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What To Do If You're Audited

No one likes to get a letter from the IRS stating that you are being audited. The good news is, that there are less than 1% of all people that file income taxes making less than $200,000 that will ever get one of these letters on any given tax year.

However, if you make more than a million you have about a 10% chance of being audited any tax year. This is typically because people that make more money tend to have more deductions and this can often trigger the audit. Generally, audits are not random and it isn’t just your turn to be audited, it is because of a pattern of deductions or offsets that triggers a computer to generate your name on a list.

If you are audited and you use an accountant, your first step should be to get in touch with this professional. From there, you can discover what needs to be done to clear up the issue, which may actually be relatively simple in many cases.

To prepare for an audit your accountant will typically have you sit down and:

• Make a complete review – your accountant will double check all information you have provided for accuracy. While uncommon mistakes can occur in copying information or in failing to enter the correct information on a software program that automatically transfers data to the accountant.
• Check your write-offs – your accountant and you should review all your tax write-offs to ensure they are correct. This can also include assisting you in determining what data or documentation will be needed to prove these claims are accurate and valid.
• Review any areas of concern – for those that are self-employed, there can be more potential concern from the IRS than for those that are employed. If you are self-employed your accountant will assist you in gathering information and even getting third-party verification of income, business-related travel and other areas where the IRS is asking for further information or verification.

Last but not least the accountant will also be able to represent you at the audit, helping you to provide the information that is needed to prove the validity of the data that you have submitted on your income tax return.

Failure to Properly Document Business Auto Use Will Cost You Big Time!

Taxpayers must be prepared to substantiate auto deductions with adequate records or sufficient evidence. Failure to do so will cost you thousands of dollars in increased taxes and/or fees to accountants or tax lawyers if you are audited.

Taxpayers should be able to substantiate:

1. The amount of each expenditure for the vehicle, including purchase price, vehicle improvements, lease payments, repair and maintenance, gas and other expenses.
2. The total mileage on each business vehicle and a breakdown of the business, personal and commuting miles.
3. The date of the business use and a brief description of the business purpose for each use and expense.

Records should be maintained in an account book, diary, log, trip sheet or similar record near the time of usage [Brown, TC Summary Opinion 2005-155(2005]. Without a written record of business or investment mileage, a tax auditor will not allow the deduction.

Without a mileage log, the taxpayer will have to convince an appeals officer or the tax court (at substantial increased costs in legal and accounting) through oral testimony and other circumstantial evidence. This can include statements from employers and customers, invoices that required the use of the taxpayer’s car for ordering and delivering and entries in calendar programs.

I prepare hundreds of business returns every year and have spoken to each one of them about these requirements. Still, I can count on one hand the business owners who actually keep a log.

Technology today can be very helpful. Both the I-Phone and the Android have an App that assists in tracking business mileage. Be sure to look for one that exports to a computer file such as Excel in order to keep a hard copy.

You can also use a digital recorder to record the necessary information. Be sure to export the file to your computer. You should also consider having this file transcribed so you can have a hard copy for your file.

Like any good CPA, I need to add a disclaimer: unfortunately, it is impossible to offer comprehensive tax info over the internet, no matter how well researched or written. And remember, I love my readers but having me bookmarked on your computer doesn’t make you a client: before relying on any information given on this site, contact a tax professional to discuss your particular situation.

Bankruptcy and Planning Your Future

There are many different situations that can occur in life that are out of your control. Sudden and unexpected medical emergencies and bills, divorce, the loss of a job, or other situations can happen that leave an individual or a couple unable to meet their financial obligations.

In these situations, and providing all legal criteria are met, bankruptcy, either Chapter 7 or 13, may be the solution to the problem. Chapter 7 bankruptcy is a liquidation of most of your assets to pay off creditors as a settlement for the debts. Chapter 13 is a repayment plan, in which you will keep many of the assets but pay them off over a period of three to five years.

Regardless of the type of bankruptcy, there will still be financial matters to consider during the process and in the years after. A financial planner can be helpful in providing education and guidance in getting back on your feet. They will also be instrumental in helping you to begin to rebuild your wealth and invest in your future.

• Budget development – While budgeting is not the reason for many people to file for bankruptcy, it can sometimes be a contributing factor. By working with a financial planner, it will be possible to develop a practical and workable budget that may provide opportunities for investing and retirement savings much sooner than you thought.
• Planning for purchases – Big purchases such as vehicles and appliances will require a credit check. After going through bankruptcy, there will be a direct hit on your credit score. A financial planner will be able to work with you to not only plan for your future but to also rebuild your credit score.
• Debt repayment plans – Not all debts are discharged in bankruptcy. Working with a financial planner can help in structuring payment plans that will pay the debts down quickly but also accommodate for your day-to-day living needs and other expenses.
• Building an emergency fund – Most financial planners will focus on working with clients to build an emergency fund. This fund will be used when situations that are unplanned for occur, but only if they are essential. This cushion helps people to make better decisions and to avoid using high-interest options such as credit cards or loans to cover these expenses.

It will be important to talk to your financial planner about your options after bankruptcy. This is a time to start fresh and make the best choices for your financial future.

