Claims for Refunds:
An amended tax return seeking a refund claim must be filed within the statute of limitations, that is within three years from the date of the timely filed original tax return or within two years from the date the person pays the tax, whichever is later. For taxpayers who filed their original return early, their return is considered filed on the due date. Common reasons to file an amended return seeking money back would include corrections to deductions related to personal, business and rental activities listed on schedules A, C or E. Taxpayers who neglected to take a deduction related to mortgage interest, business travel or rental depreciation, can correct the filing via Form 1040X. Amendments for tax credits are even more valuable as they reduce tax dollar for dollar, for example education credits. These types of amendments are favorable because they reduce tax and, if approved by the IRS, act to put money back with the taxpayer.
The most common favorable tax amendment I see is correcting depreciation on rental property. Given the complexity, taxpayers who self-prepare their returns online, don’t seem to calculate this deduction correctly or neglect to take the write off altogether. It is important to take the depreciation deduction because it is a non-cash write-off that will reduce net income without impacted cashflow. When the property is sold, depreciation is required to be recaptured as income, so if not claimed now it will be taxable regardless on sale. Calculate depreciation by taking your cost basis of the building (not including land) and dividing by 27.5 for residential rental property. To perform this calculation, you need to allocate value between building and non-depreciable land, which may be included in the property tax records.
Another frequent amendment involves changing the filing status to joint for married couples that have filed separate tax returns. This works well to reduce tax where one spouse has little or no income or has not filed altogether. I see this in my practice a lot when U.S. taxpayers marry non-citizen spouses, who may not yet have a tax identification number or have foreign income earned before the marriage. Changing the filing status to married filing jointly allows for income to be taxed over favorable combined tax rates, which leads to significant money back to the taxpayer.
Balance due 1040X:
Unfavorable tax amendments result in balances due to the IRS and usually involve correcting an egregious mistake that will likely be flagged for audit. These mistakes can be made in good faith by the taxpayer or are purposefully made by unscrupulous paid tax preparers looking to inflate tax refunds. In either case, the 1040X should be filed as soon as the error is discovered and before it is uncovered by the IRS, which may lead to more harsher consequences. Another common error I see involves the failure to include income, particularly when third parties are late in reporting income information to the IRS and the taxpayer, for example income reported on IRS Form 1099 or K-1. Generally, the statute of limitations for audits is 3 years from date of filing, however extends to 6 years if gross income is understated by 25% or more.
With balance due returns, it is recommended to pay the taxes owed as soon as possible as penalties and interest will continue to accrue. Penalties may be assessed for underpayment of taxes, negligence and fraud and are likely to go easier if you amend voluntarily versus being assessed on audit. Another advantage to filing an amendment now is that audits tend to be more expensive as they can encompass multiple years and there is no indication that amending triggers an audit. Audits originating from state taxing authorities can lead to the need to file an amended return for federal as states often share information with the IRS and vice versa.