How to Audit Proof Your Tax Return.
When it comes to acquiring real estate there are three rules; location, location and location. When it comes to audit proofing your tax return there are also three rules; documentation, documentation and documentation. Thus, the best way to audit proof your tax return is by utilizing proper documentation. Arm yourself with good records.
Your records must be accurate and complete and prepared in a timely fashion. Documentation is the key to proving your tax position. The IRS states in its official publications that you must maintain records that support accurate tax returns. The records should be made at or near the time of the expense when there is accurate recall. Such records must be permanent, accurate, and complete. Failure to meet the adequate documentation standards of the Internal Revenue Code can result in disallowance of your valid deductions. The burden of proof is on you.
There are three types of records that you should maintain. (Note: You want a filing system, not a piling system – no extra charge for that one.)
You will need the following:
1. Permanent files
2. Regular annual files
3. A daily tax diary or log
Permanent files: Includes your prior years’ tax returns, your will, investment purchases and sales, equipment and property purchase records, home purchase records, home improvement records, insurance policies, closing statements, deeds
Regular annual files: Includes sales invoices, vendor bill or receipts, time sheets and payroll records, bank statements, credit card statements
Daily tax diary or log: This may be your appointment book or similar type log. If you don’t maintain a daily tax diary and you get audited by the IRS, be sure to bring your checkbook with you to the audit.
Now what should the daily tax diary or log include? Your daily tax diary or log should include:
• Your appointments
• Where and when you travel, for example out of town travel
• Where you travel by auto – your automobile log in other words
• Where and when your entertain your business contacts, specifically business meal and entertainment expense documentation must include:
The amount of the business expense, date it took place, where it took place, what was the specific business purpose, and the business relationship of the person involved (How much, when, where, why and who)
The basic elements to be proved are: Amount, Time, Place, Purpose and Relationship
Note: A canceled check or credit card charge slip, together with a bill or receipt from the payee, ordinarily establishes the amount of expenditure. However, a cancelled check or charge slip does not by itself support a business expense without other evidence to show that it was for a business purpose. The bill or receipts determines what you actually purchased. A credit card statement alone is not enough proof.
Note: Be very careful in using banks that do not provide proof of cancelled checks.
What is the Number One tax strategy that will save you money year after year.
Most taxpayers are “cash basis” taxpayers, meaning you report income in the year you receive it and you report deductions in the year that you pay them. It is that simple. Thus the “Number One” tax strategy that will save you tax dollars year after year is the timing of your income and deductions. In other words, if you don’t receive the income, then you don’t pay taxes on it. Conversely, if you spend money on a tax deductible item you get to deduct it on your tax return and reduce your taxable income.
Sometimes, when I explain this I feel like I am stating the obvious. Heck, I am stating what should be the obvious. But I am convinced most people understand very little about income taxes. Therefore, you must learn to master the timing of your income and deductions. Postponing, deferring, reducing or eliminating taxes is what it is all about, isn’t it?
Generally, most taxpayers who expect to be in the same tax bracket from one year to the next and who want to reduce their current tax bill as much as possible should attempt to defer income to a subsequent year and to accelerate deductions into the current year. (If you suspect you might be in a higher bracket in a subsequent year, you would do just the opposite.) Do not overlook the possibilities!
Question: You are in a 28% tax bracket this year and will be in a 15% tax bracket next year and you need a new computer for your business. When should you buy it?
Answer: The current tax year
I have also seen many cases whereby I try to get my clients to accelerate income and postpone expenses in order to take advantage of the tax brackets.
Big word of warning: Make sure you understand what does “constructive receipt” mean for cash basis taxpayers? You have learned most individuals are on the cash basis of accounting, meaning income is reported for tax purposes when received and expenses are deducted for tax purposes when paid. But, in actuality income must be reported when “constructive” receipt occurs (money is available without restriction).
Example: Via mail you receive a check for the payment of a sales invoice on December 31, 2011, but you don’t deposit it until January 1, 2012 of the following year. Question: When must you report the check as income? Answer: Tax year 2011.
