Ready for a scary tax story? A few years ago, one of my clients (let's call him Mr. Jones) got one of those IRS "love letters" requesting more information. The IRS wanted to meet with Mr. Jones in person to discuss the situation.
Mr. Jones (a small business owner) was required to show up at the local IRS office with all his records. The IRS was questioning the legitimacy of several business deductions. The IRS was doing what it is allowed by law to do -- demand that the taxpayer prove that those deductions were valid.
Turns out that Mr. Jones lost the audit and ended up owing the IRS a significant amount of money -- the additional tax, plus penalty and interest for late payment of that tax. Why did Mr. Jones' lose the audit? Mr. Jones made two "classic" taxpayer mistakes:
MISTAKE #1: "NO RECEIPT, NO DEDUCTION"
Mr. Jones lost several deductions simply because he didn't have the proper documentation to prove the deductions. What do I mean by "documentation"?
Well, if the IRS requires you to substantiate a deduction on your tax return, you must be able to provide written proof that the deduction really happened. The easiest way to prove a deduction is to hang on to: a) The receipt or invoice, and b) Proof of payment, which can be a canceled check, cash receipt, or credit card statement.
Mr. Jones reported numerous deductions for which he simply didn't have the documentation. No receipts, no canceled checks, no nothing. Turns out that Mr. Jones was one of those "cash guys". Maybe you know what kind of guy I'm talking about -- he never wrote a check in his life, just carried a wad of cash around in his pocket. He paid for everything with cash, and never kept any of his receipts.
Every year he'd sit down with his wife and "remember" how much he spent on different things. No way to prove any of this, of course. He just had a "feel" for how much cash he had spent, and he had run his business for so many years that he just "knew" how much it cost to purchase certain things.
Well, this is the kind of taxpayer that the IRS loves! It really is true – generally speaking, except for a few rare exceptions, if you can't prove that you paid for something (with receipts, invoices, canceled checks, etc.), then you run the risk of losing that deduction in the event of an audit.
One of the most common questions I am asked by clients is this: "I know I paid for something, but I don't have a receipt. Should I still report the deduction?" My response is usually this: "You only need a receipt if you get audited."
At first, people don't know if I am joking or not. Well, I do make that comment with my tongue planted firmly in cheek, but there really is a lot of truth to it. If you don't have the documentation to prove a deduction, you can still report the deduction (if you want), because you only have to prove the deduction if you get audited.
But if you do get audited, knowing that there are undocumented deductions on the return, be prepared to lose the deduction. Fair enough?
And here's the other major mistake that Mr. Jones made:
MISTAKE #2: BOGUS DEDUCTIONS
It turns out that Mr. Jones wasn't completely honest with me about some of his deductions. He reported deductions that simply were not real deductions. Here's one example: Mr. Jones owned several rental houses. These rental houses, of course, required maintenance and repair work. Many times Mr. Jones would do the work himself rather than pay someone else to do the work.
Well, Mr. Jones would estimate what he would have had to pay someone else to do the work that he did himself, and then he would report that amount as a deduction, even though he didn't actually pay anybody to do the work.
In other words, Mr. Jones deducted the value of his time -- which is non-deductible. This is an important point -- you can never legitimately deduct the value of your time for work you did. You have to actually pay someone to do the labor.
If you ever get a letter from the IRS demanding additional information, you'll have nothing to fear if you do exactly the opposite of what Mr. Jones did. If you can properly document your deductions and assuming you have no bogus information, you'll pass the audit with flying colors.
Thursday, October 28, 2010
Thursday, October 21, 2010
Small Business Tax Tips - What Does it Take to Pay Zero Taxes?
How many times have you heard someone say, "I don't pay any taxes. My accountant takes real good care of me...I haven't paid a dime in taxes in years." Does that outrageous statement sound familiar?
(As David Letterman used to say, is this comment a candidate for admission into the Museum of the Hard-To-Believe?)
Maybe it's your brother-in-law, or a fellow Soccer Mom, or a co-worker at the office. And so you think to yourself, "What am I doing wrong? How come I'm paying taxes and so-and-so says he/she pays nothing? How do they do it!"
Is it really possible to pay "zero taxes"?
For purposes of this article, let's give your "no-tax" friend or relative a name. Let's call him "Charlie" (or if he is a she, just think "Charlene").
OK, what is Charlie up to? What's his secret?
Charlie has no secret. He's not doing anything that you should be doing. Do not be envious of Charlie, and here's why...
I can think of at least five reasons you should ignore whatever Charlie says about his "no-tax" situation.
