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Lessons from Top 3 Tax Mistakes when Filing Taxes

December 31, 2012 By

“Everybody makes mistakes” is a common saying that many individuals, who end up in a mess they create, normally turn to for solace. Unfortunately, when it comes to taxes, it is acceptable but comes with serious consequences, some that might leave you with a few extra dollars on your tax bill. We can however, learn from every mistake we make in life. Below are some common tax mistakes that tend to haunt taxpayers. If you haven’t committed any of them, ensure that you don’t; they are serious blunders..

1. Errors Related to the First-time Homebuyer Credit
Taxpayers love credits, but the IRS has perfected the art of tightening the rules around every credit they introduce; and first time home buyer credit was not an exception. First, the qualifying home must have been your primary personal residence for not less than 36 months at the time of claiming, (and not 35, 30 or 22). Many rushed to sell their home without understanding the restrictions, only to count their losses thereafter.

Taxpayers who were savvy enough to ask for professional help were guided, some choosing to stay a little longer to qualify as opposed to joining in the excitement only to be hit by reality later. To avoid the repayment, one has to repay the credit up to the value of the profit. If you sell at a loss or even get evicted, it might lead to no repayment or having to repay smaller amounts. Be warned that if the loan you took exceeded the price of the house, it is very possible that you owe more of the credit than you might have projected. Alternatively, rent out some rooms if you cannot afford the house, it allowed.

2. 401 (k) or Retirement Plans Withdrawals
You can withdraw money from your IRA account to cover medical insurance or for a house down payment. As much as you can avoid early withdrawal penalties by doing this, due taxes remain intact. Furthermore, the waiver on penalties is only applicable to IRAs and not job-related plans like 401 (k) or 457. If however you need money badly, you can borrow up to 50% of the account balance ($50,000) tax-free, and pay back yourself over the years. Alternatively, move the funds into your IRAs first from the retirement plans and then withdraw. Finally, get a credit card loan, which has lower rates than federal and state tax penalties.

3. Spouse’s Retirement Funds in Divorce
The Tax Code contain a special provision that allows waiving of penalties and taxes whenever the court orders a distribution from one spouse’s retirement plan that should be paid to the former spouse, a Qualified Domestic Relations Order (QPR). You can evade the 10% early withdrawal penalty by taking the money and cashing it all or cashing it all into the bank account, but you will have to pay taxes on cash you don’t necessarily need currently. The best way out is to split distribution into two funds; withdraw the much you need currently and stash the rest in an IRA.

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What Do You Know about Federal Tax Audits?

May 4, 2012 By

Tax time is never the happiest time in any taxpayer’s life, when the taxman comes knocking on your door or the IRS sends you a stern warning. But these audits are done for a reason, which is to ensure everyone is taxed fairly.

In order to quickly process tax returns for millions of people, the IRS has a number of things that will automatically call for an audit. That does not necessarily qualify you as an offender; it may just be that your filed return has something suggesting that you are trying to defraud the taxman. However, if you did everything correctly, you should have proof that you are honest and diligent in paying all your taxes. Then the IRS will agree with you and not alter your return, and you will be free from fines or even worse, a jail term.

Below is the list of the top audit- trigger factors, how to determine if you could wrong, and the proof you need to steer clear of an audit, frustration, and fines:

  1. Reporting Inaccurate Taxable Income

Lying about your taxable income is just impossible because both the IRS and you received your W-2 and 1099 forms. If you make a mall math error, the IRS will understand and correct that, but making an estimate or fudging the amount you have made, regardless of being a freelancer, may land you in deep trouble.

To be on the safe side, compare your records with the 1099 form you receive from the company and ask for corrections where necessary

  1. The Home Buyer Credit Issue

If you were a first time home buyer after April 8, 2008, and just before January 1, 2010, you probably got the first-time home buyer credit. This is like an interest-free government loan. Those who claimed the credit in 2008 are expected to pay it back over 15 years with an additional tax whereas the 2009 and 2010 claimers do not need to pay it back.