In conclusion, a basic tax strategy for tax planning is to time your income so that it will be taxed at a lower rate and to time your deductible expenses so that may be claimed in years when you are in a higher bracket.
Standard Mileage Rates for business use of a vehicle.
For 2011 the standard mileage rate for business use of a vehicle is 51 cents for January through June and 55.5 cents July through December. For 2012 the rate is 55.5 cents per mile.
The most misunderstood tax form there is
The W-4 is the most misunderstood tax form there is in my opinion. As I type this, I am in the heat of tax season and time and time again I see so many people tremendously overwitheld in taxes or underwithheld in taxes. The IRS evens offer a free W-4 calculator. You can find it at http://www.irs.gov/individuals/page/0,,id=14806,00.html
Want to know what an IRS notice means?
If you ever receive an IRS notice, there is a Notice Number in the right hand corner. Use this guide to deteremine what the IRS notice means.
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Notice Number
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Description
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Topic
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You owe a balance due as a result of amending your tax return to show receipt of a grant received as a result of Hurricane Katrina, Rita or Wilma.
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Balance Due
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You received a tax credit (called the First-Time Homebuyer Credit) for a home you purchased. This notice informs you on how to repay it.
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You received a tax credit (called the First-Time Homebuyer Credit) for a home you purchased. This notice informs you that you don't have to repay the credit as long as the home remains your main home for at least three years after you purchase it. It also explains situations where a home stops being a main home.
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You may qualify for the Additional Child Tax Credit and be entitled to some additional money.
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Additional Child Tax Credit
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We made a change(s) to your return because we believe there's a miscalculation. This change(s) affected the estimated tax payment you wanted applied to your taxes for next year.
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Change To Your Estimated Tax Credit Amount
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We made a change(s) to your return because we believe there's a miscalculation involving your Earned Income Credit. This change(s) affected the estimated tax payment you wanted applied to your taxes for next year.
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Change To Your Estimated Tax Credit Amount
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We made changes to your return because we believe there’s a miscalculation. You owe money on your taxes as a result of these changes.
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Balance Due
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We made changes to your return because we believe there's a miscalculation involving your Earned Income Credit. You owe money on your taxes as a result of these changes.
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Balance Due
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We made changes to your return involving the Making Work Pay and Government Retiree Credit. You owe money on your taxes as a result of these changes.
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Balance Due
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We made the change(s) you requested to your tax return for the tax year specified on the notice. You owe money on your taxes as a result of the change(s).
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Balance Due
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We made the change(s) you requested to your tax return for the tax year specified on the notice. You should receive your refund within 2-3 weeks of your notice.
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Refund
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We made the change(s) you requested to your tax return for the tax year specified on the notice. You're not due a refund nor do you owe any additional amount. Your account balance for this tax form and tax year is zero.
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Even Balance
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As a result of your recent audit, we made changes to your tax return for the tax year specified on the notice. You owe money on your taxes as a result of these changes.
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Balance Due
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We made changes to your tax return for the tax year specified on the notice for Individual Retirement Arrangement (IRA) taxes. You owe money on your taxes as a result of these changes.
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Balance Due
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We made the change(s) you requested to your tax return for the tax year specified on the notice. You owe money on your taxes as a result of the change(s).
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Balance Due
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As a result of your recent audit, we made changes to your tax return for the tax year specified on the notice. You owe money on your taxes as a result of these changes.
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Balance Due
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We made changes to your tax return for the tax year specified on the notice for Individual Retirement Arrangement (IRA) taxes. You owe money on your taxes as a result of these changes.
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Balance Due
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Your refund check was returned to us, so you need to update your address.
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Refund
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We were unable to apply your overpayment to your estimated tax as you requested.
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Overpayment
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We can't provide your refund through direct deposit, so we're sending you a refund check by mail.
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Direct Deposits
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You need to send us documentation of your tax-exempt status.
