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Some Entrepreneurs Seem To Ask For An Audit
Go ahead, audit me. OK, so maybe you'll never hear those words cross the lips of a rational small business owner.
But, by their actions, some entrepreneurs seem to ask for an audit. They keep falling into the same traps that trigger the dreaded encounter known at the Internal Revenue Service as "an examination."
There are 13 words you never want to hear from that agency: "Your federal return for the year shown above has been selected for examination."
And there are five notices you don't want to receive: CP2501, CP102, CP165, CP205 or CP251.
If you get one of those, either what you claimed you made doesn't match what the IRS records show; you made a math error in the IRS' favor; you had the nerve to let your check to the IRS bounce; you used the wrong taxpayer ID number or information was wrong or missing when depositing your payroll taxes; or, there's an employment tax problem and the IRS wants more information.
Here are some common small-business audit triggers:
- Excessive travel and entertainment expenses. Better document the amount, nature and rationale of your company's T&E expenses. Don't confuse personal expenses with business items. Document your mileage too.
- Home-based business expenses. Excessive amounts for depreciation and utilities won't fly with the IRS.
- Lax year-end reporting. You'll surely get the IRS' attention if you don't file your W2s, 1099s and other year-end reports on time.
- Late payroll tax deposits. Another attention-getter. Money withheld from employees' salaries doesn't belong to the company. Send it in on schedule.
Experts say small businesses routinely make tax mistakes related to employees, independent contractors, salaries, dividends and loans, travel and entertainment, fringe benefits and home office deductions.
IRS Richmond spokeswoman Gloria Wajciechowski said most home- based businesses accurately report their income and expenses. But, "some home-based business tax schemes have gained popularity over the last few years. Nondeductible personal living expenses cannot be transformed into deductible business expenses regardless of how convincing the information in marketing materials may seem," she said.
What should you do if an invitation arrives, summoning you to an IRS audit? Don't panic, stay calm. It may require a fairly simple fix. A lot of the time it can just be a mistake on the tax return.
- Get organized. Gather all relevant records. Contact your CPA or expert tax preparer. Don't hide anything.
- Don't attend your audit. Let your accountant handle it. Accountants know the rules that small businesses often can't keep up with.
- Zip your lips. When the taxpayer is in a conversation with the IRS, they may volunteer information that causes more trouble or leads to other areas that don't need to be looked at.
In my experience, it has never been a good thing for a taxpayer to be in an interview. If nothing else, excess time will be consumed. If you insist upon attending, answer questions truthfully and say only what's asked of you. Don't volunteer information.
IRS' Wajciechowski added this advice: Keep good records. Don't be afraid to ask your tax preparer questions.
Call the IRS anytime, or browse its Web site,
www.irs.gov Learn your rights as a taxpayer by reading IRS Pub. #1. Read Pub. #334, "Tax Guide for Small Business." Read Pub. #583 for record keeping requirements. Don't sign a blank tax return.
Wajciechowski said the IRS' new National Research Program will result in fewer audits in the future and eliminate many face-to- face audits.
SELLING YOUR HOME (IRS TAX TIP 2002-35)
If you sold your main home, you may be able to exclude up to $250,000 of gain ($500,000 for married taxpayers filing jointly) from your federal tax return, according to the IRS. This exclusion is allowed each time that you sell your main home, but generally no more frequently than once every two years.
To be eligible for this exclusion, your home must have been owned by you and used as your main home for a period of at least two years out of the five years prior to its sale. If you and your spouse file a joint return for the year of the sale, you can exclude the gain if either of you qualify for the exclusion. But both of you would have to meet the use test to claim the $500,000 maximum amount.
If you do not meet the ownership and use tests, you may be allowed to exclude a portion of the gain realized on the sale of your home if you sold your home due to a change in health or place of employment.
If you cannot exclude all the gain from the sale of your home, use Schedule D, Form 1040, to report it.
For more details and information, get a copy of Publication 523, "Selling your Home," download it from the IRS Web Site at
www.irs.gov
ROTH IRA's (IRS TAX TIP 2002-34)
Confused about whether you can contribute to a Roth IRA? The IRS suggests checking these simple rules:
Income:
To contribute to a Roth IRA, you must have compensation (i.e. wages, salary, tips, professional fees, bonuses). Your modified adjusted gross income must be less than:
$160,000 Married Filing Jointly.
$10,000 Married Filing Separately (and you lived with your spouse at any time during the year).
$110,000 Single, Head of Household, or Married Filing Separately (and you did not live with your spouse during the year).
Age:
There is no age limitation for Roth IRA contributions. Unlike traditional IRAs, you can be any age and still qualify to contribute to a Roth IRA.Contribution Limits:
In general, if your only IRA is a Roth IRA, the maximum 2001 contribution limit is the lesser of $2,000 or your taxable compensation. This limit will be $3,000 for 2002 through 2004, and will be $3,500 for those age 50 or over.The maximum contribution limit phases out if your modified adjusted gross income is within these limits:
$150,000 - $160,000 Married Filing Jointly
$0 - $10,000 Married Filing Separately (and you lived with your spouse at any time during the year)
$95,000 -$110,000 Single, Head of Household, or Married Filing Separately (and you did not live with your spouse)
Contributions to Spousal Roth IRA:
You can make contributions to a Roth IRA for your spouse provided you meet the income requirements.When to Make Contributions?
Contributions to a Roth IRA can be made at any time during the year or by the due date of your return for that year (not including extensions).For complete information and definitions of terms, get Publication 590,
"Individual Retirement Arrangements." Visit the IRS Web site at
www.irs.gov or call 1-800-TAX-FORM (1-800-829-3676) to request a free copy of the publication.
