It’s easy to push tax planning to the sidelines when tax laws are ever-changing and hard to understand. Here are some common (but often unfounded) reasons for avoiding tax situations, plus tips to help get past them and start paying less tax this year:
It doesn’t make a difference. This point of view is especially problematic in years with unique situations. Even in uneventful years, external forces like new tax laws can be managed if planned for in advance.
Selling a house? You can avoid taxes if primary residence requirements are met.
Starting a business? Choosing the correct entity can save you a bunch of taxes.
Getting ready to retire? Properly balancing the different revenue streams (part-time wages, Social Security benefits, IRA distributions and more) has a huge impact on your tax liability.
It’s out of your control. Timing is important when it comes to minimizing taxes, and the timing is often in your control. Bundling multiple years of donations into one to get a deduction, holding investments over one year to get a lower tax rate, and making efficient retirement withdrawals are just some examples of prudent tax strategies that you control.
There’s not enough money. There are tax strategies to be implemented at all income levels, not just those at the top of the tax bracket. Tax deductions are available for student loan interest, IRA contributions and others even if you claim the standard deduction. Certain tax credits (called refundable credits) will increase your refund even if you don’t owe taxes. Missing any of these tax breaks can unnecessarily increase your taxes.
I only need help at tax time. When the standard deduction doubled in 2018, many people assumed they could kick their feet up and wait for a big refund. That assumption proved to be false for a large number of taxpayers when their refunds came in lower than expected or turned into a tax bill. Don’t let this happen to you! Every year has it’s own set of changes and challenges that you should plan for well before tax time rolls around.
It’s too overwhelming. Tax planning is often as simple as looking for ways to reduce taxable income, delay a tax bill, increase tax deductions, and take advantage of all available tax credits. The best place to start is to bolster your level of tax knowledge by picking up the phone and asking for assistance.
Thankfully, it’s not too late to get on track for 2019. If you haven’t scheduled a tax-planning meeting, now is a great time to do so.
The IRS recently released its 2018 Data Book, including information on its audit activities for the last fiscal year. This details what you need to know regarding your audit risk, how to prepare for and what to expect in an IRS audit.
Know the facts
An IRS audit is a review to ensure your tax filings are reported correctly according to tax laws.
Both individual and business tax returns can be audited.
The IRS won’t initiate an audit by telephone.
IRS Audit Statistics
Totals
FY 2015
FY 2016
FY 2017
FY 2018
Tax returns filed in prior calendar year
191,857,005
192,936,878
195,614,161
195,750,099
Audits
1,373,788
1,166,379
1,059,924
991,168
Percentage of returns audited
Less than 1%
What are your chances of being audited?
It depends. But for most taxpayers, LOW.
Approximately 1 in 198 tax returns were audited in 2018.
The IRS audited 0.6% of all individual income tax returns filed in 2018, and 0.91% of corporation tax returns (excluding S corporations)
There are two types of audits:
Field audit: An in-person interview and review of records. It often happens at taxpayer’s home, business or accountant’s office.
Correspondence audit: A written request for more info about a specific tax return item or issue handled via mail.
Did you know? Approximately 2/3 of audits are handled through the mail.
Reasons you may be audited
Although the IRS uses random selection as one method to choose tax returns to audit, it may also flag returns because:
You’re in a higher income tax bracket.
You have math errors on your tax return.
You report no income or not all of your income.
Your tax return involves issues with other taxpayers whose returns are being audited.
Other reasons: reporting too many losses, deducting too many work expenses and claiming too many charitable contributions may also trigger an audit.
Always be prepared
Use your past tax return as a checklist of items to keep on hand:
A copy of your signed tax return and all supporting documents
Worksheets that support your return
Forms W-2
Forms 1099 (all versions)
Forms 1095
Business Forms K-1
Canceled checks of deducted items
Receipts supporting deducted items
Itemized deduction support
Child care receipts and reporting documents
Bank statements
Investment statements
Mortgage statements
Credit card statements
Major purchases or sales
Receipts for any charitable donations
Proof of fair market value for any inherited items
Mileage logs for business, charitable and medical transportation
Business meals and cellphone use documentation
Educational expenses
FYI: Always use copies of records during an audit. Keep your original documents.
More ways to prepare: Check IRS.gov to review its Audit Techniques Guides (ATGs). They are used by IRS examiners and can identify areas for potential audits, as well as help you understand what the IRS may question.
