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Swimming With Sharks: Having Your Tax Return Flagged For Audit

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June 1  |  IRS News  |   admin

Here are some hot areas that may put your tax return in the IRS audit pool

Ever wonder why some tax returns are eyeballed by the Internal Revenue Service while most are ignored? The IRS audits only slightly more than 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. And its resources are shrinking…the number of enforcement staff dropped nearly 6% last year, partly due to budget cuts. So the odds are pretty low that your return will be picked for review. And, of course, the only reason filers should worry about an audit is if they are fudging on their taxes.

However, the chances of being audited or otherwise hearing from the IRS increase depending upon various factors, including your income level, whether you omitted income, the types of deductions or losses you claimed, the business in which you’re engaged and whether you own foreign assets. Math errors may draw IRS inquiry, but they’ll rarely lead to a full-blown exam. Although there’s no sure way to avoid an IRS audit, you should be aware of red flags that could increase your chances of drawing unwanted attention from the IRS.

1. Making too much money

Although the overall individual audit rate is about 1.03%, the odds increase dramatically for higher-income filers. 2017 IRS statistics show that people with incomes of $200,000 or higher had an audit rate of 3.70%, or one out of every 27 returns. Report $1 million or more of income? There’s a one-in-eight chance your return will be audited. The audit rate drops significantly for filers making less than $200,000: Less than 1% (0.94%) of such returns was audited during 2017, and the vast majority of these exams were conducted by mail. We’re not saying you should try to make less money — everyone wants to be a millionaire. Just understand that the more income shown on your return, the more likely it is that you’ll be hearing from the IRS.

2. Failing to report all taxable income

The IRS gets copies of the 1099s and W-2s you receive, so make sure you report all required income on your return. IRS computers are pretty good at matching the numbers on the forms with the income shown on your return. A mismatch sends up a red flag and causes the IRS computers to spit out a bill. If you receive a 1099 showing income that isn’t yours or listing incorrect income, get the issuer to file a correct form with the IRS.

3. Taking large charitable deductions

We all know that charitable contributions are a great write-off and help you feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared with your income, it raises a red flag. That’s because IRS computers know what the average charitable donation is for folks at your income level. 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. And if you’ve donated a conservation easement to a charity, chances are good that you’ll hear from the IRS. Be sure to keep all your supporting documents, including receipts for cash and property contributions made during the year, and abide by the documentation rules. Always attach Form 8283 if required.

4. Claiming the home office deduction

Like Willie Sutton robbing banks (because that’s where the money is), the IRS is drawn to returns that claim home office write-offs because it has found great success knocking down the deduction and driving up the amount of tax collected for the government. 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. For 2014, you have a simplified option for claiming this deduction. The write-off can be based on a standard rate of $5 per square foot of space used for business, with a maximum deduction of $1,500. To take advantage of this tax benefit, you must use the space exclusively and regularly as your principal place of business. That makes it difficult to successfully claim a guest bedroom or children’s playroom as a home office, even if you also use the space to do your work. “Exclusive use” means that a specific area of the home is used only for trade or business, not also for the family to watch TV at night. Don’t be afraid to take the home office deduction if you’re 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. Claiming rental losses

Normally, the passive loss rules prevent the deduction of rental real estate losses. But there are two important exceptions. If you actively participate in the renting of your property, you can deduct up to $25,000 of loss against your other income. But this $25,000 allowance phases out as adjusted gross income exceeds $100,000 and disappears entirely once your AGI reaches $150,000. A second exception applies to real estate professionals who spend more than 50% of their working hours and 750 or more hours each year materially participating in real estate as developers, brokers, landlords or the like. They can write off losses without limitation. But the IRS is scrutinizing rental real estate losses, especially those written off by taxpayers claiming to be real estate pros. The agency will check to see whether they worked the necessary hours, especially in cases of landlords whose day jobs are not in the real estate business.

