Tag Archives: income tax

What are My Chances of Being Targeted for an IRS Audit?

According to the recent Kiplinger Tax Analysis, the Internal Revenue Service (IRS) is struggling with its enforcement efforts as the agency’s funding has been significantly reduced over the past several years. Some interesting statistics included:

  • 2012 audit rate for individuals was the 0.96% – approximately 1 out of 100 filed returns (lowest since 2005)
  • 2013 audit rate for individuals is projected to be at 0.80%

The odds may seem very low for the return to be picked for a review; however, taxpayers should look at the following factors (selected by Kiplinger’s Personal Finance Magazine) that could increase further scrutiny by the IRS and potentially result in a full-blown examination of your income tax return:

  1. Large Gross Income – According to the IRS statistics, even though the overall individual rate is below 1%:

i.            Taxpayers with incomes of $200,000 or higher had an average audit rate of 3.26%

ii.            Taxpayers with incomes of $1mil or higher had an average audit rate of 11.11%

  1. Failure to properly report all taxable income – The IRS receives copies of all forms 1099s and W-2s; a mismatch is easily detected by the IRS computers and a subsequent notice will be issued.
  2. Large Charitable deductions – The IRS is aware of the average charitable donation for taxpayers in various income categories (ex., taxpayers with Adjusted Gross Income in $100k-$200k range reported, on average, $3,939 charitable deduction). If your deduction is disproportionately larger, it raises a red flag. Also note that, for noncash donations in excess of $500, a form 8283 must be included with your tax return and, for noncash donations in excess of $5,000, an appraisal is required.
  3. Schedule C – Considered by some as a goldmine for IRS agents, as history shows that most understating of income and overstating of deductions is done by those who are self-employed.

i.            Hobby Losses – don’t confuse a hobby with a business. The activity must be conducted with the intent of making a profit; the law presumes you have a business if the activity at a minimum generates profit three out of five years. Also make sure that you have proper documentation for all of the expenses. If, however, you determine that the activity is actually a hobby, report any income and deduct any expenses only up to the level of income; the law prohibits writing off losses from a hobby.

ii.            Home Office – you must use the space exclusively and regularly as your principal place of business (this area of the home should not be used as a family room in the evenings or a guest bedroom).

iii.            Business Use of a Vehicle – claiming 100% business use of a vehicle is another red flag for the IRS and will get challenged; make sure you keep detailed mileage logs so that the deduction will not get disallowed.

iv.            Meals, Travel, and Entertainment – to qualify for the deduction, you must keep detailed records for each expense amount including: the place, people attending, business purpose and the nature of the discussion/meeting. Taking excessive deduction will draw additional attention from the IRS, so make sure you have proper documentation.

v.            Day-Trading Losses – many taxpayers who trade in stocks and other securities take an aggressive position of a “trader” rather than investor and report trading losses and expenses on Schedule C. The IRS is selecting those returns to determine if the taxpayers actually qualify as bona fide traders.

  1. Rental Losses – The IRS launched a “real estate professional“ audit project several years ago that targets taxpayers with real estate losses who claim to be real estate professionals. As a general rule, in order to qualify as a real estate professional, you must spend more than 50% of the working hours and 750 or more hours each year materially participating in a capacity of a real estate developer, broker, landlord, etc. If however, you hold a full-time job (outside of real estate) most likely you will not qualify as a real estate professional and the losses from your rental activity will be either limited to current year income or suspended to future years.

Claiming a higher than average deduction or loss on your income tax return may draw an unnecessary attention from the IRS; however, if you have proper documentation, you have nothing to worry about.

For more information about potential audit red flags, please contact your Aronson tax advisor or Anatoli Pilchtchikov at 301.231.6200.

 

About the Author: Anatoli Pilchtchikov is a manager in Aronson’s Personal Financial Services Group, where he specializes in tax compliance and consulting for high net worth individuals and their families, corporate executives and business owners. He manages his clients’ overall tax liabilities through proactive planning during the year and preparation of tax returns and projections.

 

Maryland Increases Personal Income Tax Rates

Maryland Governor Martin O’Malley has just signed legislation that, effective for tax years beginning after December 31, 2011, increases personal income tax rates for certain individuals and reduces allowable personal exemption deductions. The salient specifics of the legislation are that:

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What are your chances of being selected for an IRS tax audit?

The 2011 IRS Data Book, a compilation of statistical data and IRS activities, is out.  You can read the whole book here: http://www.irs.gov/pub/irs-soi/11databk.pdf or just skip to page 22 of the publication for the important stuff.

In summary, the average audit rate for individual tax returns is 1.1%.  But what’s in your return can push you above the average.  At the high end, those making more than $1 million have an audit instance of 12.5%.  At the other end, returns for those making under $200,000 and without any business or rental activities have

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Form 1099 Reporting: Failure to Do It Can Be Costly!

The IRS has changed its 2011 tax forms and added the following new questions on all business tax returns (including Schedule C for sole proprietors as well as partnership, LLC, and corporate tax returns):

    1. Did you make any payments in 2011 that would require you to file Form(s) 1099?
    2. If “Yes” did you or will you file all required Forms 1099?

Form 1099 is used to report certain payments to recipients and to the IRS.  The most common 1099 type form is Form 1099-MISC which is used to report the payment by a business for services rendered to the business (there may also be Form 1099 reporting requirements if a business pays interest or dividends).

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Need cash? Don’t borrow from the IRS!

Many businesses and individuals are experiencing cash flow difficulties in today’s economy. To ease the cash crunch, it may be tempting to delay payment of taxes in the hope that finances will improve soon. Unlike other creditors, the IRS moves relatively slowly, lulling the taxpayer into complacency. During this time, interest and penalties accrue which, in some situations, can even exceed the original tax due. When the IRS decides to act, they often file liens, levies, and other garnishments that can cause significant and sometimes permanent economic damage. In addition to these civil penalties and collection actions, the IRS can pursue criminal charges. The failure to truthfully account for or turn over taxes is a felony, with the potential of up to five years of jail time. This applies to all taxes under the Internal Revenue Code – income tax, payroll tax, gift tax, and excise tax, to name a few.

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