Tax Audits: What Signs Make You More Likely to be Audited by the IRS?

It's a major fear for most Americans: A notice from the Internal Revenue Service (IRS) summoning you for an audit.

What is it about these three letters that strikes a cord of fear in Americans' hearts? Learning the signs that could put your tax return at the top of the list for an audit, and avoiding them if possible, may put your mind at ease.

Statistically speaking, your chances of actually being audited aren't that high-according to IRS data, one in 150 individual taxpayers were audited in 2003. This number had gone down in recent years-about one of every 79 tax returns was audited in 1998-but then, in 2004, individual taxpayer audits exceeded 1 million for the first time since 1999.

Also in 2004, the IRS gathered a record $43.1 billion in enforcement revenue, a 15 percent increase from 2003. Now in 2005, the IRS plans to add more enforcement to their team, meaning that more tax audits could potentially be performed.

What adds to most people's fear of being audited is that of the unknown: Very few people know just how the IRS chooses which tax returns to audit.

"That's a very closely guarded secret that not many people in the IRS know," said Bernard S. Kent, a partner with the human resource services group at PriceWaterhouseCoopers.

Still, there are some signs that will put your tax return at the top of the "to audit" pile. So take notice of -- and by all means avoid if they're not legitimate -- these red flags that increase your chances of catching the tax examiner's eye.

A computer program called the Discriminant Index Function, or DIF, is the first way your tax return could be marked for an audit. It looks most closely at the following items:

* Higher incomes: If your income is more than $100,000, your chances of being audited increase to one in 20. Says Eric Tyson, co-author of "Taxes 2005 for Dummies," "Higher income earners are more likely to be audited because there is more tax money at stake."

* High incomes compared to the previous year

* Unreported income (investment returns, etc.)

* Income other than basic wages (contract payments, etc.)

* Home-based business: Particular attention is given to returns that claim home businesses in addition to a salary income or excessively high deductions that don't match with the business (for instance, expensive business meals for a virtual administrative assistant.) You should also be careful with how you define your home office. "The room has to be used exclusively for business purposes," said Kent. "You cannot just have a desk in your living room where you have a television set."

* Large business meal and entertainment deductions or excessive business auto use

* Low income with large business deductions: Did you report earning $40,000 and write off a $50,000 car for business? Chances are a tax examiner will find your return warrants a closer look.

* Non-Cash Charitable Deductions

* Offshore credit cards

* Large casualty losses: The rules for claiming a casualty loss are very specific, so be sure your loss qualifies before claiming it.

* Having several dependents.

Tax returns that claim the earned income tax credit-a break for those with low-incomes-are also scrutinized more closely by the IRS. That's because its requirements are complex and many honest mistakes are made by those who think they qualify, along with those who intentionally try to increase the credit's payout.

If You Have Legit Deductions, Take Them

This isn't to say that you should be afraid to make honest deductions on your tax return or shy away from credits for which you qualify in order to avoid the IRS. According to Robert G. Nath, author of "The Unofficial Guide to Dealing with the IRS," As long as your deductions and expenses are legitimate and you have documentation, they will be allowed."

In fact, most Americans overpay on their taxes, which is why we highly recommend reading Lower Your Taxes - Big Time: Wealth-Building, Tax-Reduction Secrets from an IRS Insider as soon as possible in 2005 (or you will likely end up paying the government hundreds or even thousands of dollars in taxes that should have been yours to keep.)

Written by a former IRS tax attorney and senior tax law specialist, Sandy Botkin, CPA, Esq., Lower Your Taxes - Big Time is one of the smartest under-twenty-dollar investments anyone could possibly make.

And in the event that you get the dreaded IRS letter in the mail that your tax return is being audited-don't despair. "Just because you get a correspondence audit letter, there's no need to panic," says Nath. "In fact, if you get a letter instead of a call, that indicates the IRS views the inquiry as not particularly earth shattering."

Tax Jokes and Quotes

Do you realize that some tax forms ask you to check a box if you are BLIND?

Quote: "Two years ago it was impossible to get through on the phone to the IRS. Now it's just hard to get through. That's progress." -Charles Rossotti, former IRS Commissioner

Disappointed that you never had time to write the great American novel? Don't fret, just go dig out your past tax returns.

Quote: "The Eiffel Tower is the Empire State Building after taxes."

Under the Freedom of Information Act, a man with a small business sent a request to the IRS asking if they had a file on him. The IRS wrote back, "There is now."

Quote: "It would be nice if we could all pay our taxes with a smile, but normally cash is required."

Q: Who audits IRS agents?

Quote: "Next to being shot at and missed, nothing is quite as satisfying as an income tax refund."

Q: How do you drive a CPA insane?
A: Fill out Form 1040EZ.

Quote: "The government deficit is the difference between the amount of money the government spends and the amount it has the nerve to collect."

Why is it that when the IRS loses a tax return, it is considered a mistake, but when you lose a receipt, it is considered tax evasion?

Quote: "The wages of sin are death, but by the time taxes are taken out, it's just sort of a tired feeling."

Q: How do you humble a person that flaunts their wealth?
A: Have them fill out a tax return.

Quote: "When are we going to be allowed to list the government as a dependent?"

People often say death and taxes are the same, but this is wrong. Death is a taxable event, but taxes never die.

The Implications of Income Tax Charge on Estate Planning

OverviewIn the Pre-Budget Report of December 2003 the Chancellor Gordon Brown announced proposals to levy an Income Tax charge from 6th April 2005 in those circumstances where the transferor of an asset retains and interest or continues to benefit from that asset. In the instance of real property, the 'benefit' envisaged is the transferor continuing to reside in the property he/she has allegedly given away.