What to do if you’re audited
Your tax return may never be audited. But if it happens, here are a few tips to make the process go more smoothly:
Respond to the IRS in a timely manner. If you don’t, an in-person meeting may happen.
Ask for help. NEVER tackle the IRS alone!
Know what is being asked. Get a clear understanding of the core questions.
Understand how the auditor has been trained. IRS auditors are trained in certain areas. These are published in the ATGs.
The bright side: If you are audited, you may end up with a refund. In FY 2018, approximately 30,000 audits resulted in refunds, totaling $6 million.
Sleuthing your way through a tax audit by yourself is not the same as fixing a leaky faucet or changing your oil. Here are reasons you should seek professional help as soon as you receive a letter from the IRS:
IRS auditors do this for a living — you don’t. Seasoned IRS agents have seen your situation many times and know the rules better than you. Even worse, they are under no obligation to teach you the rules. Just like a defendant needs the help of a lawyer in court, you need someone in your corner that knows your rights and understands the correct tax code to apply in correspondence with the IRS.
Insufficient records will cost you. When selected for an audit, the IRS will typically make a written request for specific documents they want to see. The list may include receipts, bills, legal documents, loan agreements and other records. If you are missing something from the list, things get dicey. It may be possible to reconstruct some of your records, but you might have to rely on a good explanation to avoid additional taxes plus a possible 20 percent negligence penalty.
Too much information can add audit risk. While most audits are limited in scope, the IRS agent has the authority to increase that scope based on what they find in their original analysis. That means that if they find a document or hear something you say that sounds suspicious, they can extend the audit to additional areas. Being prepared with the proper support and concise, smart answers to their questions is the best approach to limiting further audit risk.
Missing an audit deadline can lead to trouble. When you receive the original audit request, it will include a response deadline (typically 30 days). If you miss the deadline, the IRS will change your tax return using their interpretation of findings, not yours. This typically means assessing new taxes, interest and penalties. If you wish your point of view to be heard — get help right away to prepare a plan and manage the IRS deadlines.
Relying on an expert gives you peace of mind. Tax audits are never fun, but they don’t have to be pull-your-hair-out stressful. Together, we can map out a plan and take it step-by-step to ensure the best possible outcome. You’ll rest easy knowing your audit situation is being handled by someone with the proper expertise that also has your best interests in mind.
The recent college admission scandal involving Lori Loughlin (who played Aunt Becky in the Full House TV series) and others is shedding light on just one way people allegedly cheat on their taxes. Here are examples of some famous people in tax trouble with the IRS and helpful hints to make sure it doesn’t happen to you:
Lori Loughlin and questionable charitable donations. In this case, the IRS would investigate whether payments deducted as charitable contributions on her tax return were really charitable contributions. Regardless of how the legal charges shake out, Loughlin is looking at a large tax bill if the charity she contributed to is stripped of their non-profit status.Helpful hint: Charitable giving must be to legitimate charitable organizations, for legitimate purposes, and must be reduced by any value received in return.
Al Capone and his illegal earnings. After years of bribing and wriggling his way out of violent crime charges, Capone was charged with 22 counts of tax evasion for not reporting income on illegal activities. He was sentenced to 11 years in prison – some of which were served at Alcatraz Federal Penitentiary in San Francisco.Helpful hint: ALL income – even if obtained illegally – is taxable.
Wesley Snipes decided not to file his taxes. In 2008, actor Snipes was convicted for not filing tax returns from 1999 to 2001. Among his many arguments, Snipes used the tax protester theory claiming domestic income is not taxable. After jail time, Snipes’ offer in compromise to lower his $23 million tax bill request was shot down by the IRS.Helpful hint: Exotic tax schemes are actively monitored by the IRS. If it seems to good to be true, it probably is too good to be true and requires a second opinion.
Leona Helmsley faked her business expenses. Helmsley, A famous real estate mogul in the 1980s, had more than $8 million of renovations to her private home billed to one of her hotels so she could deduct the expense on her taxes. After being convicted, Helmsey had to pay back the $8 million and served 18 months in prison.Helpful hint: Separate business expenses from personal expenses. Open separate bank accounts and never intermingle expenses. The IRS is quick to disallow deductions when personal expenses and business expenses are mixed together.
Pete Rose hid his “likeness” income. Many famous athletes go on to sell autographs, memorabilia and get paid for appearances after they retire from their sport. Rose was no different, but he opted not to report the $354,968 he earned over a four-year period. The result was five months in prison and a $50,000 fine in addition to having to pay back the taxes he tried to avoid.Helpful hint: Don’t attempt to hide income. With less and less businesses using cash payments, the IRS now can use matching programs to quickly find underreporting problems.
