Auditing Help in Jefferson City and Central MO

How to take the bite out of the audit sting

It is no surprise that states audit their small business community as a productive way to increase revenue for their state coffers. Should you receive the dreaded notice of one of these audits, here are some ideas that can make this a more pleasant experience:

Review the sales tax rules. Know the rules in your state and locality. Pay special attention to areas that are not taxed. A quick internet search on sales and use tax audits for your state should yield examples of areas the auditor will focus their resources. Pay attention to the terminology used in these documents. Use the same terminology when talking with the auditor.

Conduct a self-audit. Prior to the arrival of the auditor, audit yourself. Begin with your sales receipts, migrate to capital purchases, and then finish with your bills. Pay special attention to internet sales and purchases you make with your credit card.

The best defense is a good offense. You may find areas in your self-audit where you paid tax when none was due. Perhaps you have production equipment and your energy providers charge you sales tax on all your power. You may be due a sales tax refund for up to three years of this production energy use.

Watch out for capital equipment. The sales tax rules on capital equipment can vary dramatically. Some vendors may be required to collect and send in sales tax on equipment purchases that are not taxable. You must then file to collect a refund.

The expense report trap. An easy way to have the auditor pay for their time is to review your expense reports. Often you do not keep receipts of items purchased at a retail store. An auditor could assess you sales tax on items purchased at Walmart, simply because you did not keep the receipt. This despite the fact that a Walmart retail store always collects sales tax.

It’s not usually taxes on your sales that gets you. Remember, it is not often the collecting and transmitting taxes on your sales that gets attention in an audit, it is the payment of use tax and sales tax purchases you make and potentially overlook.

Pre-determine scope of audit. Prior to the audit please inquire what the scope of the audit will entail. If the timing of the audit will create a hardship, request a time that is better for you and your business. Consider recommending sampling a defined period of time versus a full review of all your records.

Get help. Finally, please consider that you will typically encounter an audit of this type once or twice during your career. The auditor does this every day. So get help as soon as you receive the audit notice.

Remember, all states share information with each other. They know sales and use tax audits of small businesses often generate more income than the state pays their auditor. Knowing this, it is best to be prepared.

Helping make the IRS auditor say yes

When faced with questions on your tax return deductions, it is getting all too common for tax authorities to deny everything and then make you prove that your deductions are valid. Do not let this happen to you. Here are some suggestions.

The one-two punch

To prove your deduction most auditors are looking for two key documents. Miss one of the two and your deduction will evaporate like smoke at a campfire.

Receipts. This is the first of the sure-fire two things you must have to validate a deduction. The receipt should clearly show the company or entity, the date, the value of the activity and a clear description of the activity. In the case of donations, the receipt should also have a statement that confirms you received no benefit in return for your donation. It should also state that you are not retaining part ownership of the donation.

Proof of payment. This is the second of two sure-fire things you must have to validate a deduction. You will need a canceled check, a bank statement or a credit card receipt and related statement.

Other proof hints

Contemporaneous. Any proof of payment and receipts should generally match the date of the activity. The IRS and state agencies are quick to dismiss receipts that are obtained after the fact. A good rule of thumb is to ensure receipts and proof of payment are received at the time of the activity. If not, at least make sure you have receipts and payment proof within the tax year the deduction is taken.

Other proof. In addition to the above, there are certain deductions that require additional documentation. Here are the most common;

Mileage logs. You will need to show properly maintained mileage logs for business miles, charitable miles and any medical mile deductions.

Business records. You will need financial statements for any business related activity with supporting documentation.

Residency. If you live in multiple states or multiple countries, you may have to prove where you lived during the year. Keep records that show your physical presence to support your tax filings.

Proof of non-reimbursement. If you claim any unreimbursed business expenses, many states are asking you to prove that you were not able to get these expenses reimbursed from your employer. The easiest ways to do this are to show a denied expense report or to get your employer to write a letter that confirms your expenses are not reimbursed. Those most impacted by this are musicians, barbers/hairstylists, construction workers and anyone who uses their own tools to do their job for their employer.

Using the IRS Audit Technique Guidelines (ATGs)

While most of us are never audited, when it happens it can feel a lot like a lamb thrown in the room with a lion. The IRS auditor does these audits every day. They know what to look for and can ask leading questions that you may easily answer incorrectly. So what are some good tips when you are in the cross-hairs of an IRS audit?

Address correspondence issues with the IRS timely. Do not let the problem get to a point that a face-to-face examination is required.

Ask for help. Do this right away. Too many clients think the problem is easy to resolve, but inadvertently say the wrong thing or open another audit issue inadvertently.

Understand what is being asked. Clearly understanding the core question can simplify the solution. Why is the IRS asking to see your 1099’s? Do they have a form that you do not? Why are they asking about your small business profits? Are they thinking your business is a hobby?

See the Audit the way the IRS auditor is trained to see it. The IRS has certain areas in which they focus training for their auditors. These are published in Audit Technique Guides (ATGs) and are available for review on their web site at www.irs.gov. They are invaluable in identifying areas for potential audits AND can help you understand what the IRS likes to question. While most of the ATGs are in the business area, reviewing the topics can be useful in understanding where audit risks are and what you can do to prepare yourself in case of an audit.

