How to Get Into IRS Trouble -- Quick
© by Greta P. Hicks, CPA
There are some mistakes or oversights that will fly past the IRS
computers and eyes of suspicious employees and there are other what may
seem to be little errors that can cause major problems with the IRS rules.
Small business people who avoid this "little errors" during the
preparation of their return or for those being audited, will have more
time to manage their business and less time tangled in IRS traps. Two of
the most common traps small businesses fall into are complacency and trying
to beat the "audit lottery."
Complacency And Audit Lottery Trap
"I havenít ever been audited so I donít have to worry about
it." Maybe yes. Maybe no. The IRS audits about 4% of the self employed
business and recently they are concentrating on auditing mom and pop, cash
based businesses such as bars, restaurants, mobile food vendors, construction
workers, laundromats, and retail stores.
The chances of being audited go down dramatically to .05 if the business
is a partnership or S Corporation. Incorporating solely to reduce the risk
of an IRS audit is usually not good planning. Consider all favorable and
unfavorable facts prior to incorporating. For more details see ASBA Today,
"So why worry about it?" If you have poor or little records
when the tax man cometh, the cost of reconstructing records, of lost time,
and of legal and accounting fees will be staggering. Those of us in the
business know that it is less expensive to maintain good records that it
is to create records from bits and pieces of records that are two or three
Tax Preparation Trap
"Iím smart enough to read the instructions and do it myself.
After all, I now have Turbotax." The first rule to avoiding an intrusive
IRS audit, is to prepare a return that is accurate that will not
set off the bells and whistles of the IRS computer. Common mistakes on
returns that cause the IRS to audit the complete return.
- Failure to list all Forms 1099-INT, Interest Income, on Schedule
B, in such a way that the computer or unskilled IRS worker could find the
interest income on the return.
- Failure to list all Forms 1099-B, Sale of securities, on Schedule
D. The most common error in this department is the failure to report the
transfer of moneys from one mutual fund to another mutual fund.
- Failure to list all Forms 1099-DIV, Dividends, at gross dividends
on Schedule B and deduct the nontaxable distributions and capital gains
- Failure to report all Forms 1099-MISC, Miscellaneous Income, on
the appropriate schedule. Listing non-employee compensation with wages
and failing to complete a Schedule SE, Self-employment earnings.
Failure To Keep Records Trap
Most traps arise due to the mixed personal and business use of certain
assets and deductions. The IRS presumes all assets and deductions are personal
unless the taxpayer has the records to prove otherwise.
The typical mixed-use assets are cars, mobile phones, home computers,
boats, hunting leases, and vacation homes. Each mixed-use asset carries
with it stringent, detailed record keeping rules. Other deductions that
the IRS looks upon as personal unless proven other wise are meals, entertainment,
travel, and customer gifts. The typical trap the taxpayer falls into is
that when audited, the taxpayer does not have the detailed required records
to prove to the IRS the amount of the business versus personal use.
During an audit, the IRS will request not only canceled checks and
paid receipts or invoices, but also copies of insurance policies, contracts,
calendars, logs, travel and conference agendas, journals, and diaries.
Section 280F, 280A, and 274 of the Internal Revenue Code require automobile
logs, logs of vacation home use, and who, what, where when and why of all
travel, meals and entertainment. The IRS will want to see the actual hotel
bill not just the credit card receipt. Credit card statements and canceled
checks need to be further supported by the actual receipts
You say, "Too much!" I agree but how many deductions are
you willing to give up? For every $100 of deduction lost, the tax bite
is from $14 to $54.80.
You say, "Iíll just wait to see if I get audited." Ok,
some auditors will allow you to reconstruct logs, etc. but others stick
to the letter of the law which requires these types of records to be "contemporaneous."
You say, "What about the new rule that you donít have to have
a receipt for an expenditure under $75?" BUT, you still have to write
down detailed information, such as: The date, time, place, name, and business
purpose of the expenditure. I ask, "Which is easier, writing the name
of the personal entertainment and the business purpose of the discussion
on a credit card bill, or writing all the details on your calendar, diary
or journal? The law says no receipt required but contemporaneous record
required. The auditor says, "No receipt. No deduction."
Having your deduction disallowed because of poor records is a trap
you can easily avoid by maintaining a log on your business car and writing
the name of the person and business relationship on all credit card charges.
The Barber Shop Law Trap
Many taxpayers get trapped into thinking that the tax hints they
receive from their barber, golf buddy, manicurists, neighbor, or co-worker
are "the law." The most common tax law trap is in the buying
and selling of real estate.
Common Trap Number One.
"If I sell a piece of property, I have two years to reinvest
the money." Yes, if you sell your primary residence, you have two
years to replace that residence with a new primary residence. No, on any
other property unless you are involved in a "like kind" exchange
or an "involuntary conversation." An example of like kind exchange
is you swap your real estate for real estate owned by another person or
business. A loss due to an involuntary conversion, such as hurricane, flood,
earth quake, can be replaced with in like kind property. You usually will
need to consult an attorney and/or a certified public accountant when you
are planning a like kind exchange transaction.
Common Real Estate Trap Number Two.
"I can sell property and carry the note and no taxes are due
until I collect the money." This is true but there are tax traps.
If you sell property that has been depreciated using an accelerated depreciation
method, you may have to recapture part or all of the depreciation taken
in prior years. In an installment sale transaction, income taxes are to
be paid on all depreciation recapture in the first year of the sale. The
solution is to get a very big down payment so that you will have the money
to pay the taxes in the first year.
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List of Articles by Greta P. Hicks, CPA
GRETA P. HICKS, CPA and former IRS manager, concentrates in solutions to IRS problems and advises business and tax professional on IRS policies
and procedures. Ms Hicks is owner of TAX SOLUTIONS, Inc., a company providing
educational materials and programs on solutions to IRS problems and is
a nationally known speaker and writer on solutions to IRS problems. To
arrange for consultation contact:
Greta's web site: http://www.gretahicks.com
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