4.19.15  Discretionary Programs (Cont. 1) 
Unallowable Code (UA) Program 
Transcripts  (06-24-2014)
Resolving the -Q Freeze

  1. The -Q freeze is set by a computer generated transaction code, TC 576. The TC 576 freezes an amount claimed on a return that appears to be unallowable by tax law.

  2. The amount will remain frozen until the module is examined, surveyed, or it’s manually released through an online adjustment.

  3. To resolve the -Q freeze, the campus will need to research the reason the unallowable was coded and take one of the following actions:

    If And Then
    There is no TC 420 The unallowable was identified correctly in processing Establish AIMS using Source Code 03, Project Code 0000. Make sure that Combat Zone procedures are followed. Refer to IRM, Combat Zone.
    The unallowable was identified incorrectly in processing Release the TC 576 through a manual online adjustment using a Transaction Code 572. This will generate the 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, Closing AIMS.
    There is a TC 420 The examination has not started Follow IRM, Classifying Unallowable, Audit Codes, and Action Coded Returns, to see if it should be examined or surveyed.
    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 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.  (01-01-2010)
Additional Information

  1. Additional Unallowable Program information may be found in the following:

    • ELMS Course 18665-101, Lesson 8, Unallowables.

    • SBSE Annual Campus Exam Operating Guidelines.  (11-29-2011)
Unallowable Program and Alternative Motor Vehicle, Electric Plug In Credit or Electric Drive Motor Vehicle Credit

  1. UA 78 is when a taxpayer claims 5 or more vehicles as personal credits on Form 8834, 8910 and 8936 on their tax return.

  2. UA 79 is when a taxpayer claims the same vehicle more than once on a combination of Forms 8834, 8910, and/or 8936.

  3. These cases open in Source Code 03 and Project Code 0000.

  4. See IRM, Alternative Motor Vehicle Credit, Electric Plug-in Motor Vehicle Credit, or Electric Drive Motor Vehicle Credit, for appropriate 886A paragraphs and substantiation requirements.  (01-01-2014)
Unallowable Program and Recovery Rebate Credit

  1. Unallowable conditions 81 and 82 are based on taxpayers claiming the Rebate Recovery Credit on their 2008 tax return.

  2. Refer to IRM, Unallowables, for the specific unallowable information.

  3. These cases will open in SC 03 PC 0654.

  4. When working replies refer to Rebate Recovery Credit information in the 2008 Publication 17.

  5. The following are paragraphs that may be used on Form 886-A, Explanation of Items:

    UA Code Description
    81 The Recovery Rebate Credit you claimed on your return has been disallowed because the social security number of the primary taxpayer's name and/or the secondary taxpayer’s name is (are) invalid. Please provide a valid SSN or submit a letter from the Social Security Administration with a valid SSN for the primary taxpayer's name and/or the secondary taxpayer's name.
    82 The Recovery Rebate Credit you claimed on your return has been disallowed because the identification number of your dependent(s) is/are invalid. Please provide a valid SSN or letter from the Social Security Administration with a valid SSN for your dependent(s).  (11-29-2011)
Unallowable Program and First Time Homebuyer Credit

  1. Unallowable conditions 83 and 86 are based on taxpayers claiming the First Time Homebuyer’s Credit on their 2009 tax returns.

  2. Unallowable condition 84 is based on TY 2008 return.

  3. Refer to IRM, Unallowables, for the specific unallowable information.

  4. Refer to IRM, First-Time Homebuyer Credit IRC 36, for appropriate 886A paragraphs and substantiation requirements.  (11-29-2011)
Unallowable Program and New Motor Vehicle Excise Tax

  1. 1.Unallowable Code 87 is for taxpayers claiming the Excessive Motor Vehicle Excise Tax on their tax year 2009 or 2010 tax return. These cases are opened on AIMS in Source Code 03 and Project Code 0641.

  2. Taxpayers are allowed additional Standard Deduction by filing a Schedule L or putting the amount paid on line 7 of their Schedule A.

  3. Replies:

    If And Then
    The documentation substantiates the amount of excise tax reported on the Schedule L The Schedule L is filled out and processed correctly No change the case
    The Schedule L was incorrectly filled out when filed and the allowable amount of standard deduction is less than what was allowed in processing, (Example: The Schedule L shows an amount of Excise Tax that is greater than the vehicle purchase price.) Compute the allowable amount of additional standard deduction and revise the report. On the Form 886, explain to the taxpayer that the amount of additional standard deduction was incorrect because the Schedule L was filled out incorrectly.
  4. The following paragraphs can be used on Form 886-A, Explanation of Items:

    To be eligible for the Qualified Motor Vehicle Credit you must provide documentation that qualifies you for this credit. Please provide a copy of the valid sales contract and bill of sale for each vehicle claimed. Provide documentation such as a cancelled check or a receipt showing that the tax was paid and the date it was paid. In addition to sales contract, bill of sale, and proof the tax was paid the following requirements must be met to qualify for the credit:

    1. You must have purchased the qualified motor vehicle after February 16, 2009, and before January 1, 2010. It must be a new vehicle.

    2. The deductible tax is limited to the taxes imposed on the first $49,500 of the purchase price of the vehicle.

    3. Your deduction for the new motor vehicle credit is reduced if your adjusted gross income (AGI) is $125,000 to $134,000 for single, or $250,000 to $259,000 for married filling a joint return.

    4. You cannot deduct new motor vehicle credit if your adjusted gross income (AGI) is $135,000 or more for single, $260,000 or more for married filing a joint return.

