1.
Forgetting
to Report All Your Income
The IRS get a copy of ALL your 1099s and W-2s, and
when that income is not reported on your tax return, the IRS computer notifies
an IRS human who usually sends a 2000-PC Notice, which is a more like a paper
audit.
All sorts of red flags go up when the 1099s and or
W-2s don’t match the tax return that you file.
2.
Claiming
the Home Office Deduction
The IRS appears
to be drawn to any return which takes advantage of a legal tax loophole in a
big way. And claiming the Home Office
Deduction can reduce your tax liability greatly.
The Home Office
Deduction allows you to take a percentage of your rent, mortgage interest, home owners insurance, home improvements that
pertain to the home office, real estate taxes, utilities, and any other
expenses which are
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, to take this write-off, you must use the
space exclusively and regularly as your principal place of business. That makes
it difficult to successfully claim a guest
· 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 to 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. And attach Form 8283 if required.
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. And attach Form 8283 if required.
· 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. However, to take this write-off, 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.
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.
·
The documentation rules. And attach Form 8283 if
required.
· 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. However, to take this write-off, 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.
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.
· 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
· Deducting Business Meals, Travel and Entertainment
Schedule C is a treasure trove of tax deductions for
self-employed people. But it's also a gold mine for IRS agents, who know from
experience that self-employed people sometimes claim excessive deductions.
History shows that most underreporting of income and overstating of deductions
are done by those who are self-employed. And the IRS looks at both
higher-grossing sole proprietorships and smaller ones.
Big deductions for meals, travel and entertainment are always red flags. 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.
Big deductions for meals, travel and entertainment are always red flags. 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.
· 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 use a vehicle solely 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 if you make such a claim. 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 the 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.
· 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
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
·
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.
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.
· 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
· Failing to Report a Foreign Bank Account
The IRS is intensely interested in people with
offshore accounts, especially those in tax havens, and the federal government
has 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
($4.4 billion so far).
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
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
·
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.
· 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.
· 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 be designed 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)
· 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
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