "cash basis" taxpayers, all deductible expenses must be incurred by them in the current year. Income must be distributed to them and/or reported by them when earned.
If the taxpayer filed a joint return, conduct research to determine if both spouses received earned income during the year in question. If both spouses received earned income, request a statement from the taxpayers' employers. The statement(s) must indicate:
If the spouses were eligible to participate in the companies' subsidized health plan(s), and
The number of months (if any) that the spouses were eligible to participate in the plan.
Potential Documentation
Request a copy of the health insurance policy indicating the payment was made for qualifying individuals, i.e., the taxpayer, spouse, or dependents.
If the insurance premiums were paid by the corporation, verify premiums were included in the taxpayer's wages from the corporation (most generally will appear on Form W-2).
If premiums were paid by the taxpayer, request cancelled checks, receipts, payroll deductions, etc., to support the deduction.
The Schedule K-1, Partner's Share of Income, Deductions, Credits, etc. and/or IDRS cc BMFOL or cc BMFOLT for the S Corporation may be used to establish the taxpayer is linked to that corporation. Copies of the articles of incorporation, stock certificates or similar documentation may be used to establish whether the taxpayer is a more-than-two percent-shareholder. If the taxpayer indicates he/she qualifies by reason of attribution rules, ask the taxpayer about his/her relationship to the shareholder. A taxpayer's statement may be sufficient to establish this fact if other issues have been satisfactorily resolved. Workpapers must be documented to support the examiner's determination.
If the taxpayer is claiming payments for long-term care insurance, request birth certificates if the taxpayer's age cannot be determined from IDRS. See Publication 535, Business Expenses, to determine the aged-based limitations.
If the taxpayer paid the expenses to the insurance company, cancelled checks, documentation to show payroll deduction, etc., should be adequate to support the deduction.
Resources To Assist In Technical Determination
Useful tools:
Pub 502 , Medical and Dental Expenses, Including the Health Coverage Tax Credit.
Pub 535 , Business Expenses.
IRC 162(l), IRC 1372, IRC 401, IRC 38B and IRC 318.
If payment is for long-term care insurance, see limitations in Chapter 7 of Publication 535.
Instructions for Form 1040, U.S. Individual Income Tax Return – includes a Self-employed Health Insurance Deduction Worksheet which the taxpayer should complete to determine if there is limit to the deduction amount.
Use procedures in the following table when processing replies.
Processing Taxpayer Replies to Letter 566-S/ Letter 566-T for TDC cases and Subsequent Letters
The taxpayer replies to Letter 566-S/Letter 566-T for TDC cases,, Letter 525/Letter 525-T for TDC cases, Letter 692-M/Letter 692-T for TDC cases, or the Statutory Notice of Deficiency (SNOD) information to support the deduction You are able to determine that the taxpayer is entitled to the entire deduction Close the case "no change" .
The taxpayer replies to Letter 566-S/Letter 566-T for TDC cases, or Letter 525/Letter 525-T for TDC cases, with information to support the deduction You are able to verify that the taxpayer is entitled to part of the deduction claimed Issue Letter 525/Letter 525-T for TDC cases, or Letter 692-M/Letter 692-T for TDC cases, with Form 4549 and an appropriate explanation.
The taxpayer replies to Letter 566-S/566-T for TDC cases or Letter 525/Letter 525-T for TDC cases, with information to support the deduction You are able to determine that the taxpayer is not entitled to any part of the deduction Issue Letter 525/Letter 525-T for TDC cases, or Letter 692-M/Letter 692-T for TDC cases with Form 4549 and an appropriate explanation.
The taxpayer replies to Letter 566-S/566-T for TDC cases, Letter 525/Letter 525-T for TDC cases or Letter 692-M/Letter 692-T for TDC cases with information to support deduction You are able to determine that the amount belongs on another line on the tax return Issue Letter 525/Letter 525-T for TDC cases with Form 4549 and an appropriate explanation.