Unfortunately, tax fraudsters have used and abused this credit, and so the IRS will keenly scrutinize all claimers to see if you satisfy the requirement of having stayed in that home for more than 36 months (3 years).

It is okay if you lived in the first home you bought for a while. However, if you promptly resold it for a profit within three years or found another primary residence, you will repay the credit in full. The proof you need is just the records on the purchase of your home.

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Seeking Tax Relief? Don’t Try These Claims

May 1, 2012 By

When it comes to seeking tax deductions, taxpayers tend to go to the limit just to get even the slightest tax relief. However, some of these arguments fail to obtain favor with the IRS or the tax courts. Below are 10 most creative and crazy tax deduction claims you should not try to pull off:

Allowance for Red Blood Cell Depletion

Do not claim depletion deduction for any parts or elements of your body since, depletion is only an eligible write off for mining companies.

Too Many Overdrafts

Overdrawing your account to satisfy an overdraft, then claiming the overdraft as business expense deduction will not only cost you thousands, but also deny you a write-off.

Shoddy construction is no theft

In case your builder fails to construct your dream home leaving cracks and a series of other problems, you cannot claim this is theft at all. Trying to deduct a hefty theft loss on your tax return will not qualify you as a victim of fraud thus, you’ll certainly lose the claim.

Burnt House Deduction

A burnt house could qualify for casualty loss deduction but only if you are not the one who set the fire.

Designer Clothes

Any amount of money spent on clothes, whether just worn at work or everywhere; do not qualify for tax deduction, unless they are required uniforms.

Illicit Products

Money spent on pornographic materials and escorts do not qualify as a medical expense, as they do not cure any sexually-based medical condition, so don’t seek a tax deduction for this.

Mixing Business with Pleasure

If you take out your employees on a business on an informal trip with the “businesses” aspect being insubstantial, do not expect a tax deduction for the junket

Hush Money

In case you pay up someone to keep their mouth shut, do not expect to get tax deduction for the payment.

Wrecking a Rented Car

When you get stranded with no option to travel and opt to rent a car, be sure to drive carefully. In case you end up wrecking the car while in your possession, be ready to pay for the repair, as would be demanded by the car rental company. On the downside, you cannot claim a casualty loss deduction since the car is not legally yours.

Business Talk over Lunch

Discussing business over several lunches does not qualify the lunch bills as business expenses worth a tax deduction, as the tax court considers it personal expense.

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5 Reasons as to Why You Need to Take IRS Correspondence Seriously

March 7, 2012 By

The IRS has a robust system that matches off tax return to ensure that returns entries balance. The Automated Underreporter Program compares tax return entries with corresponding entries made on third party returns. For example, a taxpayer’s income is compared to the employer’s return and the stocks sold within a given year by a taxpayer compared with the tax returns of a stock broker or investment company. If there are any discrepancies from the comparison, the IRS sends out a correspondence letter to the taxpayer asking them to explain the difference. The IRS sends over 100 million correspondences every year to taxpayers to seek clarifications on these discrepancies. Therefore, if you have received such a letter from the IRS, then it is not unique or rare. However, having said this, it is important that you get to respond to the IRS at the soonest time possible. There are various reasons as to why you need to act on such correspondences with urgency and seriousness;

1. Correspondence Requiring Action Have Deadlines

All correspondences from the IRS will come with a deadline as to when to reply to the inquiry and respond according to the request. These deadlines are important to keep as they give an impression to the tax authority as to how genuine you are. If you respond within good time, you may receive more leniency and get better help from the IRS. The IRS is out to help taxpayers comply and therefore, timely response and proper communication will have you at a better place than ignoring the correspondence. Therefore, get to understand what the IRS is seeking from you and seek to respond before the deadline. If you do not understand or are unable to provide the information requested, it is advisable to seek the help of a professional as to your options. This will enable you take action fast and this may save you on taxes and penalties.