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Tax Exemptions
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Your tax return filing requirements may have changed: You may no longer need to pay the Alternative Minimum Tax.
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Filing Requirements
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Your tax return filing requirements may have changed: You may no longer need to file Form 941 and Form 940.
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Filing Requirements
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We have received your return.
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Confirmation of Return Receipt
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We can't provide you with your refund through a direct deposit, so we're sending you a refund check/credit payment by mail.
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Refund
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We were unable to process your monthly payment because there were insufficient funds in your bank account.
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Payment Process
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Your tax return filing requirements may have changed: You may no longer owe excise tax.
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Filing Requirements
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Your refund or credit payment was returned to us and we need you to update your current address.
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Address Update Needed
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We didn't receive a correctly completed tax liability schedule. We normally charge a Federal Tax Deposit (FTD) penalty when this happens. We decided not to do so this time.
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FTD Penalty
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We didn't receive the correct amount of tax deposits. We normally charge a Federal Tax Deposit penalty when this happens. We decided not to do so this time.
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FTD Penalty
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Notice or Letter Number
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Title
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Changes to Tax Return, Overpayment
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Balance Due
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Estimated Tax Discrepancy, Balance Due
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Overpaid Tax Applied to Other Taxes You Owe
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Notice of Insufficient Funds
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Delinquent Return Refund Hold
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Final Notice - Notice of Intent to Levy and Notice of Your Right to a Hearing
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Notice of Levy and Notice of Your Right to a Hearing
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Final Notice Before Levy on Social Security Benefits
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Request for Payment or Notice of Unpaid Balance, Balance Due
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Reminder Notice - Balance Due
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Second Request Notice - Balance Due
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Final Notice - Balance Due
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Installment Agreement Reminder Notice
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Notice of Default on Installment Agreement
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Notice of Proposed Adjustment for Underpayment/Overpayment
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Collection Information Statement Requested (Form 433F/433D); Inability to Pay/Transfer
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Balance Due on Account is Paid
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We released the taxpayer's levy.
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Proposal to Pay Accepted
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Installment Privilege Terminated
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Final Notice prior to levy; your right to a hearing
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Mail us your overdue tax returns.
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Please help us locate a taxpayer.
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Please complete and site Form 433F, Collection Information Statement.
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Installment Agreement for Direct Debit 433-G
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Installment Agreement Reply to Taxpayer
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Please call us about your overdue taxes or tax return.
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Balance Due Total to Taxpayer
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Installment Agreement for Direct Debit Revisions
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Installment Agreement Cannot be Considered
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Installment Agreement Accepted: Terms Explained
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Installment Agreement: Payroll Deduction (F2159) Incomplete
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Abatement of Penalties and Interest
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Installment Agreement Accepted - Notice of Federal Tax Lien Will be Filed
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Pre-assessed Installment Agreement
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Request for Combat Zone Service Dates
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Taxpayer Response to Reminder of Balance Due
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CC IAPND Installment Agreement Confirmation
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Balance Due Explained:Tax/Interest Not Paid
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Revision to Installment Agreement
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Installment Agreement Accepted: Terms Explained
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Reminder notice.
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We have no record of receiving your tax returns.
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Address Information Request
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Please contact us about the taxpayer levy.
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Estate Tax Changes-2011
As of Jan. 1, 2011, the available exemptions from estate, gift and generation skipping transfer ("GST") taxes all increased to $5 million per person. The gift tax exemption had previously been only $1 million, and in 2009 the estate and GST exemptions were each $3.5 million. The rate of tax for all three of those taxes is 35 percent, down from 45 percent in 2009.
The new tax law also introduced "portability" as a way for married taxpayers to save estate and gift taxes.
Until now, if a spouse with a taxable estate died without proper estate planning, and left his or her estate directly to the surviving spouse, that deceased spouse's ability to shelter property from estate taxes after both spouses died was typically lost because no "bypass" trust was created.
Even though the gift to the surviving spouse would not have caused any estate taxes to be owed, it meant the surviving spouse was left with all the property but only one exemption from estate taxes.