Common ATGs

Architects

Business Consultants

Child Care Provider

Farmers

Ministers

Veterinary Medicine

Art Galleries

Capitalization versus Repairs

Construction

Hobbies (activity not engaged for profit)

Partnerships

Winery/Vineyards

Attorneys

Cash Based Business

Research Credits

Lawsuit Awards/Settlement

Retail

If you have activity in one of these areas, it may make sense to understand what the IRS auditor is trained to look for prior getting too far into the audit process. By reviewing the specific ATG you will know the process of the IRS audit and understand how the auditor will proceed.

Each year the IRS publishes their activities in a publication called the Data Book. And each year for the past number of years the number one target of audits are those tax returns with a Schedule C for small business activity. So how to prepare yourself for a possible audit? Here are some tips.

Keep records separate. The quickest way to get a deduction for your business disallowed is to blend your personal bills with those from your business. Open a separate checking account and use a separate credit card for business expenses.

Keep logs. Keep a logbook for business miles. Keep receipts for business meetings and meals. Include the date, time, subject, and who was present at the meeting.

Ordinary and necessary. Two key words to use to qualify legitimate, deductible business expenses per the IRS are;

Ordinary: an expense that is common and accepted in your industry.

Necessary: an expense that is helpful and appropriate for your business.

Business not hobby. A qualified business activity allows for direct deductibility of appropriate expenses, where-as hobby activity expenses are severely limited. There are many facets here, but key among them is a profit motive and active participation in the activity to qualify your activity as a business.

Just because the IRS focuses their audit activities in this area does not mean you should be reluctant to take appropriate deductions. Just be prepared to defend your position with excellent records.

Question: How do I defend my Fair Market Value determination?

Answer: This question can get complicated AND expensive. First start with a definition per the IRS;

“Fair market value (FMV) is the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.”

Source: IRS Publication 561

This is the standard the IRS uses to determine if an item sold or donated by you is valued correctly for income tax purposes. It is also a definition that is so broad that it is wide open to interpretation. The difficulty here, is if the IRS decides your FMV opinion is wrong, you are not only subject to more tax, but penalties to boot. Here are some tips to help defend your FMV in case of an audit.

Understand when it is used

Fair Market Value or FMV is used whenever an item is bought, sold, or donated that has tax consequences. The most common examples are:

Buying or selling your home or other real estate

Buying or selling personal property

Buying or selling business property

Establishing values of other business assets like inventory

Valuing charitable donations of personal goods and property like automobiles

Valuing bartering of services

Valuing transfer of business ownership

Valuing the assets in an estate of a deceased taxpayer

Ideas to defend your FMV determination

Here are some suggestions to help you defend your FMV determinations.

Properly document donations. FMV of non-cash charitable donations is an area that can easily be challenged by the IRS. Ensure your donated items are in good or better condition. Properly document the items donated and keep copies of published valuations from charities like the Salvation Army. Don’t forget to ask for a receipt (confirmation) of your donations.

Donate capital items like automobiles to the correct places. You may use the FMV of a donated automobile but only if the charity you donate the item to will use it themselves, or will provide it to someone who will use it. Websites like Kelley blue book (kbb.com) can help establish the value of your vehicle when you donate it. Otherwise, the FMV of the donated vehicle will be limited to the amount the charity receives when they re-sell it.

Get an appraisal. If you sell a small business, collection, art, or capital asset make sure you have an independent appraisal of the property prior to selling it. While still open to interpretation by the IRS, this appraisal can be a solid basis for defending any differences between your valuation and the IRS.

Keep copies of similar items and transactions. This is especially important if you barter goods and services. If you have a copy of an advertisement for a similar item to the one you sold, it can readily support your FMV claim.

Take photos. The condition of an item is often a key determinate in establishing FMV. It is fair to assume an item has wear and tear when you sell or donate it. Visual documentation can be used to support your claimed amount.

Keep good records. Keep copies of invoices for major purchases. Retain bills for any improvements. Make sure your sale of property includes a dated bill of sale that clearly states transfer of ownership and amount paid for the item.

With proper planning, establishing the fair market value of an item sold or donated, can be done in a reasonably defendable way if ever challenged.

A little organization now can save money during an audit

When it comes to taking qualified deductions on your Federal Tax return three things must happen.

First, you must recognize that an expense might be deductible on your tax return.

Second, you must keep a record of the expense in an organized fashion.

Third, you must have the proper (and timely) documentation to support your deduction.

While this may seem evident to most, here are some typical areas that taxpayers often fall short, costing them plenty during tax filing season and during IRS audits.

Cash donations to charity. To deduct and support your deduction to a qualified charity you must have valid support. Donations of cash are no longer deductible if they are not supported by a canceled check or written acknowledgement from the charity. Donations of $250 or more MUST have a written acknowledgement at the time of the donation. A canceled check and bank statement are not sufficient. In addition, if you are audited at a later date you may not then have the charity issue you acknowledgement.

