You can change a personal tax return if there is a benefit to do so. Many taxpayers believe this could raise unintentional red flags with the Internal Revenue Service (IRS). However, here we will discuss how to amend a tax return and avoid penalties.

Reasons to Amend a Tax Return

Amending a tax return is a surprisingly straightforward process. According to instructions from the IRS, a taxpayer can amend a prior year’s tax return for the following reasons:

  1. Correct a previously filed tax return.
  2. Make certain tax elections (beyond the scope of this article).
  3. Change amounts, except penalties and interest, already adjusted by the IRS.
  4. Make a carryback claim due to a loss or unused credit. 

(The IRS may not allow certain tax benefits incurred in the current tax year, but you can carry these benefits back to a prior year that qualified or forward to a future year, which does not require amending a return. The most common carryback is due to a net operating loss for the current year that can be offset against income in a prior year to reduce that year’s tax liability).

The most common reason to amend a return is the first item.

How to Amend a Personal Tax Return and Avoid Penalties

Fill out Form 1040x for an individual tax return (corporations and partnerships have their own forms—we will stick to individual returns for this discussion) and prepare the appropriate forms for the original return, including the changes. You then mail the forms (along with a copy of the original return). 

Expert Note: Form 1040X requires an explanation for the amendment, but as long as it falls under the above categories, it should be acceptable.

Correcting a Previously Filed Return

Consider this scenario: A taxpayer owns a small business with a vehicle used 100% for business purposes. A previous tax preparer took this deduction as an employee business expense reported as an itemized deduction on the taxpayer’s Form 1040 Schedule A. This is legal and technically not an error. 

However, it is probably not the most advantageous way to deduct this vehicle

The taxpayer reports their business income and expenses on Form 1040 Schedule C. They are subject to income tax on the profit of the business and an additional (approximately) 15% self-employment tax on that profit.

A new accountant will examine this same scenario next year and determine that the best way to deduct this vehicle is as a business deduction on Schedule C. The benefit is not so much in the total income tax as in the savings on the self-employment tax. 

Reporting it on Schedule A does not reduce the income taxed as self-employment income, but reporting it on Schedule C does. It is a valid treatment for the vehicle this year, and it would have been the previous year. 

By amending the prior year’s tax return, the new accountant got the taxpayer a refund of approximately $2,500 (at a cost of $150 to amend the return). The interest the IRS paid back to the taxpayer for using their funds since they filed the prior return offset the price.

Does amending a tax return raise a red flag?

Amending a return alone does not usually raise a red flag with the IRS

However, the nature of the transaction might. The transaction referred to above is one incurred in the ordinary course of running a trade or business. It might come under scrutiny either year because automobile deductions tend to draw more attention. 

As long as the taxpayer has properly documented the business usage of the vehicle in both years, it is a legitimate deduction, and this treatment is safe and legal. If a taxpayer wants to amend a return for unreasonable, frivolous, or fraudulent reasons, any competent professional, such as a Certified Public Accountant or Enrolled Agent, would and should decline to do so.

Responding to a Tax Notice

A taxpayer may receive a notice from the IRS that they received a Form 1099, but the taxpayer did not include the amount of income shown on the tax return filed for that year. (This is a common occurrence.) 

As a result, the IRS assessed late payment penalties and interest of about $1,800. The taxpayer forgot to give the tax preparer their copy of the 1099.  

The new accountant noticed the same problem the following year, but the IRS had yet to find it, even though they already filed the return. The new accountant also noticed the missing income was not taxable in either year. (It is not the IRS’s responsibility to recognize this. It is the taxpayer’s.) 

The new accountant amended both returns and included the missing information, showing that both cases were non-taxable. This corrected the information the IRS was missing, saving the taxpayer $1,800 from the tax notice and avoiding the same problem the following year.

How Long Do I Have to Amend a Tax Return?

There is a time limit on amending a return. In general, if you are trying to get a refund or take a credit, you have up to three years (including extensions) after filing the initial return or within two years of paying the actual tax, whichever is later.

Can I Amend a Tax Return Myself?

Having a Certified Public Accountant or Enrolled Agent review previous tax returns can sometimes result in tax savings. Look for a professional who is knowledgeable and aggressive in tax matters (without crossing the line).  

Should a question arise with the IRS from amending a return, make sure you authorize the professional to represent you before the IRS (never represent yourself). 

The IRS only recognizes Certified Public Accountants, Enrolled Agents, or attorneys. These professionals must have a Form 2848, Power of Attorney, and Declaration of Representative signed by the taxpayer to represent you.

With the help of a professional from the start, hopefully, they won’t need to represent you. You can work with a CPA or Enrolled Agent to prepare your taxes and review previous returns, making the most of legal deductions and amending where needed.