The Dirty Dozen - IRS Audit Targets

Hi Folks,

Hope you’re all happily settled into a busy 2012.

When meeting with a tax client, we are often asked “if I do this, will it send up a red flag”?  Good question.  Well, our friends at Kiplinger’s have compiled a dirty dozen list of IRS Targets.  Here is a run-down of the top 12 and a link to the full article is at the bottom of the message.  

1. Making too much money

Although the overall individual audit rate is about 1.11%, the odds increase dramatically for higher-income filers. IRS statistics show that people with incomes of $200,000 or higher had an audit rate of 3.93%, or one out of slightly more than every 25 returns. Report $1 million or more of income? There's a one-in-eight chance your return will be audited.

2. Failing to report all taxable income

The IRS gets copies of all 1099s and W-2s you receive, so make sure you report all required income on your return. IRS computers are pretty good at matching the numbers on the forms with the income shown on your return. A mismatch sends up a red flag and causes the IRS computers to spit out a bill.

3. 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 with your income, it raises a red flag.

4. 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.

5. 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.

6. Deducting business meals, travel and entertainment

Schedule C is a treasure trove of tax deductions for self-employeds. But it's also a gold mine for IRS agents, who know from experience that self-employeds 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.

7. 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 actually use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use.

8. 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.

9. 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.

10. Failing to report a foreign bank account

The IRS is intensely interested in people with offshore accounts, especially those in tax havens, and tax authorities have had success getting foreign banks to disclose account information.

11. 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.

12. 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.

Read more: http://www.kiplinger.com/features/archives/12-audit-red-flags-the-irs-looks-for.html#ixzz1kONt6av7 

New Year, New Tax Rules

Happy New Year everybody~!  We hope you’ve all enjoyed the holidays and are well rested for the big, New Year we’ve got to get on with.

Below we’ve highlighted some tax law “changes” that took effect with the New Year.  The business changes are significant, especially for well managed real estate holders and for other capital intensive businesses.  The highlight to the individual items is the temporary reduction in the FICA tax rate for wage earners.  Happy Reading!

Business changes taking effect in 2012 and late 2011. Business changes effective in 2012 (or went into effect in December of 2011and are thus “new”), include the following:

... Longer write-off period for certain property. For specialized realty assets (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property) placed in service after 2011, a 39-year (up from 15-year) write-off period generally applies.

... Reduced bonus depreciation allowance for qualified property. For qualified property acquired and placed in service after 2011 and before 2013 (after 2012 and before 2014 for aircraft and certain long-production period property), a 50% (down from 100%) bonus first-year depreciation allowance applies under Code Sec. 168(k).

... Reduced expensing. For a tax year beginning in 2012, the Code Sec. 179 expensing election is reduced to $139,000, with a $560,000 investment-based ceiling (down from $500,000/$2 million). For tax years beginning after 2012, it will be further reduced to $25,000 with a $200,000 investment-based ceiling. Additionally for a tax year beginning after 2011, expensing can no longer be claimed for qualified real property. 

Individual changes taking effect in 2012. Individual changes that apply in 2012 include the following. Note that Congress may retroactively amend one or more of these rules:

... 2012 Social Security Wage Base. The wage base for “FICA” tax increased from $106,800 in 2011 to $110,100 in 2012.  As in prior years, there is no limit to the wages subjected to the Medicare tax, so all wages are subject to the 1.45% tax (which is matched by the employer).  Currently, there is a 2 month FICA tax rate of 4.2% for employees through the end of February and the employer portion of the tax will be 6.2% for the entire year.  Pending further legislation, the employee’s tax rate will increase back to 6.2% on March 1, 2012.  We think the reduced rate will ultimately be enacted for all of 2012 and we’ll keep you posted on those developments.

... Reduced alternative minimum tax (AMT) exemption amounts. Absent another AMT “patch,” the AMT exemption amounts for tax years beginning after 2011 revert to the significantly lower “permanent” amounts of $33,750 for unmarried taxpayers, $45,000 for joint filers, and $22,500 for married filing separately.  Crikey! If there’s no patch enacted, this little beauty will reach out and bite tens of millions of taxpayers [make sure to read that last passage out loud in your best “Crocodile Hunter” Australian accent].  We expect a legislative “patch” to be worked out either early in the year or some time after the November elections.  Again, we’ll keep you posted.

... Reduced adoption credit. For 2012, the total expenses that may be taken as a credit for all tax years with respect to the adoption of a child by the taxpayer will be limited to $12,650 (down from $13,360 for 2011), and the credit for the adoption of a special-needs child will also be $12,650 (down from $13,360 for 2011). Furthermore, the adoption credit will no longer be refundable.

... No parity for exclusion from income for employer-provided mass transit and parking benefits. For 2012, unless Congress changes the rules, the exclusion for qualified parking rises from $230 to $240 due to an inflation adjustment, but falls from $230 to $125 for employer-provided transit and vanpooling benefits.  Again, we expect that the higher exclusion amount for parking will be extended in 2012.

... Reporting foreign assets. Beginning in 2012, U.S. taxpayers who have an interest in certain specified foreign financial assets with an aggregate value exceeding $50,000 must report those assets to IRS on Form 8938, Statement of Specified Foreign Financial Assets, with their tax return.