Who Are the Latest IRS Targets? A List of 23 Audit Triggers

Transcription

1 Fall 2014 Vol. 10, Issue Market Avenue, South Suite 700 Canton, Ohio (330) INSIDE THIS ISSUE: Who Are the Latest IRS Targets? A List of 23 Audit Triggers Pg.1-2 Protect Yourself against the Latest Phone Scams Pg. 3,5 Documentation Is Key to Car and Truck Expenses Pg. 4,6 Hallkistlerblog.com Pg.5,7 Check us out online Subscribe to the digital version at Follow us Who Are the Latest IRS Targets? A List of 23 Audit Triggers Many taxpayers ask: How can I avoid an IRS audit? There's no 100 percent guarantee that you won't be picked because some tax returns are chosen randomly. However, completing your returns in a timely and accurate fashion with your trusted HK tax adviser certainly works in your favor, and it helps to know the red flags that might catch the attention of the IRS. What are your chances of being audited? For individuals, it depends on your income. In fiscal year 2013, returns reporting income under $200,000 stood a 0.88 percent chance of an audit. Those with incomes of $200,000 and more had a 3.26 percent chance. If your income was $1 million or more, you had a percent chance. What entries on your return are likely to result in a letter from the IRS? Here's a list of 23 items some tax preparers believe can trigger an audit. Some items only apply to individuals or self-employed people who file a Schedule C, while others apply to both individuals and businesses. In some cases, items are likely to only generate a letter from the IRS requesting documentation for the item. 1. Outsized charitable contributions. The IRS publishes data on the average size of charitable contributions for various income levels. If you take a deduction for an amount that is much larger than the averages, you could hear from the IRS. 2. Large property contributions. Significant charitable contributions of property require an appraisal and certain return attachments. Appraisals are often challenged by the IRS. 3. Unmatched alimony. For example, if you take a deduction for $24,000 of alimony, your ex-spouse should be reporting $24,000 of income. 4. High mortgage interest. The maximum amount of qualified home indebtedness is $1.1 million (including home equity loan). A mortgage interest deduction that's in excess of a certain percentage of the debt limit could indicate an excessive deduction. 5. Unreported income. Failure to report gambling winnings, interest and dividends, non-employee compensation (1099-MISC), K-1 items, etc. may just trigger a letter and bill from the IRS -- or it could generate an audit. 6. Unreported income from crowdfunding. Entrepreneurs, artists, charities, and others may find it easy today to raise money on the Internet through crowdfunding websites. If the money starts rolling in, these individuals and organizations likely have to report it to the IRS as taxable income. (Expenses associated with the activities can be claimed as deductions.) Many people raising money online view their endeavors as non-taxable hobbies. This could eventually result in an IRS audit. Continued on page 2

2 Page 2 HK Bulletin Who Are the Latest IRS Targets? (cont. from pg. 1) If you re involved in crowdfunding, seek the guidance of your HK tax adviser to ensure your activities are properly reported on your tax return. 7. Gambling losses. You're allowed to deduct losses on Schedule A up to the amount of your winnings, but the IRS knows that many taxpayers don't keep the required records. 8. Miscellaneous itemized deductions. Breaking the two percent of adjusted gross income threshold is difficult, so large miscellaneous, itemized deductions may perk the interest of the IRS. 9. Foreign bank accounts. Checking the box indicating that you have a foreign bank account on Schedule B could increase your chances of an audit. However, not checking the box when you should could, too. The IRS continues to get information on many foreign bank accounts. 10. Unreimbursed employee business expenses. These expenses may be deductible, but substantial amounts are likely to raise questions because they are frequently reimbursed by an employer. If the expenses involve travel and entertainment or auto usage, your chances of hearing from the IRS may increase further. 11. Cash transactions. Banks and merchants are required to report cash transactions in excess of $10, Rental losses of a real estate professional. A qualifying individual can deduct rental losses in excess of the usual $25,000 limit. Meeting the required time limit involved in real estate activities and substantiating it isn't easy. Checking the box on Schedule E could increase your audit chances. 13. Casualty losses. This can be a complicated area where appraisals and other outside information may be required. 14. Bad debt losses. Again, this is often a complex area. Many taxpayers lose on this issue because they can't show a bona fide debt existed or that a loss occurred in an earlier or later year. 15. Home office. If you use a portion of your home exclusively for your business, you can deduct the expenses and depreciation associated with the space. However, you have to show the business connection and that the space was used exclusively for business. Both can be challenged by the IRS. The tax agency can also question the expenses involved in a home office. There's plenty of opportunity for an IRS auditor to make adjustments. In general, the higher the percentage of the home claimed for business, the greater your audit chances. 16. Day-trading losses. Claiming to be a stock market day trader and taking losses on Schedule C is a red flag. 17. Net operating loss. If your business (sole proprietorship, S corporation, partnership) has losses, you may have a net operating loss (NOL) that can be carried back or forward to offset income in other years. You may be asked to substantiate the loss if you claim a refund for an earlier year or on a later return where the NOL is used. 18. Rental losses. These could be challenged if there's no revenue from the property. 19. Hobby losses. Multi-year losses on Schedule C (or a pass-through entity such as an S corporation) may be scrutinized, particularly if the business is listed as one that has elements of personal pleasure, such as horse breeding, photography, or auto racing. Your audit chances increase if the losses offset substantial other income on the return. If you file a business return, there are other triggers. Some of them also apply to rental properties. 20. Travel and entertainment. Because of the recordkeeping requirements, and the fact that some deductions can be questionable, this is a ripe area for the IRS. 21. Auto usage. The IRS is aware that many taxpayers fail to keep the required records, making this a fruitful area for an IRS adjustment during an audit. 22. Repairs and maintenance. What business property owners believe is a repair and what the tax law considers a repair is often different. The IRS may require you to capitalize and depreciate expenses that you deducted. 23. Zero officer salaries for an S corporation. If an S corporation is active, showing no salary for officers is a red flag. These are only some of the items that can trigger an audit. What should you do if you have them on your return? If you re entitled to tax breaks, it doesn't make sense not to claim them. Just make sure you have the required records and tax law justification to back them up. For example, if you're not sure if a part business/part personal trip is deductible, contact us at for a professional opinion.