Using QuickBooks to Track Business Auto Use

IRS regulations require that every business owner track the business use of their auto.  But this can be such a hassle that I can count the number of business owners who do so on one hand.  Of course, if you are audited, not having a log can cost you in increased taxes and accounting fees.

QuickBooks has a feature that allows you to track auto mileage.  When I first saw it I thought it was kind of strange.  But then it dawned on me that this was actually pretty brilliant.  Think about it—just about every business use of your auto is tied to a financial transaction.  Consider the following QuickBooks entries and their related auto use:

• Record a deposit – Drive to the bank to deposit it.
• Record a customer estimate – Travel to the customer to review the job and present the estimate (notate both of these on the QuickBooks calendar).
• Record a vendor bill – Drive to the store to buy material and supplies.
• Record a vendor payment – If you deliver the payment, you should note it in the calendar.

 http://youtu.be/N_bLX8U4AUQ

 

What To Do If Your Audited

No one likes to get a letter from the IRS stating that you are being audited. The good news is that there are less than 1% of all people that file income taxes making less than $200,000 that will ever get one of these letters on any given tax year.

However, if you make more than a million you have about a 10% chance of being audited any tax year. This is typically because people that make more money tend to have more deductions and this can often trigger the audit. Generally audits are not random and it isn’t just your turn to be audited, it is because of a pattern of deductions or offsets that triggers a computer to generate your name on a list.

If you are audited and you use an accountant your first step should be to get in touch with this professional. From there you can discover what needs to be done to clear up the issue, which may actually be relatively simple in many cases.

To prepare for an audit your accountant will typically have you sit down and:

• Make a complete review – your accountant will double check all information you have provided for accuracy. While uncommon mistakes can occur in copying information or in failing to enter the correct information on a software program that automatically transfers data to the accountant.
• Check your write-offs – your accountant and you should review all your tax write-offs to ensure they are correct. This can also include assisting you in determining what data or documentation will be needed to prove these claims are accurate and valid.
• Review any areas of concern – for those that are self-employed there can be more potential concern from the IRS than for those that are employed. If you are self-employed your accountant will assist you in gathering information and even getting third party verification of income, business related travel and other areas where the IRS is asking for further information or verification.

Last but not least the accountant will also be able to represent you at the audit, helping you to provide the information that is needed to prove the validity of the data that you have submitted on your income tax return.

2016 IRS Mileage Rate Decreases

The IRS recently announced the official standard mileage rates for 2016. The mileage rates are:

• 54 cents per mile for business use. This is a 3.5 cents per mile decrease from the 2015 business mileage rate.

• 19 cents per mile for medical and moving miles driven in 2016. This is a 4 cents per mile decrease from the 2015 rate.

• 14 cents per mile for charitable related miles driven in 2016. This remained unchanged from 2015. (The charitable rate is set by law and does not automatically adjust annually.)

The drop in fuel costs during 2015, which reached a six-year low, is the obvious reason for the declining rates.

The mileage rate can be used by businesses to reimburse employees for mileage costs incurred while driving business vehicles in an employee capacity. They must submit mileage logs and the new mileage rate must be used by the business to deduct the reimbursements and the employees to receive the reimbursement tax free.

As always—be sure to review this with your tax advisor before setting up an employee mileage reimbursement plan.

Help!! I Just Got an IRS Collection Letter!

Nothing gets your blood pressure up like getting an IRS collection letter demanding money!  So what should you do if you receive one?

First—do not panic!  The good news is that in my experience at least half of them are wrong.  Many times the IRS computer is kicking out a notice based on income reported to them on a 1099 that was reported on the original tax return correctly, but under a different name or by a different taxpayer (such as a related corporation).  These are just two of the many reasons we have seen over the years where the notice proposing a change was successfully reversed.

If you do owe the amount but can’t pay it, the IRS has procedures in place to make payments.  (This is another area where you should get your tax preparer or a CPA to help you.)

The second thing you should do is bring the letter to your tax preparer.  We have much more experience dealing with these letters and can usually tell you if it is a serious matter or not right on the spot.  If you did the return yourself, I would highly recommend getting professional help.

Third, don’t ignore the letter!  The problem won’t go away.  The IRS collection letter may be wrong, but the IRS is very good at collecting the amount they think you owe.  Please don’t wait until you receive the dreaded “Intent to Levy” letter.  Many times this is the first letter a client brings to us, and now it’s an emergency.  But this is actually the third or fourth letter in the collection series.  So please, answer the first one while you have time to properly research it and give the IRS time to fix their records.  Trust me, the IRS won’t forget you owe them!

And finally—have patience!  You are dealing with a large, inefficient bureaucracy that is very slow to remove amounts it thinks you owe.  Many times it takes us two or three letters and/or calls to get the IRS to remove the erroneous additional tax amount.

“The IRS is auditing me!! Oh God, why me?”

This is the clean version of my client’s first thoughts when they receive an audit notification.  Then, naturally, they start panicking about their return—if it was done correctly, what deductions they took, and what to do now.

If this happens to you, first of all, you have my sympathy.  Second, I suggest you have either a CPA or tax attorney represent you.  They have the training and experience to deal with an auditor.  Yes, they will charge you, but their fee can be cheaper than the changes the IRS may propose to your tax return.  Plus, it can take some of the pressure off you!