The taxpayer replies to Letter 566-S/566-T for TDC cases, Letter 525 /Letter 525-T for TDC cases, or Letter 692-M/Letter 692-T for TDC cases with information Time frame has expired, and information indicates that taxpayer is not entitled or not eligible
Prepare Form 886-A addressing correspondence received and explain disallowance.
The taxpayer replies to the SNOD with information to support deduction You are able to verify that the taxpayer is entitled to part of the deduction claimed Issue Letter 555 with a revised Form 4549 and an appropriate explanation to the taxpayer.
The taxpayer replies to the SNOD with verification of his deduction You are able to determine that the taxpayer is not entitled to any part of the deduction Issue Letter 555 with the latest Form 4549 and an appropriate explanation to the taxpayer.
The taxpayer replies to the SNOD with verification of his deduction You are able to determine the deduction amount belongs on another line Issue Letter 555 with a revised Form 4549 and an appropriate explanation to the taxpayer. Do not increase the deficiency as shown on the SNOD.
Form 1040, Schedule C - Correspondence Examination
The Form 1040, Schedule C, Profit or Loss From Business (Sole Proprietorship), is used to report the profit or loss for a business operating as a sole proprietorship. The nature of the business can be a manufacturer of a product/goods, retail and wholesale sales, or provider of a service. A taxpayer can be involved in more than one business venture. A separate Schedule C is required for each type of business.
Each type of business has certain characteristics. For example, a manufacturing activity will have costs for materials and labor included in the costs of goods sold. On the other hand, a sales-oriented activity will normally only include the cost of items for resale in their cost of goods; the labor for sales would be included in the wages as an expense of sales. Finally, a service-oriented activity will normally have no cost of goods, unless materials and supplies are sold or charged in the business.
Because the taxpayers are not accountable to anyone as sole proprietors there are opportunities for them to mix personal and business interests in the pursuit of their trade or business. It is incumbent on the examiner to recognize those instances where personal expenditures are being deducted as business expenses and to make the proper adjustments to the taxpayer's return.
If the verified expenses are determined to be personal expenses and are deductible on the Schedule A, the examiner should make the proper adjustments to the taxpayer's return.
To be deductible as a business expense, the expenditure must be reasonable, ordinary and necessary during the course of the business, and be related to the business. The objective of any correspondence examination related to a sole proprietorship is to verify the amount of the expenditures, determine if they qualify as business expenses, and that they were properly treated on the return. Correspondence examinations are limited in scope to certain line items to determine their deductibility as business expenses.
Business expenses are the costs of carrying on a trade or business, and they are usually deductible if the business is operated to make a profit. In determining whether a taxpayer is carrying on an activity for profit, nine factors are considered. No one factor alone is decisive. The issue of whether the taxpayer is carrying on an activity for profit isn't conducive to Correspondence Examination and should not be used to disallow the taxpayer's Schedule C expenses.
Schedule C-4, General Questionnaire, is sent with Letter 566-S/566-T for TDC cases, Initial Contact Letter, when Schedule C Expenses are being examined to determine the type of business involved, location, records available, ownership and how the business expenses are paid.
When the taxpayer is being examined for the income reported on Schedule C, Form 11652, Questionnaire- Form 1040 Schedule C (Profit or Loss From Business), will be sent as an enclosure with the Letter 566S/Letter 566-T for TDC cases, Initial Contact Letter. See IRM 4.19.14.6.3, EITC Schedule C Responses, for guidelines that apply to Schedule C responses for, Project Code 0288.
Sharing Economy Tax Center
An emerging area of activity in the past few years, the sharing economy, has changed how people commute, travel, rent vacation accommodations and perform many other activities. Also referred to as the on-demand, gig or access economy, the sharing economy allows individuals and groups to utilize technology advancements to arrange transactions to generate revenue from assets they possess - (such as cars and homes) - or services they provide - (such as household chores or technology services). Although this is a developing area of the economy, there are tax implications for the companies that provide the services and the individuals who perform the services. Refer to Sharing Economy Tax Center on irs.gov for guidance on tax issues that may apply to those participating in the sharing economy.