    5. If you reside in a state where there is no sales tax, you are entitled to deduct other fees or taxes imposed by the state or local government. The fees or taxes must be assessed on the car’s sales price or as a per unit fee.


      To be entitled to claim the Qualified Motor Vehicle Credit on your 2010 tax return, the Qualifying Vehicle must have been purchased after February 16, 2009 and before January 1, 2010 and the taxes must have been paid after December 31, 2009.  (01-01-2014)
Form 4136, Credit for Federal Tax Paid on Fuels

  1. Individual returns claiming Fuel Tax Credits on Form 4136, Credit for Federal Tax Paid on Fuels, above a designated tolerance will be screened in the Rejects Unit, Submission Processing, for selection under Unallowable Code 85. ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡

  2. The Form 4136 is used to claim credit for: certain non-taxable uses of fuel (including alternative fuel); kerosene used in aviation; sales by a registered ultimate vendor for certain purposes; alcohol fuel mixtures, bio-diesel mixtures, renewable diesel, and alternative fuel mixtures; certain sales or uses of alternative fuel; certain credit card purchases of diesel fuel or kerosene made by states; certain sales and uses of diesel-water fuel emulsion; and exported dyed fuel.

  3. The basic issues to evaluate are:

    1. Is the claim made by the proper claimant (for example, a mixture credit must be claimed by the mixture producer)?

    2. Is the claimant registered by the IRS, if necessary (for example, an ultimate vendor or alternate fueler)?

    3. For claims made by the purchaser, was there a nontaxable use of the fuel?

    4. For claims made by the ultimate vendor, was the sale made to the proper party (such as a state or local government)?

    5. Did the claimant make a previous claim or duplicate claim (such as on Form 8849, Claim for Refund of Excise Taxes) for the same claim amount on the same gallon of fuel?

    6. Did the claimant of a mixture credit or alternative fuel credit first reduce tax liability on Schedule C, Form 720, Quarterly Federal Excise Tax Return Second Quarter or Form 720-X, Amended Quarterly Federal Excise Tax Return, before using the Form 4136. (This does not apply to ultimate purchaser claims for nontaxable uses of alternative fuel.)

    7. Did the registered ultimate vendor claimant sell the fuel tax at a tax-excluded price or otherwise meet the required condition to allowance?

    8. For biodiesel claims, is there a Biodiesel Certificate attached to the claim?

    9. For nontaxable uses of gasoline, diesel fuel, or kerosene, was tax imposed on the fuel?

    10. It may also be important to consider whether the claimant included the amount of the excise tax in any business expense deduction taken or claimed or an amount for the production of the mixture? If so, did the claimant include the amount of the credit in income?

  4. Code as unallowable if one or more of the following criteria exists:

    • Taxpayer claims credit as an Ultimate Vendor of undyed Diesel Fuel or Kerosene and does not provide the required documentation.

    • Taxpayer claims credit for undyed diesel fuel or kerosene used in farming prior to September 30, 2005.

    • Taxpayer claims credit as a gasoline wholesale distributor.

    • Taxpayer claims a credit for an alternative fuel mixture or alternative fuel that is not registered.

  5. Processing amended returns with Form 4136. Refer to IRM, AIMS Processing Handbook for guidance on processing claims with Form 4136 issues.

  6. The following situations are highly questionable and should be considered:

    • Taxpayer claims credit for nontaxable use when there is no obvious reason for such use by the taxpayer; such as use in a train or bus.

    • The amount for the credit appears to be inflated or excessive. The amount of the credit is large for heating oil or liquefied petroleum gas.

  7. Further information on Fuel Tax Credits can be obtained in:

    • Publication 510, Excise Taxes

    • Publication 225, Farmer’s Tax Guide

    • IRM, Form 4136 Credit for Federal Tax Paid on Fuels

    • Form 4136Credit for Federal Tax Paid on Fuels

    • IRM, Excise Tax  (01-01-2015)
Erroneous Refunds

  1. 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, Recovery of Unassessable Erroneous Refunds.

  2. Erroneous refunds 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.

  3. 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.

  4. The assessable erroneous refunds generally are referred to Examination as Category A1 or A2 referrals. There are situations that an erroneous refund is created by Examination, if the case is closed incorrectly. If the case was closed with an erroneous refund, the criteria in Rev. Proc. 2005-32, IRM .Policy Statement 4-3, and IRM, Delegation Order 57 must be followed.

  5. 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, Erroneous Refund Categories and Procedures for more information on the categorizing of erroneous refunds.

  6. 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

  7. If the taxpayer did not cause the erroneous refund, and the amount of the erroneous refund is $50,000 or less, the Service must abate interest (accruing before the date of notice and demand) under IRC 6404(e)(2). 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. The classifier or examiner must determine whether the taxpayer in any way caused the erroneous refund and the workpapers must document this determination.

  8. The following procedures should be used in erroneous refunds.

    If Then
    Non-assessable erroneous refund or 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, Examination Request Master File, 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
    1. 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.

      • On Letter 566–B for discretionary or Letter 566 for EITC, check blank box and 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.

    2. When preparing Examination Report, Form 4549 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 promptly. If the amount due is not received within 21 days, interest will be assessed from the date of the refund."

    3. Include in the explanation to the taxpayer, on what line of the tax return or on what schedule the error occurred.

    4. 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.


    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 within 21 days of the request for repayment.  (01-01-2014)

  1. Alimony is a payment to or for a spouse or former spouse under a divorce or separation instrument. Refer to Publication 504, Divorced or Separated Individuals, for more comprehensive information regarding alimony.