2. Correspondences Do Not Always Mean that Something is Wrong

For many letters of inquiry from the IRS, all you will need to provide is a document to support a given payment or some explanation as to why you made a given entry or how you came up with various figures. In fact, at times, the IRS is seeking information not because you are being audited, but because a business or charity organization that you dealt with is being investigated. If your records are properly filed, this will be an easy task. If not, you will have to search for such documentation or seek a copy from the organizations or firm that provided you with the record. Therefore, when you receive such correspondence, do not panic or get stressed over it. Simply open the letter and get to know what the IRS is looking for. In most cases, the request is simple to solve and responding will bring the issue to an end.

3. Non Response Affects Right to Appeal

Another important reason as to why you need to respond to the IRS within their deadline is that your timeliness in responding affects your right to appeal an IRS decision. If you were on time with your responses, the IRS will give you a right to appeal any audit results and any taxes that the IRS claims are due. A majority of taxpayers who appeal get a reduction and on average, the taxes and penalties reduce by 40% after appealing. However, if you did not respond within the deadlines that the IRS provided with no good reason for this, you may lose your right to appeal any IRS audit results.  

4. Non Response Increases Risk of Further Audit

If you do not respond within the required time, the IRS will normally apply more scrutiny to your tax records and they will easily escalate your issue to an in-depth audit. Having the IRS audit you in depth means that they get to review more of your tax records and transactions and this only exposes you further and you may end up with more taxes, interests and penalties due. Therefore, by responding in time, you limit the audit to only the issue that the IRS is inquiring at the point.

5. The IRS Will Never “Let it Go”

Most people make the wrong assumption that if they ignore and do not respond to an IRS inquiry, the IRS will simply put the issue aside or just let it go. However, this is far from the truth. The IRS systems are so automated in such a way that non correspondence keeps the issue pending and only gets to escalate the issue further. The IRS will always follow through with an issue they are inquiring on. Therefore, to avoid any escalation or any further issues with the IRS, it is best to reply to an IRS correspondence as early as possible.

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How to Successfully Go through a Federal Tax Audit

December 29, 2011 By

IRS tax disputes are feared. Everyone tries hard to avoid situations that conflict with the law due to failure to pay taxes. It is always a good idea to clear a business’ accounts and file taxes without having problems to do with skipped taxes or other related issues.  No one ever wants to be placed under the scrutiny of an audit; it is very tiring having to go through all the rigorous processes that a tax audit entails. One spends so much time resolving audit issues and sometimes, heavy fines and penalties are levied. To avoid issues with the IRS, it is important to file tax returns correctly and promptly.

There are some tax returns that must be audited though. Tax audits have been on a steady decline and this could be attributed to the change in taxpayers’ behaviors as far as filing of tax returns is concerned. In the old system, a taxpayer had to bring all the records showing the taxes that had been paid. The auditor would then peruse through all the records in order to know how much had been paid and if there were any outstanding amounts. Today, things are totally different. A large company can no longer be subjected to such a process since it is time consuming and usually doesn’t come up with satisfactory answers. If one has to go through a federal tax audit, it is always good to comply and let the law take its course. Nonetheless, everyone agrees that it not the best experience; it is tiring and costly. Here are some things that one can do to make the process easier and faster:

  1. The IRS queries should be responded to in time. When one is asked to submit a document, it has to be done promptly. Delays can lead to fines and penalties. Most submissions have a deadline of up to 30 days thus, providing the taxpayer with adequate time to produce the document. If a person feels that he/she cannot meet this deadline, it is important to call the IRS and request for an extension, depending on the workload at hand.
  2. One should attach the necessary documents. The documents have to be in line with the demands for the audit. Transaction receipts are very important and one should have them ready for submission when required. Receipts make audit processes easy for both parties though there are people who prefer to use different types of proofs.

One has to organize well in order to face the audit panel. Having right documents in places makes one credible and reduces the need to “talk too much.” It pays off when one is coherent and confident before the audit panel.