Non-cash contributions. You need acknowledgement of these donations as well. This includes creating a detailed list of items donated, their condition, and estimated fair market value. While this level of detail in not required for small donations, it is always a good practice to take photos and create a detailed listing of items donated.

Investment purchases and sales. If you bought or sold an investment you will need to know the cost. Today’s regulations require brokers to report the cost of sales to the IRS. Many of these historic costs are wrong. Please review your broker accounts and correct any errors. It is very difficult to defend yourself in an audit when records reported to the IRS are in error.

Copies of Divorce Decrees, Alimony, and Child Support Agreements. There are often conflicts between two taxpayers taking the same child as a deduction. Do you have the necessary proof to defend your position? The same is true with alimony and child support. Keep these documents in a safe place and be ready to use them if necessary.

Copies of Financial Transactions. Keep copies of documents from any major financial transaction. This includes real estate settlement statements, refinancing documents, and any records of major purchases. These documents are necessary to ensure your cost (basis) in the property is properly recorded. The documents will also help identify any tax related items like mortgage insurance, property taxes, points and possible sales tax paid.

Mileage logs. Lack of tracking deductible miles is probably one of the most commonly overlooked documentation requirements. Properly recording charitable, medical and business miles can really add up to a large deduction. If the record is not available, the IRS is quick to disallow your deduction.

If you are not sure whether a document is needed, please retain it. If filed in an organized fashion, you can always retrieve it.

The word “audit” is enough to raise anyone’s blood pressure. If the IRS agent then tells you they want to see bank accounts and personal records you may need a heart monitor. Should this happen to you, you could be in a process known as a lifestyle audit.

Background

The lifestyle audit was a tool used by auditor’s to ascertain if the income you claim on your tax return can support how you live.

As an extreme example, perhaps you claim $30,000 in taxable income, but drive a Ferrari and you have a $700,000 mortgage. Most of us would have a hard time believing the income claimed on this tax return could support this lifestyle.

Historically, tax returns that have a history of cash transactions would be a target for lifestyle audits. So if you ran a small business (schedule C) or worked in an industry like construction, fishing, and retail you could experience this lifestyle audit.

Reason first

As you might imagine, being the subject of a lifestyle audit is stressful. It could be a more involved process than responding to a letter from the IRS questioning part of your tax return. The best defense for this type of review is good record-keeping. Here are some tips:

Understand your lifestyle risk. Do you think you can substantiate how you live with the level of claimed income on your tax return? Most of us can, but if you inherited money that allowed you to buy a new house, car or other luxury items it might raise questions. If this is the case, keep copies of documentation that supports the event.

Awareness of gift limits. Remember, you may receive up to $15,000 in gifts from any individual in any given year without tax consequences. If you receive gifts from someone, please keep record of the event.

Sales receipts. For every small business deposit in your bank account have a supporting document that substantiates the deposit’s source.

Separation. Keep separate business and personal bank accounts and credit cards. It is easier to substantiate your lifestyle spending when you do this.

Ask why. The passing of the 1998 IRS Restructuring and Reform Act limits the ability of IRS agents to conduct lifestyle audits. In current practice, a lifestyle audit may only be undertaken if the IRS agent has a reasonable cause to conduct the review. The cause might be based on information provided on your tax return or based upon information reports it has received from others. It is reasonable for you to ask for clarification from the auditor as to why they believe a lifestyle audit is in order. Perhaps proper documentation may be all that is required to answer the auditor’s questions.

Ask for help. Remember, should you receive notice by the IRS with questions regarding your tax return, ask for assistance. The same is true with notices from any other taxing authority. You are not going to be as well versed in the tax code as your auditor, so why not ask for help from someone who is.

It was revealed in a recent Taxpayer Advocate Forum in Iowa that in some cases the IRS initiates contact with taxpayers via a phone call. This initial phone call is causing confusion and potential identity theft scam concerns with taxpayers. It is now being reported that the IRS will no longer be making initial taxpayer contact via phone.

Phone Scams

While the vast majority of IRS notifications are via mail notice, in a few cases the IRS auditor was calling to set up an appointment. The conversation would include the scope of the audit and a request for records to have available for the auditor. The IRS would then send a follow-up confirmation of the interview via mail.

Because of the increase in the number and sophistication of IRS phone scams, the telephone contact practice is being stopped.

What you need to know

Assume initial calls are scams. If you receive a phone call from the IRS without prior notice, treat it as a scam. Never give or confirm your personal information over the phone.

Hang up and initiate independent contact. If someone representing the IRS calls you, get their information (name, ID number, and location) and then hang up.Then call for assistance. Consider contacting the IRS directly so you can determine if there is audit activity on your tax account with the IRS. Remember, do not use the contact information provided to you by the person calling you.

Never ignore mail notices. If you receive a mailed notice of an audit from the IRS, open the envelope and determine what they are requesting. Immediately call for assistance.

While this policy change at the IRS only impacts a few taxpayers, the mail notification consistency helps all of us more readily identify potential scams.

It was revealed in a recent Taxpayer Advocate Forum in Iowa that in some cases the IRS initiates contact with taxpayers via a phone call. This initial phone call is causing confusion and potential identity theft scam concerns with taxpayers. It is now being reported that the IRS will no longer be making initial taxpayer contact via phone.