REASON #1: Charlie is a liar. Every family has one, so don't feel bad. Let's face it, some people just like to indulge in fabrications to make themselves feel good. Charlie is telling you a big fat lie because Charlie has "issues." Nuff said?
REASON #2: Charlie is pond scum. OK, hear me out on this one. I don't mean to offend you if Charlie is a close and dear relative, or your best friend, but I'm going to give it to you straight: Charlie cheats on his tax return, and he cheats big time. There are plenty of folks out there like Charlie. He's one of the reasons that you and I pay so much in taxes -- he doesn't report all his income, and he deducts bogus expenses by the thousands.
He and his accountant may even be in cahoots on this. Charlie brings in his records and his accountant crunches the numbers, then calls Charlie and says, "You owe $5,000." So Charlie rummages around in his files and somehow managesto come up with another batch of expenses that miraculously reduce his balance due to zero. It's like magic!
End result: Charlie's tax return is a big lie. And so Charlie is a thief. Charlie should be put in jail for the tens of thousands in taxes he has illegally withheld from the government over the years.
REASON #3: Charlie is stupid. Again, I'm sorry if I'm being too hard on Charlie. But some people are so clueless about taxes that if they have no balance due on their return, or if they are getting a refund, they mistakenly believe they didn't pay any tax that year.
And believe it or not, this is actually a very common misconception that thousands of people cling to. Ah, to be so blissfully ignorant!
I hope you are not so naive to think that the "bottom line" on your tax return tells the whole story about your tax liability. It doesn't.
REASON #4: Charlie is broke. Charlie may actually pay zero taxes because --are you ready for this one? -- Charlie doesn't make any money!
Charlie owns a small business or works full-time at his self-employment activity, and Charlie may rake in hundreds of thousands in income from sales of his product or service -- but Charlie's business spends more than it brings in, and Charlie's business has a loss every year.
So Charlie doesn't really have a tax problem. Instead Charlie has any number of other problems. He has a marketing problem, or a management problem, or a personnel problem. Charlie's business is failing, and paying zero taxes is just a symptom of a business that will eventually close.
REASON #5: Charlie is just scraping by. Charlie's business may not be losing money every year, but it's not really making much either. He has a small profit -- enough to keep him busy. His business may even "look" profitable, but it's really the classic shoestring operation.
So now, I ask you, do you really want to pay zero taxes? People who don't pay taxes are usually in one of these five categories: Chronic Liars, Pond Scum, Stupid, Broke, or Just Scraping By.
The purpose of business is to be profitable. The unavoidable result of a profitable business is taxes. And yes, you should do everything legally possible to reduce those taxes. But if you are going to be successful, you are going to pay some taxes.
When it comes to taxes, stay away from Charlie.
(As David Letterman used to say, is this comment a candidate for admission into the Museum of the Hard-To-Believe?)
Maybe it's your brother-in-law, or a fellow Soccer Mom, or a co-worker at the office. And so you think to yourself, "What am I doing wrong? How come I'm paying taxes and so-and-so says he/she pays nothing? How do they do it!"
Is it really possible to pay "zero taxes"?
For purposes of this article, let's give your "no-tax" friend or relative a name. Let's call him "Charlie" (or if he is a she, just think "Charlene").
OK, what is Charlie up to? What's his secret?
Charlie has no secret. He's not doing anything that you should be doing. Do not be envious of Charlie, and here's why...
I can think of at least five reasons you should ignore whatever Charlie says about his "no-tax" situation.
REASON #1: Charlie is a liar. Every family has one, so don't feel bad. Let's face it, some people just like to indulge in fabrications to make themselves feel good. Charlie is telling you a big fat lie because Charlie has "issues." Nuff said?
REASON #2: Charlie is pond scum. OK, hear me out on this one. I don't mean to offend you if Charlie is a close and dear relative, or your best friend, but I'm going to give it to you straight: Charlie cheats on his tax return, and he cheats big time. There are plenty of folks out there like Charlie. He's one of the reasons that you and I pay so much in taxes -- he doesn't report all his income, and he deducts bogus expenses by the thousands.
He and his accountant may even be in cahoots on this. Charlie brings in his records and his accountant crunches the numbers, then calls Charlie and says, "You owe $5,000." So Charlie rummages around in his files and somehow managesto come up with another batch of expenses that miraculously reduce his balance due to zero. It's like magic!
End result: Charlie's tax return is a big lie. And so Charlie is a thief. Charlie should be put in jail for the tens of thousands in taxes he has illegally withheld from the government over the years.
REASON #3: Charlie is stupid. Again, I'm sorry if I'm being too hard on Charlie. But some people are so clueless about taxes that if they have no balance due on their return, or if they are getting a refund, they mistakenly believe they didn't pay any tax that year.
