7 IRS Red Flags – Tax Reporting Bombs That Can Kill You
Save Your Own ASS – Pay Attention To These 7 IRS Red Flags
#1 of 7 IRS Red Flags – Filing Your ‘Schedule C’ Correctly
When it comes to reporting your income and expenses, make sure you report correctly. Filing your Schedule C with obvious income holes – Such as a the donut maker who is nestled on a busy street beside a coffee shop and has a complete list of expenses, but failed to identify his income as thoroughly.
Just as big are the IRS red flags example of the donut maker who lists in their expenses – $5000 for office supplies and $50 for flour. Common sense mistakes especially throw up IRS red flags.
If you get away with an IRS Red Flags one year – You were only lucky. Luck like that doesn’t strike twice.
Partial reporting of revenue and income will result in heavy tax penalty – Accumulating from the date it was due – Calculated daily, and monthly.
If it makes sense and you can legally defend it, you may have an argument and could even win an IRS audit. Good sense tells me you won’t win 100%, but you could ‘minimize your damages if you can defend yourself in a way that resonates sincerity, is backed up with documentation, and makes tax sense.
Check your math when you Complete ANY Tax Forms – Surprising how many people wind up in an IRS audit who didn’t have time for this 10 minute IRS Red Flags exercise!
Ask a professional accountant or Tax attorney for advice in this situation – It will be the best money you EVER spent!
|Monthly Bookkeeping Records||Monthly Travel Logs||Quickbooks|
#2 of 7 IRS Red Flags – Deductions That Scream “Audit Me!”
If you take big deductions, be prepared to defend those in an Audit. You may not get that audit this year, but the IRS uses a point system and when you hit their B/S percentage signalling the IRS Red Flags, you get to go for an audit and they could take you back two years versus one year – You got away with Nothing, they will go back to that prior year as well.
Big deductions means that you own a travel business and you spend $200 on your website, but spend $10,000 on office supplies. Unless you put all your office equipment on the wrong line, then you’ll be signalling IRS Red Flags and going to an audit and paying some hefty penalties.
One fellow with a construction business wrote off his wife’s lingerie as “Small Tools” because she bought them at Sears. No way was that a ‘defendable’ expense. It triggered an audit that went back 11 years. Be smart about expenses.
Another IRS Red Flags trigger is if you report a reported salary income as $20,000, and rental or mortgage expenses as 1/2 or more of your total income. IRS Tax agents tend to think of you as either:
- Under reporting your income (This one is always #1)
- Living beyond your means on a lower than poverty level in a very (very) bad year. If this is truly your situation and you have kept the records you need to for an audit, then YES, take the deduction – ABSOLUTELY take it! If you don’t then prepare yourself for life in a very small area with a roommate with tattoos and piercings whose nickname is, “Buster.”
Defendable deductions with proper documented backup are absolutely worth taking! Never be afraid on that! You’ll get the services of the best people in the industry if you have to defend yourself in this case.
#3 of 7 IRS Red Flags – Deduction of Your Home Office
Home office deductions often get IRS Red Flags and raised eyebrow from tax agents, but if you own a legitimate business then they are a legitimate deduction.
This means that you’ll get to deduct the square footage of your home office in comparison to your total square footage of your home. You may take certain other areas of the home if they are used in your home business – washroom, kitchen area for breaks, etc . . . These are called “Common property areas” and deducted from your total square footage on a reduced percentage – Check with a professional accountant for up to date rules and regulations on these important restrictions.
What can you deduct – electricity, heat, home insurance costs, housekeeping, landscaping, furnishings, remodeling expenses. This list is not all-inclusive – there is more. Check with your local accounting professional.
Often professionals recommend against these deductions for home offices because they can be more hassle than they are worth, but my personal opinion is that if you have good records, can justify the expenses and square footage deduction then take the deduction – YES!
Key elements in being a success with a home office deduction is that you have good records and can justify AND defend the deduction.
The requirement – at the time of this writing – Is that the use of home space as office space is that it is “dedicated Office Space Only,” not combined as a living/office area in such a way as to disqualify it – For instance, do you work on your computer on the desk in the corner for work and watch movies on the same computer too – For fun/home time. If you do, then you probably will not be allowed that deduction, unless you want to take the time to calculate part time home use/business use and calculate your mortgage or rent accordingly.