Phone Scams

While the vast majority of IRS notifications are via mail notice, in a few cases the IRS auditor was calling to set up an appointment. The conversation would include the scope of the audit and a request for records to have available for the auditor. The IRS would then send a follow-up confirmation of the interview via mail.

Because of the increase in the number and sophistication of IRS phone scams, the telephone contact practice is being stopped.

What you need to know

Assume initial calls are scams. If you receive a phone call from the IRS without prior notice, treat it as a scam. Never give or confirm your personal information over the phone.

Hang up and initiate independent contact. If someone representing the IRS calls you, get their information (name, ID number, and location) and then hang up.Then call for assistance. Consider contacting the IRS directly so you can determine if there is audit activity on your tax account with the IRS. Remember, do not use the contact information provided to you by the person calling you.

Never ignore mail notices. If you receive a mailed notice of an audit from the IRS, open the envelope and determine what they are requesting. Immediately call for assistance.

While this policy change at the IRS only impacts a few taxpayers, the mail notification consistency helps all of us more readily identify potential scams.

If you were married, divorced, or changed your name for any reason during the past year, do not forget to file to change your name prior to preparing your tax return. The IRS automatically conducts a name match on the first few letters of your last name. If the name on your tax return does not match the name on file at the Social Security Administration for your social security number, here's what could happen;

You are unable to e-file your tax return

The IRS automatically accepts your income as taxable, but then disallows any deductions.

You may receive a notice from the IRS with taxes owed and underpayment penalties.

Here's what you can do.

Prior to filing your tax return, go to www.ssa.gov and download form SS-5. Fill the form with the name change and file it as soon as possible.

Also notify your employer. Double check the W-2 you receive to ensure the change was made correctly. If the change is made on your W-2, you must make sure it is changed at Social Security.

If you are planning a major financial transaction in the near future you may wish to adjust the timing of the transaction or the timing of your name change to avoid complications.

Don't forget to also change your name on other important documents like auto titles, drivers license, property titles, bank accounts, loan agreements, beneficiary documents and other accounts.

If you are unable to make the name change in a timely manner, make sure you use the name on file at the Social Security Administration AND with your employer so when filing your taxes you avoid the automatic notification of a name mismatch. Here is a link to the Social Security web site that walks through their name change process; Social Security Name Change Process

Two things have happened that have greatly reduced the ability to have a canceled check as proof when the auditor comes calling. The first is the advent of online bill paying services. The second is a regulation commonly known as Check 21. With online bill paying, you pay a bill via an online banking service. Your only receipt is often just an entry in your checking account. With Check 21, the law allows banks to digitally capture the check and then destroy the paper copy without returning it to you. So what do you do if you need proof that you paid for a tax deductible item?

Know your bank. Understand what your bank keeps and for how long. This includes digital statements and digital copies of checks (both front and back). Understand if there are any fees charged if you need to request copies of payments.

Retain copies of all bank statements. Review your records to ensure you have copies of all monthly bank statements. This is often the starting point for an IRS agent that wants proof of payment, so it should be yours as well. These copies may be in either paper or digital format. Download online copies of your statements and place them in a password protected file.

Collect copies of tax related proof of payment. Go through your statements and mark the payments that will, in all likelihood, be used as a tax deduction. Make sure you have copies of the front and back of each of these payments. If you do this work now, the copies are often still available online for no fee. Even online bill payments often have a digital copy that can be used.

Get independent acknowledgements. If you have larger payments you should also make sure you have independent acknowledgement from the merchant or organization to substantiate the deduction. This is true for charitable contributions of $250 or more, and any business or medical expenses.

While having the traditional "proof" of an expenditure is now harder to come by, the IRS understands that approved technologies are changing the type of substantiation available for them to review. By being on top of this documentation at the end of each year, you can save yourself a lot of headaches should you ever need to prove your deductions.

Less than 2% of over 145 million individual tax returns filed will be selected for audit. The percentage increases for higher income groups and tax returns in areas of specific interest to the IRS. If you should receive notice from the IRS of an impending audit please remember:

IRS computers usually flag the tax returns for audits. The vast majority of them are routine.

Because of the flagging process, your audit will usually focus on one to three categories of your tax return.

Audits do not automatically mean something is wrong. It is possible to receive a “no change” or even an additional refund as an outcome of an audit.

What to do if you are audited.

Don’t panic. Open all correspondence and make sure you respond to all requested information in a timely fashion.

Keep good records. Be prepared to support your tax return details. Do this as you prepare your tax records each year. This is the one most important things you can do.

Ask for help. You are not a tax professional, the IRS auditor is. So get help and do so as soon as possible after receiving your notice. Let professionals deal with the IRS as much as possible.

The best defense is a good offense. Identify the information in question and prepare as much as possible to defend your tax return prior to any meetings with auditors.

Answer questions, do not volunteer information. Answer only the questions under review. It helps both you and the often over-worked auditor. Avoid attending meetings with an auditor on your own.

Do not make it personal. Remember to be polite and avoid making editorial comments about anything other than what is being asked.