  2. The correspondence examiner should resolve discrepancies between the amount deducted as alimony by one taxpayer and the amount reported as income by the recipient on line 31(a) of Form 1040. For purposes of these procedures, the payer is defined as the taxpayer who claimed the alimony deduction. The recipient is the spouse or ex-spouse who the payer states received the alimony. The term taxpayer(s) refers to the recipient, the payer or both. The term alimony refers to all spousal support that meets the requirements of IRC 71. The term instrument refers to a decree of divorce or separate maintenance, a written separation agreement, a temporary decree, an interlocutory decree, or a decree of alimony pendente lite.

  3. Two of the current Alimony Programs are referenced below.

    1. 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; the Project Code for the recipient is 0142.

    2. 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.  (01-01-2014)
Initial Contact and General Processing

  1. Payers - Payer cases are initiated through ACE (Automated Correspondence Exam) processing.

    1. Payer cases are started in Status 10 with Letter 3541-A, Initial Letter Asking For Verification on Alimony Deduction.

    2. Letter 3541-A 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).

    3. Cases will be suspended for 45 days in Status 10.

    4. When the case moves into Status 22 or when a tax examiner is responding to a reply to the Letter 3541-A, the Letter 3541 along with the Form 4549 will be mailed.

    5. ACE generated reports include a substantial understatement penalty when applicable. Examiners should consider the application of accuracy penalties when working responses.

  2. 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, Preparation of Forms, and the IDRS Command Code AM424 Job Aid.

    1. Create the recipient case on AIMS no later than 30 days after closure of the related payer case.

    2. Initiate recipient cases in Status 10 with Letter 3540-A, Initial letter Inquiring about Unreported Alimony Income.

    3. Letter 3540-A, requests a copy of divorce or separation instruments if income is disputed as well as identification of any payers.

    4. Cases will be suspended for 45 days.

    5. After the suspense period, the case will be manually updated to Status 22 and Letter 3540 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.

    6. Recipient work papers 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 SSN and the primary TIN of a joint payer return if the ex-spouse filed as the secondary taxpayer.

    7. Include a copy of all relevant supporting documents provided by the payer in the recipient’s case file.

    8. Examiners should consider the application of accuracy penalties from initial contact.

    9. 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
    408 S
  3. All - Suspend all cases after initial contact for 45 days awaiting taxpayer response.

  4. 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, Non-Filer Source and Project Codes, and follow examination procedures per IRM 4.19.17, Non-Filer Program.  (01-01-2010)
No Reply

  1. If the taxpayer does not respond to the letter, prepare the case for issuance of a Statutory Notice of Deficiency.

  2. Close the case as a default if no response is received to the Statutory Notice of Deficiency after 105 days from its mail date.  (01-01-2015)
Processing Taxpayer Replies

  1. Use the following table when reviewing a taxpayer’s reply.

    If Then
    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, Taxpayer Response – Additional Information Needed.


    Treat Letter 3540 and Letter 3541 the same as Letter 525.

    The taxpayer appeals the determination Follow relevant procedures in IRM, No Response and Unagreed Cases and IRM,Transfers to Area Office Examination or Appeals.
    The taxpayer submits sufficient verification that the return is substantially correct. Close using "no change" procedures.
  2. Open a recipient case under the conditions noted in IRM (2), Initial Contact and General Processing. The related payer case needs 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.  (11-29-2011)

  1. 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.

  2. 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, separate maintenance 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, lump-sum alimony, unallocated family support, 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 taxpayer 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 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.

  3. 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.

  4. 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.

  5. Refer to IRM, Standard 3 - Workpapers Support Conclusions and IRM, Work Papers for All Cases for more information concerning workpapers.  (01-01-2010)

  1. Payers - Since payer cases are initiated systemically, it’s important to thoroughly research IDRS when working the first response.

    1. 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.

    2. Review each recipient’s account to determine if an amended return was filed to report the alimony income.

    3. 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.

    4. 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.

  2. Recipients - Perform IDRS research prior to establishing a recipient case on AIMS.

    1. 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.

    2. 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.

  3. 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.  (01-01-2015)

  1. 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.

  2. 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.

  3. Payments designated as not alimony can only be excluded from income if the recipient attaches a copy of the instrument designating the payments as not alimony to his/her return. The instrument must be attached to the return for each tax year for which the designation applies.

  4. Unacceptable documentation includes but is not limited to:

    • Unsigned (by either a judge or both affected parties), undated, or incomplete instruments,

    • Letters 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.  (01-01-2015)
Legal Terminology

  1. 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.  (01-01-2011)
Death Contingency

  1. Tax law states that for payments to be considered alimony, they must cease on the death of the recipient spouse. This "death contingency" can be stated in the instrument itself, codified in state law, or applied by operation of state or federal case law. The tax examiner must research state laws to reach a correct determination. The use of the word alimony in an instrument does not necessarily mean that the payments in question meet the requirements to be considered alimony under IRC 71.  (11-29-2011)
Pension Income

  1. QDRO - Although pension income paid to an alternative payee is not alimony, it is frequently deducted as such. Instruments can provide for the division of a pension between the plan participant and a non-participant spouse. This can be executed with a qualified domestic relations order (QDRO) that transfers the applicable percentage of distribution through the plan to a non-participant spouse.


    A QDRO is not a divorce decree. It is the document used to authorize the employer to distribute funds.

    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.

