Section 1031 and Vacation Homes

Whether you call it another tax benefit for the wealthy or help for strapped real-estate investors, it’s worth taking note that the IRS has recently clarified their position on swapping vacation homes – you can do it now tax free.

There are the usual rules that specific times, percentages and percentages of time are required to qualify but what it boils down to is that chances are owners of multiple homes now have other way of transferring assets without having to get the tax man involved.

Audit Triggers - Part 2

Yesterday I published a couple of likely triggers for an audit. As promised, here are a couple more:

High Income – Although a higher income should be considered an advantage under any other circumstance, considered from the perspective of prospective audits it is most certainly a disadvantage. And the chances of an audit jump up significantly with each income level. Past audits tell us that the chances of an audit for taxpayers making less than $100,000 is 0.93%. For incomes over $100,000 the chances jump to 1.77%, over $200,000 brings the odds up to 2.87% and over $1 million in income brings the chances of an audit to a whopping 9.37%!

Self-Employment – Because self employed taxpayers are constantly keeping an eye on their bottom line they tend to be aggressive at writing off expenses. While there are many legitimate reasons for doing so the IRS likes to verify these deductions.

While these are some of circumstances that may trigger an audit they do not necessarily guarantee one nor will avoiding them remove all possibility of one. The best defense against an audit is to always expect one. Taxpayers should make sure that their deductions are legitimate and reasonable. They should also keep well ordered records and receipts.

However never having to face an audit is certainly the best circumstance. Keeping these triggers in mind can help taxpayers reduce the risks of that happening.

Audit Triggers - Know what the IRS is looking for...

With the tax clock ticking down lots of people are finishing up their tax returns. A common question that comes up during this joyous time of year is, “How can I avoid an audit?” Fortunately for most taxpayers the question is far more common than an actual audit. Only around 1% of all taxpayers actually end up facing an audit.

Comforting as that fact is, it is in no way instructive. Knowing what is more likely to trigger an audit can go a long way to avoiding one. Avoiding these triggers will not guarantee that an audit will not occur but it will reduce the chances of one. While all of the reasons that the IRS launches an audit aren’t known, crunching the statistics of past audits does demonstrate some clear triggers.

High deductions – Any deduction that is proportionally high to the taxpayer’s income usually constitutes a red flag. Determining what’s high is the trick here. The IRS publishes an annual book, “Statistics of Income.” Although the book gives ranges for typical incomes some logic needs to be applied. If a taxpayer is at the lower end of a particular income range but claims the upper limits of deductions associated with that range then that deduction may still trigger an audit review even though the deduction is technically within the accepted limit.

Cash Income – Any profession that deals with a lot of cash, such as waiting tables, tends to spark the curiosity of IRS audit agents. One of the first things they compare in cases such as this is bank deposits vs. claimed income.

These are a couple of common triggers that can set off an audit. Tomorrow I'll share another couple of potential red flags. Remember, avoiding these doesn't necessarily guarantee avoidance of an audit but it can certainly reduce the possibility of one.

Is the IRS Unconstitutional?

They come around with almost the same annual regularity as Christmas or New Years – the arguments that the US tax system is illegal, unconstitutional or, one of my favorites, dependant on the voluntary participation of the tax payer.

This year the anti-tax/anti-IRS voices seem particularly loud as they rally around a couple of the more visible candidates for the Republican nominee for president – Ron Paul and Mike Huckabee. While Huckabee’s tax proposal might be a softer version of Paul’s slash and burn vision of the IRS, both have attracted the admiration of disgruntled tax payers of all stripes.

But under its current charter the IRS feels secure. With equal regularity although with perhaps a little less attention, comes the IRS’s rebuttal to these accusations. The Truth About Frivolous Tax Arguments is a fascinating read. It goes way beyond the “Oh, please” reaction that would be mine if addressing these arguments were my responsibility. The document meticulously examines and refutes the most common of these arguments.

‘Tis the Season to Give – Make Sure It Counts Next April

It is the time of year when a lot of taxpayers like to take the time to give something back. Whether you contribute money or property to your favorite charity, make sure that you are familiar with IRS regulations if you intend to claim a tax deduction.

In the first place, you need to know if the organization even counts. Some don’t. The IRS says that qualified organizations include, but are not limited to, “Federal, state, and local governments and organizations organized and operated only for charitable, religious, educational, scientific, or literary purposes, or for the prevention of cruelty to children or animals.” It’s best to check with the people that run the organization itself; they’ll know. Be sure to get the appropriate paperwork from them if the contribution is worth more than $250.

Time doesn’t count. While contributing your time to a charitable cause is certainly adminrable, it can’t count towards a tax deduction. Expense incurred can but not the time itself.

So, embrace the spirit of the season now. But just take a moment to review the IRS’s rules if you plan to claim deductions in April.

That Depends On What the Meaning of the Word "Individual" Is.

Do you have to pay taxes? This isn't a libertarian vs. sane person question; politics has nothing to do with it. Under the current situation in the US do you have to pay taxes?

Well, according to Sherry Peel Jackson the answer is a shrug and a resounding "I dunno!"