3 Volume 10, Issue 4 Page 3 Protect Yourself against the Latest Phone Scams Phone scams aren't new, but they are getting more sophisticated. Many people rejoiced when caller ID was introduced because it became easier to avoid unwanted calls, but it was only a matter of time until thieves developed ways to use caller ID like a Trojan Horse, enticing you to pick up the phone. They may mimic your bank or your credit card company or even a government agency like the IRS. Consumer Beware Across the country, people of all ages and financial backgrounds receive bogus phone calls from scammers pretending to represent their banks or credit card companies. The goal? To convince consumers to provide personal information to access accounts or simply send payment. For example, the Pennsylvania Attorney General's Bureau of Consumer Protection has recently received numerous complaints from victims who received calls from toll-free numbers telling them that holds were placed on their credit or debit card accounts. Then the callers instruct victims to press "1" and enter their credit card numbers to release the hold. Unsuspecting consumers who follow these instructions give away their credit card numbers, which fraudsters can immediately use to make online purchases or create fake cards for future use. However, credit card companies never ask consumers to give their information this way. If you receive such a call and are concerned about your credit card account, hang up and call the number on the back of your card instead. Another scam reported in Virginia involves prepaid money cards. Here, the perpetrator pretends to be an agent of the power or phone company, making a courtesy call for an overdue balance. Then the bogus agent claims that the company's credit card machine is out-of-order and requests the victim to pay the bill using a reloadable prepaid card. Similar scams have been reported in Minnesota and North Dakota using PayPal accounts. IRS Reminder about Phone Scams In August, the IRS repeated a reminder it made during tax season about phone scams. The tax agency continues to hear from taxpayers who have received unsolicited calls from individuals demanding payment while fraudulently claiming to be from the IRS. Based on the 90,000 complaints that Treasury Inspector General for Tax Administration (TIGTA) has received through its telephone hotline to-date, TIGTA has identified approximately 1,100 victims who have lost an estimated $5 million from these scams. "There are clear warning signs about these scams, which continue at high levels throughout the nation," said IRS Commissioner John Koskinen. "Taxpayers should remember their first contact with the IRS will not be a call from out of the blue, but through official correspondence sent through the mail. A big red flag for these scams are angry, threatening calls from people who say they are from the IRS and urging immediate payment. This is not how we operate. People should hang up immediately and contact TIGTA or the IRS." It's important for taxpayers to know that the IRS: Never asks for credit card, debit card, or prepaid card information over the telephone; Never insists that taxpayers use a specific payment method to pay tax obligations; Never requests immediate payment over the telephone and doesn't take enforcement action immediately following a phone conversation. Taxpayers usually receive prior notification of IRS enforcement action involving IRS tax liens or levies. Potential phone scam victims may be told that they owe money that must be paid immediately to the IRS or they're entitled to big refunds. When unsuccessful the first time, phone scammers sometimes call back trying new strategies. Continued on page 5