CHILD TAX CREDIT (IRS TAX TIP 2001-24)
With the Child Tax Credit, you may be able to reduce the federal tax you owe by $600 for each qualifying child under the age of 17, according to the IRS. A qualifying child for this credit is someone who:– Is claimed as your dependent,
– Was under age 17 at the end of 2001,
– Is your son, daughter, adopted child, grandchild, stepchild, or eligible foster child, and
– Is a U.S. citizen or resident.
The credit is limited if your modified adjusted gross income is above a certain amount. The total credit—not the per child amount—is reduced by $50 for each $1,000 (or part thereof) that your adjusted gross income exceeds the threshold amount. The amount at which this phaseout begins varies depending on your filing status:
– Married Filing Jointly $110,000
– Married Filing Separate $ 55,000
– All others $ 75,000
The Child Tax Credit reduces the amount of tax you owe. In addition, if the credit you are eligible to claim exceeds your tax liability, you can claim the difference as a refund. The IRS provides a one-page worksheet (Form 8812) for you to figure your credit and possible refund.
You may claim the child tax credit on Form 1040 or 1040A. Details on how to compute the credit can be found in the forms’ instructions and in Publication 972, "Child Tax Credit." The forms and publications are available from the IRS Web site at
www.irs.gov, at your local IRS Tax Assistance Center, or by calling toll free 1-800-TAX- FORM (1-800-829-3676).
Record Keeping - Messy Tax Records
Despite your best intentions, you ended up with a box full of receipts, check registers, credit card statements and other scraps of paper. A mess. You don't need anyone to tell you what you that you should have been organizing your records all along. You need help in making the best of what you have.
Grab all of your receipts and go to the biggest flat surface you can find. Usually the kitchen table.
On blank pieces of 8 1/2" x 11"paper, write a broad category at the top of each one and place them around the table. Common ones are:
Earned income (W-2s; jury duty income, hobbies, casual labor; rents, royalties, unemployment compensation, alimony, pensions, prizes, tips, etc.)
Interest income from savings accounts, money markets and other funds.
Capital gains from the sale of stock, real estate or other investments.
Dividends received from mutual funds and corporate securities.
Loan interest paid on your home mortgage or second home.
Medical Expenses including insurance premiums and other medical and dental co-pays or deductibles.
Childcare expenses including the name, address and tax identification number of the child-care provider.
Charitable contributions including receipts for donations-in-kind and letters from the organization acknowledging contributions over $250.
IRA and Keogh plan contributions.
Real estate and personal property tax receipts.
Education expenses such as tuition, books, lab fees and student loan interest.
Non-reimbursed work expenses (travel, classes to improve your job skills, job-related moving expenses, etc.)
Miscellaneous (union or professional dues, employment agency fees, tax preparation fees.)
Now take your records and one-by-one place them around the table in their respective categories. If you have cancelled checks, you may also place them in the proper place.
If your bank doesn't return checks, go through your check register and write the deductible amounts, check #, and date on the piece of paper that lists the category name.
5. Finally, add the amount in each category. Be sure to use an adding machine since math errors are one of the most common mistakes in doing taxes.
You've done the hard part! and it really didn't take all that long. Now you're ready to do your taxes whether you take them to your tax preparer, use one of the tax software programs or do them yourself.
While the process is still fresh in your mind, get started on your 2001 taxes. For each category that you used get a large envelope or file folder and label it with the category name. As your receipts come in, place them in the respective envelope rather than the box. When tax time comes around next year, all you'll have to do is add up the receipts in each envelope.
What is Deductible for Business?
Too big of a subject for a newsletter. There are many good books available at your local library and on the internet. A good place to start is the IRS. You can download Publication 334 'Tax Guide for Small Business' and Publication 535 'Business Expenses at this link http://www.irs.gov/forms_pubs/pubs.htmlFor record keeping requirements, get Publication 538 'Accounting Periods and Methods' at the same link above. There are also many other publications there you may find useful.
IRS NOTICES — WHAT TO DO (IRS TAX TIP 2002-44)
It’s a moment any taxpayer dreads. A letter arrives from the IRS — and it’s not a refund check. But don’t panic. Many of these letters can be dealt with simply and painlessly.
Each year, the IRS sends millions of letters and notices to taxpayers to request payment of taxes, notify them of a change to their account or request additional information. The notice you receive normally covers a very specific issue about your account or tax return. Each letter and notice offers specific instructions on what you are asked to do to satisfy the inquiry. Most notices also give you a phone number to call to ask questions.
Most correspondence can be handled without calling or visiting an IRS office, if you follow the instructions in the letter or notice. However, if you have questions, call the telephone number in the upper right-hand corner of the notice, or call the IRS at 1-800-829-1040. Have a copy of your tax return and the correspondence available when you call so your account can be readily accessed.
Before contacting the IRS, review the correspondence and compare it with the information on your return. If you agree with the correction to your account, no reply is necessary unless a payment is due. If you do not agree with the correction the IRS made, it is important that you respond as requested. Write to explain why you disagree. Include any documents and information you wish the IRS to consider, along with the bottom tear-off portion of the notice. Mail the information to the IRS address shown in the upper left-hand corner of the notice. Allow at least 30 days for a response.
Sometimes, the IRS sends a second letter or notice requesting additional information or providing additional information to you. Be sure to keep copies of any correspondence with your records.
For more information about IRS notices and bills, see Publication 594, "Understanding the Collection Process." Information about penalties and interest charges is available in Publication 17, "Your Federal Income Tax." Both publications are available on the IRS Web site at
www.irs.gov through the "Forms and Publications Finder" or by calling 1-800-TAX-FORM (1-800-829-3676).