Schedule C - Car and Truck Expenses
For a sole proprietorship, the car and truck expenses must be ordinary and necessary, and paid or incurred in the carrying on of a trade or business. A taxpayer may use the standard mileage rate or actual expenses for car and truck expenses, but not both. When using the standard mileage rate, the taxpayer must show by diary, log or other means how many business miles and total miles were driven in a tax year. If the taxpayer is claiming actual expenses, records must be maintained to establish all the costs associated with the operation and maintenance of the vehicles as well as documentation to support the computation of the business use percentage. In addition, if the business use percentage is not greater than 50 percent there may be limitations imposed on certain expenses. Special rules apply for leased vehicles. Examiners must comment on personal usage of the vehicles in the workpapers. See Pub 463, Travel, Gift, and Car Expenses.
Form 886-A Schedule C-5, Car and Truck Expenses, which includes the Schedule C-5 Car and Truck Expenses questionnaire, is sent with Letter 566-S/566-T to request substantiation documentation for car and truck expenses claimed on Schedule C.
Schedule C - Travel Expenses
For a sole proprietorship, the travel expenses must be ordinary and necessary expenses of traveling away from home in the pursuit of a trade or business. In addition, there are specific record keeping requirements for travel, expenses (IRC 274(d)). For all travel expenses, taxpayer must provide information to support the location, dates, business purpose, and who they met with along with the required receipts for the deductions claimed. See Pub 463, Travel Gift and Car Expenses.
It is imperative that the examiner establish the taxpayer's "tax home" in order to accurately determine the eligibility of the amounts deducted as "away from home" expenses. See Chapter 1 of Pub 463, Travel, Gift, and Car Expenses. The examiner must also determine whether the nature of the travel is temporary (generally, lasting less than one year) or indefinite. If it is determined that a trip qualifies as business travel, all the associated costs (airfare, rail fare, bus fare, lodging, meals, taxis, etc.) are also deductible. However, if the taxpayer is accompanied by a spouse, other family member or relative, the expenses for that person are considered nondeductible personal expenses unless he/she is performing bona fide business services.
Special allocations are required if a taxpayer is mixing personal and business activities on any given trip. For tax years prior to 2018, Form 886-A Schedule C-7, Travel, Meals and Entertainment Expenses, including on page 2a, Schedule C, Travel, Meals and Entertainment Expense Questionnaire, will be sent to request substantiation documentation for travel, meals and entertainment expenses claimed on Schedule C.
Schedule C - Meals and Entertainment Expenses for TY 2018-2025
For expenses paid or incurred after December 2017, the tax law has changed due to the Tax Cuts and Jobs Act (TCJA) of 2017. Traditionally, meals and entertainment expenses have followed the same set of rules. For expenses after December 31, 2017, meals are now treated differently from entertainment expenses. For TY 2018-2025, Form 15500, Substantiation Documentation Needed from Taxpayer for Travel and Meal Expenses Claimed on Schedule C, will be sent to request substantiation documentation for travel and meal expenses claimed on Schedule C, and will include on page 2a, Travel and meal Expenses Questionnaire.
TCJA removed substantiation requirements of IRC 274(d) for entertainment and meal expenses (paid or incurred after December 31, 2017), unless the meals are purchased separately from the entertainment or the cost of the meal is stated separately from the cost of the entertainment on the bill, invoice, or receipt. See Reg. section 1.274-11(b)(1)(ii). However, business travel meals are still subject to the IRC 274(d) substantiation requirements. See IRC 274(d)(1)
Entertainment includes any activity considered to provide entertainment, amusement, or recreation. Generally, entertainment expenses are non-deductible for expenses paid after December 31, 2017. Facilities used in connection with entertainment and related membership dues (such as country club dues) are also non-deductible. Meal expenses are limited to 50 percent unless an exception applies. (See Pub 463, Travel Gifts and Car Expenses, for a list of exceptions.)