4 Page 4 HK Bulletin Documentation Is Key to Car and Truck Expenses When it comes to vehicle expense tax deductions (and costs related to other "listed" property), as well as travel and entertainment expenses, the law is clear and strict on required documentation. There is little wiggle room, as illustrated in one recent U.S. Tax Court case. What Is Listed Property? Listed property is a special classification for assets that lend themselves to both personal and business use. The designation is for tax purposes only and has no meaning for financial reporting. Examples of listed property include automobiles, trucks, airplanes, and computers (except those used exclusively in a regular business establishment. Facts of the Recent Case Lee Baker worked as a self-employed truck driver. He owned a 1995 Mack Truck tractor, which he used to haul tank trailers. He did not own the trailers. The taxpayer claimed approximately $63,638 of expenses related to his truck business for the year at issue. Of the total, he claimed $38,516 for fuel, $12,200 for truck maintenance, and the remainder for other expenses. However, he provided no documentation to support any of the expenses claimed. In the case of listed property, you generally must provide support for the: Amount of each business use (for example, mileage or hours); Date of the usage; Amount of any other expenses (such as gas and mainte nance); Business destination; and Business purpose. The court noted that listed property includes autos and other property used as a means of transportation, unless there's an exception. It went on to say one of those exceptions is property used directly in the business of transporting persons or property for compensation or hire. A Credible Witness Because the property use didn't have to meet the strict substantiation requirements, the court could estimate the taxpayer's expenses under the "Cohan Rule. In this case, the court found the taxpayer was a credible witness. He testified that his claim for fuel expenses of $38,516 was based on his estimate of 65,000 miles at 6.75 miles a gallon. The court used an average cost of $2.47 a gallon for diesel, based on U.S. Energy Information Administration prices for the year. That produced a cost of $23,785. The court believed the taxpayer drove a substantial number of miles, but without any documentation to support his testimony, it found he was entitled to a deduction of $18,000 for fuel costs. The court allowed $500 for insurance, $500 for oil changes, and $400 for licenses (the taxpayer claimed $1,500, $1,722, and $1,450, respectively). The court found it did not have enough evidence to substantiate maintenance, storage, taxes, and travel expenses the taxpayer incurred and allowed no deduction for these items. (Lee Anthony Baker, T.C. Memo ) Lessons for Other Taxpayers Most taxpayers don't lose deductions as a result of some esoteric rule of tax law. They are lost because of inadequate records. The general rule is that you must prove the business purpose and payment, usually by an invoice and a check. You may be able to support the deduction by other means, such as a diary for small items where a receipt is difficult to get. If you don't have adequate documentation, the courts can use the Cohan Rule to estimate expenses for most other types of expenditures, such as office supplies and utilities. Continued on page 6

5 Volume 10, Issue 4 Page 5...Latest Phone Scams (cont. from pg. 3) Victims may even hear background noise that mimics a call site. If you get a phone call from someone claiming to be from the IRS, here's what you should do: Fraudsters have convincing methods of persuading people that they're legitimate IRS agents, including: Using fake names (often common names and surnames) and IRS badge numbers; Reciting the last four digits of a victim's Social Security number; Spoofing the IRS toll-free number on caller ID to make it appear that it's the IRS calling; Sending bogus IRS s to victims to support their bogus calls; and Following up with bogus calls from someone pretending to be the local police or DMV to support threats of jail time or driver's license revocation. If you know you owe taxes or you think you might, call the IRS at IRS employees at that line can help you with a payment issue, if there really is one. If you know you don't owe taxes or have no reason to think that you do (for example, you've never received a bill or the caller made some bogus threats as described above), then call and report the incident to TIGTA at If you've been targeted by an IRS-related scam, you can also contact the Federal Trade Commission and use their "FTC Complaint Assistant" at FTC.gov. Please add "IRS Telephone Scam" to the comments of your complaint. Taxpayers should be aware that there are other unrelated scams (such as a lottery sweepstakes) and solicitations (such as debt relief) that fraudulently claim to be from the IRS. The IRS encourages taxpayers to be vigilant against phone and scams that use the tax agency as a lure. The IRS doesn't initiate contact with taxpayers by to request personal or financial information. This includes any type of electronic communication, such as text messages and social media channels. The IRS also doesn't ask for your personal identification number, password, or similar confidential access information for credit card, bank, or other financial accounts. Recipients should not open any attachments or click on any links contained in the message. Instead, forward the to phishing@irs.gov. For more information or to report a scam, give us a call at or go to and type "scam" in the search box. hallkistlerblog.com: If you're not following hallkistlerblog.com here s a sample of what you missed! InvestOhio: Is it time to revisit this credit? By Keith Arner, CPA, CVA, Partner At Hall, Kistler & Company, taxes are always at forefront of what we do, but we realize that for many of our clients, year-end is always a busy time of year with the holidays, your kids or grandkids school functions, etc. However, this period is also a critical time for year-end tax planning. One area I see that is often overlooked is to take advantage of the InvestOhio credit. I have found this credit to be of great tax benefit for our clients. Several years ago, the State of Ohio announced the InvestOhio Program for small businesses. Over the past few years, I have been involved in applying for and receiving hundreds of thousands of dollars worth of Ohio Income Tax Credits for Hall, Kistler & Company s clients. Since the initial launch, the State of Ohio adjusted the holding period from 2 years to 5 years, which deterred a lot of Continued on page 7