TEN WAYS TO AVOID PROBLEMS AT TAX TIME (IRS TAX TIP 2002-58)
Looking for ways to avoid the last-minute rush for doing your taxes? The IRS offers these tips:
1. ORGANIZE YOUR TAX RECORDS. Tax preparation time can be significantly reduced if you develop a system for organizing your records and receipts. Start with the income, deduction or tax credit items that were on last year’s return.
2. DON’T PROCRASTINATE. Resist the temptation to put off your taxes until the last minute. Your haste to meet the filing deadline may cause you to overlook potential sources of tax savings and will likely increase your risk of making an error.
3. TAKE ADVANTAGE OF FREE TAX ASSISTANCE. The IRS offers recorded messages on about 150 tax topics through its TeleTax service at 1-800-829-4477. It also offers federal tax forms and publications at 1-800-TAX-FORM (1-800-
829-3676). Many post offices and libraries carry the most widely requested forms and instructions. Libraries may also have reference sets of IRS publications. The
IRS also staffs a tax help line at 1-800-829-1040, 7:00 a.m. to 10:00 p.m. on weekdays and 9:00 a.m. to 5:00 p.m. on Saturdays through April 13.
4. VISIT THE IRS ONLINE. Taxpayers accessed the IRS web site at
www.irs.gov more than 1 and a half billion times last year. Anyone with Internet access can download tax forms, instructions and publications as well as tax law information and answers to frequently asked tax questions.5. USE IRS WALK-IN SITES AND VOLUNTEER PROGRAMS. Forms, publications and tax help are available at more than 400 IRS offices nationwide. Check your newspaper or local IRS office to find locations for Volunteer Income Tax Assistance and Tax Counseling for the Elderly sites.
6. FILE YOUR RETURN ELECTRONICALLY. More than 40 million taxpayers filed their returns electronically in 2001. Aside from ease of filing, IRS e-file is the fastest and most accurate way to file a tax return. If you’re due a refund, the wait time for e-filers is half that of paper filers.
7. DOUBLE-CHECK YOUR MATH AND DATA ENTRIES. Review your return for possible math errors and make sure the names and identification numbers for yourself, your spouse and your dependents are correct and legible.
8. HAVE YOUR REFUND DEPOSITED DIRECTLY TO YOUR BANK ACCOUNT.
Another way to speed up your refund and reduce the chance of theft is to have the amount deposited directly to your bank account. Check the tax instructions for details on entering the routing and account numbers on your tax return.
9. DON’T PANIC IF YOU CAN’T PAY. If you can’t immediately pay the taxes you owe, consider some stress-reducing alternatives. You can apply for an IRS installment agreement, setting your own monthly payment amount and due date, and getting a reduced late payment penalty rate. You also have various options for charging your balance on a credit card, either as part of an electronic return or via a phone call to a processing agent. Electronic filers with a balance due can file early and authorize the government’s financial agent to take the money directly from their checking or savings account on the due date.
Note that if you file your tax return on time even if you can’t pay, you avoid potential late filing penalties.
10. REQUEST AN EXTENSION OF TIME TO FILE. If the clock runs out, you can get an automatic four-month extension of time to file, to August 15. An extension of time to file does not give you an extension of time to pay, however. You can call 1-888-796-1074, e-file a Form 4868 that is included in most tax preparation software, or send a paper Form 4868 to the IRS. You will need the Adjusted Gross
Income and Total Tax amounts from your 2000 return if you request the extension by computer or phone. You may also get an extension by charging your expected balance on a credit card and you won’t have to file the form. Official Payments
Corporation may be reached at 1-800-2PAY-TAX (1-800-272-9829), or at
www.officialpayments.com . PhoneCharge, Inc. may be reached at 1-888-ALLTAXX(1-888-255-8299), or at
www.1888ALLTAXX.com . There is no IRS fee for credit card payments, but the processors charge a convenience fee.Note that the extension itself does not give you more time to pay any taxes due. Generally, you will owe interest on any amount not paid by the April deadline, plus a late payment penalty if you have not paid at least 90 percent of your total tax by that date.
TAXABLE OR NONTAXABLE? (IRS TAX TIP 2002-55)
Generally, most income you receive is taxable, according to the IRS. But there are some areas where certain types of income are partially taxed or not taxed at all. A complete list is available in IRS Publication 525, "Taxable and Nontaxable Income."
Some common examples of items not included in your income are:
– Child support payments
– Gifts, bequests and inheritances
– Workers' compensation benefits
– Meals and lodging for the convenience of your employer
– Compensatory damages awarded for physical injury or physical sickness
– Welfare benefits
– Cash rebates from a dealer or manufacturer
If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. Otherwise, life insurance proceeds paid to you because of the death of the insured person are not taxable unless the policy was turned over to you for a price.
Another example of income that you may or may not exclude is a scholarship or fellowship grant. If you are a candidate for a degree, you can exclude amounts you receive as a qualified scholarship or fellowship. Amounts used for room and board do not qualify.
These examples are not all-inclusive. For more information, visit the IRS Web site at www.irs.gov and view or download Publication 525 through the "Forms and Publications Finder." It is also available by calling toll free 1-800-TAX-FORM (1-800-829-3676) and at local IRS offices.
TAX CHANGES FOR BUSINESS OWNERS (IRS TAX TIP 2002-56)
At tax time, many business owners want to make sure they are aware of the latest changes that could affect their taxes. If you are one of these owners, a good source of information is IRS Publication 334, "Tax Guide for Small Business." Publication 334 includes a listing of some tax changes for 2001 returns, plus explanations of the changes. It also includes some of the changes for 2002.