The former IRS agent and CPA decided that she would find a way to not pay taxes. According to her she could found no clear, legal instruction that she should have to pay up. She did find that taxes are imposed upon "every married individual" but with no definition of the word individual, she just wasn't sure whether or not she was one.

If the definition of the word individual includes the phrase "common sense" I might have to agree with her.

Luckily the jury of her peers did have some common sense - and perhaps a little resentment that they had been paying taxes while Jackson wanted to bring in her $100K per year tax free - and found her guilty. She faces up to four years in prison.

Audits - Be Prepared

In a previous post we looked at the likely-hood of any one taxpayer facing an audit. While the odds are low, every US taxpayer should be prepared for the possibility of an IRS audit.

Anyone that claims deductions beyond the standard deductions should be prepared to defend their tax return. Self-employed worker, small business owners, anyone claiming investment losses or virtually any other financial circumstance beyond the usual salary minus standard deduction scenario should be prepared.

Taking deductions or claiming that certain expenditures are business expenses reduce the total taxes owed. The IRS expects make taxpayers to make such claims. Deciding what is a legitimate deduction or business expense is left largely up to the taxpayer and her advisors. Deciding whether to accept them is up to the IRS and, in the case of an audit, the auditing agent. Therefore surviving an audit depends on being prepared to defend the deductions taken.

Good record keeping is the key to being prepared. Save all receipts and keep them in an orderly way so that if an audit ever happens locating them will be easy. Keep records of all transactions that affect each year’s taxes – both income and deductions. Make sure that all transactions are clear, traceable and can be explained. Maintaining honest and straightforward financial records will offer most taxpayers the ability to survive an audit.

Will You Face an Audit?

Probably not.

It’s the dread of every US taxpayer – the IRS audit. Most citizens only have a vague idea of what an audit is and how to prepare for it. Everyone has heard nightmarish stories of audits – lost receipts, probing questions about deductions taken years ago, and, the worst, owing huge sums of back taxes. The audit has been called the financial equivalent of a rectal examine.

The odds of being audited by the Internal Revenue Service are really quite slim. Of 131 million returns received by the IRS for the 12 month period ending October 2005, only 1,216 were audited. But it’s a perpetual possibility for which everyone must be prepared.

Many taxpayers take the standard deductions and will never have to worry with the years of old receipts and financial records from the past. In fact if the IRS decides to take a look at the tax history of a citizen who has only taken standard deductions, chances are she will never know that she was investigated. The IRS agents will simply look at her past returns, see that she took the standard deductions, and move on to the next taxpayer.

C'mon, IRS, Don't Be So Shy!

A couple of Senators want the IRS to speak up a bit about one of it's benefits.

In a letter to Acting IRS Commissioner Kevin Brown Senators Max Baucus (D-MT) and Chuck Grassley (R-IA) asked that the Saver's Credit receive a bit more publicity.

The Saver's Credit is a dollar to dollar tax deduction - up to $2000 - available to American tax payers that make contributions to a retirement account.

The Senators acknowledge that many taxpayers have taken advantage of this savings incentive but millions more haven't, most likely because they simply don't know about it. The lawmakers would like the IRS to make this deduction better known to the American taxpayer through a variety of measures, including adding a specific line for it to the 1040EZ form.

Tax Break Balances Minimum Wage Hike

Maybe that extra value meal doesn't need a price hike, after all

If you are like me, when you first heard about the increase in the federal minimum wage, you had serious concerns. How will this affect the cost of my value meal number 2 at McDonald's? Will I be able to afford to continue clogging my arteries on a regular basis?

In seriousness, most of us agree that trying to make ends meet on $5.15 per hour is close to impossible. But would a wage increase actually help the working poor, or would it just drive the prices of goods and services up to the point where the working poor still couldn't afford them?

It turns out that our lawmakers did have some sympathy for the small business owners who would be most impacted by the increase in expenses brought on by the minimum wage hike. Along with the wage increase, a series of tax breaks for small businesses was passed. These include expanded deductions and write-offs, along with incentives to hire people from some economically disadvantaged groups, such as people on public assistance and people just released from prison.

Sounds like a potentially win-win situation, not only for small businesses and minimum wage workers, but for everyone who doesn't want to see the rising costs of doing business reflected in the amount we pay for our goods and services.

IRS Plans Random Audits

So, you’ve done everything right and completely above board on your taxes. You even rejected some of your accountant’s suggested deductions because they seemed a little close to the edge. Nothing, you told yourself, to raise any flags with the IRS. The money lost over a deduction or two was worth knowing that you wouldn’t face an audit.

Well, things have changed and even the most studiously honest tax returns may face review. The IRS is bringing back a controversial audit lottery that will randomly target taxpayers. Apparently no groups will be given special attention and no one is exempt from being possibly selected.

The first bunch of 13,000 tax payers will be selected from various income categories this autumn and reviews will commence in October.

Is there anything that you can do to prepare? Not really. Some audits will be carried out without the taxpayer even being aware that it is happening. If the IRS is able to confirm the return with their records then the investigation will stop. But most cases are expected to result in some face to face time with the taxpayer.