Amounts paid or incurred in tax years 2021 and 2022, for food and beverages provided by a restaurant are 100% deductible. See IRC Section 274(n)(2)(D)and Notice 2021-25
If food or beverages are provided during or at an entertainment event, and the food and beverages were purchased separately from the entertainment or the cost of the food and beverages was stated separately from the cost of the entertainment on one or more bills, invoices, or receipts, a taxpayer may be able to deduct the separately stated costs as a business meal expense. For more information, see IRC Section 1.274-11, -12.
Examples for TY 2018-2025: For each example, assume that the food and beverage expenses are ordinary and necessary expenses under IRC 162(a) paid or incurred during the taxable year in carrying on a trade or business and are not lavish or extravagant under the circumstances. Also assume that the taxpayer and the business contact are not engaged in a trade or business that has any relation to the entertainment activity.
1. (i) Taxpayer A invites B, a business contact, to a baseball game. A purchases tickets for A and B to attend the game. While at the game, A buys hot dogs and drinks for A and B. (ii) The baseball game is entertainment as defined in IRC 1.274-2(b)(1)(i) and, thus, the cost of the game tickets is an entertainment expense and is not deductible by A. The cost of the hot dogs and drinks, which are purchased separately from the game tickets, is not an entertainment expense and is not subject to the IRC 274(a)(1) disallowance. Therefore, A may deduct 50 percent of the expenses (100 percent for tax years 2021 and 2022) associated with the hot dogs and drinks purchased at the game.
2. (i) Taxpayer C invites D, a business contact, to a basketball game. C purchases tickets for C and D to attend the game in a suite, where they have access to food and beverages. The cost of the basketball game tickets, as stated on the invoice, includes the food and beverages. (ii) The basketball game is entertainment as defined in IRC 1.274-2(b)(1)(i) and, thus, the cost of the game tickets is an entertainment expense and is not deductible by C. The cost of the food and beverages, which are not purchased separately from the game tickets, is not stated separately on the invoice. Thus, the cost of the food and beverages also is an entertainment expense that is subject to the IRC 274(a)(1) disallowance. Therefore, C cannot deduct any of the expenses associated with the basketball game.
Schedule C - Mortgage Interest
Mortgage interest deducted on a Schedule C should be directly related to a business asset. If the taxpayer is using a structure for both business and personal activities, an allocation must be computed to properly reflect the amount attributable to the business. If an adjustment is made to remove a portion of the mortgage interest because it is deemed to be a personal expense, the examiner must consider whether it may still be deductible as an itemized deduction on the Schedule A.
Form 886-A Schedule C-3, Interest, will be sent to request substantiation documentation for interest expenses claimed on Schedule C.
Schedule C - Legal and Professional Fees
Amounts paid to attorneys, accountants, appraisers, engineers, etc., for services related to the operation of a business are deductible as business expenses. Amounts paid for wills, estates, divorce and tax preparation fees (except for business returns such as Forms 941 and 940) are personal expenses and should not be deducted as a business expense (however, if they qualify as a personal expense the proper adjustment must be considered). The costs of defending an action in criminal court are not deductible as a business expense unless the charges are attributable to the taxpayer's trade or business, see Pub 529 Miscellaneous Deductions. Expenses incurred before the business commences are considered start-up or getting ready expenses and are not currently deductible (these expenses may be capitalized and amortized if the taxpayer makes a proper election). Illegal payments (bribes, kickbacks, etc.) are not deductible as business expenses. Expenses related to the acquisition of real estate or a capital asset should be added to the basis of that asset and depreciated. Legal or professional fees incurred in the process of acquiring, creating, or enhancing intangible property should be capitalized and amortized. Fees incurred in defending or perfecting title to real property, tangible personal property, and intangible property, such as a patent should be capitalized and depreciated or amortized. The examiner should seek technical assistance if the issue of capitalization and depreciation is being considered.
Form 886-A Schedule C-2, Legal and Professional Fees, will be sent to request substantiation documentation for legal and professional fees claimed on Schedule C.