6 Page 6 HK Bulletin...Car and Truck Expenses (cont. from pg. 4) Even if the court does apply the Cohan Rule, it must have some basis for estimating the expenses. For example, say you are a plumber and have only two cell phone bills for the year under audit. The court can estimate your annual bill. If you have no bills at all, the court may decline to help you. And the courts are hardly generous. Frequently, the amount allowed is a fraction of what is claimed, assuming the court believes you to be credible. For meals, entertainment and listed property usage (cars, trucks, etc.), the requirements are more specific, and the Cohan Rule isn't available. For vehicles, you must document the: Cost and date of each expense; Mileage for each business use; Date of vehicle use; Business destination; and Business purpose of the trip. Each of these applies to each trip. In addition, you'll need the date you started using the vehicle for business and the total miles during the year. The best approach is a diary (or app for your smart phone, tablet, or other device) with the date, destination, business purpose, start and stop odometer readings, and expenses. The recording should be made as close as possible to the time of the trip. That could be the same day or within the week. The longer you delay, the less credible the record. The Complexities and Exceptions Those are the basics. The rules are actually much more complex. There are exceptions, but they apply in limited situations. For example, you may be able: To record the length of a business route once a week with the total miles traveled, if you travel the same route every day servicing customers, or during the week on specific days. You may be able to establish the date of each trip with a receipt, record of delivery, or other documentary evidence. The less obvious the business purpose, the more explanation may be needed. To account for several uses of your car that can be considered part of a single use, such as a round trip or uninterrupted business use, with a single record. Minimal personal use, such as a stop for lunch on the way between two business stops, is not an interruption of business use. To use sampling to record your business usage, but you'll have to demonstrate by other evidence that the periods for which an adequate record is kept is representative of the use throughout the tax year. Talk with your tax adviser. If you're audited, one of the first things the IRS will ask for is your car diary. Auditors know that most taxpayers won't be able to produce an adequate, if any, log. And, just 10,000 business miles probably equates to more than $5,000 in deductions. If you have no log, the agent starts the audit with $5,000 on his side. That's assuming only one vehicle that is inexpensive to run. The same rules apply to leased vehicles. Taking the standard mileage? That will allow you to avoid computing depreciation as well as tracking gas, maintenance, and insurance costs, etc., but the other recordkeeping rules (mileage, date, etc.) still apply. Employee Seeking Vehicle-Expense Reimbursement Whether you reimburse using the actual or standard mileage method, the same recordkeeping rules apply. When employees use a company car, the same recordkeeping rules apply. Undocumented mileage must be included as income on the employee's W-2. While the requirements may sound draconian, once you're in the habit, it's not that bad. The rules are lengthy because they cover a broad spectrum of activities. Contact HK and we may be able to suggest ways to reduce your paperwork,

7 Volume 10, Issue 4 Page 7 hallkistlerblog.com: (con t. from page 5) business owners from applying for the credit on their taxes. Recently, the State of Ohio amended the law to change the holding period back to 2 years, making the credit a lot more attractive. InvestOhio is a non-refundable personal income tax credit to investors that provides new equity (cash) into Ohio small businesses. There are several unique ways to structure this cash infusion into your company. That cash investment into the company is required to be invested into one of five categories of allowable expenditures within six months of its receipt. The investor must then retain his or her ownership interest for a 2-year holding period before the tax credit may be claimed. The small business must similarly retain the property that it purchased from the cash infusion for the entire 2- year holding period. If this sounds like something that may work for your company, contact Keith at or keith@hallkistler.com, as now is the time to revisit this important tax credit. Karen M. Brenneman, CPA, MT Managing Partner Michael G. Eberhart, CPA, CVA Senior Partner John J. Skakun, CPA Partner S. Franklin Arner, CPA Partner Keith A. Arner, CPA, CVA Partner 220 Market Avenue South, Suite 700 Canton, Ohio (330)