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How to Prove that You Sent Documents or Payment to the IRS

December 1, 2011 By


According to the IRS internal codes and the tax law, it is the responsibility of the taxpayer to prove that a document was sent to the IRS or a payment was made to the IRS. This means that if you send a document or check to the IRS and it is misplaced somehow, then you are responsible and it is deemed that you did not send such items. However, if you have evidence to show that you indeed sent the item, even if the item gets misplaced, then you are off the hook. It is therefore, important that any correspondence with the IRS comes with some proof. Below are some of the ways that you can prove that you made such correspondence:

Electronic Filing Receipt

The drive by the IRS to have taxpayers file returns electronically has bore significant fruit with the 2010 tax year, seeing over 70% of filers choosing to go electronic. With electronic filing, the evidence of receipt is more straightforward as one receives an acknowledgment of receipt or a rejection within hours of filing. Furthermore, with the Modernized e-File (MeF) set to go fully operational in the 2012 tax returns, the new system promises to provide an acknowledgment within minutes of filing. Once you receive the electronic acknowledgment, it is advisable to print a copy and file it in your tax portfolio as evidence of having filed.

Electronic Tax Payments

The IRS provides an electronic way in which tax payers can remit their taxes. This is especially used for payment of business tax dues. The system is called EFTPS. When you make a payment through this IRS system, the system generates a receipt for the transaction and you can print this as evidence of payment of tax.

Certified or Registered Mail

The taxpayers who choose to file their tax returns manually will need to seek for an alternative confirmation for their filing. The best way of getting a confirmation that you have filed is by sending the tax return forms to the IRS via registered mail. This way, you get a receipt of proof that you indeed sent the documents. You may also use other non U.S. Postal Service options such as UPS or FedEx. However, the IRS has warned that the law does not recognize these other options as evidence for having filed and therefore, it may be best to keep it safe and use registered mail. Another important instruction when mailing IRS documentation and tax checks is to ensure that you post one item per envelope. The IRS only guarantees the receipt of one document if more than one of the documents are sent.

Those who file manually and who send their tax payment via check through post will need to ensure that the time they send the documents or check is on or before the deadline. The internal IRS code provides a “timely mailing, timely filing” rule that states that the IRS deems a document filed at the time of posting and not at the time the IRS receives such documents or check. This makes it much easier to track deadlines for those who choose to post.

Credit Card and Bank Payment

For credit card payment, the IRS has outsources the process to 3 private companies to handle all debit card and credit card transaction. Each of these suppliers provides a receipt for the transaction of payment of taxes. Furthermore, a statement from your credit card company showing the payment to the tax agents can suffice as evidence for tax payment. If you are using any other bank payment service such as bank checks, then your bank statement will show the clearing of the check or any other transfers to the IRS.

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Your Emails and the IRS

November 30, 2011 By

When it comes to dealing with the IRS insofar as claiming tax credits or deductions, providing income details, providing tax related expenses, and any other tax related information, it is advisable to keep as much information as possible to yourself and avoid disclosing personal communication such as emails. However, emails may also be used to support various transactions such as tax credits. Therefore, when dealing with the IRS, you need to know when to use your emails and when not to reveal your email communications. Below are some guidelines when corresponding with the IRS concerning your email:

Proof toward Some Deductions

One of the ways that emails become handy is when you are proving some tax relief claims. You can use emails as support documentation for tax credits and tax deductions. Emails showing correspondence for some qualifying work related expense or emails that show receipts for purchase of an item online may be used to support various transactions.

When to Keep the IRS Away from your Emails

On the other hand, there are times when giving IRS email information would work against you. This is especially so in the case of an IRS audit. Providing extra information may put you in problems and help the IRS auditor prove that some taxes are due. In such case, avoid revealing any email information until you are sure that it has no tax implications. However, the IRS may seek other ways of accessing your emails, such as getting them from your email service provider.

When the IRS Demands Emails

Under the Stored Communications Act and the Electronic Communications Privacy Act of 1986, the government is required to have a warrant in order to demand emails for the last 6 months from you or from your internet provider. Ideally, this means that the government will not require a warrant when seeking emails which are older than 6 months. Therefore, as a government agent, the IRS is also bound by these two laws. Furthermore, in a recent case that involved a government agent that had sort to get emails that were older than 6 months from an internet service provider, the court ruled that the government agent was at fault and that the laws that permitted the government to get emails older than 6 months were unconstitutional. Following precedence from this law, government agents, including the IRS have relaxed their use of the 6 month rule to get to emails forcefully. Therefore, the IRS is unlikely to go behind your back and get emails from your email service provider without your permission so as to prove that a credit was fraudulent or some other information for their audits.