6. Deducting 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 experience that self-employeds sometimes claim excessive deductions. History shows that most under-reporting of income and overstating of deductions are done by those who are self-employed. And the IRS looks at both high-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 high for the business. Agents are on the lookout for personal meals or claims that don’t satisfy the strict substantiation rules. To qualify for meal or entertainment deductions, you must keep detailed records that document for each expense the amount, the place, the people attending, the business purpose and the nature of the discussion or meeting. Also, you must keep receipts for expenditures over $75 or for any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast.

7. Claiming 100% business use of a vehicle

Another area 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 of an automobile is red meat for IRS agents. They know that it’s extremely rare for an individual to actually use 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 scrutinize your records. Make sure you keep detailed mileage logs and precise calendar entries for the purpose of every road trip. Sloppy record keeping makes it easy for the revenue agent to disallow your deduction. As a reminder, if you use the IRS’ standard mileage rate, you can’t also claim actual expenses for maintenance, insurance and other out-of-pocket costs. The IRS has seen such shenanigans and is on the lookout for more.

8. Writing off 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 the loss-generating activity sounds like a hobby — horse breeding, car racing and such — the IRS pays even more attention. Agents are specially trained to sniff out those who improperly deduct hobby losses. Large Schedule C losses are always audit bait, but reporting losses from activities in which it looks like you’re having a good time all but guarantees IRS scrutiny.

You must report any income you earn from a hobby, and you can deduct expenses up to the level of that income. But the law bans writing off losses from a hobby. For you to claim a 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 that you’re in business to make a profit, unless IRS establishes otherwise. If you’re 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 businesslike manner and can provide supporting documents for all expenses.

9. Running a cash business

Small business owners, especially those in cash-intensive businesses — think taxis, car washes, bars, hair salons, restaurants and the like — are a tempting target for IRS auditors. Experience shows that those who receive primarily cash are less likely to accurately report all of their taxable income. The IRS has a guide for agents to use when auditing cash-intensive businesses, telling how to interview owners and noting various indicators of unreported income.

10. Failing to report a foreign bank account

The IRS is intensely interested in people with offshore accounts, especially those in tax havens, and tax authorities have had success getting foreign banks to disclose account information. The IRS has also used voluntary compliance programs to encourage folks with undisclosed foreign accounts to come clean — in exchange for reduced penalties. The IRS has learned a lot from these programs and has collected a boatload of money (we’re talking billions of dollars).

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. This means filing Treasury Department Form 90-22.1 by June 30 to report foreign accounts that total over $10,000 at any time during the prior year. And those with lots more financial assets abroad may also have to attach IRS Form 8938 to their timely filed tax returns.

11. 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 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 make large cash purchases or deposits, be prepared for IRS scrutiny. Also, be aware that banks and other institutions file reports on suspicious activities that appear to avoid the currency transaction rules (such as persons depositing $9,500 in cash one day and an additional $9,500 in cash two days later).

12. Taking higher-than-average deductions

If deductions on your return are disproportionately large compared with your income, the IRS may pull your return for review. But if you have the proper documentation for your deduction, don’t be afraid to claim it. There’s no reason to ever pay the IRS more tax than you actually owe.

The bottom line is, if you get audited, hire a professional to represent you. Never, never, never, represent yourself before the IRS. It’s like swimming with sharks while wearing a swim suit made from fresh meat.

If you have any questions, comments or concerns please call Anthony Imbimbo CPA  at (619) 497-1040

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New Federal Mileage Rates

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May 3  |  IRS News  |   admin

For 2020, the IRS has reduced the deductible mileage rates by 1/2 cent per mile for Business and Medical purposes.

Federal Mileage Rate in 2019 was 58 cents per mile for business miles driven, up from 54.5 cents in 2018. 20 cents per mile driven for medical or moving purposes, up from 18 cents in 2018. It is also 14 cents per mile driven in service of charitable organizations.

For IRS purposes, the deductible medical mileage rate in 2020 has been adjusted to to 17 cents per mile driven for medical or moving purposes, this is a decrease from 2019 by ½ cents per mile.  The deductible mileage rate for charitable deductions remained unchanged from 2019 at 14 cents per mile .