Then I suggest rummaging through your records to find the back-up for your tax return.  When we say back-up, the IRS wants RECEIPTS, RECEIPTS, RECEIPTS!!  Credit card statements and bank statements do not have itemized details, so the IRS can disallow your deductions.  The IRS is tough and likes to play hardball, so you need to have proof that you indeed paid for all the deductions you have claimed.

Unfortunately, an IRS computer is to blame for most audits.  Every tax return filed is analyzed by a computer program called the Discriminant Function (DIF), and it scores your return compared to other returns similar to yours.  Based on that score, the DIF will determine if you are a candidate for an audit.  For example, if you have a business that made $100,000 in sales and you took a deduction of $ 75,000 in advertising (not many businesses spend most of their sales income on advertising), chances are you’ll raise flags.  Though only a small percentage of tax returns are actually audited, deductions like these will surely increase the chances.  Trust me, you don’t want to win this lottery.

Author and attorney Frederick W. Daily (Stand Up to the IRS, $29.99, Nolo Publishing) lists the following items as factors that are likely to figure into the audit selection process.  These include:

Comparative size of the item to the rest of the return.  This is like the advertising analogy.  It does not make sense to the IRS that you spent 75 percent of your income on one expense.

An item on the return is out of character for the taxpayer.  Example:  A restaurant owner claiming 25 percent of their expenses on travel.

An item is reported in an inappropriate place on the return.  For example, $2,000 of credit card interest is reported as a business expense.  The IRS might suspect that you improperly deducted personal interest as a business deduction.

Evidence of intent to mislead on the return.  Filing a tax return with missing schedules or not providing all the information asked for on the forms raises questions.

Your gross income.  The IRS targets higher earners.  If you make over $100,000 per year, your odds of an audit are 1 in 20 versus 1 in 100 for the general population.

Self-employment income.  The IRS is most suspicious of people in business for themselves.  Sole proprietors are four times more likely to be audited than a wage earner.

Losses from businesses and investments claimed on the tax return.  If your business and investments show losses on your tax return, the IRS may want to know how you paid your bills.  Taxpayers reporting a small business loss are most likely to be audited.

Sloppiness and round numbers.  A messy return, especially if handwritten, attracts attention.  The use of rounding is a dead giveaway that you are estimating and not reporting from records.

So how do you avoid an audit?  Well, you may not be able to.  I always advise my clients to take every deduction that they are entitled to.  The key is to have the back-up to support the deduction!  I cannot stress that enough.  If you do, then you will be sitting pretty during an IRS audit.

Tax Break on iPads

The following article appeared in the July 2015 issue of Small Business Tax Strategies (a publication worth checking out at www.SmallBizTax.net):

The IRS has informally indicated that iPads and other tablets will be treated like cell phones when employers provide them to employees.  Thus, employees won’t be taxed on the value of personal use, as long as the devices are provided primarily for business reasons rather than as a form of compensation.

Similarly, reimbursements made by employers to employees for personally owned iPads generally should not be subject to tax when used primarily for business.

Remember, this isn’t an official IRS regulation.  But I believe that iPads would fall under the “similar telecommunications equipment” discussed in IRS Notice 2011-72.  That notice mainly covered cell phones provided by employers to employees, but it makes sense that the IRS would expand it to tablets and iPads.

IRS Posts Charitable Deduction Tips

Over the last few years, IRS auditors have been focusing on charitable contributions.  The IRS is always suspicious that taxpayers are inflating their charitable deduction amount (I first wrote about this on my 3/1/12 blog titled IRS Declares War on Charitable Contributions).  Failing to follow the strict letter of the tax law and IRS regulations will result in your deduction being disallowed.

 

The IRS recently posted a reminder on its website featuring nine tax deduction tips (IRS Tip 2013-45 04/01/13):

1. To qualify for a deduction, you must make the donation to a qualified charitable organization.  You can’t deduct contributions made to an individual, a political organization, or a candidate.
2. A taxpayer must file Form 1040 and claim itemized deductions on Schedule A.  They must also must file Form 8283 for non-cash charitable deductions that exceed $500 for the year.
3. If you receive a benefit of some kind in return for your contribution, you can only deduct the amount that exceeds the fair market value of the benefit you receive.  An example of this is reducing your donation by the value of a meal you receive at the event.
4. Donations of stock or other non-cash property are usually valued at fair market value.  Used clothing and household items need to be in good condition.  Special rules apply to vehicle donations.
5. Fair market value is generally the price you would receive if you sold the item.
6. You must have a written record of your donation to deduct any cash gift, regardless of the amount.  The documentation should include the name of the organization and the date and amount of your contribution.
7. For gifts above $250, you must obtain a written statement from the qualified organization detailing the amount of the cash donation or a description of any property given.  It must also state whether the organization provided any goods or service in exchange for the gift.
8. You may use the same document to meet the requirements of a written statement for any cash gift and a written acknowledgement for contributions of $250 or more.
9. If a taxpayer donates one item or a group of similar items that are valued at more than $5,000, Section B of Form 8253 must be completed.  Be sure to obtain an appraisal from a qualified professional before making a donation of this size.