If you feel you are being treated unfairly remember there are numerous means within the system to help you, from talking to a supervisor to using the IRS taxpayer advocate service.

No one likes the stress involved when your tax return is under the audit spotlight. Here are some ideas to avoid some of the more common audit triggers.

Report everything that has an informational tax return. If you are like most Americans, you will receive numerous 1099’s, W-2’s, and 1095’s in the mail. The IRS receives them too. If your tax return does not meet or exceed this reported income you can count on receiving a notice from the IRS. Some hints:

Make a list of the forms received last year

Update the list with any new vendors or employers

Check off each of them when you receive them

Match the reports…even when they are wrong. When reviewing your tax return make it easy for the IRS programs to match what is being reported to them. If an amount is incorrect, try to get it changed. If not possible, report the incorrect amount (so it matches the IRS records) and then correct it with an explanation.

Get your key information right. Social security numbers must be valid. Names must match social security numbers. Mis-matches here are sure to be noticed.

Get your dependents right. You and an ex-spouse must consistently report your dependents. Both of you cannot claim a child as a dependent. If an ex-spouse claims paying you alimony, it must match alimony income on your return.

Understand the chances of audit. Each year the IRS reports audit rates by income level and type of tax return. While the overall audit rate is around 1 percent, it is much higher for high income tax returns and returns that have small business activity (Schedule C).

Even if you believe you have done everything correctly, audits happen. Should it happen to you please do not hesitate to seek help.

Here are five tax topics that seem innocent but can cause problems if not handled correctly.

Gambling winnings. If you receive a tax form at a casino for your winnings, that information is sent to the tax authorities. Since the form typically only contains the amount you won, save copies and records of any gambling losses. Do not file your tax return without discussing this.

Maturing CDs. Be careful with maturing CD’s in a retirement account that are rolled over into new CDs. Your financial institution may provide you with tax forms showing the distribution, but not the rollover. You will need to account for this on your tax return.

Retirement distributions. Make note of any distributions from your retirement accounts and note the type of account. You should receive informational 1099’s for the distributions. Depending on your age and the type of retirement account, a number of tax surprises could occur if not properly recorded. This includes early withdrawal penalties, potential Required Minimum Distribution penalties, and income tax on the withdrawals.

Gifts over $15,000. If you provide gifts in excess of $15,000 ($30,000 for a couple) to any one person during the year, you must fill out a gift tax form and potentially pay tax on the excess gift amount.

Contemporaneous documentation. The time to put together proper documentation to support your deductions is when the activity takes place. For example, if you misplace a receipt for a charitable donation, you can go back to the organization and ask for a copy of the “old receipt” but a new receipt to replace the one you lost is not valid documentation. Common areas where this is important are charitable contributions, mileage logs, and other itemized deductions.

A Great tip to stay out of the audit spotlight.

One of the best audit tips available can be summed up in one simple word. Match.

Spend a minute or two pretending you work for the IRS. What would you do to identify tax returns worth auditing? If you suggest matching filed tax returns with the information provided to you about that taxpayer from other sources you would be right on the mark. The IRS runs an automated matching program that kicks out mismatches and helps identify audit targets without much effort on their part. Knowing this:

Double check name matches. If you are recently married or divorced ensure your filed tax return matches the name on file with the Social Security Administration. This may mean filing a tax return with an outdated name until the name change can be processed.

Create a master list of tax forms given to you. Who is sending information about you to the IRS? The most common sources are your employer, your bank, your investment bank, your health insurance company, and your retirement accounts. Make a list of these sources and ensure your tax return matches the information they are providing.

Correct before filing. Try not to file tax returns with incorrectly reported information on your W-2s or 1099s. Contact the provider of the form as soon as possible and try to have the form corrected and resubmitted to the government.

Match incorrect then correct. If you have incorrect information on forms already sent to the government, first enter the incorrect information on your tax return. This is for the benefit of the IRS matching program. Then correct the information. Include comments explaining why the original form is in error. Save the documentation that supports your position. With this approach you will be filing a correct return and you will not trigger the government matching program.

If you receive a notice from the IRS that something does not match what was submitted by you, consider requesting a copy of the information reported to them to determine where the mismatch occurred.

IRS has broad authority to seize bank accounts

If someone manipulates cash transactions to avoid required bank reporting to the Treasury Department, they are using the technique of structuring their transactions. Knowing what is reported and the power given to the IRS to seize related assets can be important.

Background

In an effort to identify questionable illegal transactions, financial institutions are required to report any monetary amounts over $10,000 to the Treasury Department. If someone knowingly structures their transactions to avoid this reporting, the Bank Secrecy Act allows the IRS to legally seize these assets. The old rules provide fairly broad discretion in this area and many innocent taxpayers not only had assets frozen, but found it virtually impossible to get their funds returned to them.

Example

Vocatura’s Bakery in Norwich, CT did most of their bakery trade in cash. To help their local banker not have to fill out required federal forms when they deposited $10,000 or more, they tried to make lower deposits. One day the IRS showed up at their business and seized over $65,000 of their deposits suspecting illegal activity through use of this structuring activity. Using civil forfeiture rules, the IRS permanently seized this small business’ assets. Three years and lots of legal fighting later, the business finally got their money back. Here is a link to their story; IRS Returns Bakery’s Money After 3 Years.