In Criminal Cases

However, when the IRS has reason to believe that you are involved in a criminal act, they can easily get a search warrant and compel your email service provider to provide emails whether within 6 months or beyond. The IRS has a Criminal Investigation Division that has the authority to issue such a search warrant. However, such a warrant is only issued when the IRS as sufficient information to believe that you are committing a criminal offense.

In Case of Tax Scam

One of the times that the IRS can get a warrant to review your emails is if they suspect that you are involved in generating or spreading tax scam emails. Tax scam emails are considered criminal and therefore, the IRS investigators can seek approval to review your emails from your email service provider.

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Invoke Spousal Tax Relief to Gain Time

November 22, 2011 By


Are you married? And if so, for how long have you been married? If you are married, do you file joint tax returns each season? Partners that file joint tax returns are equally responsible in case any issue of tax liability arises. This method of filing for tax returns can cause problems, especially when only one party fills the Form 1040 and the other blindly signs it.

Being a venture that is prone to liabilities arising, it is mandatory that both parties take full responsibility in filling and signing of tax return forms. Ignorance and negligence of some couples, to fully involve themselves in marital finances and filing of tax returns, has caused them not only fiscal troubles, but tax troubles as well.

Fortunately, there is always rescue available. When a wife or husband finds out that the other spouse has misfiled tax returns, then he/she can ask the IRS to cut some slack. The Internal Revenue Service has three choices available to taxpayers who have incurred problems as a result of their spouse’s or ex- spouses’ creative ways of filing tax returns:
Firstly, the innocent spouse relief frees the victim of any additional tax debt. This applies when one’s spouse or ex-spouse failed to inform the IRS of new income, improperly reported income, or claimed credits or deductions that are improper.

Secondly, the innocent spouse may claim liability separation relief, which splits additional tax debt between the spouses. This may occur in case an item on a joint tax return was not properly reported. Usually, each spouse is allocated the amount he/she is responsible for.

Thirdly, he or she may claim equitable relief, which may only be applicable if one does not qualify for either of the two choices mentioned above. An appropriate example is failure to properly report an item on a joint tax return, and more specifically, if it is attributable to the other spouse.

The tax relief enjoyed by spouses has come under fire from many sides like Congress and the National Taxpayer Advocate. A lot of the debate has been centered on the premise that spouse relief has for a long time, been “too restrictive.” The problem lay with the former IRS rules which stated that when one discovered or realized that the other spouse had manipulated joint tax returns, time would have already expired for the innocent party to claim for innocent relief. The rule under contention stated that a taxpayer ought to request for relief within two years after the first date of IRS’s attempt in tax collection.

The rules have since been reviewed and now, innocent parties have an extended time frame within which they may apply for relief. Normally, the duration of time allowed depends on whether the applicant has a due balance or is seeking a refund. This implies that one may have a time frame of between 3 to 10 years to request for relief. Therefore, should one realize that the IRS is after his/her back due to an error committed by a spouse during the filing of a joint tax return, he/she should immediately request spousal tax relief, regardless of the time frame

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How to Manage the IRS in Case of an Investigation

October 12, 2011 By

Over 1 million taxpayers are audited every year. Most of those audited are audited through a letter. The IRS sends a letter to the taxpayer, requesting further information concerning item(s) in the tax return. If the taxpayer being audited responds to such a letter with the required information, then it will typically end the IRS investigation. However, at times, the investigation may not be conclusive or one could have given wrong information on his or her tax return. In such a case, the IRS may seek further investigation that may result in back taxes, penalties, and interest. If you ever receive any of these audit letters from the IRS, here is some information that can help you out:

Respond to the IRS in a Timely Manner

IRS auditors are human and thus, subjective to some extent. This means that if you are pleasant and respond to them in a timely manner, you may have a much better time and receive some leniency and favors in return. On the other hand, if you ignore the audit letters or are rude to an IRS auditor as they seek for information concerning your taxes, then you may end up with a more intense audit and harsher consequences. The IRS auditors usually have quite some leeway when settling tax cases and you can gain some mileage by simply being polite and cooperative.