Business Success Secrets: Lessons Business Owners Keep Learning the Hard Way! No Pain – No Change! The Unofficial Business Owner’s Slogan



The myth most business owners believe: I can still get the job done, it can wait.

Why this myth causes a problem: Just about every week I meet with business owners who have waited too long to address an issue that has now become an emergency! The numbers of potential problems just waiting to trip up a business owner are almost limitless. The most common first symptom that a business owner usually has is a shortage of cash.

The truth successful business owners learn the hard way! You can never rest! A successful business owner is always on the lookout for little problems that can grow into huge problems that can threaten the survival of their company.

One of the ways they do this is by updating their strategic plan at least annually. They pay particular attention to external threats that are affecting their business now and could threaten their very survival in the future.

 

I know that this sounds somewhat melodramatic. But, consider the fate of BlockBuster. A decade ago they had a rapidly expanding business and were a leader in the home entertainment market. But, they failed to see the threat that a small startup named Netflix represented. Now they are in bankruptcy.

 

The second thing a successful business does is review their internal systems annually. They are looking for better ways to deliver their products and meet the needs of their customers. Failing to do this often leads to a competitor who took the time to improve their systems stealing your customers.

 

Third, they review their marketing and sales tools to make sure they are still reaching and appealing to their “ideal” customer. With the internet and social media changing the way your customers are interfacing with businesses almost on an hourly basis, failing to at least consider the impact of these items on your business may make you the next “Blockbuster”.

 

Fourth, a successful business owner understands that their employees are one of their most important assets. They review their personnel needs with their current employees and determine whether any changes are needed. Do they need new employees, an improved training program, a better recruitment plan, changes in the compensation plan and many, many more employee related items?

 

Finally, a successful business owner doesn’t ignore the financial side of their business. They have accounting systems that provide them with accurate data that allows them to make educated business decisions rather than making decisions based on a hunch. They have a budget that supports their business goals. And finally, they also understand the importance of tax planning.

 

Lesson learned:  If you want to grow a profitable business you must plan for success and solve problems before they grow to such a size that they threaten the very survival of your business.          

Tax Tip of the Week – Determining Deductible Business Expenses

Every business owner has tons of business expenses that they “need” in order to run their business. And, every business owner believes that everything they spend should be deducted on their tax return. But, the tax code makes reporting these expenses to the IRS tricky. According to the law, some expenses are fully deducted, some expenses are only partially deducted and other expenses are never deductible.

This will be the first in a series on the topic of deductible business expenses. But, let’s start this week with a brief overview on the topic.

So, what is a business expense?

Business Expense - Money spent or cost incurred in an organization's efforts to generate revenue, representing the cost of doing business.

This can be pretty vague. I have heard this one almost a hundred times a tax season, “I need to buy suits for work so that is a business expense.”  Hate to burst your bubble; but, according to the IRS it’s not. As a general rule, nothing is deductible unless you can point to somewhere in the IRS code that states it is.

So, how do you know if something qualifies as a business expense?  In order for an expense to be deductible it must meet the following four categories:

• The expense is ordinary and necessary for business.
• The expense is current (in other words for the current year).
• The expense is directly related to your business.
• The expense is in reasonable amount

I’ll give you an example of an expense that meets all of the criteria. Your business phone services:

• You need a phone line for your business to contact customers and for customers to reach your business.
• The bills you paid during the tax year will be deducted on that year’s tax return. The phone line is only used for business purposes.
• And hopefully you’re not being ripped off and your bill is a reasonable amount.

Now here is a similar scenario but some of the expenses might not be deductible.  Your cell phone bill:

• You use your cell phone for business and personal use. We usually estimate what is used for business and personal and use a percentage of what you paid.
• We can only use what you paid in the tax year so if you paid December’s bill in January what you paid in January will not be used in this tax return but next years
• Again whatever you use for business is deductible so if you have a family plan you cannot take other family member’s portion of the bill as a business deduction unless they work for you and genuinely use it 100% for business.
• Last but not least, reasonable amount you have a small, low tech business and you spend $1,500 on a new cell phone, you better be prepared to prove to IRS that is a necessary business expense and is used for business purposes.

In future parts of this series will go into more detail of the four items that a taxpayer must prove in order to deduct a business expense along with examples of expenses that are never deductible.

  Like any good CPA, I need to add a disclaimer: unfortunately, it is impossible to offer comprehensive tax info over the internet, no matter how well researched or written. And remember, I love my readers but having me bookmarked on your computer doesn’t make you a client: before relying on any information given on this site, contact a tax professional to discuss your particular situation.

Tax Tip of the Week- IRS Audit Red Flags: The Dirty Dozen

Here are twelve hot spots on your return that can raise the chances of scrutiny by the IRS.

By Joy Taylor, Assistant Editor, The Kiplinger Tax Letter www.kiplinger.com/links/auditredflags

Ever wonder why some tax returns are audited by the IRS while most are ignored? Well, there’s a whole host of reasons to this age-old question. The IRS audits only about 1% of all individual tax returns annually. The agency doesn’t have enough personnel and resources to examine each and every tax return filed during a year. So the odds are pretty low that your return will be picked for an audit. And of course, the only reason filers should worry about an audit is if they are cheating on their taxes.