  2. OPM Reporting - Problems may arise in connection with Form 1099-R issued from Office of Personnel Management (OPM). Prior to the year 2000, OPM reported the gross pension distribution on Form 1099-Rs to the participant spouse. The participant spouse then reported the gross amount of distribution as pension income and deducted the amount apportioned to the non-participant spouse as alimony. In the year 2000, OPM started issuing separate Form 1099-Rs to the participant spouse and non-participant spouse showing their respective distributions. The plan participant spouse was not notified of the change. Consequently, the participant spouse continued to deduct the apportionment, thereby creating a double deduction. A copy of both the front and back of the Annuity Statement must be received to verify the taxpayer claimed the entire pension amount.

  3. DFAS Reporting - Military retirees frequently under report pension income due to Defense Finance and Accounting Services (DFAS) practices. In some instances DFAS issues a Form 1099-R to the participant spouse for the full amount of the distribution paid to the participant spouse and the non-participant spouse. In other instances, separate Form 1099-Rs are issued to the participant spouse and non-participant spouse showing only the amount of their respective distributions. When the non-participant spouse receives a Form 1099-R from DFAS, the participant spouse should not exclude the pension amount reported on the Form 1099-R that is issued to the non-participant spouse from taxable income. 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

  4. 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.

  5. Disability Pensions - The non-taxable nature of a disability pension does not transfer to the non-participant spouse. The disabled participant spouse cannot take a deduction for non-taxable distributions transferred to a non-participant spouse unless they are first reported in taxable income. The non-participant spouse is required to report the income on his/her tax return. DFAS began a two-tier disability pension in 2005. Only a disability or CSRS (Civil Service Retirement System) is non-taxable. This may account for a discrepancy in the participant’s taxable income.


    Do not use alimony language when adjusting pension income.  (12-12-2008)
What is DIF CORR (Source Codes 02 and 06)

  1. Discriminate Information Function (DIF) examines non-complex credits, deductions and/or expenses on Nonbusiness returns. Some examples are:

    • Interest

    • Taxes

    • Contributions

    • Medical Expenses

    • Simple miscellaneous expenses such as union dues, work clothes, and small tools

  2. DIF order could be utilized to select high income taxpayers with high DIF score for audit.

  3. DIF returns require classification.  (12-12-2008)
Procedures for DIF CORR (Source Codes 02 and 06)

  1. Use Initial Contact Letter 566 (SC) to notify taxpayer of review.

  2. Check off the issues on the back of Letter 566 (SC) using classification check sheet.

  3. Put a copy of the letter in the case file.

    If Then
    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 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, Schedule A for Schedule A issues.  (01-01-2010)
Schedule A

  1. For all examined Schedule A items, the examiner should check for:

    • Altered photocopies of paid bills.

    • Bank coding of the cancelled check 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.

  2. Medical and Dental Expenses: The examiner should have the taxpayer send in the following documentation (Exhibit 4.19.15-16., Form 886-A. Schedule A - Medical and Dental Expenses):

    • Copies of 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

    • A copy of the medical insurance handbook or policy describing the benefits and reimbursement policy.


      The Archer Medical Savings Account program expired on December 31, 2007.

  3. When the requested documentation is received, the examiner should:

    • Ensure that insurance reimbursements are excluded from deductions. 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).  (01-01-2014)
Nondeductible Medical Expenses

  1. This list is not all inclusive.

    Nondeductible Purchases Explanation
    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.

    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.  (11-29-2011)
Taxes Paid

  1. 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

    • Real estate taxes

    • New motor vehicle taxes (vehicles purchased after 2/16/2009 and before 1/01/2010)

    • Personal property taxes

  2. For additional information on deductible taxes refer to IRM, Taxes and Fees –Deductible and Nondeductible.

  3. For taxes paid, the examiner should consider having the taxpayer send in the following documentation:

    Category 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 Exhibit 4.19.15-13., Form 886-A – Schedule A - State and Local General Sales Tax Deduction or State and Local Income Tax Deduction

  4. The following is a list of nondeductible taxes (not all inclusive):

    • Sales Tax (Tax Year 2003 and prior).

    • Federal Income and Excise taxes.

    • Social Security Taxes (FICA (Federal Insurance Contribution Act)).

    • 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.

  5. 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.

    • Refunds of real estate taxes deducted in prior years should be reported on the "Other Income" line of the Form 1040.

  6. Evaluating Taxpayer Responses:

    • 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 the deduction for new motor vehicle taxes, evaluate the taxpayer’s documentation to ensure: the taxpayer is the original owner and user of the vehicle (in other words, the vehicle is “new”); the vehicle was purchased after February 16, 2009, and before January 1, 2010; and the amount is limited to the taxes imposed on the first $49,500 of the purchase price of the vehicle.

    • A taxpayer cannot deduct new motor vehicle taxes if his or her modified adjusted gross income (AGI) is $135,000 or more ($260,000 or more if filing status is married filing jointly).

    • A taxpayer’s deduction for the new motor vehicle taxes is reduced if a taxpayer’s AGI is $125,001 to $134,999 ($250,001 to $259, 999 if married filing jointly).

    • 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:

    If Then
    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.
    ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡
    • ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡

      If Then
      ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡
      ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡  (11-29-2011)
Home Mortgage Interest Deductions

  1. 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.

  2. 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

  3. ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡  (11-29-2011)
General Requirements

  1. 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 , Evaluating Taxpayer Responses.)

  2. 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.

  3. 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.)