What you should know

Be aware of the rule. As more small businesses try to avoid the high charges associated with credit cards, they must also be aware of the Bank Secrecy Act rules. Establish a good relationship with your banker and have them understand your business to help create a potential ally if needed. Do not knowingly try to avoid the $10,000 reporting rule.

Consistent numbers. Create a regular routine of sales deposits. Do not save up deposits and then deposit similar amounts. This could raise red flags.

The rules are changing. In a recent change, the IRS will still pursue structuring violations, but will try to more closely align action taken with knowledge of criminal activity. The government must show that the taxpayer knows of the rules and knowingly structures their transactions to avoid the reporting.

There are bad guys. Money laundering is a big problem. Whether it be drug money, terrorist fund raising, bootlegging or other illegal activity, excess cash deposits will raise suspicions. So while the IRS uses their tools to catch these crooks, they are making an active attempt to keep innocent taxpayers out of their net.

Think twice about automatically paying the amount due on a notice

Quotes from actual IRS correspondence received by clients:

"Thank you for your correspondence. We currently do not have a copy of the correspondence we sent to you regarding your child's tax return."

"Our records show we received a 1040X...for the tax year listed above. We're sorry but we cannot find it."

"Our records show you owe a balance due of $0.00. If we do not receive it within 30 days, appropriate collection steps will be taken".

"Payment is due on your account. Please submit payments on or before June 31 to avoid late payment penalties and interest."

It's pretty tough to pay a balance due of $0 on June 31st when June only has 30 days. The message should be clear. If you receive a notice from the IRS do not automatically assume it is correct and submit payment to make it go away. The same is true for any state notices. They are often in error. So what should you do?

Stay calm. Try not to over-react to the correspondence. This is easier said than done, but remember the IRS sends out millions of notices each year. The vast majority of them correct simple oversights or common filing errors.

Open the envelope. You would be surprised at how often clients are so stressed by receiving a letter from the IRS that they cannot bear to open the envelope. If you fall into this category try to remember that the first step in making the problem go away is to open the correspondence.

Careful review. Review the letter. Make sure you understand exactly what the IRS thinks needs to be changed and determine whether or not you agree with their findings. Unfortunately, the IRS rarely sends correspondence to correct an oversight in your favor, but it sometimes happens.

Respond timely. The correspondence received should be very clear about what action the IRS believes you should take and within what timeframe. Ignore this information at your own risk. Delays in responses could generate penalties and additional interest payments.

Get Help. You are not alone. Getting assistance from someone who deals with this all the time makes the process go much smoother.

Correct the IRS error. Once the problem is understood, a clearly written response with copies of documentation will cure most of these IRS correspondence errors. Often the error is due to the inability of the IRS computers to conduct a simple reporting match. Pointing the information out on your tax return might be all it takes to solve the problem.

Certified mail is your friend. Any responses to the IRS should be sent via certified mail. This will provide proof of your timely correspondence. Lost mail can lead to delays, penalties, and additional interest on your tax bill.

Don't assume it will go away. Until a definitive confirmation that the problem has been resolved is received, you need to assume the IRS still thinks you owe the money. If no correspondence confirming the correction is received, a written follow-up will be required.

The word “audit” is enough to raise anyone’s blood pressure. If the IRS agent then tells you they want to see bank accounts and personal records you may need a heart monitor. Should this happen to you, you could be in a process known as a lifestyle audit.

Background

The lifestyle audit was a tool used by auditor’s to ascertain if the income you claim on your tax return can support how you live.

As an extreme example, perhaps you claim $30,000 in taxable income, but drive a Ferrari and you have a $700,000 mortgage. Most of us would have a hard time believing the income claimed on this tax return could support this lifestyle.

Historically, tax returns that have a history of cash transactions would be a target for lifestyle audits. So if you ran a small business (schedule C) or worked in an industry like construction, fishing, and retail you could experience this lifestyle audit.

Reason first

As you might imagine, being the subject of a lifestyle audit is stressful. It could be a more involved process than responding to a letter from the IRS questioning part of your tax return. The best defense for this type of review is good record-keeping. Here are some tips:

Understand your lifestyle risk. Do you think you can substantiate how you live with the level of claimed income on your tax return? Most of us can, but if you inherited money that allowed you to buy a new house, car or other luxury items it might raise questions. If this is the case, keep copies of documentation that supports the event.

Awareness of gift limits. Remember, you may receive up to $15,000 in gifts from any individual in any given year without tax consequences. If you receive gifts from someone, please keep record of the event.

Sales receipts. For every small business deposit in your bank account have a supporting document that substantiates the deposit’s source.

Separation. Keep separate business and personal bank accounts and credit cards. It is easier to substantiate your lifestyle spending when you do this.

Ask why. The passing of the 1998 IRS Restructuring and Reform Act limits the ability of IRS agents to conduct lifestyle audits. In current practice, a lifestyle audit may only be undertaken if the IRS agent has a reasonable cause to conduct the review. The cause might be based on information provided on your tax return or based upon information reports it has received from others. It is reasonable for you to ask for clarification from the auditor as to why they believe a lifestyle audit is in order. Perhaps proper documentation may be all that is required to answer the auditor’s questions.

