Wednesday, January 21, 2015

The Dreaded IRS Audit...The Reality


There is a fear of an IRS audit.  People have heard all kinds of stories and have many ideas about what will cause an audit and how to avoid it.  For example some fear that taking a deduction that they are entitled to will make them the target of an IRS audit.  I have also heard clients say both that filing on time will prevent an audit and also that filing an extension will avoid an audit.  So what is the reality of IRS audits.  

Who gets audited and why


The IRS audits aroud 1% of tax returns they receive.  That sounds like random selection but there are things that increase your chances of selection.  Ordinary taxpayers with ordinary income and deductions if audited are usually just a random and very unlikely selection.  In fact none of my cleints that can be described this way have ever been randomly selected for an audit.  Most audits are triggered by the unusual or areas of suspect by the IRS.  The IRS itself indicates there are randomly selected audits but most of these are based on a statistical formula.  Here is a quote from irs.gov.
When returns are filed, they are compared against “norms” for similar returns. The “norms” are developed from audits of a statistically valid random sample of returns. These returns are selected as part of the National Research Program which the IRS conducts to update return selection information.
So if you claim a deduction that is outside the statistical norm your return is more likely to be selected for an audit.  

Other reasons the IRS selects returns for audits are "document matching", when the information on your return does not match the information reported by others.  

The other reason given by the IRS is:
Related examinations - returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit.

The Statistics


According to a Forbes article, based on IRS statistics from 2010, 30% of audits in that year were for people that claimed the Earned Income Tax Credit (EITC)...an area identified as abusive by the IRS. At a training session provided by the IRS a few years ago they mentioned abusive tax schemes in this area and the IRS were taking a closer look at it.  

Summarizing other findings mentioned in the Forbes article, your chances of being audited increased due to higher income, especially if your income exceeded $1 million.  Also, it appears audit risk increases with non-business income over $200,000 and even more if you had business activity in addition.  

So appears that if you do something unusual or have more income you are more likely to be audited.  

Experience with audits


Very few of my clients get audited but here are some common audit situations according to my experience.  The most common audits that I have seen are brought in by people that have prepared their own returns and have improperly reported or neglected to report securities (usually stocks) transactions.  What happens is the information on the tax return does not match what is reported. What was reported to the IRS was the gross amount of the transaction and now they also get the basis information in most cases but the IRS is looking to see if the gross amount reported matches what is on the tax return.  

So the taxpayer may have lost money or broke even on a trade and they don't report it or they report the net amount.  The IRS computer catches that the return doesn't match the information received and sends out a letter that the taxpayer owes taxes on the gross amount.  It is simple to fix by filing a proper amended return showing the gross amount and also subtracting the basis and costs.  These notices cause much anxiety but almost never are as bad as they sound and can easily be rectified.  For example I have had new clients bring in notices indicating that they owe tens of thousands of dollars only to find when we amended the return that they did not owe any at all or very little when the basis was taken into account on the amended return.


I did have a client audited for a statistical oddity.  My client received notice of an audit by mail of their moving expenses.  This client qualified for the deduction for a move from Hawaii to the mainland which is a statistically large moving expenses.  The audit requested that the client provide supporting documentation.  The client was upset but when they realized everything had been done properly on their tax return and they could provide what the IRS asked for everything was fine and the deduction was allowed.  Now here is the real problem, the IRS notice said the deduction had been disallowed and the client owed the tax on it.  It wasn't until the end of the notice that it indicated if she could provide supporting documentation the return would be changed back to as filed...and it was.  The problem is the emotion from reading the beginning of the notice that you owe money that caused the client to be unable to understand the rest of the letter.  Fortunately she sent me the letter and we got it resolved. 

Notification of an Audit


Note that the example above was an audit by mail not a case where the IRS comes to your home.  So many audits such as this one are handled through the mail.  Interestingly you can be notified of an audit by a telephone call but it is confirmed by a letter and never by email.  Here is what the IRS indicates about a notification by telephone.
So be very careful of both telephone and especially emails indicating you are the subject of an IRS audit.