2020

2019

Business

57.5 cents per mile

58.0 cents per mile

Medical

17 cents per mile

20 cents per mile

Charitable

14 cents per mile

14 cents per mile

For 2019 Tax Returns, you can deduct expenses that relate to your work as an employee if any of the following apply to you:

  • Qualified performing artist

  • Fee-basis state or local government official

  • Armed forces reservist

  • Impairment-related work expenses

  • Your employer entered code “L” for box 12 of your W-2

Deductible business use of your car does not cover normal commuting to your usual place of work. Qualified deductible business use includes:

  • Driving to a business meeting away from your usual workplace

  • Meeting clients or customers

  • Getting from your home to a temporary workplace

  • Getting from your regular workplace to a second workplace, for the same job or business

Expenses for primary transportation to medical care facilities that qualify as medical expenses are:

  • Actual fees or fares for a taxi, bus, train, or ambulance

  • Out-of-pocket expenses for using your own car, or the standard mileage rate

  • Fees for tolls and parking

Qualified performing artist – An artist that meets the following requirements:

  • Performed in the performing arts as an employee for at least two employers during the last tax year.

  • Received at least $200 in wages from each of the two employers.

Fee-basis – An agreed amount for a single job regardless of the time required to complete the job.

Impairment related work expenses – Expenses incurred from the purchase or payment related to special equipment, training, or anything else related to your ability to perform work with your impairment.

W-2 Box 12

W-2 Box 12 Codes:

  • A — Uncollected Social Security or RRTA tax on tips. Include this tax on Form 1040 Schedule 4 line 58.

  • B — Uncollected Medicare tax on tips. Include this tax on Form 1040 Schedule 4 line 58.

  • C — Taxable cost of group-term life insurance over $50,000 (included in W-2 boxes 1,3 (up to the Social Security wage base), and box 5.

  • D — Elective deferral under a 401(k) cash or arrangement plan. This includes a SIMPLE 401(k) arrangement.

  • E — Elective deferrals under Section 403(b) salary reduction agreement.

  • F — Elective deferrals under Section 408(k)(6) salary reduction SEP.

  • G — Elective deferrals and employer contributions (including non-elective deferrals) to a Section 457(b) deferred compensation plan.

  • H — Elective deferrals to a Section 501(c)(18)(D) tax-exempt organization plan.

  • J — Nontaxable sick pay (information only, not included in W-2 boxes 1, 3, or 5).

  • K — 20% excise tax on excess golden parachute payments.

  • L — Substantiated employee business expense reimbursements (nontaxable).

  • M — Uncollected Social Security or RRTA tax on taxable cost of group-term life insurance over $50,000 (former employees only).

  • N — Uncollected Medicare tax on taxable cost of group-term life insurance over $50,000 (former employees only).

  • P — Excludable moving expense reimbursements paid directly to a member of the U.S. Armed Forces. (not included in Boxes 1, 3, or 5)

  • Q — Nontaxable combat pay. See the instructions for Form 1040 or Form 1040A for details on reporting this amount.

  • R — Employer contributions to your Archer medical savings account (MSA). Report on Form 8853:, Archer MSAs and Long-Term Care Insurance Contracts.

  • S — Employee salary reduction contributions under Section 408(p) SIMPLE. (Not included in Box 1).

  • T — Adoption benefits (not included in Box 1). Complete Form 8839:, Qualified Adoption Expenses, to compute any taxable and nontaxable amounts.

  • V — Income from exercise of nonstatutory stock option(s) (included in Boxes 1, 3 (up to the Social Security wage base), and 5). See Publication 525, Taxable and Nontaxable Income, for reporting requirements.

  • W — Employer contributions (including amounts the employee elected to contribute using a Section 125 cafeteria plan) to your health savings account (HSA).

  • Y — Deferrals under a Section 409A nonqualified deferred compensation plan.

  • Z — Income under a nonqualified deferred compensation plan that fails to satisfy Section 409A. This amount is also included in Box 1 and is subject to an additional 20% tax plus interest. See Form 1040 instructions for more information.