Schedule C - Repairs and Maintenance
Expenses incurred to repair or maintain equipment and property used in carrying on a trade or business are generally deductible as business expenses. However, if the taxpayer pays or incurs amounts for the improvement of tangible real or personal property, these costs are generally treated as capital expenditures and depreciated over the appropriate recovery period. Amounts are treated as improvements if they are for betterments to tangible property, for replacements of tangible property, or for adapting tangible property to a new or different use. If the taxpayer determines the expenditures are for an improvement, then the taxpayer may still be entitled to a deduction if these expenditures are for the recurring activities that the taxpayer expects to perform to keep the property in an ordinarily efficient operating condition. For example, deductible repairs may include repainting exteriors and interiors of business buildings, repairing broken windowpanes, replacing worn-out minor parts, sealing cracks and leaks, and changing oil or other fluids to maintain business equipment.
See Treas. Reg. 1.263(a)-3, for additional information on the definition of improvement and exceptions to the improvement rules. Examiners should review receipts and invoices to identify the property that was repaired or improved and to determine the nature of the work done on the property. Examiners should further consider whether these expenditures were for improvements or other capital expenditures. Examiners should seek technical assistance if they are considering an adjustment to capitalize and depreciate any given repair or maintenance expense.
Form 886-A - Schedule C - , Repairs and Maintenance, and Schedule C - Repairs and Maintenance Questionnaire, will be sent with Letter 566-S/566-T to request substantiation documentation for repairs and maintenance expenses claimed on Schedule C.
Excess Business Losses for TY 2018 - TY 2025
The Tax Cuts and Jobs Act of 2017 limited the amount of losses from the trades or businesses of non-corporate taxpayers that can be claimed each year. For tax years 2018-2026, taxpayers cannot deduct an excess business loss in the current year. However, the excess business loss is treated as a net operating loss (NOL) carryover. Form 461, Limitation on Business Loss, is used by non-corporate taxpayers whose net losses from all of their trades or businesses are more than $250,000 ($500,000 for married taxpayers filing a joint return.) See Form 461 for instructions and details.
The limitation established by the Tax Cuts and Jobs Act of 2017 was extended through TY 2026 by The American Rescue Plan Act of 2021.
Schedule C Referrals from the Social Security Administration
When the Social Security Administration (SSA) determines during an investigation that a taxpayer's self-employment earnings have been omitted or incorrectly reported on Form 1040, the IRS is notified via a Self-Employment Determination Posting Record (SE-DPR).
These referrals are worked in Project Code (PC) 1502 and include cases that contain questionable Schedule C income and refundable credits. There are three potential issues:
Dependents.
All credits will be worked as statutory issues and adjusted based on changes to the three classified issues.
Since the focus of a PC 1502 examination is to determine if the taxpayer had self-employment income, Schedule C net profit is questioned. Form 11652, Questionnaire - Form 1040 Schedule C, is sent with the Initial Contact Letter.
The Earned Income Tax Credit (EITC) is a statutory change only. Based on the facts of the case, consider if a two-year ban is applicable. See IRM 4.19.14.7.1, 2/10 Year Ban - Correspondence Guidelines for Examination Technicians (CET).
If SSA Form 795, Statement of Claimant or Other Person, SSA Form 7008, Request for Correction of Earnings Record, or similar statement is received from the taxpayer/rep, contact your Campus Fraud Coordinator (CFC) for guidance on a referral to fraud. See IRM 4.19.10.4, Fraud Referrals.
Subsequent year pick up returns are opened with Tracking Code (TC) 0900. Research the prior and subsequent year patterns and if the same issues are present or a pattern of abuse is noted, strongly consider imposing a 2-year ban or make a referral to your CFC.
Project Code 0288, Questionable Schedule C with EITC
The focus of PC 0288, Questionable Schedule C with EITC, is to determine if the taxpayer had self-employment income. These are single issue cases where only Schedule C net profit is questioned.