  4. 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:

    If AND all of the following are met Then
    The points are paid to acquire a main home in connection with a loan that is secured by that home.
    1. Paying points is an established business practice in the area and the points were not more than points generally charged in the area,

    2. The taxpayer uses the cash method of accounting,

    3. The amount is clearly shown on the settlement statement (reported as points, loan origination fees, loan discount, discount points),

    4. 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,

    5. The points are calculated as a percentage of the principal loan and,

    6. 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, Limits on the Home Mortgage Interest Deduction below.  (11-29-2011)
Evaluating Taxpayer Responses

  1. The documentation provided by the taxpayer must verify that all of the requirements listed under IRM, General Requirements, are met. Request additional documentation as needed using standard examination procedures.

  2. 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.

  3. The taxpayer may deduct interest only on a main home and a second home. If the taxpayer submits mortgage documentation for more than two qualifying residences, then the taxpayer may select which two properties meet this description.

  4. 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. If there is a duplicate deduction, then the interest should be adjusted to reflect the correct amount.

  5. 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.

  6. 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.

  7. 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:

    • ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ,

    • The documentation provided by the taxpayer indicates that the deduction is subject to the limits described in IRM, Limits on the Home Mortgage Interest Deduction, or

    • You are working a Project Code 0417 case for Excess Mortgage Interest Deduction.  (01-01-2014)
Limits on the Home Mortgage Interest Deduction

  1. The following table describes when the taxpayer’s home mortgage interest deduction is limited based on the type of mortgage debt:

    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 taken out after October 13, 1987 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). 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, 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, Evaluating Excess Mortgage Interest Taxpayer Responses for a discussion of fair market value). Interest paid in that year is fully deductible.
    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, Excess Mortgage Interest Deduction – IRC 163 below.
  2. 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, Excessive Mortgage Interest Deduction – IRC 163, for detailed procedures.  (11-29-2011)
Excess Mortgage Interest Deduction – IRC 163

  1. 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.

  2. 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.

  3. When initiating Project Code 0417 cases, send Letter 566 with Form 886-H-INT, Mortgage Interest and the Mortgage Interest Deduction Limitation Worksheet [to be published].  (11-29-2011)
Computing the Limit on the Mortgage Interest Deduction

  1. 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.

  2. 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.

  3. 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.

  4. Apply the limit on deductible mortgage interest to deductible points as well.  (11-29-2011)
Evaluating Excess Mortgage Interest - Taxpayer Responses

  1. The documentation provided by the taxpayer must verify that all of the requirements listed under IRM, General Requirements are met.

  2. Process responses to the initial contact letter as follows:

    If ... And ... Then ...
    No Reply,   Disallow the entire mortgage interest deduction.
    Taxpayer replies with insufficient information to determine average balance of at least one of the mortgages,   Disallow the entire mortgage interest deduction.
    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.
  3. Observe the following guidelines when determining the extent of an excess mortgage interest deduction:

    1. 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.

    2. Accept the taxpayer’s explanation for how the loan proceeds were used, unless the documentation shows otherwise.

    3. 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.

    4. 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.


      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.

    5. The taxpayer may elect to deduct the limited mortgage interest as an 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.

    6. 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. ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡  (01-01-2014)
Charitable Contributions

  1. Taxpayers may claim an itemized deduction for contributions or gifts made only to or for the use of qualified charitable organizations and governments. Payments to qualified organizations are considered contributions if they are made without getting, or expecting to get, anything of equal value.  (01-01-2015)
Qualifying Payments

  1. The following table provides some examples of qualifying and non qualifying payments.

    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 time or services
    Certain automobile and travel expenses incurred when doing charitable work Personal living expenses incurred while performing services for a qualified organization
    Cost and upkeep of uniforms required when doing charitable work Amounts paid for the benefit of a specific person  (10-01-2011)
Qualifying Organizations

  1. Some qualified organizations are listed in Publication 78 – Cumulative List of Organizations. If an organization is not listed in Publication 78 and is not a church or governmental agency, the taxpayer should be able to obtain a copy of the letter issued to the organization by the IRS granting it "qualifying organization" status.

  2. 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
    Nonprofit schools and hospitals, 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, etc. Individuals, political groups or specific candidates for public office.
    Volunteer fire departments  (10-01-2003)
Types of Contributions

  1. Contributions can be in the form of cash or non-cash. Examples of the types of contributions are:

    Type of Contribution Example
    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  (01-01-2015)
Amount of Contribution Deduction

  1. In general a taxpayer can deduct the full amount of a properly substantiated cash contribution, subject to certain percentage limitations.

  2. 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.

  3. For non-cash contributions, the deduction is usually equal to the fair market value of the property on the date of the donation.

  4. 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.

  5. The taxpayer may make a qualified charitable distribution from a traditional or Roth IRA (Individual Retirement Account). The taxpayer must be age 701/1 at the time of the distribution and the maximum annual amount of the exclusion for the charitable distribution is $100,000. In general, the distribution is not deductible as a Schedule A charitable contribution. An exception applies if the taxpayer had non-deductible IRA contributions.

  6. If the amount claimed is a carry-over from a prior year, request verification for that amount and current year contributions. This does not constitute an audit of the prior year.

  7. For contributions of motor vehicles, including automobiles, boats, and airplanes, 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.