However, the chances of you being audited or otherwise hearing from the IRS can increase depending upon various factors, including whether you omitted income, the types of deductions or losses claimed, certain credits taken, foreign asset holdings and math errors, just to name a few. Although there’s no sure way to avoid an IRS audit, you should be aware of red flags that could increase your chance of drawing some unwanted attention from the IRS. Here are the 12 most important ones:

1. Failure to report all taxable income.
The IRS receives copies of all 1099s and W-2s that you receive during a year, so make sure that you report all required income on your tax return. the IRS computers are pretty good at matching these forms received with the income shown on your return. A mismatch sends up a red flag and causes IRS computers to spit out a bill. If you receive a 1099 for income that isn’t yours or the income listed is incorrect, get the issuer to file a corrected form with the IRS.

2. Returns claiming the home-buyer credit.
First-time homebuyers and longtime homeowners who claimed the homebuyer credit should be prepared for IRS scrutiny. Make sure you submit proper documentation when taking this credit. First-time homebuyers have to attach a copy of their settlement statement to the return, and longtime homeowners should also attach documents showing prior ownership of a home, including records of property tax and insurance coverage. All claims for this credit are being screened. As of May 2010, more than 260,000 returns had been selected for correspondence audits (examinations done by mail rather than face-to-face) because filers did not attach the necessary documents to their tax returns. And those numbers will continue to grow.

Also, the IRS has ways of policing the recapture of the homebuyer credit. Generally, the credit is required to be recaptured if the home is sold within three years for homes brought in 2009 or 2010 and within 15 years for homes bought before 2009. The IRS is checking public real estate databases for sales of homes for which the credit was taken.

3. Claiming large charitable deductions.
This comes up again and again because the IRS has found abuse on audit, especially with those taking larger deductions. We all know that charitable contributions are a great write-off and help you to feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared to your income, it raises a red flag. That’s because the IRS can tell what the average charitable donation is for a person in your tax bracket. Also, if you don’t get an appraisal for donations of valuable property or if you fail to file Form 8283 for donations over $500, the chances of audit increase. Be sure you keep all your supporting documents, including receipts for cash and property contributions made during the year, and abide by the documentation rules. And attach Form 8283 if required.

4. Home office deduction.
The IRS is always very interested in this deduction, primarily because it has a pretty high adjustment rate on audit. This is because history has shown that many people who claim a home office don’t meet all the requirements for properly taking the deduction, and others may overstate the benefit. If you qualify, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance, and other costs that are properly allocated to the home office. That’s a great deal. However, in order to take this write-off, the space must be used exclusively and on a regular basis as your principal place of business. That makes it difficult to claim a guest bedroom or children’s playroom as a home office, even if you also use the space to conduct your work. Exclusive use means a specific area of the home is used only for trade or business, not also where the family watches TV at night. Don’t be afraid to take the home-office deduction if you’re otherwise entitled to it. Risk of audit should not keep you from taking legitimate deductions. If you have it and can prove it, then use it.

5. Business meals, travel and entertainment.
Schedule C is a treasure trove of tax deductions for self-employeds. But it’s also a gold mine for IRS agents, who know from past experience that self-employeds tend to claim excessive deductions. Most under-reporting of income and overstating of deductions are done by those who are self-employed. And the IRS looks at both higher-grossing sole proprietorships as well as smaller ones.

Big deductions for meals, travel and entertainment are always ripe for audit. A large write-off here will set off alarm bells, especially if the amount seems too large for the business. Agents know that many filers slip in personal meals here or fail to satisfy the strict substantiation rules for these expenses. To qualify for meals or entertainment deductions, you must keep detailed records generally documenting the following for each expense: amount, place, persons attending, business purpose and nature of discussion or meeting. Also, receipts are required for expenditures over $75 or any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast.

6. Claiming 100% business use of vehicle
. Another area that is ripe for IRS review is use of a business vehicle. When you depreciate a car, you have to list on Form 4562 what percentage of its use during the year was for business. Claiming 100% business use for an automobile on Schedule C is red meat for IRS agents. They know that it’s extremely rare that an individual actually uses a vehicle 100% of the time for business, especially if no other vehicle is available for personal use. IRS agents are trained to focus on this issue and will closely scrutinize your records. Make sure you keep very detailed mileage logs and precise calendar entries for the purpose of every road trip. Sloppy recordkeeping makes it easy for the revenue agent to disallow your deduction. As a reminder, even if you use the IRS’ standard mileage rate to deduct your business vehicle costs, ensure that you are not also claiming actual expenses for maintenance, insurance and other out-of-pocket costs. The IRS has found filer noncompliance in this area as well and will look for this.

7. Claiming a loss for a hobby activity.
Your chances of “winning” the audit lottery increase if you have wage income and file a Schedule C with large losses. And, if your Schedule C loss-generating activity sounds like a hobby…horse breeding, car racing, and such…the IRS pays even more attention. It’s issued guidelines to its agents on how to sniff out those who improperly deduct hobby losses. Large Schedule C losses are audit bait, but reporting losses from activities in which it looks like you might be having a good time is just asking for IRS scrutiny.