Ask for help. Remember, should you receive notice by the IRS with questions regarding your tax return, ask for assistance. The same is true with notices from any other taxing authority. You are not going to be as well versed in the tax code as your auditor, so why not ask for help from someone who is.

Alimony audits

The U.S. Treasury Department recently released an audit report revealing a disturbing level of non-compliance in alimony reporting on tax returns. This non-compliance will result in a vast increase in tax return reviews now and in the years to come. Here is what you need to know.

The study

The Treasury Inspector General for Tax Administration (TIGTA) recently conducted an Audit of 2010 tax returns that claimed an alimony deduction. What they found:

Over 560,000 taxpayers reduced their income for alimony paid in 2010.

47% of the claimed alimony deduction tax returns did not match required income reporting from those who received the alimony.

The discrepancy was more than $2.3 billion in unreported 2010 income.

Please note: You may reduce your income for qualified alimony payments. Those that receive alimony must include the payments as income on their tax return. As a clarification, in most cases, spousal maintenance is considered alimony by the IRS while child support is not considered alimony.

Further, the audit determined that the IRS does not adequately track this non-compliance. Nor are proper penalties being assessed when the person paying alimony does not correctly report the Social Security Number (SSN) or Tax Identification Number (TIN) of the person receiving the funds.

Things to consider

If you receive alimony. You must report this income on your tax return. If you are receiving income from an ex-spouse that you believe is child support, have documentation to support this claim.

Mis-match audits will rise. The IRS has corrected their audit filters to capture major alimony mis-matches. Given this, you should expect a notice or audit if there is a major alimony discrepancy.

Penalties are coming. If you do not correctly report the SSN or TIN of the person receiving alimony you will now start to see penalty notices. The programming error in the IRS system has been corrected. So get a correct identification number for the person who receives your alimony payments and report it on your tax return.

Keep documentation close. Since you know the risk of audit in this area is high, keep your documentation handy. If paying alimony, having it automatically deducted from your paycheck will help you accurately report your payment amounts.

File a tax return. In 2010, $937.2 million of the claimed alimony deductions had no corresponding income tax returns filed reporting the income. This non-reporting area is a highly recommended audit target for the IRS.

Talk to your ex. While possibly an unpleasant task, a quick discussion regarding claimed alimony can identify whether you have a reporting problem. Hopefully, this communication can solve any potential problems prior to the involvement of the IRS.

As a final note, alimony will no longer be a taxable event for divorce decrees after 2018. However, prior rules apply for divorces finalized prior to this date.

Missing a Form? Not an Excuse.

If you don’t receive a W-2 or 1099, is this a defense to protect yourself from not reporting the income during an audit?

In short, the answer is no. You are required to report your income whether your employer or customer filed the correct form or not. So what can you do to ensure you do not find an audit surprise in your future due to a simple omission of income from a report you did not receive? Here are some tips:

Keep good records. Do not depend on someone else’s records to file your taxes. Keep your own records and then use them to ensure the information on your tax return is accurate.

Make a list. Start making a list of your employers and others you believe should be sending you a W-2, 1095, 1098, 1099 or other tax form. Put the list in a file and check off each name when you receive their form. Use last year’s tax return to help you create your initial list.

Double check. When you receive the forms, review your records to see if you agree with the information reported to you. Use your last paycheck stub to check your wage reporting, use your bank statement to confirm interest income, use your investment statements to confirm stock and mutual information and use invoices to confirm miscellaneous income.

Take charge. If you are missing a form or the form received is in error, contact the firm supplying you the information and get it corrected as soon as possible. If tax filing due dates are approaching, you may need to file an extension while waiting for the corrected form.

Record the correct information, no matter what. Record the correct information on your tax return, even if you lack the required form. Not receiving a tax form is not a workable audit defense.

If you receive a notice from the IRS regarding a possible missing item, consider filing an information request to see what the IRS has on file for you. It may help better identify the area of mismatch.

Constantly changing scams require your attention

Believe it or not, pretending to be an IRS agent is one of the favorite tactics of scam artists, according to the Better Business Bureau. The con artists impersonate the IRS to either intimidate people into making payments over the phone, or to send misleading emails tricking people into sharing personal information digitally.

You can defend yourself against these scammers by knowing these simple rules:

Rule 1: Expect a letter first

In almost every case, the IRS will send you a letter via standard mail if they need to get in touch with you. This will alert you to expect future communication from the agency and instruct you on the best ways to get in touch with them.

What to do: If you get a letter from the IRS that is unexpected or suspicious, it should have a form or notice number searchable on the IRS website, www.irs.gov. If something doesn't look right, you can call the IRS help desk at 1-800-829-1040 to question it.

Rule 2: Never over email

The IRS will never initiate contact with you using email. A common scammer trick is to send emails to taxpayers using accounts and graphics that imitate the agency's. They may threaten imprisonment or fines if you don't pay up, or promise an extra refund if you send money to "prepay" your taxes. Often the emails contain links to an official-looking fake website to collect payments. Clicking on them may also trigger the installation of virus programs on your computer.