    If ... And ... Then ...
    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
    1. the fair market value on the date of the contribution, or

    2. 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/was 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 was 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 was 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 was transferred to a needy individual.  (01-01-2015)
Acceptable Documentation for Charitable Contributions

  1. The following table lists examples of acceptable documentation for charitable contributions.

    Type of Contribution Types of Documentation
    Cash contributions of less than $250 to a single organization, including regular contributions to a single organization – for example $10 a week to a church Cancelled checks, receipts, verification of electronic funds transfer, bank records, 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, Acceptable Documentation for Charitable Contributions, (6) through (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 to a single organization For each such donation -the taxpayer must provide 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 received, 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 receive/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, Acceptable Documentation for Charitable Contributions, (6) through (9) below for additional information where there is doubt regarding the authenticity of statements for verifying contributions.
    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 in consideration and a good faith estimate of the value of those goods or services.
    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 property. 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 fair market value of the property at the time of the contribution, and any terms or conditions attached to the gift.
    Non-cash contributions of $250 or more. Taxpayer must provide a written statement from the organization. Refer to IRM, Acceptable Documentation for Charitable Contributions (6) through (9) below.
    Non-cash contributions over $500 but not more than $5,000 Taxpayer must provide 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.
    Non-cash contributions over $5,000 Same documentation as above for non-cash gifts up to $5,000 except, in lieu of Form 8283, Section A, Form 8283, Section B, must be completed and attached to the return. The taxpayer must also obtain a qualified appraisal unless the non-cash contribution meets the exceptions for inventory, publicly traded securities or intellectual property. (See Publication 561, Determining the Value of Donated Property).
    Non-cash contribution of property over $500,000 Taxpayer must attach appraisal to return unless contribution is inventory, publicly traded stock, or intellectual property. Form 8283 must also be completed and attached to the return. Everything required for property over $5,000 is also required.
    Contribution of motor vehicle, including automobiles, boats and airplanes of more than $500 Taxpayer must attach Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, or other statement received from the charitable organization that reports the same information as the Form 1098-C. A qualified appraisal is also required if the taxpayer is entitled to deduct the fair market value, and the deduction is $5,000 or more for motor vehicles.
    Clothing and household furniture not in good used condition or better (contributions made after 8-17-2006) If the amount claimed is more than $500 for a single item of clothing or household item, the return must include a qualified appraisal that substantiates valuation of more than $500.
    Easements in Registered Historic Districts 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.

  2. Exhibit 4.19.15-19., Form 886-A. Schedule A - Gifts to Charity.

  3. Taxpayers can provide information via mail, fax or telephone.

  4. Contributions are deductible only in the year they are made. Checks, receipts and other documentation provided by taxpayers should be dated for the tax year in question.

  5. 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 is filed, or

    • the due date of the return, including extensions.

  6. For contribution of $250 or more, acceptable charitable organization statements must include:

    • Name of the organization

    • Amount of the contribution

    • Date of the contribution

  7. For all cash and non-cash contributions of $250 or more (each, not in aggregate) in addition to the above-listed requirements:

    • Amount of cash

    • Description of the non-cash contribution

    • 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 and services, if any, that the organization provided in return for the contribution consisted entirely of intangible religious benefits, if that was the case

  8. 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 (10)(10), Acceptable Documentation For Charitable Contributions, below.

  9. 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 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 when the statement appears questionable.

  10. If you question the authenticity of the acknowledgement/statement, for:

    • Cash contributions - verification should be requested, i.e., cancelled checks or bank records, receipt from organization.

    • All contributions - verification can be requested from the organization to ascertain it provided the acknowledgement/statement submitted by the taxpayer.

  11. Most taxpayers make cash contributions for which they have no receipts. Taxpayers must maintain, as a record of a contribution, a bank record 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.

  12. If the taxpayer provides acceptable documentation for a portion of the deduction and provides a statement that the balance was made in cash, but does not include the information stated above, use your judgment in allowing the amount claimed, but see the note regarding cash contributions beginning with tax year 2007.  (01-01-2014)
Limitations on Contributions

  1. For individuals:

    • 50 percent limit: A taxpayer’s contribution deductions are limited to a maximum of 50 percent of the taxpayer’s adjusted gross income (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" all charities.

    • 20 percent limit: Deductions are limited to 20 percent of AGI for contributions of capital gain property to certain private foundations.


    Certain special limitations apply to contributions of conservation easements. These special limitations do not apply to contributions made in taxable years beginning after December 31, 2013, check IRC 170(b)(1)(E).

  2. 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.

    • 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 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.

  3. Certain deductions are limited to basis. In addition to percentage limitations, a deduction for certain contributions of property is limited to the taxpayer’s adjusted basis in the property. These include contributions such as:

    • Ordinary income property (such as inventory or short-term capital gain property)

    • Property to charities that are not public charities

    • Tangible personal property that is not used by the charity in its charitable function (such as property that is sold by the charity). For contributions of tangible personal property after September 1, 2006, special rules apply.  (10-01-2003)
Additional Research Material

  1. For additional information on allowable deductions you may refer to Publication 526, Charitable Contributions, for the tax year you are examining.  (04-17-2008)
Charitable Contribution Rules - Project Code 0391, Project Code 0392 and Project Code 0629

  1. Project Code 0391 is Charitable contributions carryover with no prior year Schedule A.

  2. Project Code 0392 is Charitable contributions carryover with prior year contributions of less than 50 percent of AGI.

  3. Project Code 0629 is Charitable contributions and identifies returns with a deduction for cash contributions. PC 0629 cases are automated for ACE processing.

