We all know that the IRS looks at less than 1% of returns filed. The good news is that they are short on personnel and funding and a vast majority of those audited simply get a letter that they have to pay. The likelihood of the dreaded, and it should be, tax audit escalates depending on various factors: income level; types of deductions/tax breaks that you claim; the business that you are engaged in; and whether you own foreign assets.
So, the number one way to get their attention is to do something we all try to do, year after year: make lots of money! But we are talking about those that make “real” money, so, report $1 million or more of income and there is a 1-in-23 chance that your return will be audited.
Then, your deductions should be statistically proportionate with your income. Your accountant can comment on whether you are stretching things and where, we believe, if you have a valid deduction and reason for claiming it, to stand tall. Many deduction investigations can be cleared with discussion between us and the IRS. There is rarely a reason to pay the IRS more tax than you owe. But what we do advise is to make sure you consider higher-than-average deductions with knowledge and thought.
While we wish to remind you that if your charitable deductions are disproportionately large compared with your income, it raises the audit risk flag, we know that we all do our fair share of charitable assistance, whether in the form of contributions or our volunteer work. It’s hard to overlook the big charitable gifts you made during the year, but the little things add up too. For those of us who volunteer, we can easily miss the write-off of out-of-pocket costs incurred while doing work for a charity. Just a reminder, if you drove your car for charity in 2018, remember to deduct 14 cents per mile, plus parking and tolls paid. Ways to support these possibly questioned deductions are by keeping journals and when your contributions total more than $250, protect yourself by obtaining an acknowledgement from the charity documenting that support that you provide. This potential audit is quite easy for us to close as it’s hard to question well documented generosity.
Many of us run a business in order to make our above average incomes, however, the IRS believes that self-employed people may sometimes claim excessive deductions and may not report all their income. So, higher-grossing sole proprietorships, those reporting at least $100,000 of gross receipts on a Schedule C, and business owners who report a substantial loss can expect a greater chance of having to go through one of these audits. But still, some self-employed taxpayers get a big break under the new law, and Schedule C is a treasure trove of tax deductions for self-employed people.
Agents are on the lookout for personal meals or claims that don’t satisfy the strict substantiation rules. Remember, in order to qualify for meal deductions, you must keep detailed records for that document for each expense: the amount; place; people attending; business purpose; and nature of the discussion or meeting. Also, it is best to keep receipts for expenditures over $75 for lodging or any other expense while traveling away from home. The new tax law eliminated the deduction for entertainment expenses, so business owners need to be careful when deducting entertainment expenses such as golf fees or sports tickets for a client outing.
Cash-intensive businesses will get special scrutiny and now also those who freelance service through the sharing economy. Pass-through firms such as S-Corporations, partnerships and limited liability companies face less audit risk. When you depreciate a car, you have to list on Form 4562 the percentage of its use during the year that was for business. Claiming 100% business use of an automobile raises a flag on an individual’s because it is rare for someone to actually use a vehicle 100% of the time for business. The best way to protect yourself from this audit risk is to have another vehicle available for your personal use.
We all love our heavy SUVs and large trucks, and of course, use them for business. As these are eligible for more favorable depreciation and expensing write-offs, we love to buy them late in the year. These are areas where we are seeing increased IRS inquiry, so be sure that you keep detailed mileage logs and precise calendar entries for the purpose of every road trip. Exceptional record-keeping is your best defense with these deductions.
Many in the real estate industry are attracted to the exception for those who spend more than 50% of their working hours and over 750 hours each year materially participating in real estate as developers, brokers, landlords, or the like to circumvent the passive loss rules and take deductions for investments in real estate. Others like to fanaticize that they actively participate in the renting of their property, so that they can deduct up to $25,000 of loss against other income. WARNING: The IRS actively scrutinizes rental real estate losses, especially those written off by taxpayers claiming to be real estate pros. It will question those who claim that they are real estate professionals and whose W-2 forms or other non-real estate Schedule C businesses show lots of income. Without documentation of working the necessary hours, especially in cases of landlords whose day jobs are not in the real estate business, the Tax Examination will be painful.
Most of this article is to clue you in on the high-risk areas but if you don’t want to hear from the IRS then be sure to report all of your taxable income. Remember, the IRS gets copies of all the 1099s and W-2s that you receive, so at a minimum, be sure that you report all required income on your return. Like sales slips we get at retail stores, these little slivers seem to not all find their way to us from our clients. The IRS computers are pretty good at matching these up.
Whether you are a business, individual, or non-profit – we will outline specific steps you can take to minimize taxes, maximize loan eligibility, or enhance the value of your property. With one call or email we will provide you with a professional, complimentary financial Statement evaluation – no obligation. Just visit Czarbeer.com/tax-offer or contact us at info@czarbeer.com, or call (212) 397-2970 and we will be happy to help you and answer your questions.