Tax laws don’t allow you to deduct hobby losses on Schedule C; however, you do have to report any income earned from your hobbies. In order to claim a hobby loss, your activity must be entered into and conducted with the reasonable expectation of making a profit. If your activity generates profit three out of every five years (or two out of seven years for horse breeding), the law presumes you’re in business to make a profit, unless the IRS establishes to the contrary. If audited, the IRS is going to make you prove you have a legitimate business and not a hobby. So, make sure you run your activity in a business-like manner and can provide supporting documents for all expenses.

8. Cash businesses.
Small business owners, especially those in cash-intensive businesses…taxi drivers, car washes, bars, hair salons, restaurants and the like…are an easy target for IRS auditors. The agency is well aware that those who primarily receive cash in their business are less likely to accurately report all of their taxable income. the IRS wants to narrow the tax gap, and history has shown that cash-based businesses are a good source of audit adjustments. It has a new guide for agents to use when auditing cash intensive businesses, telling how to interview owners and noting various indicators of unreported income.

9. Failure to report a foreign bank account.
The IRS is intensely interested in people with offshore accounts, especially those in tax havens. U.S. tax authorities have had some recent success in trying to get foreign banks (such as UBS in Switzerland) to disclose information on U.S. account holders. Also, the IRS had a voluntary compliance program where people came in and reported their foreign bank accounts and foreign assets in exchange for lesser penalties than they would have otherwise been subject to. The IRS has learned a lot from these probes.

Failure to report a foreign bank account can lead to severe penalties, and the IRS has made this issue a top priority. Make sure that if you have any such accounts, you properly report them when you file your return. Keep in mind, though, that if you have never previously reported the foreign bank account on your return, and you decide to do so for the first time in 2010, that might also look suspicious to the IRS.

10. Engaging in currency transactions.
The IRS gets many reports of cash transactions in excess of $10,000 involving banks, casinos, car dealers and other businesses, plus suspicious activity reports from banks and disclosures of foreign accounts. A recent report by Treasury inspectors concluded that these currency transaction reports are a valuable source of audit leads for sniffing out unreported income. The IRS agrees and it will make greater use of these forms in its audit process. So if you are a person who makes large cash purchases or deposits, be prepared for IRS scrutiny. Also, beware that banks and other institutions file reports on suspicious activities that appear to avoid the currency transaction rules (such as persons depositing $9,500 cash one day and an additional $9,500 cash two days later).

11. Math errors.
One of the biggest reasons that people receive a letter from the IRS is because of mathematical mistakes they make on their tax returns. If you make an error in your favor, you are going to hear from the tax man, and there is a greater risk of the IRS pulling the whole return for audit. So take time to ensure all your calculations are correct. Even though math errors may not lead to a full-blown audit, it’s always best to remain under the radar of IRS computers.

12. Taking higher-than-average deductions.
If deductions on your return are disproportionately large compared to your income, the IRS audit formulas take this into account when selecting returns for examination. Screeners then pull the most questionable returns for review. But if you’ve got the proper documentation for your deduction, don’t be scared to claim it. There’s no reason to ever pay the IRS more tax than you actually owe.

Read more: http://www.kiplinger.com/features/archives/12-audit-red-flags-the-irs-looks-for.html#ixzz1IgoCiuRd
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Tax Tip of the Week- Cash Donations Substantiation Requirements

Ahhh!! Tax Season is in full swings here at the office, so creativity is temporarily taking a back seat. So until we get past our deadline, we will still do our best to post our weekly blog but they will be taken from our tax resources. This one is from QuickFinder 1040 for 2010.

No deduction is allowed unless the taxpayer has either (1) bank records (for example, a cancelled check or account statement) or (2) written acknowledgment from the charity documenting the contribution's amount and date. [IRC §170(f)(17)]. This means that donors who give cash will need to get written acknowledgement for the charity to claim a deduction. Using a check for small donations, rather than cash , may be preferable.

Charitable contributions of $250 or more in any one day to any one organization must have written substantiation from the organization. A canceled check is not sufficient to support the deduction [IRC §170(f) (8)]. The acknowledgment letter must be received by the earlier of the date the tax return is filed for the contribution year or the extended due date for filing, including extensions. Payroll deduction contributions: Employees can substantiate a payroll deduction of $250 or more with (1) a Form W-2 or other document from the employer showing payroll deduction, and (2) a pledge card or other document prepared by the charity.

Tax Tip of the Week- Let’s Talk Meals & Entertainment Deductions

I regularly have conversations with my business owners about meals and entertainment deductions. A lot of business owner’s know they can deduct meal and entertainment expenses they just don’t know when or how to document theses items.

First, let’s go over what qualifies as a meal or entertainment deduction: (taken from 1040 Quickfinder 2010)

The cost of entertaining a client, customer or employee can qualify as an ordinary and necessary business expense. Entertainment activities can include the cost of meals (food, beverages, tax, and tip). Entertainment can be provided at facilities such as nightclubs, social clubs, sport facilities or theatres, or on hunting, fishing, vacation and similar trips.