Now, though, when a spouse dies and leaves property directly to the surviving spouse, that surviving spouse can add the unused portion of the deceased spouse's $5 million exemption to his or her own $5 million exemption, thereby potentially doubling the amount that can be given away during life and at death.
This is available even if the couple completely fails to plan. To take advantage of portability, the executor of the deceased spouse's estate needs to file a federal estate tax return and make a special election.
In order to prevent people from accumulating multiple $5 million exemptions from a handful of deceased spouses, portability is only available with your last spouse.
So for example, if a wealthy widow with $10 million of exemption (her own plus that of her deceased husband) marries a wealthy man who then dies shortly after their marriage, leaving his entire multimillion-dollar estate to his children from his first marriage, the wealthy widow's exemption will be reduced to $5 million. In that case, her last husband would have no unused exemption for her to claim. The exemption from her first husband would no longer be counted, thereby costing her children $1.75 million in extra estate taxes when she later dies.
And the $5 million exemption from gift, estate and GST taxes will be indexed for inflation starting in 2012. And since the exemption is already such a large number, even small percentage increases will result in big additional amounts that can be given away tax free. For example, a 4 percent inflation adjustment increases the $5 million exemption by $200,000.
Most importantly, though, the new tax laws are in effect for only two years. Unless Congress addresses these same tax issues again in 2012, right in the middle of a presidential election year, the estate tax exemption will revert to $1 million and the rate of tax will increase to 55 percent in 2013. Portability of the estate tax exemption between spouses would go away as well.
For most married couples, it is now crucial to have documents that maximize flexibility. Estate planning documents need to account for the possibility that the new laws may remain effective after 2012, that the old pre-2001 tax laws could once again be in place, or that different and unknown tax laws may be enacted
How to choose a tax preparer
Selecting a tax preparer is a very important task. But how do you know if you have made the right choice?
I recommend that you give the tax preparer the Tax Factor test.
Fees- Are the tax preparation fees fair and reasonable?
Availability – Will the tax preparer have time for me and my schedule?
Communication – Can the tax preparer communicate to me in plain English, so that I too can understand?
Timeliness - Will you prepare my tax return in a timely manner and make me aware of tax deadlines?
Openness – Will you be open to my point of view and concerns and listen to me?
Results – Not all tax preparers get the same result. Does the tax preparer have my best interests in mind and work with me to obtain the best results?
Tax Act Highlights
Certain key Tax Act Highlights (Signed 12-17-10)
The law extends the 10%, 15%, 25%, 28% 33%, and the 35% individual tax rates for 2011 and 2012.
For 2011 and 2012, the personal exemption phase-out does not apply.
For 2011 and 2012, the itemized deduction phase-out does not apply.
The additional standard deduction for real property taxes, net disaster losses and sales tax on new car purchases for non-itemizers was not extended for 2010 and thereafter.
0% and 15% capital gain rates are extended through 2012.
0% and 15% rates on qualified dividend of non-corporate taxpayers are extended through 2012.
The employee’s share of the social security tax for 2011 is reduced from 6.2% to 4.2%.
A self-employed individual’s social security tax rate for 2011 is reduced from12.4% to 10.4%.
Audit-proof charitable contributions
Uncle Sam usually rewards you for your charitable giving. As long as you meet the tax law requirements, you can write off donations. But you must comply with strict new recordkeeping rules that went into effect in 2007.
To make your charitable contribution deductible, refrain from giving gifts in cash. Write a check or charge it instead. If you can’t produce the required records, in an IRS audit you will lose the deduction.
The Pension Protection Act of 2006 imposed new requirements for donations. Under current law, the IRS won’t allow a deduction for a contribution of cash, a check or any other monetary gift unless you maintain a record of the contribution such as a bank statement with cancelled check, a credit card statement or a written acknowledgement provided by the qualified charity. Note contributions of $250 or more must have a written acknowledgement provided by the qualified charity.