  • AA — Designated Roth contribution under a 401(k) plan.

  • BB — Designated Roth contributions under a 403(b) plan.

  • CC — For employer use only.

  • DD — Cost of employer-sponsored health coverage.

  • EE — Designated Roth contributions under a governmental 457(b) plan. This amount doesn’t apply to contributions under a tax-exempt organization Section 457(b) plan.

  • FF — Permitted benefits under a qualified small employer health reimbursement arrangement.

  • GG — Income from qualified equity grants under section 83(i).

  • HH — Aggregate deferrals under section 83(i) elections as of the close of the calendar year.

Are miscellaneous itemized deductions allowable?

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March 5  |  California, IRS News  |   admin

Miscellaneous itemized deduction rules recently changed and are not allowable for Federal Tax purposes but they are still allowable for California Tax purposes.

Miscellaneous itemized deductions are certain business and non-business expenses that individuals as taxpayers who otherwise itemize deductions may take against their taxable income. Such miscellaneous expenses are allowed only to the extent that they exceed 2-percent of a taxpayer’s adjusted gross income. Miscellaneous itemized deductions may also be limited by the overall itemized deduction phase-out.

These expenses include employee business expenses, expenses of producing income, expenses related to filing tax returns and certain hobby expenses. Specifically, the miscellaneous itemized deductions available to a taxpayer are:

  • Professional society dues;

  • Employment-related educational expenses;

  • Home office expenses;

  • Professional books, magazines and journals;

  • Work clothes and uniforms;

  • Union dues and fees

  • A portion of unreimbursed business-related meal and entertainment expenses;

  • Other unreimbursed employee business expenses;

  • Employee expenses for which reimbursements are included in income;

  • Rental of a safe-deposit box;

  • Expenses incurred for tax counsel and assistance;

  • Costs of work-related small tools and supplies;

  • Investment expenses;

  • Fees paid to an IRA custodian; and

  • Certain expenses of a partnership, grantor trust or S corporation that are incurred for the production of income.

Additionally, there are some miscellaneous expenses that are not subject to the 2-percent of adjusted gross income limitation. These include:

  • Bond premium amortization for taxable bonds;

  • Gambling losses for the year up to the extent of gambling winnings;

  • Casualty and theft losses associated with income-producing assets; and

  • Federal estate tax on income in respect of a decedent.

Federal Tax Reform

The Tax Cuts and Jobs Act (TCJA) signed into law on December 22, 2017, made changes to the Internal Revenue Code (IRC). In general, California Revenue and Taxation Code (R&TC) does not conform to the changes. California taxpayers continue to follow the IRC as of the specified date of January 1, 2015, with modifications. For Schedule CA (540), California Adjustments – Residents, adjustments due to the TCJA, see the specific line instructions for the following items:

  • Combat zone extended to Egypt’s Sinai Peninsula

  • Moving expenses and reimbursements

  • Limitation on deduction of business interest

  • Limitation on employer’s deduction for fringe benefit expenses

  • Limitation on wagering losses

  • Sexual harassment settlements

  • IRC Section 965 deferred foreign income

  • Global intangible low-taxed income (GILTI) under IRC Section 951A

  • Excess business loss

  • Student loan discharged on account of death or disability

  • Qualified equity grants

  • Expanded use of 529 account funds

  • California Achieving a Better Life Experience (ABLE) Program

  • Living expenses for members of Congress

  • Limitation on state and local tax deduction

  • Mortgage & home equity indebtedness interest deduction

  • Limitation on charitable contribution deduction

  • College athletic seating rights

  • Casualty or theft loss(es)

  • Miscellaneous itemized deductions

In general, for taxable years beginning on or after January 1, 2015, California law conforms to the IRC as of January 1, 2015. However, there are continuing differences between California and federal law. When California conforms to federal tax law changes, we do not always adopt all of the changes made at the federal level.

