NEW YORK (MainStreet) — With the Internal Revenue Service digging behind seat cushions looking for extra cash, it’s no surprise it’s getting more aggressive about taxpayers who pay a lot of mortgage interest but don’t declare a lot of income.
Goodness knows, the federal government needs the money. At a time when the federal deficit stood at $1.4 trillion, federal tax revenues fell off a cliff not too long ago. According to a study by the American Institute for Economic Research, federal tax monies declined by $138 billion from April 2008 through April 2009. That’s a 34 percent drop in tax revenues, the AIER reports.
That’s the biggest reason why the IRS is taking a keener interest in your mortgage interest — it might lead them to a nice tax payday unless you’re careful.
Here’s what the IRS is looking for, and what you can do about it:
If you’re a homeowner, every tax season the IRS gets a copy of your mortgage interest statement, also known as IRS form 1098 (your lender sends a copy to you and to the IRS). Form 1098 shows the exact amount of interest you paid on your monthly mortgage for the previous tax year.
The number on that tax form is a significant clue to the IRS. Agency computers can “match” the interest deduction that your lender provides with the number on your tax form, using your Social Security number.
By comparing your tax returns with the data your mortgage lender provides, the IRS has had some good luck digging up some loose cash — all at taxpayer expense. According to the U.S. Treasury Inspector General for Taxpayer Administration, the IRS tracked down 227,000 tax returns looking for answers on mortgage deduction discrepancies in 2004 and 2005.
That led to 70,000 refiled tax returns, and $276 million in back taxes on newly calculated mortgage interest deductions. How did TIGTA do the math? According to its Web site, TIGTA sampled 1098 tax forms from 2005 that showed mortgage interest of more than $20,000 and attempted to match it to corresponding tax returns. The research found that the unpaid tax amount based on misreported mortgage deductions ranged between $352 million and $900 million – not exactly chump change to Uncle Sam, who obviously needs the money these days.
Plus, it’s not just the federal government. Some states, such as California, have created campaigns targeting taxpayers who might be abusing the mortgage interest deduction rules.
According to the California Franchise Tax Board, the state collected $40 million in a pilot program in 2007. (Read the full TIGTA report.)
What can you do if you’re targeted?
If you do get an IRS notice asking you to clear up a mortgage interest deduction issue, make sure you respond right away. Include any appropriate mortgage statements, canceled checks or copies of correspondence from any family members, businesses or friends who either gave you or loaned you money to pay your mortgage. You’ll need to include copies of your tax returns for the year in question.
Also, know what the IRS is really looking for in a mortgage interest matter – the source of the funds used to pay your mortgage interest.
Obviously, it helps to be more thorough in filing the appropriate mortgage interest number when you file your tax returns. And make sure to file tax returns every year — the IRS can audit you for the rest of your days if you don’t file. Eliminate that potential horror show by filing your taxes for any years you’ve missed, thus getting the IRS off your back in the process.
Maybe the biggest takeaway is knowing that, if you fudged your mortgage interest deduction on your taxes, the IRS may already be on to you. In an economic climate where tax money is short, don’t be surprised when the IRS gets more aggressive about examining your mortgage interest.