When the taxpayer is being examined for the income reported on Schedule C, Form 11652, Questionnaire - Form 1040 Schedule C (Profit or Loss From Business), will be sent as an enclosure with the Letter 566-S/Letter 566-T for TDC cases, Initial Contact Letter.
See IRM 4.19.14.6.3, EITC Schedule C Responses, for guidelines that apply to Schedule C responses for PC 0288.
EITC is a statutory change only for cases in PC 0288. The taxpayer must have earned income to claim EITC. If the decision is made to remove the self-employment income, applying the 2-year EITC ban needs to be considered based on the facts of the case. Follow the guidance in IRM 4.19.14.7.1, 2/10-year ban - Correspondence Guidelines for Examination Technicians. Managerial approval is required for all 2/10-year ban cases.
If the PC 0288 case has an AIMS Tracking Code 0649. a 2-year ban was applied at case selection because it is the third year the case has been selected and the taxpayer has claimed EITC after it was disallowed in two prior years. If the taxpayer responds, make the determination to leave the ban or remove the ban with managerial approval.
Return Preparer Analysis Tool (RPAT) Program
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AIMS Openings:
Project Code (SPC) 0258, Source Code 49 will be used when opening the inventory. The inventory will be opened by SB/SE team.
AIMS Tracking Code, when applicable.
Procedures for processing the inventory. Correspondence Exam will:
Classify the returns based on the pre-identified issues.
If overview or audit issues are identified in the inventories, limit the scope of the audit to those issues. However, if other issues/credits or Schedules appear egregious and the issue requires examination, scope can be expanded with concurrence from manager/lead/Classification TCO.
Inform HQ analyst of any trends, patterns of false documents. Do not submit fraud referrals unless coordinated with HQ analysts.
Do not routinely disallow the entire Schedule A in its entirety, unless a pattern of abuse is noted. See IRM 4.19.15.25.5., Examining the Schedule A on Preparer Referrals, for further discussion.
Issue Initial Contact Letter 566-S /Letter 566-T for TDC cases, 30 day and 90 day letters per normal procedures.
Document the workpapers, with any statements provided/made by the taxpayer.
Follow examination and closing procedures as provided under PC 0133 Program. See IRM 4.19.15.25, Return Preparer Referrals, IRM 4.19.15.20, Schedule A, IRM 20.1, Penalty Handbook, IRM 4.19.13.26 Campus Exam Identity Theft, IRM 4.19.15.3, Education Tax Credits, General Requirements and Exam Programs, and other sections as applicable.
SB/SE HQ analyst may forward the audit results on the egregious preparers to CI HQ quarterly on Form 13649, Multi-Case Inventory Referral (formerly Referral for SB/SE Campus Correspondence Examination), for preparer penalty considerations or to LDC on a secured E-mail.
Programming has been established through DDb to identify each scheme and related taxpayers so that the examination results can be queried at the HQ level by the Scheme Identification Numbers and Project Codes.
CI Education Credit Program
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Project Code (PC) 0385, Source Code 70 will be used when opening the inventory and the inventory will be opened by the WDD team.
AIMS Tracking Code, if applicable.
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Procedures for processing the inventory:
Issue audit letters as specified under PC 0133 Program. See IRM 4.19.15.25, Return Preparer Referrals.
Follow examination and closing procedures as provided under PC 0133 Program. See IRM 4.19.15.25, Return Preparer Referrals.
IRM 4.19.15.20, Schedule A . IRM 4.19.15.3, Education Tax Credits - General Requirements and Exam Programs, IRM 20.1, Penalty Handbook, IRM 4.19.13.26 Campus Exam Identity Theft, and other IRM sections as applicable.
Effective for tax years after 2015, if the taxpayer's claim for AOTC is due to reckless or intentional disregard of rules and regulations, a 2-year ban may apply. If the claim is fraudulent, a 10-year ban may apply. The 2 and 10-year bans do not apply to the Lifetime Learning Credit or the tuition and fees deduction. See IRC section 25A(i)(7), and IRM 4.19.14.7.1, 2/10 Year Ban -= Correspondence Guidelines for Examination Technicians.