Provide the Information Needed

When contacted by the IRS to provide them with information, mail the required documentation as soon as possible. If you do not respond fast, you will get into further problems with the IRS. The IRS will normally start out with a polite letter but if you fail to respond, the subsequent letters often become more demanding and harsh. Therefore, respond to the IRS as soon as you receive such a letter. If the information that the IRS is requesting for is not readily available, then you can always ask for an extension of a week or two to obtain and/or prepare the required documentations.

Negotiate Your Position       

If you have the required documentation requested from the IRS, sending it should settle any audit matters. However, you may find yourself in a situation where you are “on the wrong.” In such a case, you will need to know your options. One advisable thing to do in such an instance is to seek professional help. You will need to negotiate your position with the IRS to get the most favorable terms. Therefore, you can get help and ask as many questions to see how you can best position yourself in the situation. You can find out the options that you have or see if you can be entitled to various waivers and reliefs. The IRS provides reliefs such as an Offer in Compromise or Installation Agreement that can help you better manage back taxes.

Stick to the Agreement

Once you agree with the IRS on a plan to settle the tax issue, ensure that you stick to the plan. If you have agreed on an Installation Payment Plan for example, ensure that you pay the required installments in a timely manner. This not only helps you avoid further confrontations with the IRS, but can also work to your advantage in case you get into another tax problem in the future.

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Handling an IRS Audit

October 11, 2011 By

Every year, the IRS audits many taxpayers. In 2010, about 1.6 million were audited for the 2009 tax year. This represented 1.1% of all taxpayers. Many of those audited were high income earners. The IRS audits taxpayers for various reasons: some taxpayers are audited out of a random draw, some are audited because they have suspicious and red-flag transactions on their tax returns, and some are audited because they have items that do not coincide with the IRS’s cross-referencing system.

Most of the audits that the IRS undertakes are letter audits – the IRS sends a letter to a taxpayer asking them to mail back various support documentation for items in their tax returns. Besides the letter audits, the IRS can also conduct a physical audit at your office or business premises. They can also ask you to visit the nearest IRS office to provide various documentations to have your audit conducted.

If you happen to be one of the targets of an IRS audit this year, you should properly prepare and provide the information needed to avoid further investigations. Below are some tips that can help you go through an IRS audit successfully:

Preliminary Review of the IRS Letter to Understand what is Needed

The first step you will need to take when contacted by the IRS is to review what the IRS auditor is asking for and try to understand why they are asking for the documentation or further information. The IRS has a system that matches off entries that you indicate in your tax return with entries from third party documentations. Most letter audits from the IRS are sent due to a mismatch of information from this cross-referencing system. Therefore, check to see if you indicated the correct amounts in your tax returns or if you missed out on anything. Some inquiries are straightforward and by mailing the relevant documentation, the IRS auditors are usually satisfied.

Professional Help

From your preliminary review of the IRS audit contact, you can then determine whether you need some professional help from a tax attorney or from a tax preparer. If you do not have the information that the IRS is looking for or if you find the nature of the inquiry as too complex to figure out on your own, you can consult with a tax professional. The professional will help you draft a response to the IRS or will accompany you to the IRS office for a physical audit.

Do Not Volunteer Information

This is one area that many taxpayers fail in when undergoing an IRS tax audit. When you are asked for specific information by the IRS, only provide the specific documentation or answers that they are seeking. Providing more information only sets you up for further probing. This is another reason why you may need a professional to assist you while responding to the IRS.

Do not be too Quick to Pay

If the IRS determines that you have back taxes due from their audit, do not be in a rush to pay off the taxes. You can always negotiate your position. The IRS can be wrong and therefore, always ensure that you have verified the new standing (you can enroll the aid of a professional). You can always challenge the IRS in tax court if need be, and many taxpayers have indeed, won over the IRS in many cases.

 

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