Avoiding IRS Traps
© by Greta P. Hicks, CPA
There are several typical traps that befall taxpayers during the
preparation of their return and for those who are being audited by the
IRS. The most common traps a taxpayer falls into is complacency and trying
to beat the "audit lottery."
Complacency And Audit
"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 cash based businesses such
as attorneys, bars, restaurants, construction workers, Laundromats, and
The chances of being audited go down dramatically to .05 if the business
is a partnership or S Corporation.
"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 of 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, it to prepare a return that is accurate that that will now 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 any dummy 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
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 such as car, mobile phone, home computers,
boats, hunting leases, and vacation homes each carry with them stringent,
detailed record keeping rules. Typical 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 upon
audit, the taxpayer does not have the detailed required records to prove
to the IRS the amount of the business versus personal use.
Upon 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.
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 other 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
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 lot for that of 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 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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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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