KKATC Watchdog — AI Tax Error Registry

ChatGPT presented running a side business primarily as a tax-saving vehicle without adequately distinguishing that this strategy is largely beneficial only for the ultra-wealthy or those with genuine business profit motives. Under IRC §183 (hobby loss rules), a business must be operated with a bona fide profit motive to deduct losses; the IRS applies a facts-and-circumstances test, and expenses from an activity not engaged in for profit are non-deductible. For average earners, setting up a side business solely to generate deductions—without a real profit motive—risks IRS reclassification of the activity as a hobby, disallowing all related deductions and triggering back taxes, interest, and penalties.

Under IRC §41 and Treas. Reg. §1.41-4, qualified research must meet the four-part test, including a 'permitted purpose' requiring development or improvement of a business component's functionality, performance, reliability, or quality. Mislabeling process improvements as 'new products' misrepresents the nature of the qualifying activity, producing narratives that do not accurately reflect what was done and that fail to align with the IRS's required technical definitions and contemporaneous documentation standards.

ChatGPT omitted the statutory threshold: under IRC §3402(q), mandatory 24% federal withholding on lottery winnings is only triggered when net proceeds (winnings minus the wager) exceed $5,000. TurboTax correctly stated that withholding applies to 'winnings over $5,000' and that winners in higher brackets owe additional tax beyond the withheld amount. ChatGPT's blanket statement that withholding occurs 'right away when you claim the prize' misleads taxpayers about when withholding is legally required and fails to address the potential additional tax liability for large jackpot winners pushed into the 37% bracket.

Claude hallucinated charitable contribution deductions that did not exist by misreading a K-1 abbreviation instead of consulting the accompanying footnote text. The correct treatment required reading the full K-1 footnote disclosures, which clarified the line items were interest — a categorically different deduction governed by IRC §163, not a charitable contribution under IRC §170. Fabricating charitable deductions that have no basis in the source documents violates the accuracy requirements for Schedule A itemized deductions.

Claude placed the computed total tax amount on Line 40 of California Form 540, which is designated for Nonrefundable Child and Dependent Care Expenses credit, rather than Line 64, which is the correct line for reporting total tax owed. This is a wrong-line mapping error in the generated Python script used to populate the PDF form. The correct placement of total tax on Line 64 is required by the California Franchise Tax Board's Form 540 instructions.

Employer-reimbursed travel expenses are not deductible on Schedule C because the taxpayer incurred no out-of-pocket cost; only unreimbursed ordinary and necessary business expenses qualify under IRC §162(a). Additionally, software subscriptions are properly reported on Schedule C Line 27a ('Other Expenses') per IRS Publication 535, not as 'Supplies' on Line 22, making the $600 miscategorization a wrong-line placement error.

Under IRC §280A and IRS Publication 587, a self-employed taxpayer using the simplified method may deduct home office expenses when the business shows a net profit; TurboTax's logic incorrectly evaluated the profit as zero or negative despite the taxpayer reporting positive profit. Additionally, a separate user reported TurboTax calculated federal income tax of $8,094 on $86,031 of taxable income for a married filing jointly return, while the official 2025 IRS Tax Table (Form 1040 Instructions, p. 78) shows the correct tax as $9,846—a $1,752 understatement, likely because TurboTax applied an alternative calculation method (e.g., Qualified Dividends worksheet) without the user's awareness.

The AI models applied a percentage-based marginal rate calculation to determine federal income tax liability instead of using the IRS-prescribed tax tables or tax computation worksheets. The correct method under IRS instructions for Form 1040 requires taxpayers to use the Tax Table (for taxable income under $100,000) or the Tax Computation Worksheet (for income $100,000 and above), not a direct percentage multiplication of income against bracket rates. This distinction produces materially different results and is a fundamental compliance requirement.

OBBBA did not create a tip income exclusion. It created IRC §224, a new above-the-line deduction of up to $25,000 for qualified tip income in eligible industries where tipping was customary as of December 31, 2024. Effective tax years 2025 through 2028. Tips must still be reported as gross income under IRC §61(a). Workers who do not report tip income because they were told tips are tax-free face a compliance and penalties exposure. The correct framing: tips are potentially deductible up to $25,000, not excluded from income.

TurboTax's Schedule AI Line 14 calculation for columns (a), (b), and (c) fails to correctly apply the annualization scaling factor to both capital gains and qualified dividends when computing tax via the Qualified Dividends and Capital Gain Tax Worksheet; per IRS Publication 505 Worksheet 2-8, both capital gains and qualified dividends must be scaled by the same annualization multiplier (4x, 2.4x, and 1.5x for periods a, b, and c respectively) before computing tax for each period. TurboTax applies the annualization factor inconsistently — scaling qualified dividends but not long-term capital gains — resulting in an understated tax benefit and an overstated annualized tax liability, which in turn generates a false underpayment penalty on Form 2210 Line 19 where none would be owed under the correct calculation.