Irony


It is ironic, most of the time the people with the fear of being audited because of an allowed deduction actually qualify for the deduction and the ones that really want to take the deduction don't really qualify for it.  The lesson is if you qualify for a deduction and can support it you should not be afraid to take what you are entitled to.  However, if you are not entitled to it you should have integrity and not take it.  

The other irony, is the information published about audits that does not come from the IRS.  Where does this come from?  Like the Home Office Deduction making a return more likely to be audited.  I have not found that information anywhere from an IRS source.  It is ironic because the net benefit from most of these deductions is very small.

The other irony is the CPA that teaches a course about audits whose clients get audited all the time. Why would your clients be audited all the time if only around 1% of returns are audited.  I think the answer is obvious.

Documentation


As a CPA I am, of course, very interested in IRS audits.  How do I keep my clients from getting audited and what do I do so that they will be OK if they get audited.  So here is what the IRS says about documentation in the event of an audit:
The law requires you to retain records used to prepare your return. Those records generally should be kept for three years from the date the tax return was filed. 
The IRS does accept some electronic records. If records are kept electronically, the IRS may request those in lieu of or in addition to other types of records. Contact your auditor to determine what can be accepted to ensure a software program is compatible with the IRS's.

 So keep proper documentation for your tax returns.

In researching this subject I also found this Kiplinger article to interesting on 14 IRS audit red flags. It provides more specifics but in general agrees with what I have written here.

The CPA Superhero wants to help you to succeed in business, life, and in retirement.  While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero
972-439-1955
jeff.jhtaxes@gmail.com

Follow the CPA Superhero on Twitter too at:


My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.

Friday, January 16, 2015

Business Tax Credits: The Research and Development Tax Credit




Business Credits


Business credits are not just for the big boys like Apple, Inc. and Google, Inc. but they can mean thousands of dollars for your business. Business credits are not widely discussed nor is much information published by the IRS on the subject. As a result many businesses are "leaving money on the table". If you own a business you do well to find a CPA that has working knowledge of business tax credits.

For example, does your business have research and development expenses for developing new products? If so it is likely that your business qualifies for the Research and Development Tax Credit. In Amy Feldman's recent article in Inc. "The Essential Startup Guide to Tax Time" she mentioned a situation where an app developer discovered that they qualify for the research and development tax credit. They found by amending their prior three years of tax returns for the credit that they got $30,000 in taxes back. To my small business clients that qualify for the research and development tax credit as well as the tip credit these credits are worth thousands of dollars a year to them. Your business too may qualify for these credits and that may mean thousands of dollars for you and your business.

How They Work

Credits are really powerful on your tax return because they do more than simply reduce taxable income they reduce actual taxes.  So say a business has $100,000 in qualified R&D expenses and based on the calculation they are (as an example only) entitled to a credit of $14,000 which will actually reduce their taxes dollar for dollar so it means a $14,000 reduction in taxes.  So what is The Research and Development Tax Credit? Who can take the credit and how is it calculated?

What is The Research and Development Tax Credit


The IRS describes the credit as a credit for increasing research activities. If your business has qualified research and development expenses the business may be entitled to the credit. The following is included in the definition of  qualified research expenses provided by the IRS with form 6765:

Qualified research means research for which expenses may be treated as section 174 expenses. This research must be undertaken for discovering information that is technological in nature, and its application must be intended for use in developing a new or improved business component of the taxpayer. In addition, substantially all of the activities of the research must be elements of a process of experimentation relating to a new or improved function, performance, reliability, or quality. All of the research activities must be applied separately with respect to each business component of the taxpayer. The research credit generally is not allowed for the following types of activities.
• Research conducted after the beginning of commercial production.
• Research adapting an existing product or process to a particular customer’s need.
• Duplication of an existing product or process.
• Surveys or studies.
• Research relating to certain internal-use computer software.
• Research conducted outside the United States, Puerto Rico, or a U.S. possession.
• Research in the social sciences, arts, or humanities.
• Research funded by another person (or governmental entity).

