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Tax Issues

What Might Increase The Chances of Your Return Being Audited By the IRS?

Risk of audit should not keep someone from taking legitimate deductions
   -   Keep receipts and good records

If you get a letter from the IRS assessing additional taxes, don’t just assume they are right.
   -   Chances are, you just need to provide additional information
   -   Review your records and compare it to the adjustments in the letter
   -   Seek help from a tax professional

Income level
   -   IRS overall audit rate is about 1.11% - Chances of being audited are very

       low unless egregious mistakes are made
   -   If income is over $200,000, chance of audit increases to 3.93% or about one

       out of every 25 returns
   -   If income is under $200,000, chance of audit decreases to 1.02%
   -   Income over $1 million, 1 in 8 chance of return being audited

   -   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
   -   Large charitable donations disproportionate to income is likely to draw

       attention to a tax return
   -   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

Home office deduction
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
   -   Mortgage interest and real estate taxes, two biggest portions of home office

       deduction usually deductible as itemized deductions
   -   May be a better write-off for renters

Deducting rental losses
   -   Can deduct up to $25,000 of rental losses if:
   -   Adjusted Gross Income is < $100,000 (phases out between $100k and

   -   Actively participate in the renting of your property (can’t have somebody

       else manage your property)
   -   Exceptions for real estate professionals


Reporting business income and expenses on Schedule C or Form 2106 (Unreimbursed Employee Business Expenses)
   -   IRS has most success auditing this form
   -   Sole-proprietors often make mistakes in understanding legitimated

       eductions 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:
           -   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
           -   Facts and circumstances test:
               -   Manner in which taxpayer carries on business
               -   Expertise of taxpayer or advisors
               -   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
           -   If “hobby”, must claim all income from activity and expenses are limited

               to amount of income collected – can’t generate losses

Kipplinger - "IRS Audit Red Flags: The Dirty Dozen" - "America's most (and least) charitable states"

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