To qualify for a deduction, the entertainment expense must be directly related to associate with the active conduct of a trade or business, or for the production or collection of income.

So what does this mean in English? If you take a client, employee or business associate out to eat or for a night on the town and you did this for a BUSINESS purpose you can take it as a business deduction. You can even host an event for clients, employees or business associates and take the expenses as a deduction if the event is held to benefit your business.

Of course this must be done in good reason. You shouldn’t spend $10,000 on a client wining and dining them when you only expect $200 dollars in business. That’s not good business plus if you were to be audited the IRS can rule the deduction excessive not allow them.

Now when it comes to documenting these events YOU MUST SAVE THE RECIEPT!!! The IRS does not always want to accept bank or credit card statements as proof of a deduction! Also on the receipt you need to write who attended the event and what was the business purpose of it.

For example you take your staff to lunch to go over new policies you have set. You would need to keep the receipt, note who attended and the purpose, to go over new company policies and procedures. It’s as easy as that. But you need to make sure you do this step if you intend on deducting this expense.

And here is another kicker the IRS has, meal and entertainment deductions are limited to 50%. So, if you have $6,000 of meal and entertainment expenses the IRS will only allow you to deduct $3,000.

I know this a lot to take in but this is the general explanation of these types of deductions. If you need more information, just call my office at 915-857-8158 and we’ll do our best to clear this up for you.

Like any good CPA, I need to add a disclaimer: unfortunately, it is impossible to offer comprehensive tax info over the internet, no matter how well researched or written. And remember, I love my readers but having me bookmarked on your computer doesn’t make you a client: before relying on any information given on this site, contact a tax professional to discuss your particular situation.

Surviving an IRS Audit Series - Business Meals & Entertainment Expenses

 

Many of my clients ask me about the rules regarding meal and entertainment tax deductions. Generally, the only time you are allowed to take this type of deduction is if you own a business. Individual may take these types of expenses as an itemized deduction if it is job related and is over 2% your gross income.

If you do own a business, the expense of providing entertainment to a client, customer, or employee can qualify as an ordinary and necessary business expense. Expenses such as meals (food, beverage, tax and tip) and entertainment at facilities like nightclubs, social clubs, sport facilities, or theatres can be deducted. Even expenses for vacations, hunting and fishing trips can be taken if it is an ordinary and necessary business expense. Unfortunately, the cost of renting or owning a facility is not deductable nor is the cost of club dues. 

In order to show that your deductions are directly related to your business, you must:

1.   Prove that the main purpose of the event was business

2.   Engage in business with a person or persons during a meal or entertainment activity

3.   Have a reasonable expectation of receiving income or some other specific business benefit in the future.

Basically, you will need to prove that business was discussed or occurred during the event or you held the event or meal in hopes to obtain future business.

The IRS will not allow a qualifying deduction if they rule the expense too lavish or extravagant. The IRS will not disallow your deduction just because you took a client to Cattleman’s; but, they may not allow a deduction if you spent one million dollars on an event that will only bring in twenty thousand dollars in sales. Skyboxes and luxury box rentals may fall under this rule if these facilities were rented for more than a single event.

These meal and entertainment deductions are not 100% deductable there is 50% limit. This means you can only deduct half of what you actually spent on your tax return. Taxes and tips related to a meal or entertainment, cover charges for admission to a night club, room rental for a business dinner or party and parking at a sports arena are all expenses that are subject to the 50% limit. If an expense is reimbursed it is no longer deductable.

Just like everything else, you must have RECEIPTS, RECEIPTS, RECEIPTS!!! The IRS requires you to show who attended the event or meal, how much was spent and where it took place. An easy way to document this is to write on the actual receipt who attended and what was the business purpose for the meal. For an event, you can keep all the receipts in an envelope and write the event details and business purpose on the envelope.

If you want to research this matter in greater detail, you can visit www.irs.gov and search for Publication 463, or you can call us at 915-857-8158 and we can help you answer any questions.

Sited from 1040 Quickfinder 2008

The IRS Is Auditing Me!! Oh God, Why Me?

 

“The IRS is auditing me!! Oh God, why me?” This is the clean version of my client’s first thoughts when they receive their audit report.  Then, naturally, they start franticly thinking about their return; if it was done correctly, what the heck did they deduct and what to do now. 

If this happens to you, first of all, you have my sympathy. Second, I suggest you have either a CPA or tax attorney to represent you. Reason being, they have the training and experience to deal with an auditor. As I mentioned before, they will charge you but their fee can be cheaper than the changes done to your tax return. Plus, it can take some of the pressure off you! Then, I suggest rummaging through your records to find the back-up for your tax return. When we say back-up the IRS wants RECEIPTS, RECEIPTS, RECEIPTS!! CREDIT CARD STATEMENTS AND BANK STATEMENTS DO NOT HAVE ITEMIZED DETAILS SO THEY CAN DISALLOW YOUR DEDUCTIONS. The IRS is tough and are playing hard ball. So you need to have proof that you indeed paid for the deductions you have claimed.