And believe it or not, this is actually a very common misconception that thousands of people cling to. Ah, to be so blissfully ignorant!
I hope you are not so naive to think that the "bottom line" on your tax return tells the whole story about your tax liability. It doesn't.
REASON #4: Charlie is broke. Charlie may actually pay zero taxes because --are you ready for this one? -- Charlie doesn't make any money!
Charlie owns a small business or works full-time at his self-employment activity, and Charlie may rake in hundreds of thousands in income from sales of his product or service -- but Charlie's business spends more than it brings in, and Charlie's business has a loss every year.
So Charlie doesn't really have a tax problem. Instead Charlie has any number of other problems. He has a marketing problem, or a management problem, or a personnel problem. Charlie's business is failing, and paying zero taxes is just a symptom of a business that will eventually close.
REASON #5: Charlie is just scraping by. Charlie's business may not be losing money every year, but it's not really making much either. He has a small profit -- enough to keep him busy. His business may even "look" profitable, but it's really the classic shoestring operation.
So now, I ask you, do you really want to pay zero taxes? People who don't pay taxes are usually in one of these five categories: Chronic Liars, Pond Scum, Stupid, Broke, or Just Scraping By.
The purpose of business is to be profitable. The unavoidable result of a profitable business is taxes. And yes, you should do everything legally possible to reduce those taxes. But if you are going to be successful, you are going to pay some taxes.
When it comes to taxes, stay away from Charlie.
Tuesday, October 19, 2010
Looking For a Good Tax Preparer?
Your search is over at http://www.goodtaxpreparer.com/.
Here's a sneak peak at what you'll find on this site:
Here's a sneak peak at what you'll find on this site:
Thursday, October 14, 2010
Taxpayers Beware: Tax Scam Emails Are Back!
Have you received any really weird emails lately that look they are from the federal government? I did. It's so weird, it makes you wonder what kind of person takes the time to come up with this junk.
This type of tax scam emails surface on the internet from time to time. There's only one thing you can do – delete it! And don't even think about clicking on any links inside the email.
And always remember this:
The IRS does not initiate taxpayer communications through e-mail.
Here's the beginning of a scam email I received this week:
EXCERPT FROM TAX SCAM EMAIL
SUBJECT: LAST NOTICE: Your Federal Tax Payment has been rejected.
Your Federal Tax Payment ID: 010375250 has been rejected.
Return Reason Code R21 - The identification number used in the Company Identification Field is not valid.
Please, check the information and refer to Code R21 to get details about your company payment in transaction contacts section:
In other way forward information to your accountant adviser.
2. m i. Robert H. DOROUGH, born 10 Feb 1704 in James City County, Virginia.
EFTPS: The Electronic Federal Tax Payment System
PLEASE NOTE: Your tax payment is due regardless of EFTPS online availability. In case of an emergency, you can always make your tax payment by calling the EFTPS.
END OF EXCERPT FROM TAX SCAM EMAIL
Amazing, isn't it?
The rest of the email is a bunch of mumbo jumbo that makes no sense whatsoever.
For more info on internet tax scams, check out the IRS website:
"How to Report and Identify Phishing, E-Mail Scams and Bogus IRS Web Sites"
http://www.irs.gov/privacy/article/0,,id=179820,00.html?portlet=1
This type of tax scam emails surface on the internet from time to time. There's only one thing you can do – delete it! And don't even think about clicking on any links inside the email.
And always remember this:
The IRS does not initiate taxpayer communications through e-mail.
Here's the beginning of a scam email I received this week:
EXCERPT FROM TAX SCAM EMAIL
SUBJECT: LAST NOTICE: Your Federal Tax Payment has been rejected.
Your Federal Tax Payment ID: 010375250 has been rejected.
Return Reason Code R21 - The identification number used in the Company Identification Field is not valid.
Please, check the information and refer to Code R21 to get details about your company payment in transaction contacts section:
In other way forward information to your accountant adviser.
2. m i. Robert H. DOROUGH, born 10 Feb 1704 in James City County, Virginia.
EFTPS: The Electronic Federal Tax Payment System
PLEASE NOTE: Your tax payment is due regardless of EFTPS online availability. In case of an emergency, you can always make your tax payment by calling the EFTPS.
END OF EXCERPT FROM TAX SCAM EMAIL
Amazing, isn't it?
The rest of the email is a bunch of mumbo jumbo that makes no sense whatsoever.
For more info on internet tax scams, check out the IRS website:
"How to Report and Identify Phishing, E-Mail Scams and Bogus IRS Web Sites"
http://www.irs.gov/privacy/article/0,,id=179820,00.html?portlet=1
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