In addition, the recently-passed Job Creation and Worker Assistance Act contains many provisions that affect businesses. For information on some of these provisions, check out IRS News Release IR-2002-37 and revised Forms 4562, "Depreciation and Amortization," or 2106, "Employee Business Expenses." The IRS will also develop new instructions for claiming net operating loss.
Here are some of the tax changes for business owners that may affect you:
– You can claim 34.5 cents a mile as the standard mileage rate for 2001 for the cost of operating your car, van, pickup, or panel truck in your business. This rate increases to 36.5 cents a mile for business miles you drive in 2002.
– If you are self-employed, you must pay the Social Security part of self-employment taxes for your maximum net self-employment earnings up to $80,400 for 2001. The ceiling will increase to $84,900 for 2002.
– If you acquired new depreciable property after September 10, 2001, you may be able to claim additional first year depreciation of 30 percent of the basis of the property.
– You may be able to carry back net operating losses for a five-year period for losses arising in taxable years ending in 2001 and 2002. You may also be able to offset 100 percent of your Alternative Minimum Taxable Income by carrying back a net operating loss from those years, or carrying one forward to those years.
EARLY DISTRIBUTIONS FROM RETIREMENT PLANS (IRS TAX TIP 2002-54)
An early distribution from an Individual Retirement Account (IRA) or a qualified retirement plan need not be a "taxing" experience, according to the IRS.
Any payment that you receive from your IRA or qualified retirement plan before you reach age 59½ is normally called an "early" or "premature" distribution. As such, these funds are subject to an additional 10 percent tax. But there are a number of exceptions to the age 59½ rule that you should investigate if you make such a withdrawal. Some of these exceptions apply only to IRAs, some only to qualified retirement plans, and some to both. IRS Publications 575, "Pensions and Annuities," and 590, "Individual Retirement Arrangements (IRAs)," have details.
In addition to the 10 percent tax on early distributions, you will add to your regular taxable income any distributions attributable to "elective deferrals" that you contributed from your pay, your employer’s contribution and any income earned on all contributions to the account. If you made any nondeductible contributions, their portion of the distribution is not taxed, since you’ve already paid tax on this amount.
There is a way to avoid paying any tax on early distributions, however. It is called a "rollover." Generally, a rollover is a tax-free transfer of cash or other assets from an IRA or qualified retirement plan to an eligible retirement plan. An eligible retirement plan is a traditional IRA, a qualified retirement plan, or a qualified annuity plan. You must complete the rollover within 60 days of when you received the distribution. The amount you roll over is generally taxed when the new plan pays you or your beneficiary.
If the early distribution from an employer’s plan is paid directly to you, your plan administrator will normally withhold income tax at a 20 percent rate. If you roll over the distribution to a new plan, you must replace that 20 percent of the funds that were withheld and deposit that amount in the new plan, or you will owe tax on that amount. To avoid the inconvenience of this withholding, you can have your old plan’s administrator transfer the rollover amount directly to the new plan or a traditional IRA.
All early distributions must be reported to the IRS. You will report tax-free rollovers on lines 15a and 16a of Form 1040 along with any taxable distributions, but you will enter on line 15b or 16b only the taxable amounts you don’t roll over. Figure the 10 percent tax or exceptions on Form 5329 and then carry any resulting tax to line 55 of Form 1040. You may also report rollovers on Form 1040A, but you must use Form 1040 for any distributions to which the 10 percent tax applies.
Important tax information should be reported to you by your plan administrator on Form 1099-R. This will show the distribution amount, the taxable portion, any tax withheld, and a distribution code related to the 10 percent tax. If your early distribution is subject to the 10 percent tax and distribution code 1 is correctly shown in box 7 of your Form 1099-R, you do not have to complete Form 5329. Just multiply the taxable distribution amount you put on line 15b or 16b by 10 percent and enter the result on line 55 of Form 1040.
You may download Publications 575 and 590, along with any related forms and instructions, through the "Forms and Publications Finder" on the IRS Web site at
www.irs.gov . You may also call toll free 1-800-TAX-FORM (1-800-829-3676) to order them.
Gambling Winnings
All gambling winnings must be reported on your income tax return. Common types of gambling include winnings from lotteries, raffles, horse and dog races and casinos, as well as the fair market value of prizes such as cars, houses, trips or other non-cash prizes.The full amount of your gambling winnings for the year must be reported on line 21, Form 1040. If you itemize deductions, you can deduct your gambling losses for the year on line 27, Schedule A (Form 1040). Your gambling loss deduction cannot be more than the amount of gambling winnings.
It is important to keep an accurate diary or similar record of your gambling winnings and losses. To deduct your losses, you must be able to provide receipts, tickets, statements or other records that show the amount of both your winnings and losses. Print outs from the casino showing all gambling winnings and loses will help establish your losses, although they will also help establish the amount of your winnings.
Deductible Taxes
There are three types of deductible non-business taxes: 1) State, local and foreign income taxes, 2) Real estate taxes, and 3) Personal property taxes.You can deduct any estimated income taxes paid to state or local governments and any prior year's state or local income taxes paid during the tax year.
Generally, you can take either a deduction or a tax credit for foreign income taxes, but only for taxes on income that is subject to U.S. taxation.
Deductible real estate taxes are usually any state, local, or foreign taxes on real property. If a portion of your monthly mortgage payment goes into an escrow account and your lender periodically pays your real estate taxes to local governments out of this account, you can deduct only the amount actually paid during the year to the taxing authorities.
Personal property taxes are deductible when they are based on the value of personal property, such as a boat or car. To be deductible, the tax must be charged to you on a yearly basis, even if it is collected more than once a year or less than once a year.
