Halloween Tax Tips: How to Eliminate All Fear of the IRS

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.

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.

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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

The Biggest Tax Increase in History May Be Coming to a Neighborhood Near You

It's true.

If Congress and the President do nothing, everyone's personal tax rates will go up on January 1, 2011. There's quite a debate in Congress about this right now, with the usual bickering and name-calling that we pay our beloved politicians to engage in.

This is because the so-called "Bush Tax Cuts" are going to expire on 12/31/10 and unless Washington passes a law to extend the current tax rates, they will revert to the higher rates in existence prior to the rates passed when Bush was in office.

What do you think Washington should do?

Let the world know by posting comments below.

And if you want to learn more about this situation, here are some fascinating articles that go into more detail . . .

From the Wall Street Journal . . .
There's a Tax War in Congress and what you should do now . . .
http://online.wsj.com/article/SB10001424052748704644404575481903960961386.html?mod=WSJ_Taxes_Taxes_2

Here's a Republican view . . .
http://politics.usnews.com/opinion/articles/2010/09/13/chuck-grassley-tax-increases-would-cause-more-unemployment.html

And here's what a Democrat has to say. . .
http://politics.usnews.com/opinion/articles/2010/09/13/sander-levin-dont-extend-bush-tax-cuts-for-the-rich.html

And even Oprah has something to say about taxes this week . . .
http://www.tmz.com/2010/09/17/oprah-winfrey-australia-giveaway-audience-gift-all-expenses-paid-no-catch-no-taxes-no-strings-attached/

What Happens If You File a Business Income Tax Return After Sept 15?

The due date for business income tax returns on extension is September 15. If that date has passed and you still haven't filed a return for your corporation, partnership or LLC that is being taxed as a corporation or partnership, what are the consequences?

The short answer is this: You will probably pay for your tardiness.

The long answer is twofold:

Scenario 1 - Balance due returns.
If the business has a balance due on the return that hasn't been paid yet, the late payment penalty and interest charge clock has been ticking since the original due date of the return (March 15 for corporations and April 15 for partnerships).

For corporations and LLC's being taxed as a corporation, the tax had to be paid by March 15 to avoid these charges. For partnerships and LLC's being taxed as a partnership, the tax had to be paid by April 15 to avoid these charges.

In addition to late payment penalty and interest, you can also be charged a late filing penalty if you did not file an extension and then file the return after the original due date, or if you did file an extension but then file after the extended due date of September 15. (More on that below.)

Scenario 2 - Zero balance due returns.
Typically, only regular corporations have tax liability on their corporate income tax returns (Form 1120). S Corporations (Form 1120S) and partnerships (Form 1065) usually have no income tax liability on their income tax returns because the profit "passes through" to the owners' personal income tax return and the tax gets paid there.

So if there's no tax, aren't S Corps and partnerships off the hook if they file a return late? Unfortunately, no.

There is a penalty for not filing a return on time. As mentioned above, there is a late filing penalty even when there is no tax due. The penalty is $89 for each month or part of a month the return is late (up to 12 months), multiplied by the number of shareholders/partners/members in the business during any part of the year for this return. Ouch!

Example: you have an S Corp or partnership or LLC that has 3 owners. You filed the extension and so now the return is due September 15. But you've all been busy and the return didn't get filed by September 15. Automatically, even if you file on September 16, you've already incurred a late filing penalty of $267 ($89 times 3).

And for every month that passes without the return being filed, you are penalized another $267. Another ouch!

Well, do I have your attention now? I hope so. If you haven't filed the return yet, do yourself a favor and save yourself hundreds of dollars and get the return done ASAP.

Is there any way to avoid paying these late payment penalties, interest charges, and late filing penalties? Yes. If the late payment or late filing is due to "reasonable cause", you can attach a reasonable cause statement to the return and request the IRS to waive the penalties and interest.

What is "reasonable cause"? There are several situations that usually qualify, such as death in the family, serious illness, theft, and natural disasters.

7 Things Every Business Owner Should Know to Avoid Running Afoul of the IRS

One of the most controversial grey areas of tax law is the "independent contractor vs employee" issue.

Most small businesses hire workers to perform services, i.e. outsourcing.

Is the person you hire an employee or an independent contractor?

Does it really matter? You better believe it does!

The answer to that question is critical. And if you don't answer it correctly, you can end up in big trouble.

If you treat someone as a contractor and that person is really an employee, the IRS can re-classify that person as an employee and you'll be responsible to pay the taxes that should have been withheld from his/her paychecks, plus the employer's payroll taxes, plus penalties and interest for late payment.

Ouch!

So it's in your best interest to get this right.

Here are some tips to help you make the correct classification, courtesy of the IRS:

7 Things Every Business Owner Should Know
About Independent Contractors vs. Employees

1. The IRS uses three characteristics to determine the relationship between businesses and workers:

- Behavioral Control covers facts that show whether the business has a right to direct or control how the work isdone through instructions, training or other means.

- Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker's job.

- Type of Relationship relates to how the workers and the business owner perceive their relationship.

2. If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees.

3. If you can direct or control only the result of the work done -- and not the means and methods of accomplishing the result -- then your workers are probably independent contractors.

4. Employers who misclassify workers as independent contractors can end up with substantial tax bills. Additionally, they can face penalties for failing to pay employment taxes and for failing to file required tax forms.

(As I said before.....OUCH!)

5. Workers can avoid higher tax bills and lost benefits if they know their proper status.

6. Both employers and workers can ask the IRS to make a determination on whether a specific individual is an independent contractor or an employee by filing a Form SS-8, Determination of Worker Status for Purposes of Federal
Employment Taxes and Income Tax Withholding, with the IRS.

7. You can learn more about the critical determination of a worker’s status as an Independent Contractor or Employee at IRS.gov by selecting the Small Business link.

Additional resources include:
-- IRS Publication 15-A - Employer's Supplemental Tax Guide
-- IRS Publication 1779 - Independent Contractor or Employee
-- IRS Publication 1976 - Do You Qualify for Relief under Section 530?

These publications and Form SS-8 are available on the IRS website (www.IRS.gov) or by calling the IRS at 800-829-3676.

Many Happy Returns,
Wayne