This particular home expense deduction is calculated this way: (simple numbers used – Not a ‘real’ example)
- Percentage of Home office square footage used for office space (10 x 5 = 50 sq ft)
- Home Expenses ($10)
- Divided by Total square feet of your home (100 sq ft)
- Divided by home mortgage or rent amount ($100)
- So, if your dedicated home office space was 50 feet, total square home footage = 100, your deduction would be 100 feet divided by 50 = (50/100 = 50%) = 50% ($50 in this example)
- 50% is the allowable percentage you can use for your home office expenses – lights, heat, etc . . . ) For this example, $10 divided by 50% = $5
- Your total home office expenses deduction for this example = $50 + $5.00 = $55.00
- Part Time home business use of home expenses using this example is calculated by the number of hours your work area is used in the day for business reasons, then divide that amount by 24 hours, lastly, multiply the total by the designated business part of your total home expense. Part time in this example = 8 hour days, 5 days a week, 8/24 x 50/100 x $10 home expenses = 3 x .5 = $1.50 (This amount is less if you work fewer than 5 days a week).
- For larger home business expenses than income – carry this extra over into your next tax year, don’t take all of it for current year if you don’t have to. Red flag if you try to make your home office deduction take your business into a state of “Loss”.
#4 of 7 IRS Red Flags – Car Business Use Expenses
Anytime you say that 100% of an asset you use for personal use is ‘strictly’ business, you throw up IRS red flags fireworks – 100% of car use on a personal vehicle, when you only own one vehicle, for instance.
Mileage records are essential if you intend to take this deduction. You must include these details:
- Trip date
- Trip Purpose
- Trip Mileage – Don’t have time to record these things, make a list of where you went – address, then Google maps for your travel distance, print off that sheet, write trip date and purpose of trip on that sheet, attach it to your records. This is acceptable.
There are standard mileage deductions allowed, however, you still need a mileage log and record of expenses. Keep one in your glove compartment.
Don’t lie and you’ll be fine.
#5 of 7 IRS Red Flags – Are you operating a Business or participating in your favorite hobby
As a business owner Are You:
- Experienced and successful in the business you are in
- Operating in a business-like manner
- Keeping good books and records
- (at least) Trying to make a profit
These are the IRS Red Flags guidelines that tax agents require to determine if you are operating a business versus having a hobby.
Even though you operate within these guidelines, you may have incurred a loss over several years and your business may come into question as a result, but as long as you operate and can prove that you operate within these guidelines, you should not have issues.
IRS Red flags go up when you report big losses, but show large income, or no income.
#6 of 7 IRS Red Flags – Padding the Earned-income tax credit With Phony Dependents
In the example above in #3 – The same fella writing off his wife’s lingerie as Small Tools also wrote off his dog as his child. Maybe, just maybe he could have gotten away with writing off his dog as his “mascot,” or even a security system, because the dog went everywhere with him and served as his security, however, giving the dog a social security number was the WRONG thing to do. He got about 2 years with “Buster.”
Don’t go there, It’s not a matter of “If” you get caught, it is a matter of “When” you get caught.
#7 of 7 IRS Red Flags – Rental Property Losses That Smother Income
Being an active property manager is essential to pass the IRS Red Flags audit test with this. Even though you may have incurred a loss on a rental property, there are limitations for current year deductions – Know them.
IRS Red Flags – Conclusion
As in ANY tax return, Check your deduction standards against those of the people who do this for a living. They know the rules and regulations. You don’t and it’s THAT SIMPLE.
When it comes to throwing up IRS red Flags, get the advice of a professional accountant, or tax attorney.
Use this rule as your rule of thumb – Can I prove it with documentation?
More IRS Red Flags – How To ‘Audit Proof’ Your Bookkeeping – See my post on Useful Bookkeeping Tips to Help You In An Audit
Honest mistakes may be forgiven, blatant mis-representation will not be. Avoid these 7 IRS Red Flags with diligent attention to details.