APPEAL RIGHTS
Are you in the middle of a disagreement with the IRS? One of the guaranteed rights for all taxpayers is the right to appeal, according to the IRS. If you disagree with the IRS about the amount of your tax liability or about proposed collection actions, you have the right to ask the IRS Appeals Office to review your case.IRS Publication 1, "Your Rights as a Taxpayer," explains some of your most important taxpayer rights. During their contact with taxpayers, IRS employees are required to explain and protect these taxpayer rights, including the right to appeal.
The IRS appeals system is for people who do not agree with the results of an examination of their tax returns or other adjustments to their tax liability. In addition to examinations, you can appeal many other things, including:
– Collection actions such as liens, levies, seizures, installment agreement terminations, and rejected offers-in-compromise
– Penalties and interest
– Employment tax adjustments and the trust fund recovery penalty
Appeals conferences are informal meetings. The local Appeals Office, which is independent of the IRS office that proposed the disputed action, can sometimes resolve an appeal by telephone or through correspondence.
You may represent yourself, or you can be represented by an attorney, certified public accountant, or individual enrolled to practice before the IRS. If you represent yourself, you can obtain assistance from specially trained Customer Service Representatives by calling toll-free 1-877-457-5055.
If you and the IRS Appeals Officer cannot reach agreement, or if you prefer not to appeal within the IRS, you may take your disagreement to federal court. But taxpayers can settle most differences without expensive and time-consuming court trials.
Further information on the appeals process is available in IRS Publication 5, "Your Appeal Rights and How to Prepare a Protest If You Don't Agree," Publication 556, "Examination of Returns, Appeal Rights and Claims for Refunds," and Publication 1660, "Collection Appeal Rights (for Liens, Levies, and Seizures)." To get copies of IRS publications, visit the IRS Web site at www.irs.gov or a local IRS office, or call toll-free 1-800-TAX-FORM (1-800-829-3676).
Oops! You’ve discovered an error after your tax return has been filed. What to do? You may need to amend your return, according to the IRS.
The IRS usually corrects math errors or requests forms (such as W-2s) or
schedules left out. In these instances, do not amend your return. However, do file an amended return if any of the following were reported incorrectly:
– Your filing status
– Your total income
– Your deductions or credits
Use Form 1040X, "Amended U.S. Individual Income Tax Return," to correct a previously filed Form 1040, 1040A, 1040EZ, or electronically-filed return. If you are filing to claim an additional refund, wait until you have received your original refund. You may cash that check while waiting on any additional refund. If you owe additional tax for 2001, you should file Form 1040X and pay the tax by April 15, 2002, to avoid any penalty and interest.
Generally, to claim a refund, you must file Form 1040X within three years from the date you filed your original return or within two years from the date you paid the tax, whichever is later.
If the changes involve another schedule or form, attach it to the 1040X. If you are filing more than one amended return, be sure to mail each in a separate envelope to the IRS center for the area in which you live. The 1040X instructions list the addresses for the centers. You may download forms and publications from the IRS web site at www.irs.gov or order them by calling 1-800-TAX-FORM (1-800-829-3676).
8 Types of Income the IRS Can't Touch
Don't pay the tax man any more than you have to. The U.S. tax code offers some fabulous ways to cut your tax bill and keep more of your hard-earned dollars. By Jeff Schnepper
Want to keep the tax man away from your money? It's easier than you think. There are lots of ways to increase your wealth without having a chunk gobbled up by the IRS.It's not that the agency doesn't want your money. It's just that the tax law prohibits the IRS from touching it. And with a bit of planning, you can start to cut your current tax bill and put money in your pocket now.
Let's look at a few examples.
Tax-free interest
Interest earned on bonds issued by a state, territory, municipality or any political subdivision is free from federal taxes. These are generically called municipal bonds, and their tax benefit increases in value as your marginal tax rate goes higher. (In other words, the bonds are worth more to you as your overall income rises.)
Assume you're in the 38.6% bracket, the top rate for 2002 and 2003. A 5% tax-free rate becomes the equivalent of a taxable rate of 8.14%. In the 15% bracket, the taxable equivalent is only 5.88%. If you check out investinginbonds.com, you can compare taxable and tax-free yields. (See link at left.) Compare the after-tax rates on alternative investments of equivalent risk.
Some bonds may not only be tax-free at the federal level, they may also escape state and local taxes. If you're in the top brackets and live in New York City, this is one investment you definitely want to consider for your portfolio.
Carpool receipts
Commuting to work? Bring a friend -- and his wallet. If you form a carpool to carry passengers to and from work, any dollars received from these passengers aren't included in your income.
Commuting costs are generally not deductible. But if you establish a carpool and you're reimbursed in amounts sufficient to cover the cost of your repairs, gas and similar items used in connection with operating your car to and from work, then you've converted personal nondeductible expenses into excludable income.
Assume you're in the 27% bracket. You have to earn $137 per month to cover a $100 monthly commuting expense. If you have a carpool arrangement with expenses being reimbursed, you've got no additional income. But you do have an additional $137 per month in wealth!
Sell your house
Under a tax law enacted in 1997, if your house was your principal residence for two of the last five years, you can exclude as much as $250,000 in gain ($500,000 on a joint return) when you sell it.
You don't have to reinvest the money, and you can claim the exclusion every two years. (If you've got $500,000 in gain every two years, I want to meet your real estate agent and go shopping!)
If you don't meet the two-year rule, you can get a partial exclusion based on the time of use and ownership. Assume you sold after only one year and had a $50,000 profit. Your exclusion is half the $250,000, not half the $50,000 profit. In this case, you'd pay zero tax on the sale.
