WHO IS THE IRS AUDITING AND HOW TO PROTECT YOURSELF?

WHO IS THE IRS AUDITING AND HOW TO PROTECT YOURSELF?

 

By Jeffrey Brooks, CPA, CFP, MBA for JBrooks Wealth Advisors, PC, a Professional CPA and CFP Firm  jeff@jbrookswa.com  602-292-2009  Please consult with your professional tax CPA regarding your specific circumstances!

 

Once the celebration occurs at midnight on December 31st, it will be too late to go back and protect yourself by proper documenting your income and deductions.

 

SUCCESSFUL BUSINESS OWNERS

 

One of the biggest percentage chances of audits are for those business owners who have adjusted gross income over $500,000. The percentage audit risk increases to  for those reporting income of $1 million to $5 million.

 

The problem is that many of these business owners own multiple business entities which increase the number of audits. These related entities are called “flow through” because they are from partnership and S corporations.

The sad thing is that their well-meaning CPAs are not proactive or aggressive enough to recommend strategies to reduce income taxes. Therefore, these business owners are paying tax on inflated taxable income!

 

PARTNERSHIPS  & VEHICLE DEPRECIATION DEDUCTIONS
What is the fastest-growing kind of tax returns filed? The partnership is being elected more often than any other type of entity.  Every audit looks carefully at what is called the Outside Basis Schedule that proves that the partner was allowed or not allowed to take losses or whether a draw is taxable or not.  The Form 6198 is always requested by the IRS.  Your CPA should have an Outside Basis schedule prepared for each partner.   This article does not have enough space or time to go into more detail.   One common error is when the CPA partner’s CPA fails to add back health insurance and personal use of company auto into an account called guaranteed payments.   I see on a regular basis where S corporations prepared by CPAs and tax preparers commonly make this error.

 

VEHICLE DEPRECIATION IS BEING CHECKED.

 

Businesses that buy vehicles to be used in their delivery business or service business sometimes think that they can write off the entire purchase price through a fast depreciation method called Section 179. Unfortunately unless the proper documentation is kept, IRS has “kicked out” these deductions and instead forced the business to write off these vehicles  under Section 280F. For example under Rev. Proc 2014-21 passenger vehicles are limited to only $3,160 depreciation for the first year.  So if a 5500 pound vehicle was purchased for $35,000, only $3160 times the business percentage use would be allowed unless proper planning and documentation was used based on proactive advise of  a caring and dedicated tax CPA!!

 

REAL ESTATE PROFESSIONAL VERSUS REAL ESTATE INVESTOR

 

People who have jobs are trying to grow their wealth and save taxes by buying, fixing up and leasing or selling real estate because:

  •  tax rates at all-time highs,
  •  interest rates at an all-time low,
  •  there is a fear of losing money in the stock market,  and
  •  The real estate market is coming back

     

    Enter the newer category called the “Real Estate Professional” that allows investors to write off all of the losses in the year of the loss without regard to adjusted gross income amounts.

     

    In the past this has been a problem for richer taxpayers  who  were not allowed to take any losses until the property was sold or adjusted gross income decreased below $100,000 due to the tax law.

     

    This is still the law unless the taxpayer meets the rules to be a real estate professional.  In a “nutshell” Real Estate Professionals have to work over 750 hours in the real estate activities including acquisition, construction, development, leasing, repairs (can hire workers) and management AND work less hours at their regular job. For example if a taxpayer worked 1500 hours in the Real Estate Professionals activities but only 800 hours in their job AND document their time spent, they would be able to take losses despite earning over $100,000 in adjusted gross income before the real estate losses. I have oversimplified. I explain to my clients all of the specifics so you will need to follow ALL of the rules. There isn’t enough space in this article to go into more detail.

     

    The IRS has an audit guide on how to audit taxpayers who claim to be Real Estate Professionals.  The rental income and expenses are recorded on Schedule E Rental profit or loss so IRS will scrutinize Schedule E’s with large losses. However, if proper documentation is kept the IRS should be satisfied. Enough said?

     

    So if IRS wins, taxpayers will not be considered Real Estate Professional. Those taxpayers who  have adjusted gross income over $150,000, will lose all of their rental losses on Schedule E unless they disposed of the property.

     

    For example, an investor who is not considered a Real Estate Professional who has adjusted gross income of under $100,000 can deduct a loss of up to $25,000, while an investor with adjusted gross income of $125,000 can deduct $12,500 and an investor with adjusted gross income of $150,000 can deduct zero.

 

 

THE IRS CONTINUES TO TRY TO COLLECT PAYROLL EMPLOYMENT TAXES!

Employee versus independent contractor is a big issue for not only the federal government but the state governments.  We recently went through a state unemployment audit that we won because our independent contractor agreement met the IRS 20 conditions of independent contractor.  We have just one independent contractor and our firm and the independent contractor drafted the agreement carefully to clearly delineate between an employee and independent contractor.

 

Second the IRS wants to make sure that Form 1099s are all being issued when required. If the independent contractor refused to give their Social Security Number or  Federal ID number than back up withholding is required to avoid the company being forced to pay a penalty.

 

The S corporation reasonable compensation issues are being looked at carefully. Congress has not defined how much  is reasonable and how much is not reasonable.

 

Remember that when the ACA’s (Obama Care) employer mandate takes effect in 2015 and 2016, the employee versus independent contractor determination will become more important. Employer ACA (Obama Care) penalties can be up to $3,000 for each misclassified employee.

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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JBrooks Wealth Advisors, PC.

Certified Public Accountant
Address: 4647 N 32nd Street, Suite B245
Phoenix, Arizona 85018
Phone: 602-292-2009
Email: jeff@jbrookswa.com