Child Tax Credit (CTC), Additional Child Tax Credit (ACTC), Refundable Child Tax Credit, and Credit for Other Dependents (ODC)
For specific eligibility requirements, see IRM 4.19.14.12.1, Child Tax Credit.
Information for Individual Taxpayer Identification Number (ITIN) has been moved to IRM 4.19.14.12.1.7, What is an ITIN?, and IRM 4.19.14.12.1.8, ITIN and ATIN issuance Date.
Programs and Initial Contacts
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Additional issues can include the ODC, Earned Income Tax Credit (EITC), American Opportunity Tax Credit (AOTC), Head of Household (HOH) filing status or other related issues. The Project Codes (PCs) are:
SB/SE Project Codes
Project Code Title
Project Code Descriptions
0555 Child Tax Credit, Qualifying Child SSN Citizenship Code <> (not) A or B Taxpayers claimed Child Tax Credit (CTC) for a qualifying child (QC) with a citizenship code that was not an A or B. Citizenship Codes identify the child's citizenship and are located on IDRS CC DDBKD. Values are:
A. - U.S. Citizen
B - Alien allowed to work
C - Alien not allowed to work
D - Other Alien
E - Alien student
F - Conditionally legalized alien, status not known.
Issue Letter 566-S or Letter 566-T (for TDC cases) along with Form 14815 Supporting Documents to Prove the Child Tax Credit and Credit for Other Dependents for 2018-2020/Form 14815-A Supporting Documents to Prove the Child Tax Credit and Credit for Other Dependents for 2021.
0056 Credit for Other Dependents (ODC) Taxpayers who claimed the Credit for Other Dependents (ODC) for three or more qualifying dependents (QD). ODC QD is an ITIN, filed a return, and/or is a DUPTIN. Issue Letter 566-S or Letter 566-T (for TDC cases) along with Form 14815 Supporting Documents to Prove the Child Tax Credit and Credit for Other Dependents for 2018-2020/Form 14815-A Supporting Documents to Prove the Child Tax Credit and Credit for Other Dependents for 2021.
W&I Project Codes
1179 Additional Child Tax Credit (ACTC)
Original returns or claims for refund (Forms 1040-X) claiming Additional Child Tax Credit (ACTC).
Taxpayers claimed the credit for individuals who may not be the taxpayer's dependents, may not meet the U.S. citizen or resident requirement, or (for CTC/ACTC after 2017) don't have the required SSN (valid for employment), or citizenship code is not A or B.
The return can have other related issues.
Letter 566-S will be issued via the filer bridge, and claims will be initiated using the Letter 566-D, along with Form 14815, Supporting Documents to Prove the Child tax Credit (CTC) and Credit for Other Dependents (ODC) for 2018-2020/Form 14815-A, Supporting Documents to Prove the Child Tax Credit (CTC) and Credit for Other Dependents (ODC) for 2021
For tax years prior to 2018, Form 14800, Child Tax Credit and Additional Child Tax Credit - Explanation of Items, is sent with the ICL. Send Form 886-H-DEP when Form 14800 is used.
1334 Refundable Child Tax Credit Original returns or claims for refund (Forms 1040-X) for tax year 2021 claiming questionable Refundable CTC for individuals who:
may not be the taxpayer's dependents,
may not meet the US citizen or resident requirement or don't have the required SSN (valid for employment) or
citizenship code is not A or B,
or the taxpayer's principal place of abode may not have been in the U.S. for more than half the year.
Letter 566-S will be issued via the filer bridge, and claims will be initiated using the Letter 566-D, along with Form 14815-A, Supporting Documents to Prove the Child Tax Credit (CTC) and Credit for Other Dependents (ODC) for 2021
Do not use Form 886-H-DEP when Form 14815-A is used.