Who can take the credit


Interestingly software and app developers can qualify for this credit. Any business, individual, estate or trust who has qualified research and development activities may qualify for this credit. Pass through entities, whose profits are passed through to their shareholders/members, can also take the credit and pass it through to their shareholders/members.

Please note there are special rules and whether or not you can take the credit depends on your facts and circumstances.

I found it very interesting too that the qualified expenses are only for research and development conducted in the United States, Puerto Rico, or a U.S. possession.  So the companies that do their research and hold patents in other countries to avoid U.S. taxes can not also benefit from this credit...in theory.

How is it calculated


There are two ways to calculate the credit, the regular credit or the alternative simplified credit (ASC). Many small businesses will elect the ASC.  The ASC basically takes your current year qualified research expenses and subtracts half of the average of your qualified research expenses from the last three years and then gives you 14% of that number as a credit.

Documentation


Obviously your business will need to document its qualified research expenses.  In the event of an audit the IRS will be very interested in your documentation to make sure you are only taking the credit you are entitled to.  You ought to keep records of the work done and be able to show a direct link to the research versus other non research work or expenses.

Amending prior year returns

Businesses with qualified research and development expenses can go back and amend their prior three years of tax returns and potentially get back significant money.  So it is imperative to act quickly to be able to go back and amend all three years.  For example to amend corporate returns for 2011 to 2013 a business may need to amended their return for 2011 by this March 15th filing deadline.  So act quickly and contact me to take advantage of this opportunity.

Other


Unused business credits may be carried back one year or carried forward 20 years.

Regarding use of this credit to make mergers and acquisitions more attractive Karen Klein explained in her Business Week article on "The R&D Tax Credit Explained for Small Business":
"Because the credits can be claimed in one year and taken in another year, they can be transferred to new ownership. The credits also legitimize a company’s technology. A lot of small companies claim the credit every year because they are looking to be acquired by a larger corporation, and if they have R&D credits on their books it proves they have technology someone else is likely to want."

Benefit Like The Big Boys


You too can use business credits like the big boys, Apple Inc. and Google Inc., if you meet the qualifications.  You do not have to be a huge publicly traded company or have a team of CPAs to profit from these credits.  You could be leaving thousands of dollars "on the table."  If you have research and development expenses or have employees that receive tip income that is reported on their W-2 you should contact me to find out how I can help you to benefit from Business Tax Credits. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

The CPA Superhero wants to help you to succeed in business, life, and in retirement.  While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero
972-439-1955
jeff.jhtaxes@gmail.com

Follow the CPA Superhero on Twitter too at:


My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.


Wednesday, January 14, 2015

Obamacare and My Tax Return: What Do I Need to File?



The time has come to file your 2014 U.S. income tax return and you need to know what you need for the Obamacare (The Affordable Care Act) filing requirements.

In many cases it will be simple.

  • If you had the required coverage you simply check the box on your tax return (1040 line 61) and you are done. 
  • If you are not required to file a tax return you will not need to file to claim an exemption.  Here is the quote from the IRS: 
"No. If you are not required to file a federal income tax return for a year because your gross income is below your return filing threshold, you are automatically exempt from the shared responsibility provision for that year and do not need to take any further action to secure an exemption. If you are not required to file a tax return for a year but file one anyway, you will be able to claim the exemption on your tax return."

  • If you are a dependent on someone else's tax return you should not have any reporting requirement for Obamacare (The Affordable Care Act).

Premium Tax Credit:
To receive or if you received the Premium Tax Credit you will need to file form 8962 which will calculate your credit and reconcile it with what you received.  You should receive a form 1095-A that will help you complete form 8962.

