Here we are in the middle of tax filing season, and we all want to make sure we get the biggest refund possible, or at least owe as little to Uncle Sam as we can legally get away with, right? If you are doing your own taxes using one of the software programs out there, good luck to you. I hope you don’t miss anything! If you really want to make sure your taxes are done right, that you are fully compliant and that your returns will be the most accurately done as they can be done, go to an Enrolled Agent for your tax preparation. The following red flags should be well known by a tax professional, especially one of America’s Tax Experts, an Enrolled Agent.
For those of you that choose to go it alone, there are some areas that are at the top of the list for being audited by the IRS that you should be aware of so that you don’t fall into any traps. The top five that are scrutinized are:
- Charitable Donation Deductions – These are a great write off on your personal taxes if you itemize. However, if they are considered by the IRS to be excessively large, particularly in comparison to your income level, it could raise that red flag and trigger an audit. It is critical that you have documentation to substantiate these. Gifts by cash typically require you to have copies of checks, a receipt from the 501(c)(3) that you contributed to at the very least. If a non-cash contribution is over $500 you absolutely have to have an appraisal or some other form of documentation proving the value of the donation.
- Business Use of a Vehicle – This one seems like an “easy money” deduction on a tax return, right? Not so much! You again have to be able to substantiate the deduction. A mileage log is a critical piece of the puzzle on this one. If you do not have a detailed mileage log, showing the business purpose, beginning and ending mileage – for each trip – and dates of the trips, you can pretty well count on an IRS Revenue Agent to disallow the deduction.
- Business Meals, Travel and Entertainment – If you have large deductions for meals and entertainment, especially if it is out of line for your business or profession, it can trigger an audit. You have to be able to substantiate the business purpose for the expense. This means that you need to keep detailed records for these expenses including the purpose of the meeting, the place of the meeting, the people involved in the meeting and what business issues were discussed. To take it one step further, if the expenditure is $75 or more you had better have a copy of the receipt or it will get tossed in an audit.
- Rental Real Estate Losses – This is a bit of a tricky one. If you buy a property as an investment and you rent it out, you should be able to write off any losses that you incur, right? The IRS say not so fast. There are some rules you have to follow. First of all, passive loss rules prevent you from deducting the losses on your tax return. Passive loses can be defined by “participation” in the rental process. If you are a Real Estate professional that spends at least half of your time participating in Real Estate Development, Broker, Landlord or other related activity, then you can write off the losses without any limitation. If you own a rental property and actively participate in the rental of your property, then you have the right to deduct up to $25,000 in losses as long as your Adjusted Gross Income doesn’t exceed $100,000. If your AGI is between $100,000 and $150,000 there is a phase out of what you can deduct. If you have an AGI in excess of $150,000 bye bye write off!
- Small Businesses – A self employed person that reports that income on a Schedule C is, unfortunately, at a bigger risk simply because they report their income on Schedule C. An IRS Revenue Agent knows from experience that this is a possible gold mine for them. Many of those that are self employed either under-report their income or over-inflate their expenses in order to pay lower taxes. It is even worse if you are in a business that they consider to be a “cash-intensive” business. They are also beginning to take a closer look at the smaller S Corporations, and LLCs .
The bottom line to all of this is simple: Keep good records, do things honestly and ethically, and if you do get that nasty audit notice in the mail, contact an Enrolled Agent to help you. They are not only great at the initial tax preparation, they are experts in Tax Representation and can help you through your situation all the way up to Tax Court.