1335 Refundable Child Tax Credit Recertification Tax year 2021 original returns or claims for refund (Forms 1040-X) claiming refundable Child Tax Credit when subject to ACTC recertification. The credit may have been claimed for individuals who:
may not meet the U.S. citizen or resident requirement or
don't have the required SSN (valid for employment), or
for taxpayers whose principal place of abode may not have been in the U.S. for more than half the year.
Letter 566-S will be issued via the filer bridge, and claims will be initiated using the 566-D, along with Form 14815-A, Supporting Documents to Prove the Child Tax Credit (CTC) and Credit for Other Dependents (ODC) for 2021
1516 Additional Child Tax Credit Recertification (Non-ITIN)
Original returns or claims for refund (Forms 1040-X) claiming Additional Child Tax Credit (ACTC) when subject to ACTC recertification.
For 2018-2020 returns, Form 14815, Supporting Documents to Prove the Child Tax Credit (CTC) and Credit for Other Dependents (ODC) for 2018-2020, is sent with the ICL. For 2021 returns, Form 14815-A, Supporting Documents to Prove the Child Tax Credit (CTC) and Credit for Other Dependents (ODC) for 2021, is sent with the ICL.
Do not send Form 886-H-DEP when Form 14815 or Form 14815-A is used.
In general, issues are systemically identified and initial contact letters are automated. For manual initiations, after completing research to determine the issues for examination, initiate cases with Letter 566-S/566-T for TDC cases, Initial contact Letter. Use the check boxes to identify the issues in question. If other issues not shown on Form 14815 /Form 14815-A are selected for examination, use additional forms to request needed documentation. Follow the procedures in IRM 4.19.13 , General Case Development and Resolution, and IRM 4.19.14.12.1 , Child Tax Credits.s.
Individual Taxpayer Identification Number (ITIN) ACTC
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Additional issues can include the AOTC, HOH filing status, Child and Dependent Care Credit (CDCC), Federal Income Tax Withholding (FITW), and EITC and ACTC claimed for dependents with SSNs or other related issues. The Project Codes (PCs) are:
0900 ITIN ACTC and other issues
1518 ITIN ACTC recertification and other issues
1175 ITIN ACTC preparer/promoter scheme
In general, issues are systemically identified and initial contact letters are automated. For manual initiations, after completing research to determine the issues for examination, initiate PC 0900 and 1518 cases with Letter 566-S/566-T for TDC cases, Initial Contact Letter, and initiate PC 1175 cases with Letter 566-B/ Letter 566-J for TDC cases, ICL 30-Day Combo. Use the check boxes to identify the issues in question. Include Form 886-H-ITIN, Dependent-Related Tax Benefits and Credits - Explanation of Items, when requesting documentation for the selected issued. Form 886-H-ITIN (SP) is available in Spanish. If other issues not shown on Form 886-H-ITIN are identified for examination, use additional forms to request needed documentation. PCs 0900 and 1518 can also be used with claims for refund. Follow procedures in IRM 4.19.13, General Case Development and Resolution, IRM 4.19.14.12.1, Child Tax Credits, and the ITIN-specific guidance in IRM 4.19.15.35.1.3.1, ITIN ACTC - Acceptable Documentation.
ITIN ACTC - Acceptable Documentation
The table below states, in general, what documentation may verify specific requirements for ITIN ACTC cases for tax years prior to 2018. For Additional information regarding acceptable documentation, refer to:
IRM 4.19.14.6.4 , EITC - Filing Status
IRM 4.19.14.6.5 , EITC - Personal Exemptions and Dependents
IRM 4.19.14.12 , Other Credits
IRM 4.19.15.3 , Education Tax Benefits - General Requirements and Exam Programs
Child Tax Credit and Additional Child Tax Credit (tax years prior to 2018) The qualifying child must be a United States (US) citizen, US national or US resident alien. See IRM 4.19.14.12.1.6, US Resident Alien, and IRM 4.19.14.12.1.11, Requirements for CTC/ACTC for Tax Years Prior to 2018.