Suppose you realize you’ve missed out on a tax deduction or credit on your 2010 return. Or maybe you unintentionally failed to report income or miscalculated a capital gain or business deduction.
Should you file an amended return? It often depends on whether you owe the IRS money or it owes you.
You owe the IRS
Clearly, the decision is a lot easier if you paid less tax than you should have on your original return.
Strategy: File an amended return right away. Don’t panic—it doesn’t mean you’re going to jail—but it’s best to come clean with the IRS as soon as possible. If you file an amended return within a few weeks of submitting the original, the IRS probably won’t tack on any penalties. Of course, you still will be held liable for the amount already due plus interest dating to the original due date.
On the other hand, if you simply keep your fingers crossed and pray the IRS doesn’t detect the error, you’re playing with fire. If the IRS eventually catches up to you, you may have to pay hefty penalties on top of the back taxes and interest. The IRS generally has three years to audit your return; six years if you underreported income by 25% or more. And if fraud is involved, there is no statute of limitations.
Tip: Hold onto tax records for a minimum of three years. To be on the safe side, you should keep them at least six or even 10 years. You may need these records to support your position.
If you can’t pay the tax bill in full right now, file the amended return anyway. Then you can negotiate a deal when the IRS tallies up the damages.
The IRS owes you
It’s a different story if you discover an error that would tilt your return in your favor. In that case, you might think it’s a no-brainer: File the amended return and collect the tax savings that are rightfully yours. But it’s not that simple.
Here’s why: First, it might not be worth the hassle or expense if a missed deduction or credit amounts to chump change. If you’re paying a tax pro for tax return preparation, the cost of filing an amended return might be close to or greater than the tax difference.
Second, you could be drawing extra attention by submitting your return for a second time. It gives the IRS another shot at giving the entire return the once-over.
Tip: Although some tax experts claim that filing an amended return increases the risk of an audit, there’s no real proof to back that up. But it certainly raises the visibility of your return.