While seeing well-known celebrities in the press for tax trouble makes for interesting reading, there are useful tax lessons for all of us. It provides an opportunity to see how IRS employees think and what they are reviewing.
The IRS continues to focus their audit activities in key small business areas. The wise business owner is well advised to be able to defend the following five areas to keep the IRS at a comfortable distance:
Business or hobby? Be ready to provide proof your business is truly a business and not a hobby. Those who fail in the eyes of the IRS can have their expense deductions severely limited, while still required to report the income. Make sure you can answer and provide documentation for these four questions:
What is your profit motive?
Are you an active participant in the business?
Are you conducting the activity in a business-like manner?
What expertise do you have in the service or products your business provides?
Reasonable shareholder salary. S corporations are in the unique situation where some compensation is excluded from payroll taxes. Many businesses take this too far. The IRS is looking closely at businesses who avoid paying a reasonable salary in order to lower their Social Security and Medicare bills. When determining salaries for shareholders, consider their experience, duties, responsibilities and time devoted to the business. Once you have a picture of their ongoing contributions to the business, research comparable positions and salary ranges to pinpoint a fair salary. Save your findings and calculations as backup to provide in the event of an audit.
Contractors or employees? Make sure consultants and other suppliers are not employees in disguise. The IRS looks at how much control you have over the work being done – the more control you exert the higher likelihood you may have an employee versus a contractor. Penalties can be very steep if the IRS decides your consultant is really your employee. If in doubt, ask for a review.
Expenses for meals and entertainment. The IRS is now disallowing any entertainment deductions, even if there is business conducted before or after the event. That means business meal documentation is now more important than ever and should include receipts, who attended the meal, and the business purpose of the meal. Bringing food in for business lunches rather than going out is a safe way to show business intent. If you have an event with both entertainment and food included, get two receipts – one for the entertainment and one for the food.
File your Forms W-2 and Forms 1099. Don’t forget to file all required 1099s and W-2s. Most of them are due on or before Jan. 31. The IRS is penalty crazy in this area with up to $270 per missing or incorrect form.
Knowing what the IRS is looking for helps you prepare should it turn its focus to your business.
The more things change the more they stay the same. This is especially true when it comes to reviewing your tax situation. Mark your calendar to review these essential items each year to ensure you are not missing something that could cause tax trouble when you file your tax return:
Required minimum distributions
If you are 70½ or older, you may need to take required minimum distributions (RMDs) from your retirement accounts. RMDs need to be completed by Dec. 31 every year after you turn the required age. Don’t forget to make all RMDs because the fines are extremely hefty if you don’t – 50 percent of the amount you should have withdrawn.
Your IRS PIN
If you are a victim of IRS identity theft you will be mailed a one-time use personal identification number (PIN) as added security. You can expect to receive your PIN in the mail sometime in December. Save the PIN as it is required to file your Form 1040. If you would like to sign up for the PIN program, you can do so on the IRS website. Note that once you are enrolled in the program, there is no opt out. A PIN will be required for all future filings with the IRS.
Retirement Contributions
You may wish to make some last-minute contributions to qualified retirement accounts like an IRA. This can be $5,500 for traditional or Roth IRAs plus an additional $1,000 if you are 50 or older. Contributions to traditional IRAs need to happen by April 15, 2019 to be deducted on your 2018 tax return.
Harvest Gains and Losses
Profits and losses on investments have their own tax rates from 0 percent to as high as 37 percent. Knowing this, make plans to conduct an annual tax review of investment moves you wish to make. This includes:
Understanding investments held longer than one year have lower tax rates as long-term capital gains.
Trying to net ordinary income tax investment sales with long-term investment losses.
Making full use of the annual $3,000 loss limit on investment sales
Timing matters with investment sales and income taxes, so having a year-end strategy can help lower your tax bill.
Last-Minute Tax Moves
While your last-minute tax move opportunities may be limited, here are a few ideas worth considering:
Make donations to your favorite charities to maximize your itemized deductions.
Consider contributions of up to $100,000 from retirement accounts to qualified charities if you are older than 70½.
Make tax efficient withdrawals from retirement accounts if you are over 59½.
Delay receipt of income or accelerate expenses if you are a small business.
Take advantage of the annual $15,000 gift-giving limit.
Understanding your current situation and having a plan will make for a smooth tax filing process and maximize your tax savings.