  4. 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 17 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.  (04-17-2008)
Initial Contact

  1. The following table shows the Initial Contact Letter to send to the taxpayer.

    Project Code Issue Letter Amount to Disallow
    PC 0391
    PC 0392
    Letter 566/Form 886-A with applicable explanation Schedule A, Line 17 - Carryover from prior year
    PC 0629 Initial Contact Letter 566/Form 886-A Documents Request  (04-17-2008)
No Response Cases

  1. Take the following action if the taxpayer has not replied to the most recent letter by the normal purge date.

    Latest Letter issued Action
    Letter 566 Issue Letter 525 with Form 4549/Form 4549-EZ.
    Letter 525 or Letter 692 (SC/CG), 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.  (01-01-2010)
Processing Taxpayer Replies to Letter 566

  1. The following describes the processing of taxpayer replies to Letter 566 for Project Codes 0391, 0392 and 0629 cases:

    If And Then
    The taxpayer responds to Letter 566 You are able to verify that the taxpayer is entitled to all of the amount as a contribution deduction. Follow procedures in IRM, Campus Closing Actions.
    The taxpayer responds to Letter 566 You are able to verify that the taxpayer is entitled to part of the amount as a contribution deduction. Issue Letter 525 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 You are unable to verify that the taxpayer is entitled to any part of the amount claimed as a contribution deduction. Issue Letter 525 with the Form 4549/Form 4549-EZ and an appropriate explanation to the taxpayer. Follow normal Letter 525 procedures for mail out and suspense.
    The taxpayer replies to Letter 566 with information he is entitled to an additional deduction for contributions You are able to verify that he is entitled to an additional deduction. Issue Letter 525 with a Form 4549/Form 4549-EZ and an appropriate explanation to the taxpayer. Follow normal Letter 525 procedures for mail out and suspense.  (04-17-2008)
Closing Actions

  1. Take the necessary action to close the case based on the chart below.

    If the Taxpayer Then
    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 or Letter 692 (SC/CG) 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, show the entire amount of the assessment.  (01-01-2015)
Casualty and Theft Losses

  1. 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.

    • The taxpayer may deduct Nonbusiness casualty or theft losses only to the extent that:

      Dollar Requirements for Deduction
      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.
    • The Katrina Emergency Tax Relief Act of 2005 (KETRA) and the Gulf Opportunity Zone Act of 2005 (GOZA); and the Food, Conservation and Energy Act of 2008 (also referred to as the Kansas Disaster Area) suspended the $100 and 10 percent of adjusted gross income limitations on casualty or theft losses of personal-use property to the extent that the losses arose in the:

      Hurricane Katrina disaster area on or after 8/25/05 and were attributable to Hurricane Katrina.
      Hurricane Rita disaster area on or after 9/23/05 and were attributable to Hurricane Rita.
      Hurricane Wilma disaster area on or after 10/23/05 and were attributable to Hurricane Wilma.
      Kansas Disaster Area on or after May 4, 2007 and were attributable to the storms and tornados.


    Simple disappearance of money or property (lost or mislaid) is not a theft.

  2. The 10 percent limit does not apply to losses of personal use property attributable to federally declared disasters declared in tax years beginning after 2007 and that occur before 2010. (The $100 ($500 for TY 2009) limit, however, does apply.)

  3. The special rules that were in effect in 2008 and 2009 for losses of personal use property attributable to federally declared disasters do not apply to losses occurring in 2010 and later years. Instead, these losses are subject to the 10% of AGI limit and are deductible only if you itemize your deductions. These losses are subject to the $100 per loss limit. The special rules do apply to a loss you are deducting in 2010 from a disaster that was declared a federal disaster in tax years beginning after 2007 and that occurred before 2010. For details see the Form 4684 instructions

  4. In order to deduct a casualty loss, the taxpayer must be able to show all of the following:

    1. The type of casualty (car accident, fire storm, etc.) and when it occurred.

    2. That the loss was a direct result of the casualty.

    3. 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.

    4. The amount of any insurance reimbursement.

  5. In order to deduct a theft loss, the taxpayer must be able to show all of the following:

    1. When the property was discovered missing.

    2. The property was stolen.

    3. The property belonged to the taxpayer.

    4. Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.

  6. The following situations can result in casualty losses:

    • Car accidents.

    • Earthquakes.

    • Floods.

    • Fires.

    • Government-ordered demolition or relocation of a home that is unsafe to use because of a disaster.

    • Hurricanes.

    • Mine cave-ins.

    • Shipwrecks.

    • Sonic booms.

    • Storms.

    • Tornadoes.

    • Vandalism.

    • Volcanic eruptions.

  7. Considerations when taxpayer qualifies for a Disaster Area Loss:

    1. A Presidentially 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 from a disaster that occurred in a Presidentially Declared Disaster Area, the taxpayer can choose to deduct that loss on his current year return or by amending the return in the prior year. Ensure the taxpayer is not claiming the same expenses for both years.

    2. The taxpayer must reduce his casualty loss by funds received under any disaster provision and by any insurance reimbursement.

  8. Kansas and Midwestern Disaster Areas:

    1. For taxpayers affected by Kansas storms and tornadoes that began on May 4, 2007, refer to Publication 4492-A. Refer to Publication 4492-B if the taxpayer was affected in Midwestern disaster area.

    2. The losses of personal use property that arose in these disaster areas are not subject to the $100 or 10 percent of adjusted gross income limitation.

    3. The replacement period for property in these disaster areas that was damaged, destroyed or stolen has been extended from two to five years. For more information see Publication 547, Casualties, Disasters, and Thefts.  (11-29-2011)
Employee Business Expense (EBE) Cases

  1. 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. 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.