What to do: Don't respond to any email communications supposedly from the IRS. Don't click on any links. Delete the email or forward it to phishing@irs.gov to help catch the scammers.

Rule 3: Proper phone call etiquette

After notification via the USPS, the real IRS may call you to discuss options to handle delinquent taxes or an audit. A real IRS agent or a debt collector won't demand immediate payment without giving you an opportunity to question or appeal the bill. Nor will they threaten lawsuits, arrest or deportation. Their tone should not be hostile or insulting. Finally, if they ask for payment, they should be asking you to make it out only to the United States Treasury.

What to do: If you get a call from the IRS or an IRS debt collector, politely ask for the employee's name, badge number and phone number. They shouldn't hesitate to provide this information. You should then end the call and dial the IRS at 1-800-366-4484 to confirm the person's identity.

Rule 4: Check in-person visits

Ask the person for their credentials. Every IRS agent should be able to produce two forms of credentials: a pocket commission card and a personal identity verification card issued by the Department of Homeland Security, also called an HSPD-12.

What to do: Never provide sensitive information nor confirm information they may have without first independently verifying they are legitimate representatives of the IRS. If you have concerns you can call the IRS at 1-800-366-4484 to confirm the person's identity.

You do not need to navigate this problem on your own. Call immediately for assistance. It is good to have a knowledgeable expert on your side.

Few things are more unnerving than having your tax return selected for an IRS audit. The IRS uses that "audit anxiety" to help keep taxpayers honest on their tax returns.

DIF scores count

The IRS evaluates tax returns based on their "DIF" scores, a set of IRS formulas known as the "Discriminate Function System." About three-quarters of all returns audited are selected by the DIF computer, which compares deductions, credits, and exemptions with the norms for taxpayers in each income bracket.

While these formulas are kept very secret by the IRS, you can count on having a higher audit probability if you fall into certain categories or report certain things on your tax return.

What interests the IRS?

Some higher risk areas include the following -

1. Tax protests. Both the IRS and tax courts are getting fed up with what they consider frivolous tax protests. If you file a return stating that you owe no tax because the dollar is worthless or make some other such protest, you'll probably be audited.

2. High income. Because auditing higher-income taxpayers is likely to produce more additional tax revenue than auditing lower-income taxpayers, this category is targeted by the IRS.

3. Certain occupations. Taxpayers whose occupations produce cash income, such as taxi drivers and waiters, run a higher risk of being audited. Self-employed individuals, particularly independent contractors, are IRS targets for the same reason; they are more likely to have unreported cash income.

4. No preparer or a problem preparer. If you have a complex return and prepared it yourself, or if your return was prepared by someone on the IRS's problem-preparer list, you are more likely to be audited.

5. Certain deductions. The IRS has found it profitable to audit returns that claim office-in-the-home deductions, travel and entertainment deductions, and certain other write-offs where they feel taxpayers stretch the truth.

6. Related party transactions. Taxpayers who involve family members in their financial operations are more likely to be scrutinized by the IRS. Paying wages to your children, lending money to relatives, splitting income among family members, or running a family business will make the IRS more interested in your returns.

7. Abusive tax shelters and offshore accounts. In the last few years the Internal Revenue Service has detected a proliferation of abusive trust tax evasion schemes. It also believes some people are using offshore credit cards to evade paying U.S. income taxes. The Service intends to expand its efforts to crack down on abuses in these areas.

Your best audit defense

Unless there is suspicion of fraud or substantial understatement of income, the IRS has three years from the due date of your return to initiate an audit. Typically, most returns are selected within two years of their filing date.

The best defense in an audit is a two-part strategy:

1. Have supporting documentation for all deductions and credits.

2. See your accountant immediately upon notification that you're being audited.

A professional can put your mind at ease, find the information that the IRS wants more quickly than you can, and very likely will save you money in the long run by getting a faster and more favorable conclusion to the audit.

File your tax return or else

In order to continue receiving a Premium Tax Credit you must file income tax returns as soon as possible. Any delay could stop eligibility for advance payments of this credit during the current tax year. Remember, these payments help reduce each month’s health insurance premium. It could also generate notices from the IRS to pay back some or all of prior advance payments of the credit.

Background

Those who use the Affordable Care Act to purchase health insurance on the Marketplace are often eligible to reduce their insurance premium using the Premium Tax Credit. Many had the credit sent directly to their health insurance company each month to reduce their premium. This is called “advance payments of the premium tax credit” by the IRS.

Current Situation

The IRS is now reviews payments of the Premium Tax Credit. To continue receiving the credit you must file tax returns. If you filed an extension and do not plan to file your tax return until October 15th, you could be ruled ineligible for the credit next year because you have not yet filed your tax return.

Impact

Your insurance premiums could increase next year if you are ruled ineligible for the advance premium credit payment. This could cause financial hardship. You may be asked to repay prior year Premium Tax Credit Payments as well.

Action

If you received any Premium Tax Credit or expect to do so in the future, you must file tax returns as soon as possible per the IRS.

Call if you need a review of your situation.