If the taxpayer receives a benefit in exchange for a charitable contribution, the deduction is reduced by the value of the benefit received.
Note: Here is the kicker; there is no “de minimis” exception. The new rules apply to all monetary contributions – no matter what the amount. In other words you can’t simply keep a log of cash contributions like you did in the past. Keep this requirement in mind when you throw loose change or dollar bills into a collection plate or bucket.
Here is more directly for the IRS:
To deduct any charitable donation of money, a taxpayer must have a bank record or a written communication from the charity showing the name of the charity and the date and amount of the contribution. A bank record includes canceled checks, bank or credit union statements and credit card statements. Bank or credit union statements should show the name of the charity and the date and amount paid. Credit card statements should show the name of the charity and the transaction posting date.
Donations of money include those made in cash or by check, electronic funds transfer, credit card, and payroll deduction. For payroll deductions, the taxpayer should retain a pay stub, Form W-2 wage statement or other document furnished by the employer showing the total amount withheld for charity, along with the pledge card showing the name of the charity.
Prior law allowed taxpayers to back up their donations of money with personal bank registers, diaries or notes made around the time of the donation. Those types of records are no longer sufficient.
This provision applies to contributions made in taxable years beginning after Aug. 17, 2006. For taxpayers that file returns on a calendar-year basis, including most individuals, the new provision applies to contributions made beginning in 2007.
The new law does not change the prior-law requirement that a taxpayer get an acknowledgement from a charity for each deductible donation (either money or property) of $250 or more. However, one statement containing all of the required information may meet the requirements of both provisions.
To help taxpayers plan their holiday-season and year-end donations, the IRS offers the following additional reminders:
- Contributions are deductible in the year made. Thus, donations charged to a credit card before the end of the year count for that year. This is true even if the credit-card bill isn’t paid until next year. Also, checks count for the current year as long as they are mailed this year.
- Check that the organization is qualified. Only donations to qualified organizations are tax-deductible. IRS Publication 78, available online and at many public libraries, lists most organizations that are qualified to receive deductible contributions. The searchable online version can be found on IRS.gov under, “Search for Charities.” In addition, churches, synagogues, temples, mosques and government agencies are eligible to receive deductible donations, even though they often are not listed in Publication 78.
- For individuals, only taxpayers who itemize their deductions on Schedule A can claim a deduction for charitable contributions. A taxpayer will have a tax savings only if the total itemized deductions (mortgage interest, charitable contributions, state and local taxes, etc.) exceeds the standard deduction. Use Schedule A, available now on IRS.gov, to determine whether itemizing is better than claiming the standard deduction.
- For all donations of property, including clothing and household items, get from the charity, if possible, a receipt that includes a description of the donated property. If a donation is left at a charity’s unattended drop site, keep a written record of the donation that includes a description of the property and its condition.
- The deduction for a motor vehicle, boat or airplane donated to charity is usually limited to the gross proceeds from its sale. This rule applies if the claimed value of the vehicle is more than $500. Form 1098-C, or a similar statement, must be provided to the donor by the organization and attached to the donor’s tax return. See IRS Publication 526, Charitable Contributions, for more information
Deducting Company Holiday Parties
The cost of a holiday party for your employees is automatically deductible. No business meeting or business function has to take place. This employee party is not subject to the 50% deductibility rule that applies to entertainment expenses
You may allow your employees to bring their spouses to the holiday party. You deduct the cost of entertaining the spouses just as you deduct the cost of entertaining the employees. Thus, a holiday party for employees and their spouses is 100 % deductible.
Because the party is 100 percent deductible, you should enter the cost of the party in a category other than entertainment, because entertainment is usually only 50% deductible If using QuickBooks set up and account entitled, Business and Entertainment-50% and another account entitled, Business and Entertainment-100%.
To prove your deduction, you should document the names of the employees and spouses who attended the party. Plus, you should have both receipts and canceled checks to prove your expenditures. There are no limits on this deduction other than the standard requirement that the expenses may not be lavish and extravagant