Exemptions or Shared Responsibility Payment:
You will need to file form 8965 to claim an exemption and this form is also used to calculate the amount of your Shared Responsibility Payment (the penalty).

  • If you have a "Marketplace Granted Coverage Exemption" you will need the Exemption Certificate Number.  
  • For IRS exemptions you simply complete the form 8965.  Here is the quote from the IRS:  
For a coverage exemption that you qualify to claim on your tax return, all you need to do is file Form 8965 with your tax return – you do not need to call the IRS or obtain the exemption in advance.
Click here for a post including the exemptions from Obamacare (The Affordable Care Act).

Please note that tax preparers have yet to begin filing tax returns and the above information is the latest available as of today (January 14, 2015).  Once we begin filing returns and actually use these forms I may have some updates for you.  For example, the instructions for the form 8965 are currently available only in draft form.  When they are finalized things could change.  

The CPA Superhero wants to help you to succeed in business, life, and in retirement.  While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero
972-439-1955
jeff.jhtaxes@gmail.com

Follow the CPA Superhero on Twitter too at:


My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.

Tuesday, January 6, 2015

Things That Will Make You Money - Number 17 - Be Aware/Open to Opportunities


Really successful people do things that other people will not do.  One very important thing they do is to keep themselves open to and aware of opportunities.  This is like going from being closed off to just one room in your house and opening the door and finding the possibilities in all the other rooms. Sometimes in our mind we limit ourselves to where we are and get closed off to other opportunities that are open to us.

Open to Other Possibilities

What happens is we start to think only certain things are possible for us. As opposed to identifying what we want to achieve and working toward it, we let others or that voice in our own head tell us what we can and should do. Personally I do not like to do what most of the world is doing and I don't like limiting myself.  But in reality sometimes I get closed off because of what is going on in my head. It is a fight we all face. The question for each of us is do we just continue with the ideas we have been conditioned to or do we challenge them and ourselves?

As a result or considering other possibilities I personally have zero...yes absolutely zero debt...and I live where I want to live right now. I have always made choices that terrify others but I try not to let fear or negative emotions affect my decision making. I like being different and really successful people are different from the mainstream.

Taking Charge of Emotions

Really successful people are not worried that most other people are making different choices. In fact if everyone were doing what they were thinking about they would really reconsider their options. Big time traders always anticipate what the majority are going to do and they get in ahead of everyone else and get out when everyone else is listening to the advise of their cabdriver/bartender/neighbors and they start getting in. They take their money and run to the next thing before everyone else gets in too late. They are trailblazers and calculated risk takers and as a result they get different results than everyone else does.

Reality: Failure and Success

Full disclosure: sometimes when you do things that most people are afraid to do it does not work out well (at that time). Unfortunately in this world not every good idea works at the time you get in. Just like in sports such as baseball where a batter tries to get a base hit and the really successful succeed just 3 times out 10. The most successful basketball players actually miss more shots than everyone else but they also make more as well. The nature of the world today is so many things don't work out. The really successful don't allow that to make them stay safe on the porch. They get out and "run with the big dogs" and if something does not work out they either adjust their plan or make a new one. The best hitters in baseball sometimes smile when they fail because they learned something that will help succeed later in the game. Things will not turn out as you hoped every time and that is OK. But you should learn something every time that you can use to succeed.

Empower Yourself 

Be a really successful person by not allowing negative feelings, like fear of failure, to keep you from exploring opportunities. Most people won't do this but if you do you will feel alive because you made a plan and went for it. That is the related thing that really successful people do, they do their homework and they don't act without really checking things out.  Really successful people don't emotion rule their decisions.  Rather they take control of their decisions and their lives.

The CPA Superhero wants to help you to succeed in business, life, and in retirement.  While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero
972-439-1955
jeff.jhtaxes@gmail.com

Follow the CPA Superhero on Twitter too at:


My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.