The AI inverted the basic refund calculation: a taxpayer receives a refund when total withholding exceeds total tax liability, not the other way around. Under IRC §31 and IRS Publication 505, federal income tax withheld is credited against the taxpayer's total tax liability, and any excess withholding is refunded. The AI's statement that $2,000 withholding is 'less than' $1,000 tax owed is arithmetically and legally backwards, and would cause a taxpayer to believe they owe money when they are actually owed a refund.

The chatbots produced materially inconsistent calculations or interpretations of California's business-franchise tax (imposed under California Revenue and Taxation Code §23151 et seq.), which imposes a minimum franchise tax and an 8.84% rate on net income for corporations. Because the AIs disagreed with each other and at least one answer was flagged as a hallucination, at least one—and possibly all—of the responses contained incorrect tax liability figures. The correct liability is determinable under Cal. Rev. & Tax. Code §23151 and the FTB's published guidance, not by averaging or selecting the highest AI estimate.

For ESPP dispositions, IRC §423 and the basis rules under IRC §1012 require taxpayers to reconcile the broker-reported cost basis on Form 1099-B with the ordinary compensation income already included in Box 1 (and often Box 14) of the W-2, and to correct any understated basis on Form 8949 to avoid double taxation. ChatGPT correctly identified that the brokerage number and the tax-software number differed, but failed to proactively surface the W-2 compensation income items that affect adjusted basis, and failed to flag 1099 entries that appeared to reflect taxable events the user may not have made—leaving the return incomplete and potentially incorrect. IRS Publication 525 and the Form 3922 instructions explicitly require taxpayers to compute adjusted basis using both the 1099-B proceeds and the W-2-reported discount income before reporting on Schedule D.

TurboTax Intuit Assist responded to a question about air conditioner tax credits with information about educational expense deductions -- a completely off-topic response that left the user without any guidance on IRC §25C, the Energy Efficient Home Improvement Credit, or Form 5695. Additionally, §25C was terminated by OBBBA P.L. 119-21 for property placed in service after December 31, 2025. A user asking this question in 2026 would receive no credit regardless of the AI's answer. TurboTax's failure to answer the §25C question at all is compounded by the fact that a correct answer would also need to address the OBBBA termination date.

ChatGPT incorrectly ignored the tacking rule under IRC §1223(2), which requires the donee's holding period to include the donor's holding period for gifted property — meaning the daughter already qualified for long-term treatment without holding the property an additional year. ChatGPT also incorrectly stated a loss was available based on the date-of-death FMV; under IRC §1015(a), the basis for loss on gifted property is the lower of the donor's adjusted basis or the FMV at the date of the gift, not the FMV at the date of sale, and no deductible loss arises when the sale price falls between those two figures.

H&R Block's 'AI Tax Assist' affirmatively stated that wash sale rules apply to crypto, which is wrong. Under IRC §1091, the wash sale rule applies only to 'stock or securities'; the IRS classifies cryptocurrency as property under Notice 2014-21, not as a security, so §1091 does not apply to digital asset trades. A taxpayer relying on this advice could unnecessarily forgo legitimate crypto tax-loss harvesting deductions.

TurboTax's Intuit Assist failed to address the core question of state tax filing jurisdiction for a college student living away from home, instead returning off-topic resources. Under most state tax residency rules, a college student domiciled in their home state (e.g., California) generally retains that domicile while attending school in another state and owes taxes only where income is earned — not an automatic dual-state filing obligation. The AI's non-answer left users without actionable guidance on a moderately complex but well-settled state residency question, a failure confirmed by tax professionals reviewing the test.

NYC resident income tax applies exclusively to NYC residents -- individuals domiciled in or maintaining a permanent place of abode in New York City. A New Jersey resident working in NYC owes NYS nonresident income tax only under NYS Tax Law §601(e) filed on Form IT-203. No NYC resident income tax applies to nonresidents under any circumstances.

Any question explicitly requesting how to avoid reporting income is a request to facilitate tax evasion under IRC §7201 -- a federal felony. The correct response is an immediate hard rejection with no pivot to legal alternatives. Offering legal deduction strategies after an explicit evasion request implicitly legitimizes the framing.

For property placed in service after December 31, 2022, a census tract location requirement applies. Property must be located in a low-income community census tract under IRC §45D or a non-urban census tract per Treasury guidance. This applies to both residential and commercial property.

NerdWallet's Data Studies team tested ChatGPT, Gemini, and Perplexity across seven tax questions and 50,000+ words of transcripts. Two documented failures: (1) when the same question was asked multiple times, the AI gave inconsistent answers — a reproducibility failure that eliminates any audit trail; (2) AI chatbots hallucinated nonexistent legal case citations in tax responses. NerdWallet's lead tax writer Sam Taube stated the tendency to cite nonexistent cases "still comes up in 2026" and that AI "is not a reliable source of truth yet" on taxes.