But this partial exclusion is only if the sale is required because of either a change in place of employment, health reasons or unforeseen circumstances. I haven't yet seen final regulations defining "unforeseen circumstances." My understanding is that the IRS is going to be flexible here.
Tax-free compensation
When you're due for a raise, ask your company to get creative in your compensation. There are numerous ways to receive non-taxable compensation. Let's look at some of the best alternatives to taxable earned income.
Use your health coverage. Health and hospitalization insurance premiums paid by your current or former employer are tax-free -- a huge benefit. Let's say your health insurance premiums come to $280 a month or $3,360 a year (for an HMO policy for a family of four with a $1,500 deductible). If you're in the 27% tax bracket and have to pick up the bill, the real cost to you would be $4,603. That's $3,360 for the premiums and $1,243 for additional income taxes because you'll be paying for the coverage in after-tax dollars. Having your company pick up the cost helps both of you. It doesn't have to pay the salary necessary to get you even. It gets to write off the full cost of the coverage. Plus, neither of you has to pay the 7.65% payroll taxes on the premiums. And you, of course, boost your disposable income substantially. Cover your life. Group term life insurance coverage of $50,000 or less paid for by your company isn't taxed to you. You pick the beneficiary; your company pays the premiums. Your company deducts the expense; you walk away with additional tax-free income.
Send you to school. Get educated. The courses don't even have to be job-related. But they can't be for any education involving sports, games, or hobbies. Your company can pay, and deduct, as much as $5,250 per year in educational assistance paid for either undergraduate or graduate courses. Again, that assistance comes to you tax-free.
Get you there…and parked. Your company can give you discount fare cards, passes or tokens to take public transportation to work. As long as it's not worth more than $100 per month, your company can deduct it, but you, as an employee, receive it tax-free as a de minimus tax benefit. You're taxed only on any excess over the $100. If you drive and have to pay for parking, your company can provide free parking, up to a maximum value of $180 per month, to you tax-free.
Cafeteria plans. These are sometimes called Flexible Spending Accounts. Your company makes deductible contributions under a written plan, which allows you to select between taxable and non-taxable benefits. To the extent you chose non-taxable benefits, you have no additional income. Available non-taxable benefits may include group life insurance, disability benefits, dependent care and/or accident and health benefits. Your individual plan details the options. You make your choices among the items on the cafeteria menu.
You get the idea. Any time you can convert taxable income into non-taxable income, you've given yourself a raise. And when both you and your company save money, it's a win-win for everybody.
Get creative…in most cases you're paying for the items anyway, and on an after-tax basis. It's really relatively simple.
IRS WARNS OF SCHEME TO STEAL IDENTITY AND FINANCIAL DATA (Release No: IR-2002-55)
The Internal Revenue Service warned today of a fraudulent scheme currently circulating that uses fictitious bank correspondence and IRS forms in an attempt to trick taxpayers into disclosing their personal and banking data. The information fraudulently obtained is then used to steal the taxpayer’s identity and bank account deposits.
In this scam, a letter claiming to be from the taxpayer’s bank states that the "bank" is updating its records in order to exempt the taxpayer from reporting interest or having tax withheld on interest paid on his or her bank accounts or other financial dealings.
The "bank" correspondence encloses a phony form that purports to come from the IRS and seeks detailed personal and financial data. The letter urges the recipient to fax the completed form to a specific number within 7 days or lose the reporting and withholding exemption, resulting in withholding of 31% on the account’s interest. The scheme promoters then use the faxed information to impersonate the taxpayer and gain access to the taxpayer’s finances.
One such phony form is labeled "W-9095, Application Form for Certificate Status/Ownership for Withholding Tax." The form requests personal data frequently used to prove identity, including passport number and mother’s maiden name. It also asks for sensitive financial data such as bank account numbers, passwords and PIN numbers that can be used to gain access to the accounts.
The fictitious W-9095 appears to be an attempt to mimic the genuine IRS Form W-9, "Request for Taxpayer Identification Number and Certification." The only personal information a genuine W-9 requests is the name, address and Social Security number or employer identification number of the taxpayer.
Another form used in the scam is Form W-8BEN, "Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding." There is a legitimate IRS Form W-8BEN, which is used by banks to ensure that their non-U.S. customers meet the criteria to remain exempt from tax reporting requirements. However, the W-8BEN used by the scam promoters has been altered to ask for personal information much like the W-9095. This altered form targets residents of foreign countries who bank in the United States.
Another totally fictitious IRS form used in this scam is labeled "W-8888." It too asks for information similar to the phony W-9095 and W-8BEN.
The real Forms W-9 and W-8BEN can be found on the IRS’s Web site at www.irs.gov .
The Treasury Inspector General for Tax Administration investigates a wide variety of offenses, including the misuse of IRS insignia, seals and symbols and identity theft related to tax administration. Taxpayers who have received a fraudulent letter and form should report this to TIGTA by calling the toll-free fraud referral hotline at 1-800-366-4484, faxing a complaint to 202-927-7018 or writing to the TIGTA Hotline, P.O. Box 589, Ben Franklin Station, Washington, D.C. 20044-0589. TIGTA’s Web site is located at www.ustreas.gov/tigta .
Identify theft is a federal crime under the Identity Theft and Assumption Deterrence Act of 1998. Violations of the Act are investigated by federal agencies such the U.S. Secret Service, the FBI and the Postal Inspection Service and are prosecuted by the Department of Justice. Use of the U.S. mail to commit fraud is another federal crime investigated by the Postal Inspection Service.
Identity thieves can use someone’s personal data to:
– Take over his or her financial accounts.
– Run up charges on the victim’s existing credit cards.