The instructions provided with California tax forms are a summary of California tax law and are only intended to aid taxpayers in preparing their state income tax returns. We include information that is most useful to the greatest number of taxpayers in the limited space available. It is not possible to include all requirements of the California Revenue and Taxation Code (R&TC) in the instructions. Taxpayers should not consider the instructions as authoritative law.

2019 Tax Law Changes

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January 3  |  IRS News  |   admin

There are some significant changes to the tax law for 2019.

Medical Deductions

Starting in 2019, medical expenses (health insurance and out of pocket medical expenses) must exceed 10% of Adjusted Gross Income (AGI) to be deductible. This is up from 7.5% from 2018. Please note that California has not adopted this change.

Affordable Care Act Tax Penalty

Beginning in 2019, you will no longer be penalized for not being covered for health insurance. Please note that the Premium Tax Credit is still available for those seeking health insurance with lower income.

Alimony Eliminated

Beginning January 1, 2019, Alimony payments are no longer deductible. Alimony payments received beginning in 2019 will no longer be taxable as income. This change does not effect prior year returns. Please note that California has not adopted this change.

Child and Dependent Care Credits

Beginning in 2018 and carrying on to 2019, the IRS grants a tax credit for dependent children of $2,000. This is up from $1,000. Also, for other dependents, a tax credit of $500 is available.

Early Distributions from Retirement Plans

The IRS has liberalized early distributions from retirement plans. In most cases (taking a distribution before age 59 1/2) these are subject to a 10% penalty. Beginning in 2019 the IRS has added exceptions to the 10% penalty for hardship including: medical expenses, preventing eviction or foreclosure, tuition for higher education expenses, purchasing a home, paying the funeral expenses for a family member, or losses due to federally declared disasters. California has not conformed to this Federal tax law change.

If you need advice on a solid tax strategy, please call Anthony W. Imbimbo for a complimentary consultation.  Anthony W. Imbimbo, CPA is a tax expert with over 35 years’ experience.  Call him today at 619-497-1040.

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More IRS Tax Audits

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October 3  |  Audit Proofing, IRS News  |   admin

Taxpayers, you have been warned.

The IRS requested a 5.33% increase in enforcement activities (examinations, collections, and investigations) for the government’s fiscal year 2011. Increases in the federal government’s budget have allowed the IRS to hire new revenue agents, revenue officers, and special agents.

For FY 2010, the House approved a $5.504 billion increase in the IRS’s budget in order to focus on enforcement activities. In an effort to reduce the “tax gap,” the difference between what the government thinks it should collect and what it actually does, the IRS has been conducting more and more audits of employment tax, income tax, and Schedule C filers especially.

Ensure proper tax preparation with a local qualified CPA. Call our office at 619-497-1040 today.

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Understanding the IRS

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October 3  |  IRS News  |   admin

What words come to your mind when you think of the IRS? Perhaps strict, unsympathetic, uncompromising, or merciless? That is actually just fine with them.

The IRS prides themselves on such a self-image, because somehow it gets them what they want. The combination of fear and respect fuels the voluntary compliance with tax laws that they demand.

Seven regions and 63 districts, consisting of over 102,000 employees, make up the IRS’s organizational structure. The following are common titles of the enforcement people of whom you may want to be aware.

Tax Auditors: typically conduct audits of 1040 tax returns and related schedules in the local IRS office, but may occasionally audit 1040s with uncomplicated Schedule C’s.

Revenue Agents: conduct audits of more complex 1040s and business returns, such as the U.S. Return of Partnership Income (Form 1065) and the U.S. Corporation Income Tax Return (Form 1120). These audits are usually conducted on site at the taxpayer’s business.

Revenue Officers: collect delinquent taxes.

Special Agents: handle serious cases through criminal investigations and can make arrests.

Tax examiners: an alternate term used to describe both tax auditors and revenue agents, who belong to IRS’s Examination Division.

With the IRS, rather than giving you the benefit of the doubt, they automatically doubt any and all of your benefits. Do not expect to change their minds when going into an audit armed with only courteous, law-abiding behavior.

If you fall into the situation in which you receive an invitation to an audit, we can help you plan your strategy. Give us a call at 619-497-1040.

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