The best way to handle a tax audit from Uncle Sam is to avoid one from the start. Regardless of whether you win a battle with the IRS, audits are stressful, time consuming, and a waste of good business time. With audit rates on the rise, it is worth taking a few moments to learn how best to avoid them. Based on our experience, we provide you with some key ways to reduce your chances of receiving an audit from the IRS.
HIGH RISK AREAS
If you make more than $150,000 a year, your risk and probability of an audit increases. That means that it's even more important to keep adequate records to substantiate your deductions. Since 2005 the IRS has been redeploying their resources to focus on those with investments, sole-proprietors and partnerships, and those in high income brackets.
Unreported taxable income is a common red flag. The IRS discovers unreported taxable income when its computers match the taxable income you reported on your tax return with information gathered from banks and others. For example, if you failed to report interest earned on your bank savings account, the IRS typically will catch you when it matches the bank's interest payment records against your tax return. Make sure you have accounted for all 1099 Forms, etc. from mutual funds, banks and other income sources.
Self-Employed and Cash Incomes
Because past audit evidence has proved that most under-reporting of taxable income and abuse of tax deductions occurs among those who are self-employed, these individuals are audited by the IRS far more frequently than employees on a company's payroll. The same holds true for individuals who traditionally receive payment in cash (i.e., taxicab drivers, and waiters). Also, the IRS will at times conduct tests of certain individuals to determine their reported taxable income can support his or her lifestyle.
Unless you are prepared to defend them, don't take tax deductions that may be questionable. The key words are "reasonable and relative" in relation to income. If you earn $165,000 and claim $125,000 in deductions; or if you live in Beverly Hills and report only $30,000 income, don't be surprised if the IRS requests a meeting.
One of the biggest and most commonly audited items by the IRS for individuals in their own business, and employees of companies who use their car in business, is the tax deduction for business transportation. It is important that you keep good records of all tax deductible automobile expenses and a mileage log showing business miles driven.
Your Business Expenses Must be Business Expenses
Also avoid schemes that claim you can convert personal expenses into allowable business expenses just by calling them business expenses. If you're "in business," and if you have a "profit objective" that you can substantiate, then the conversion potential is legal. But you really must be "in business."
Home office tax deductions are scrutinized by the IRS. Since the tax rules for deducting home office expenses on your tax return are complicated, make sure you qualify to deduct it. By claiming the home office deduction, you increase your chances for an IRS audit. However, if you're clearly entitled to claim it, then you should do it if it's substantial enough to make a tax difference. However, if the tax savings are minimal, it is unwise to claim the tax deduction at all.
Be skeptical that there's a secret vehicle or structure that can insulate your income from tax. All of these claims have been rejected so often that if you just make these frivolous return arguments in tax court, you'll be hit with a penalty of as much as $25,000.
Accountability Services is a FULL-SERVICE accounting and outsourcing firm that provides an innovative approach to each client's particular needs. Our mission is to provide the small and mid-size service company with high-level financial solutions at an affordable rate. Unlike traditional accounting firms, we take an integrated advisory approach--looking at the whole system, not just the accounting basics--offering a coordinated set of services, ranging from traditional accounting to associated business and financial consulting.
As the 2008 presidential election approaches, many of you may have begun to identify with the lyrics from Kenny Rogers' 1978 hit song "The Gambler." The uncertainties that accompany major political changes can cause financial anxiety. For those of you with concentrated stock options or portfolios with significant unrealized capital gains, knowing how to play your investment "hand" becomes more than a game. The fact that investor-friendly tax positions will expire at the end of 2010 - that we are now experiencing the lowest tax rates on both income and capital gains since WWII - only adds to the stress. What could happen regarding taxes and estate planning? For you, understanding the answer to the question "Should I pay the taxes now?" will make the decision to hold or to sell less of a gamble.
While everyone's situation is unique and special circumstances must be taken into account when discussing taxes and estates, including current market conditions and an environment of potentially higher tax rates, the following approaches should be considered:
- Reevaluate strategic asset allocation on an after-tax basis for different tax rates.
- Review the tax-exempt fixed income allocation, as it will become more attractive relative to other taxable income strategies and hedge fund alternatives.
- Continue to hold tax-advantaged strategies, with the knowledge that, for mutual funds, the advantage will be less than for a similar strategy employed in a separate account structure.
- Consider appreciation-oriented strategies such as buy-and-hold growth stock portfolios versus value-oriented strategies.
- Determine if tax-arbitrage trading strategies are still advantageous with higher tax rates.
- Decide on the best time to realize long-term capital gains.
Accountability Services LLC
I hope you find The Bottom Line an informative tool. If you are not yet a client, I invite you to explore our company, meet some of our team members, and get to know more about our expertise and services. We are a full-service accounting and outsourcing firm customizing our services to meet our clients' needs. We provide accounting, analysis, bookkeeping, budgeting, tax preparation, business planning, technology solutions, and consulting services. We make ourselves accessible, will spend time with you, and take pro-active measures to keep everyone on-track throughout the year. If you're interested in learning more, please call us at 206.522.0110 or visit us on the web at www.accountabilityservices.biz.