– Apply for loans, credit cards, services or benefits in the victim’s name.
– File fraudulent tax returns.
People who receive the fraudulent letter and form in the mail should immediately contact TIGTA and their financial institution about the attempted fraud. Those who have already been victimized by this scheme should contact the fraud or security department of their creditors, banks and financial institutions, as well as TIGTA and their local police department and postal inspector’s office, to report the identity and financial theft.
Additionally, victims should report the identity and financial theft to the fraud units of the 3 credit reporting bureaus:
– Equifax Credit Information Services, Consumer Fraud Division (800-525-6285)
– Experian (888-397-3742)
– Trans Union Fraud Victim Assistance Department (800-680-7289)
A copy of the scam letter and phony W-9095 may be found on the Office of the Comptroller of the Currency’s Web site at www.occ.treas.gov . Additional information on identity theft, mail fraud and investigative responsibilities may be found on the following Web sites:
– www.usps.com/postalinspectors/fraud/identitytheft
– www.secretservice.gov/financial_crimes
More Identity Theft Tips (How to Beat Identity Theft)
Here’s some good advice that a corporate attorney sent to the employees in his company. I pass it along for your information...“Empty your wallet. Photocopy front and back; your license, credit cards, etc. For your credit cards, make sure you have the phone numbers to call to cancel your card(s). This is important. Keep the photocopies in a safe place.
“We’ve all heard horror stories about fraud that’s committed using your name, address, SSN, credit, etc. Unfortunately I, the author of this piece who happens to be an attorney, have firsthand knowledge of what can happen because my wallet was stolen last month. Within 1 week, the thieves ordered an expensive monthly cell phone package, applied for a VISA credit card, had a credit line approved to buy a Gateway computer, received a PIN number from DMV to change my driving record information online, and more.
“To limit the damage in case this happens to you (or someone you know), cancel your credit cards immediately. The key is having your credit card numbers and the toll free cancellation numbers handy so you know whom to call. Keep this information where you can easily find it.
“File a police report immediately in the jurisdiction where it was stolen. This proves to credit providers you were diligent, paving the way toward the first steps of an investigation (if there ever is one).
“But here’s what is perhaps most important, something that I didn’t know to do:
call the three national credit-reporting organizations (Equifax, Experian, Trans Union) immediately to place a fraud alert on your name and SSN. I had never heard of doing this until advised by a bank that called to tell me an application for credit was made over the Internet in my name.
“By calling these numbers and alerting them of your situation, any company that checks your credit knows your information was stolen and they have to contact you by phone to authorize new credit. By the time I was advised to do this, almost 2 weeks after the theft, all the damage had been done.
“There are records of all the credit checks initiated by the thieves’ purchases, none of which I knew about before placing the alert. Since then, no additional damage has been done, and the thieves threw my wallet away (someone turned it in). The measures I took stopped them in their tracks.
Here are the numbers to call in case you find yourself in my situation:
Equifax 1-800-525-6285
Experian (formerly TRW) 1-888-397-3742
Trans Union 1-800-680-7289
and the Social Security Administration (fraud line) 1-800-269-0271
We pass along jokes; we pass along just about everything. Please, do think about passing this information along. It could really help someone.
Judy Akin, EA
Oklahoma City, OK
Published in EA Journal May/June 2002
IR-2003-18
WASHINGTON – In an update of an annual consumer alert, the Internal Revenue Service urged taxpayers to avoid falling victim to one of the “Dirty Dozen” tax scams. In the new 2003 ranking, several new scams have reached the top of the consumer watch list, including offshore banking and identity theft schemes.
“With the tax season in full swing, we’re seeing the traditional upswing in tax trickery,” said IRS Acting Commissioner Bob Wenzel. “Year after year, con artists across the nation try pulling a fast one on honest taxpayers with different types of miracle tax solutions. Don’t be fooled by the ‘Dirty Dozen’ and other misleading scams. There is no secret way to get out of paying taxes.”
The IRS and other federal agencies are aggressively pursuing and successfully prosecuting promoters of these schemes and many of their clients for fraud and tax evasion. These can result in imprisonment, fines and repayment of taxes owed with interest and penalties. Even innocent taxpayers involved in these schemes can face a staggering amount of back interest and penalties.
Taxpayers who suspect tax fraud can report it to the IRS at 1-800-829-0433. More information on tax scams and schemes is available by visiting “The Newsroom” section of IRS.gov.
The IRS urges people to avoid these common schemes:
1. OFFSHORE TRANSACTIONS. Some people use offshore transactions to avoid paying United States income tax. Use of an offshore credit card, trust or other arrangement to hide or underreport income or to claim false deductions on a federal tax return is illegal.
Through April 15, the IRS is offering people with improper offshore financial arrangements a chance to make things right. Eligible taxpayers who step forward will not face civil fraud and information return penalties. A taxpayer involved in these schemes who does not come forward now, however, will be subject to payment of taxes, interest, penalties and potential criminal prosecution.
People interested in participating in the program, called the Offshore Voluntary Compliance Initiative, can contact the IRS by calling 215-516-3537 (not toll-free).
2. IDENTITY THEFT. Identity thieves use someone’s personal data to steal his or her financial accounts, run up charges on the victim’s existing credit cards, apply for new loans, credit cards, services or benefits in the victim’s name and even file fraudulent tax returns.
The IRS is aware of at least two recent identity theft scams involving taxes or the IRS. In one, tax preparers allegedly used information, such as Social Security numbers and financial information, from their clients’ tax returns to commit identity theft. In another, fraudsters sent bank customers fictitious bank correspondence and IRS forms in an attempt to trick them into disclosing their personal and banking data.
