“Commonly Missed Income Tax Deductions and IRS Audit Avoidance”
Guests:
Sean Mawhinney, Attorney at Law
Law Offices of W. Sean Mawhinney, PC
www.mawhinneylaw.com
1-800-ERASE-DEBT
Rick Van Valkenburgh, CPA
Brad Bradley Company
Certified Public Accounts
www.bradbradley.com
801-572-6884
Missed tax deductions:
- Cancellation of Debt income from foreclosures and short sales
o Can be excluded from income if on primary residence
o Other situations in which cancelled debt income may be excluded
- American opportunity credit
o Up to $2,500 credit for college tuition and books and fees.
§ Up to $1,000 of credit refundable even if no income to report on tax return
o Credit phases out for single taxpayers with income over $80,000 and married filing joint taxpayers with income over $160,000.
- Out-of-pocket charitable donations
o Mileage, food, supplies for activities in connection with a charitable organization like church or school can be added to itemized deductions.
o Be sure to keep receipts and document the activity
§ In a Dec 15, 2011 article on MSNBC, 24/7 Wall St. reviewed IRS data and came up with the 10 most charitable states
§ Utah ranks #1 as the most charitable state
- Job hunting costs
o If looking for a position in the same line of work expenses can be added to miscellaneous itemized deductions.
§ Food, lodging, and transportation if traveling away from home and overnight, cab fares, employment agency fees, cost of printing resumes, business cards, postage, and advertising.
o if looking for a job in a new line of work, or if looking for your first job, job-hunting expenses aren't deductible
- Moving expenses
o New job must be at least 50 miles away from old home
- Student loan interest
o If paid by mom and dad it is deductible by the student on their own tax return, not by mom and dad on their tax return
o IRS considers it a “gift” from mom and dad
- Child care credit
o 20%-30% of child care costs if it allows you to work.
o Better option might be child care reimbursement plan through work.
§ Plan contributions are pre-tax
- State income tax paid with previous year's state tax return is an itemized deduction.
- State Sales Tax deduction
o Better for states that don't have a state income tax but might still work for some in Utah, especially if their state income taxes paid during the tax year are low.
§ Sales tax on purchase of vehicle, RV, plane, or supplies for home improvements may increase benefit of deducting state sales tax instead of state income tax
§ If claim state sales tax deduction and receive state income tax refund, refund isn’t included on next year’s tax return as income
- Reinvested dividends
o Remember to include reinvested dividends in the cost of your stock or mutual funds when you sell it and calculate the gain
- Refinancing points
o Amortized over the life of loan.
o If you sell the house or refinance again with a different lender, deduct remainder of points not previously deducted
- Energy saving home improvements
o 10% of qualified costs up to max $500 credit.
o If you've taken this credit in previous years, you can only take additional credit if you haven't already reached the $500 max
What increases the chance of an audit:
- Risk of audit should not keep someone from taking legitimate deductions
o Keep receipts and good records!
- If you get a letter from the IRS assessing additional taxes, don’t just assume they are right.
o Chances are, you just need to provide additional information
o Review your records and compare it to the adjustments in the letter
o Seek help from a tax professional
- Income level
o IRS overall audit rate is about 1.11% - Chances of being audited are very low unless egregious mistakes are made
o If income is over $200,000, chance of audit increases to 3.93% or about one out of every 25 returns
o If income is under $200,000, chance of audit decreases to 1.02%
o Income over $1 million, 1 in 8 chance of return being audited
- Underreporting
o All W-2s and 1099s are sent to IRS. Their computers easily check to see if you reported what was reported to them under your social security number. A mismatch will generate an automatic letter assessing additional taxes, including interest and penalties
- Large charitable donations
o Large charitable donations disproportionate to income is likely to draw attention to a tax return
- Home office deduction
o IRS has traditionally been successful in disallowing home office deductions for numerous reasons:
§ Inadequate documentation
§ Home office is not principal place of business
§ Home office is not exclusively used for business
o Mortgage interest and real estate taxes, two biggest portions of home office deduction usually deductible as itemized deductions
o May be a better write-off for renters
- Deducting rental losses
o Can deduct up to $25,000 of rental losses if:
§ Adjusted Gross Income is < $100,000 (phases out between $100k and $150k)
§ Actively participate in the renting of your property (can’t have somebody else manage your property)
o Exceptions for real estate professionals
- Reporting business income and expenses on Schedule C or Form 2106 (Unreimbursed Employee Business Expenses)
o IRS has most success auditing this form
o Sole-proprietors often make mistakes in understanding legitimate deductions and in keeping adequate records
§ Business meals, travel, and entertainment
· If amount seems too high for the business, IRS may take notice
§ Deducting 100% of business use of vehicle
· Most taxpayers who use their car for business purposes don’t keep a mileage log
· IRS says log must be “contemporaneous” – this means you can’t make it up after-the-fact
· Commuting doesn’t count toward business mileage
§ Large losses on Schedule C
· Especially if multiple years of large losses
· IRS may consider activity a “hobby”, unless:
o Must have profit motive
§ Activity is presumed to be “for-profit” if gross income exceeds deductions for 3 or more out of 5 consecutive years
o Facts and circumstances test
§ Manner in which taxpayer carries on business
§ Expertise of taxpayer or advisers
§ Time and effort spent on activity
§ Expectation assets used will appreciate in value
§ Taxpayer’s success in other business activities
§ Taxpayer’s history of income/loss with respect to activity
§ Amount of occasional profits, if any
§ Financial status of taxpayer
§ Elements of personal pleasure or recreation
o If “hobby”, must claim all income from activity and expenses are limited to amount of income collected – can’t generate losses
How to Use your Refund:
- Vacations and toys are fine but revolving debt is costing you money each day!
- Pay off your debt with your tax refund!
- Best thing you can do for your family is to get out of debt as quickly as possible and tax refund season is the time!
- Many revolving debts may be negotiated down
Tax tips excerpts from the Kiplinger Letter, November 2011