  2. Returns may be requested for this issue.

    1. Returns will be reviewed to determine if expenses appear in line with the occupation on the Form 2106.

    2. Returns will be classified for other issues.

  3. Initial Contact Letter 566 (SG/CG) (ICL) and explanation of the substantiation required to support the employee business expense will be issued to the taxpayer.

    1. Use the approved questionnaire/explanation on Form 886-A. (See Exhibit 4.19.15-3, EBE Questions. Exhibit 4.19.15-21, Form 886-A – Schedule A – Job Expenses and Other Miscellaneous Deductions.)

    2. Also request any entries that are missing on the Form 2106.

    3. Request any receipts or records specific to the amounts on the Form 2106 in question.

  4. Follow normal suspense time frames. If there is no response to the ICL, issue a report disallowing the entire employee business expense amount.  (01-01-2010)
Evaluating EBE Taxpayer Responses

  1. All responses need to be evaluated using judgment considering what is known about the occupation.

  2. The reimbursement policy of the employer is the starting point for all EBE audits and MUST be secured.

  3. 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.

  4. An expenditure for travel, meals, or entertainment, to the extent it is lavish or extravagant, shall not be allowable as a deduction.

  5. Unless the taxpayer is eligible to use and does use the government per diem rates, documentary evidence is required for:

    1. Any expense for lodging while traveling away from home, and

    2. Any other expenditure of $75 or more.

  6. 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:

    1. Amount of each expenditure.

    2. Time or date of the travel, entertainment, or gift.

    3. Place of the travel or entertainment; description of the gift.

    4. Business purpose for each expenditure.

    5. Business relationship to the taxpayer of each person entertained, using an entertainment facility, or receiving a gift.

  7. Many expenses not listed in (5) above can be summarized, or aggregated. See Publication 463Travel, Entertainment, Gift, and Car Expenses, Section 5 Record Keeping for a table that shows the substantiation requirement for specific expenses.

  8. 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.

  9. Travel expenses for conventions, seminars, and similar meetings are deductible under IRC 162 if the taxpayer’s attendance benefits or advances his trade or business. No deduction is allowable if a taxpayer is attending for social, political, or other purposes not related to his trade or business.

  10. 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.

  11. 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.

  12. Any issues beyond the expertise of the examiner assigned the case should be referred to the lead examiner to secure the appropriate technical guidance.

  13. 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.

  14. Additional Items to consider. Consider the following points when working EBE cases.

    Employee Business Expense Auditing Techniques
    When examining employee business expenses, you must consider whether the employer has an expense allowance or reimbursement plan.
    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, you may encounter nondeductible expenses that were reimbursed.
    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.
    If the statement is prepared for the purpose of examination, be sure the author has sufficient knowledge of the expense allowance or reimbursement plan.
    If the statement presented from the employer is vague, discuss with your manager or lead the possibility of making a third party contact.
    Be logical in organizing the examination. It may be better to structure the examination of these expenses into categories i.e., travel, entertainment, 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.
    Look for recurring names for entertainment and meals, as well as recurring locations for travel. Recurring names may indicate a family member or a friend.
    Be mindful of travel dates. Are the dates during holiday periods? If travel dates are during holiday seasons, this may indicate personal expenses.
    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.
    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.
    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.
    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 recharacterized 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.
    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.
  15. The employer's letter regarding the company's reimbursement policy helps to establish:

    1. the business expenses were ordinary and necessary, and

    2. 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.  (01-01-2014)
Additional Information

  1. Additional EBE information and materials should be referenced when working EBE cases. These include:

    • Publication 463 – Travel, Entertainment, 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)  (01-01-2015)
Miscellaneous Deductions

  1. 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.

    • Exhibit 4.19.15-14.Form 886-A - Schedule A - Other Miscellaneous Deductions. Exhibit 4.19.15-21.Form 886-A - Schedule A - Job Expenses and Other Miscellaneous Deductions.

  2. The table below lists deductions subject to the two-percent AGI limitation, deductions not subject to the two-percent AGI limitation, and nondeductible expenses.

    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. Deductible expenses not subject to the two-percent of AGI limitation are::
    • Casualty and theft losses from income-producing property.

    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).

    Examples are:
    • Business bad debt of an employee

    • Expense of education that is work related if 1) it maintains or improves skills required in the taxpayer’s present work, 2) it is required by the employer or the law to keep the taxpayers' current salary, status, or job, and the requirement serves a business purpose of the employer, and 3) the education is not necessary to meet minimum requirements to qualify the taxpayer in the taxpayers' trade or business and does not qualify the taxpayer for a new trade or business. (Only for the taxpayer and not for the taxpayer's dependents).

    • Legal fees related to 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

    • 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

    • Fees and licenses such as car or marriage licenses and dog tags.

    • Fines or penalties.

    • Health Spa expenses.

    • Hobby

    • 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.

    • Value of loss of wages.

    • Adoption expenses, but see Adoption Credit.

    • Personal accounts.

    • Travel expenses for another individual

    • Voluntary unemployment benefit contributions.

    • Cost of a wristwatch.

    Tax preparation fees (Line 22 of Schedule A)
    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:
    1. expenses to produce or collect income that must be included in the taxpayer's gross income,

    2. expenses to manage, conserve or maintain property for producing gross income, and

    3. expenses to determine, contest, pay, or claim a refund of tax. These expenses must be reasonable and closely related to these purposes.

    Examples are:
    • 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

    • Service charges on dividend reinvestment plans

    • Trustee's administrative fees for IRA

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