Monday, December 27, 2010

Happy New Year, time to change your oil!

As I’ve written previously, we defend a lot of people that have been selected by IRS for examination. Sometimes these exams go well, particularly if the taxpayer has tight records and good explanations, and other times it’s more difficult, such as when documentation is spotty, or the explanations defy logic.

Our office is good at dealing with these issues, but recently we were surprised by an audit that had tight records, good explanations, and still is a struggle. The case involves automobile deductions for a business.

Most of you are (or should be) aware of the IRS’ requirement that business auto use be substantiated by contemporaneous records, commonly referred to as a logbook. The log should show business and personal use, and these records are the basis for determining how much of the cost of the auto can be deducted. The regulations require the log be kept by the taxpayer on a current basis, not constructed after the fact.

An IRS agent we are dealing with in the Long Beach office has a different take on the use of a logbook. Our client in question DID keep a log book (really!) and DID document his costs for the auto. He also wrote down the odometer readings at the beginning and end of the year in question in order to determine a percentage of business use. So far, so good, and this effort probably puts him in the top 5% of taxpayers in terms of documentation.

However, our agent has decided that the odometer readings must be corroborated by an outside third party! In our case the taxpayer maintained the vehicle himself or had friends do his service and repairs, and he has no independent service records showing odometer readings as of Jan.1 or Dec 31. This apparently is enough for the IRS agent to disregard the logbook and arbitrarily disregard the taxpayer’s calculations. Nowhere in the Code or Regulations is there a requirement for annual independent third party corroboration of odometers, yet our agent is insisting.

Unfortunately for our client this delays concluding the exam and creates unnecessary angst for the taxpayer. The IRS agent’s position will be unsustainable if we take it to Appeals, but in the meantime the poor taxpayer must deal with the stress and costs of an unresolved IRS audit.

So, in order to protect you from egregious interpretations of the law such as this one, my advice to you: Take your business vehicles in to a garage and get them serviced in the next week or two, and keep the service receipt that shows the odometer reading.

It’s an easy way to protect you from overzealous auditors.

Friday, December 17, 2010

A little clarity…

By now you’ve probably seen the headlines and heard the political rhetoric about the new tax law that was enacted yesterday. While a complete discussion of all the aspects of the law is more than I can fit in here (and more than you want to read, no doubt), I want to clarify a couple things.

First, let’s talk about “tax cuts”. Despite what you read and hear politicians say, there were only three taxes actually cut in this legislation. By cut, I mean reduced. They are 1) Alternative Minimum Tax (AMT), 2) the estate tax, and 3) Social Security payroll tax.

The AMT “cut” saved millions of taxpayers from seeing their taxes increased dramatically due to provisions that expired last December. This fix was supported by most congressional leaders as the AMT has been widely criticized as being too encompassing, potentially affecting any married couple earning anything north of about $75k. Hardly a break only for the wealthy, and every year Congress has tinkered with this to avoid hitting people too hard.

The estate tax rate, currently at ZERO, was scheduled to increase to 55%. It will now be 35%. Exemption amounts also have changed, but the net effect of this legislation was to reduce the amount of tax some future estates will pay. It’s a break for future heirs because rates will be less than what they otherwise would have risen to, but a big INCREASE from what they are today.

People who work for a living and generate earned income pay a percentage (6.2%) to the government for social security. For wage earners it comes right out of your paycheck, for Self Employed folks it takes the form of the Self Employment Tax. For 2011, the percentage will be reduced by 2%. This is a true freebie for anyone working, and isn’t based on level of income.

So where are the tax cuts for the rich? Arguably most of the above could apply to the wealthy just like the rest of us, but the big fuss was over expiring provisions that would have raised taxes on the highest earners. These provisions were not allowed to expire, thus preventing a tax increase on the wealthy.

In the world of political sound bites, preventing a tax increase is portrayed as a tax cut.