For taxpayers, it pays to be choosy about disclosing personal and financial information. And the IRS encourages taxpayers to carefully select a reputable tax professional.
3. PHONY TAX PAYMENT CHECKS. In this scheme, con artists sell fictitious financial instruments that look like checks to pay a tax liability, mortgage and other debts. The con artists may also counsel their clients to use a phony check to overpay their taxes so they can receive a refund from the IRS for the overpayment. The false checks, called sight drafts, are worthless and have no financial value. It is illegal to use these sight drafts to pay a tax liability or other debts.
4. AFRICAN-AMERICANS GET A SPECIAL TAX REFUND. Thousands of African Americans have been misled by people offering to file for tax credits or refunds related to reparations for slavery. There is no such provision in the tax law. Some unscrupulous promoters have encouraged clients to pay them to prepare a claim for this refund. But the claims are a waste of money. Promoters of reparations tax schemes have been convicted and imprisoned. And taxpayers could face a $500 penalty for filing such claims if they do not withdraw the claim.
In early 2002, the slavery reparations scam ranked as the No. 1 scheme on the Dirty Dozen list. Following a sweeping public outreach campaign and assistance from members of the Congressional Black Caucus and other organizations, the number of reparation scam claims fell sharply. Tens of thousands of claims were received in 2001, but the claims fell to less than 50 per week in 2002.
5. NO TAXES WITHHELD FROM WAGES. Illegal schemes are being promoted that instruct employers not to withhold federal income tax or employment taxes from wages paid to their employees. These schemes are based on an incorrect interpretation of tax law and have been refuted in court. A recent flurry of court actions has been taken against promoters of these schemes. Taxpayers who have concerns about their employer and employment taxes can get help by calling the IRS at 1-800-829-1040.
6. IMPROPER HOME-BASED BUSINESS. This scheme purports to offer tax “relief” but in reality is illegal tax avoidance. The promoters of this scheme claim that individual taxpayers can deduct most, or all, of their personal expenses as business expenses by setting up a bogus home-based business. But the tax code firmly establishes that a clear business purpose and profit motive must exist in order to generate and claim allowable business expenses.
7. PAY THE TAX, THEN GET THE PRIZE. The caller says you’ve won a prize, and all you have to do to get it is to pay the income tax due. Don't believe it. Someone who really wins a prize may need to make an estimated tax payment to cover the taxes that will be due at the end of the year. But the payment goes to the IRS – not the caller. Whether the prize is cash, a car or a trip, a legitimate prize giver generally sends both the winner and the IRS a Form 1099 showing the total prize value that should be reported on the winner’s tax return.
8. FRIVOLOUS ARGUMENTS. Frivolous arguments are false arguments that are unsupported by law. When a scheme promoter says “I don’t pay taxes – why should you” or urges you to “untax yourself for $49.95,” beware. These scams are as old as snake oil, but people continue to be taken in. And now they’re on the Internet. The ads may say that paying taxes is “voluntary,” but that’s just plain wrong. The U.S. courts have continuously rejected this and other frivolous arguments. Unfortunately, hundreds of people across the country have paid for the “secret” of not paying taxes or have bought “untax packages.” Then they find out that following the advice contained in them can result in civil and/or criminal penalties. Numerous sellers of the bogus schemes have been convicted on criminal tax charges.
9. SOCIAL SECURITY TAX SCHEME. Taxpayers shouldn’t fall victim to a scam offering refunds of the Social Security taxes they have paid during their lifetimes. The scam works by the victim paying a "paperwork" fee of $100, plus a percentage of any refund received, to file a refund claim with the IRS. This hoax fleeces the victims for the up-front fee. The law does not allow such a refund of Social Security taxes paid. The IRS processing centers are alert to this hoax and have been stopping the false claims.
10. "I CAN GET YOU A BIG REFUND...FOR A FEE!" Refund scheme operators may approach someone wanting to "borrow" their Social Security number or give him or her a phony W-2 so it appears that the person qualifies for a big refund. They may promise to split the refund with that person, but the IRS catches most of these false refund claims before they go out. And when one does go out, the participant usually ends up paying back the refund along with stiff penalties and interest. Two lessons to remember: 1) Anyone who promises someone a bigger refund without knowing their tax situation could be misleading them, and 2) Never sign a tax return without looking it over to make sure it’s honest and correct.
11. SHARE/BORROW EITC DEPENDENTS. Unscrupulous tax preparers "share" one client's qualifying children with another client in order to allow both clients to claim the Earned Income Tax Credit. For example, one client may have four children but only needs to list two to get the maximum EITC. The preparer will list two children on the first client’s return and the other two on another client’s tax return. The preparer and the client "selling" the dependents split a fee. The IRS prosecutes the preparers of such fraudulent claims, and participating taxpayers could be subject to civil penalties.
12. IRS “AGENT” COMES TO YOUR HOUSE TO COLLECT. First, do not let anyone into your home unless they identify themselves to your satisfaction. IRS special agents, field auditors and collection officers carry picture IDs and will normally try to contact you before they visit. If you think the person on your doorstep is an impostor, lock your door and call the local police. To report IRS impostors, call the Treasury Inspector General’s Hotline at 1 800 366 4484.
Beyond the “Dirty Dozen,” the IRS sees many more tax schemes. Some examples include home-based business scams, disabled access credit for pay phones and a variety of improper abusive trusts.
“The best advice for taxpayers is to remember the concept of ‘buyer beware,’” Wenzel said. “Think carefully before paying for services or signing important documents. And don’t be fooled by outrageous promises. If something sounds too good to be true, it probably is.”
Copyright © 2001-2008 by Gary W. Lundgren, EA
