Wednesday, February 17, 2010

Red flags and white flags

Often we get asked: “If I claim (fill in the blank), is it a red flag?” Our response is usually a long winded explanation ending with, “it depends”. The truth is, the IRS’s formula for selecting returns to audit is a well kept secret. Some returns are selected completely by random, and others are scored for audit based on an internally developed rating system. The returns that score highest are reviewed and if they look like good candidates, they are sent to either a regional office for an audit by mail, or a local office for a face to face throwdown. Nobody knows exactly what will set off alarms at IRS, but there are some things you can be mindful of that will limit your likelihood of having to deal with any imperial entanglements.

First, make doubly sure you claim ALL your income that is disclosed on a 1099 form. IRS is very efficient at matching these to returns and will generate notices automatically when they do not find what they expect to see on your return. This is low hanging fruit for them as it is all handled by computer.

Second, avoid large negative numbers from your sole proprietorship. If your Schedule C is negative, you must be prepared to clearly support all of your costs here with evidence that they were “ordinary and necessary” business costs AND prove that you really paid them. A real accounting system instead of a shoebox full of paper scraps will help a lot when you are asked to produce records. Be prepared to prove that you are running a legit business instead of trying to deduct a hobby or scam.

Have a rental property? Large numbers for maintenance and repairs will invite scrutiny as many times these cost are more properly capitalized and depreciated over time.

Do you have a lot of unreimbursed employee expenses? If you incur job related costs that are not covered by your employer, they may be questioned if they have a large impact on your tax. You will need to be able to prove that they were clearly job related and explain why they weren’t reimbursed by your employer.

If legit, you should not back away from claiming deductions that are so called red flags. But, unless you want to be hoisting a white flag at audit time you must prepare for it when you prepare your return.

Thursday, February 11, 2010

More on charitable deductions

This is the third installment in my blogs about charitable donation deductions. Previously, we discussed the new rules for Haitian Relief deductions (1/27/2010), and donations of autos & boats (12/7/2009).

We are now seeing a steady inflow of individuals bringing in their 2009 data for tax return prep. One common question is: What can I deduct as charitable donations? Many people think that if you give money to a nonprofit you can always deduct it. But its not necessarily so. Let me give you a few examples.

Money given to a charity or religious organization in exchange for a service or product is only deductible to the extent that the value of the service or product received is less than what you paid for it. Example – you attend a fundraising dinner and pay $50 for a plate of spaghetti. If the value of the meal was $5, then you may take a deduction of $45 for the excess. Most large fundraising events will disclose this amount on your receipt or ticket so you don’t have to become a food critic to support your deduction.

Same thing applies when you buy a book, DVD’s CD’s etc for a package price. These have a value, and the charity will disclose to you how much you can deduct for tax purposes out of the total you actually gave for all that stuff you bought.

But what about money spent for charity raffles, bingo, games, etc? No deduction, says IRS, for any money spent on games of chance.

However, if you spend your own funds on behalf of a charity for unreimbursed travel, meals, supplies, educational seminars, uniforms or anything that supports the organization, and you are acting as an official representative of the organization, you can deduct these costs. An example would be a scout leader taking training, buying a uniform, and paying for gas to take a scout troop on a campout. In this case you would need to not only prove your expenses, but also have some documentation from the organization that you were acting in some official capacity, not just on your own behalf.

Monday, February 8, 2010

Here we go again

California’s fiscal crisis does not show any signs of resolution. Despite assurances from the Governor and legislators that the state will remain able to pay its bills through June 30, John Chiang, State Controller, has released a warning that that may not be the case.

According to Mr Chiang, California could very well run out of cash by March 30.

Does this mean that we will be treated to IOU’s and delayed tax refunds? Right now it’s not looking very clear and if you take steps to prepare for it you can limit your exposure to making involuntary loans to the State legislature.

But what should you do? Well, first of all you need to get your tax returns filed ASAP. Right now there are no delays in processing refunds. If they owe you money, an electronic return with automatic deposit of refund will get you your money in a few short weeks.

What if they start issuing IOU’s and you’re still waiting for missing data? Here’s where it gets tricky. First of all, if you are typically looking for a big refund you should take steps to avoid overpaying your taxes by reducing withholding. That s a good rule in general. Second, if you already have a built up refund that may not be received back soon, you may want to bank on applying that refund to your 2010 taxes. In so doing you pay your 2010 estimated tax with their IOU. Next, dramatically reduce your 2010 withholding so that your current employer increases your paycheck right now, returning the money to you a little every payday, starting immediately.

Next post: More on charitable deductions

Thursday, February 4, 2010

No tax deduction for the good looking!

As I‘ve previously shared with you, we frequently receive questions from clients asking what else they can deduct to lower taxable income. In the “bet you haven’t tried this one” category falls a recent tax court decision that allowed a taxpayer to deduct the costs of a sex change operation as a medical deduction.

The taxpayer was born male, but was diagnosed with gender identity disorder. The treatments for the disorder included gender reassignment surgery and breast augmentation. IRS disallowed all of it, calling it cosmetic surgery and claiming that the disease had to arise from an organic pathology.

Enter the tax court. The court determined that gender identity disorder was a disease along the lines of a mental disorder and that treatments for it fell within the parameters of allowable medical costs. However, the court balked at the breast augmentation, stating that its goal was to improve the taxpayer’s appearance and not promote proper body function. Was that a nice way of saying that not only was this person seriously conflicted, but she was ugly to start with too?

We won’t know. Court decisions don’t include pictures.