Unfortunately, an IRS computer is to blame for most audits. Every tax return filed is analyzed by a computer called the Discriminant Function(DIF),  and it scores your return compared to other returns similar to yours. Based on that score, DIF will determine if you need to be audited. For example, you have a business and made $100,000 in sales and took a deduction of $ 75,000 in advertising (not many businesses spend most of their sales income on advertising), chances are you’ll raise flags. Though a small percentage of tax returns are actually audited, deductions like these will surely increase the chances.  Trust me, you don’t want to win this lottery.  

Author and attorney Frederick W. Daily (Stand Up To the IRS, $29.99, Nolo Publishing) lists the following items as factors that are likely to figure into the audit selection process. These include:

· Comparative size of the item to the rest of the return. This is like the advertising analogy. It does not make sense to the IRS to spend 75% of your income on one expense.

· An item on the return is out of character for the taxpayer. Example: A restaurant owner claiming 25% of their expenses on travel.

· An item is reported at an inappropriate place on the return. For example, $2,000 of credit card interest is reported as a business expense. The IRS might suspect that you improperly deducted personal interest as a business deduction.

· Evidence of intent to mislead on the return. Filing a tax return with missing schedules or not providing all information asked for on the forms raises questions.

· Your gross income. The IRS target higher earners. If you make over $100,000 per year, your audit likelihood is 1 in 20 versus 1 in 100 for the general population.

· Self-employment income. The IRS is most suspicious of people in business for themselves. Sole proprietors are four times more likely to be audited than a wage earner.

· Losses from businesses and investments claimed on the tax return. If your business and investments show losses on your tax return, the IRS may want to know how you paid your bills. Most likely to be audited are taxpayers reporting a small business loss.

· Sloppiness and round numbers. A messy return, especially if handwritten, attracts attention. The use of rounding is a dead giveaway that you are estimating and not reporting from records.

So how do I avoid an audit? Well, you may not be able to. I always advise my clients to take every deduction that they are entitled to. But, the key is to have the back-up to support the deduction! I cannot stress that enough. If you do, then you will be sitting pretty during an IRS audit.

Future posts in this series will discuss the most common deductions and what documentation is required.

IRS Audits? Those Still Exist?

OK, the IRS auditors aren't as bad as the tattooed, green haired punk trying to take your daughter out on a date. But, if you are a small business owner, it can be just as threatening to your business financial health.

First and foremost, the IRS is back and in a BIG way. In the seventies and eighties the IRS in El Paso was very active and there was a very decent chance that a small business owner would experience an audit, especially as their business sales increased. Starting in 1995, there were senate hearings on abuse of power by the IRS. The end result was budget cuts for the IRS and a reduction in the number of audits nationwide, including the El Paso area.  For example, none of the tax returns I prepared had been chosen for an audit between1991 to 2006. This would have never happened before! In the last two years, three of my returns have been audited. In two of these cases, I warned my clients that their tax return had red flags for an audit, but unfortunately they did not believe one would happen. And from what I have seen and heard, more audits are to come.

Since the IRS wasn’t doing their job, business owners’ didn’t see the need to keep proper records. Why should they? They had never even heard of any of their fellow business owners being audited. In 2004, Congress realized that and started increasing the budget. In El Paso, this has translated into the IRS tripling their current auditing staff.

The best analogy for what is happening is a busy intersection where the speed limit is 25 MPH. No one drives that slow but, all of a sudden there is a speed trap on that street for a week straight. The law hasn't changed - only the enforcement. That is what is happening with the IRS. Business owners were always supposed to have the proper documentation for all expenses deducted on their return but few ever did!

If you are a business owner you are definitely a target! The IRS believes that:

1.    You are hiding income.

2.    There are taxes to be collected from you.

3.    You don't have the necessary documentation to back up claimed deductions- in most cases they are right.

Another big change with the current audit process is that the new IRS auditors are sticking to the letter of the law. To put it simply - if it isn't written down it didn't happen! The older auditors in the 70's an 80's were more willing to negotiate a reasonable amount if your records were not complete. The new auditors are making a decision to throw out any deduction not fully backed up. They know that you have the right to take them to tax court. And, they know that you have a much better chance to win there if you can show adequate evidence that you had the deduction. But, they also know that it will cost you $5,000 to $10,000 to hire a tax attorney and they are betting that many taxpayers will just decide to pay the tax to end the suffering. It’s like an expensive game of chicken.

Do not underestimate the financial risk of an audit to your business! Almost 80% of audits result in the IRS assessing more taxes with penalties and interest. Not to mention the cost of representation!

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A common misconception is that your tax preparer will represent you for free. Sorry, don’t take it personal; but, all I sell is my time, knowledge and experience. When you hire us to prepare your tax return we, are preparing your taxes from the information you provide us. But, we are not auditing it to determine that you have proper documentation as required by the IRS. This is true of all tax preparers nationwide.

The time lost to prepare for an IRS audit is another cost to the business owner. This is time that could and should have been used to get new customers or improve your business operations.

So, how can a business owner defend themselves? The only defense is to accept that an audit is a real risk. Learn what documentation you need and develop systems to gather the information needed, not only to survive an audit, but to make the process run as fast and smoothly as possible. Future posts in this series will provide you with the information you need to accomplish this.