How the Charge Applies
The Government refer to such assets as 'pre-owned assets' and, broadly speaking, its intention is to tax the 'annual value' of such assets as a benefit-in-kind on the former owner still enjoying the use of the asset. The annual value on which the charge is based will be the open-market rental for a property or a fixed percentage of the capital value of most other assets to which the new charge applies. Any amounts which the transferor pays for the use of the asset - rent for example - will be deducted from the annual value in arriving at the taxable benefit.
The charge will also apply if a person provides the funds to purchase an asset which they go on to enjoy the benefit of after 5th April 2005.

Rationale Behind the Charge
The charge is intended to counter many Inheritance Tax planning schemes, but unfortunately, it will also impact many innocent and unintended victims. Thankfully, the legislation has included some exceptions to the application of the charge. The charge will not apply if;
The asset was gifted before 8th March 1986

The asset is owned by the transferor's spouse

The asset is, in fact, still caught by the 'Gifts with Reservation' rules and as such Inheritance Tax applies instead (hence, the Income Tax charge will not be levied on top).
The asset was sold at an arm's length price for cash (even if to a connected party).
The transferor of the asset had themselves inherited it and their ownership had ceased as a result of a Deed of Variation affecting that inheritance.
The transferor's continued enjoyment of the asset is merely incidental or has arisen only as a result of an unforeseen change in family circumstances.
The annual taxable benefit (after deducting any contributions by the transferor, where necessary) does not exceed 2,500.

The Inland Revenue have also confirmed that the charge will not apply in most cases where a taxpayer has funded life insurance policies held on trust. Finally, there is also an 'Opt Out' option whereby the transferor can opt not to pay the charge provided the asset is included back into their estate and therefore consequently being subject to Inheritance Tax.
The Implications of the Charge

Most of the Inheritance Tax Planning techniques usually involve a widow or widower having continued enjoyment of their former spouse's share of the property and thus it would appear on first inspection that in the majority of cases the charge would not apply as the transferor themselves would not be around to continue to enjoy or benefit from the property.

However, a problem seems to arise where a couple own their property as joint tenants prior to commencing their tax planning strategy and subsequently changing their ownership title to tenants in common. Where the widow or widower formerly owned the property as joint tenants they had a share in ownership of the whole property. This means that the new Income Tax charge could conceivably apply to their continued occupation of the property after their spouse's death.

A possible consequence of this for the future might mean that instead of acquiring property as joint tenants which has been the general rule, the wise policy would be to own the property as tenants in common instead. But how many people are aware of this distinction? Will legal advisors be prepared to explain the tax implications of acquiring property with the different legal titles?

Conclusion
How far will the new charge impact on current Inheritance Tax Planning schemes? As yet, it is too soon to tell, as the rules have not been fully fleshed out and as yet, it is too soon to say with any certainty what will happen and which schemes will be affected.

But it seem fair to argue that the current Labour Government is doing its utmost to tax its citizens at every possible turn. Inheritance Tax avoidance schemes - indeed any tax avoidance scheme -are not unlawful. Planning for the future does not mean that people are engaging in tax evasion - which IS unlawful. But the policies being employed leave an uncomfortable impression of an angry parent chastising their child simply for being astute and planning for the future!

Needless to say, the whole approach leaves a somewhat bitter taste in one's mouth.

Are You An Innocent Victim of These Popular Myths?

Misconceptions, misinterpretations and just plain "untruths" are floating about income taxes. Believing them could be costing thousands of tax dollars!

Myth: A Professional Tax Preparer knows all there is to know about taxes so you don't have to know anything them.

Truth: Tax Preparer's/CPA's/Accountants are not uniformly informed about ALL tax laws. Most are able to file a personal income tax and know all the laws and how to apply them to personal income tax.

There are thousands of excellent, hard-working accountants doing a great job. And if you use a tax professional, maybe they have done everything possible to reduce your taxes. But many professional tax preparers are just tax preparers.

They may know how to prepare a tax return in their sleep. They know what numbers go on which form. But that's about all they know.

A good tax preparer is not trained in tax reduction strategies.'

The only way you are assured to get the tax deductions you are entitled to, as a Home-Based Business Owner, is to become informed yourself.

Myth: You must "itemize" in order to take Home-Based Business expenses.

Truth: Many people misunderstand the terminology here.

When you "itemize" your income tax you file Form A&B and take such things as medical, home mortgage interest etc. You will only "itemize" if the total of Form A is over the standard deduction (for 2003 taxes?$4,700 single, $9,500 married)

Some people call this filing "long form."
All taxpayers have the opportunity to itemize if it is to their advantage.

Whether you "itemize" or not has NO bearing on your Business.

Myth: You're not making a profit so there is no advantage to filing business income taxes.

Truth: This is so not true! There's many tax advantages to filing a Home-Business tax return and especially so if you are not making a profit. If you also work a job, be it part-time or full time, in addition to your Home-Based business it is especially beneficial to you to file a business tax return.

Expenses incurred in your business can be taken against your job income thus reducing your taxable dollar, which decreases your tax liability.

Myth: Because you work a full-time job your Internet Marketing Business is just a hobby.

Truth: Only another Internet Marketer can truly understand the hours and money spent on what someone else would call a "hobby"!

The rules clearly state you have a business if you meet 8 rules. Four of the most important rules to meet are:
1. Expertise of the taxpayer or his/her advisors. That would mean your expertise in Internet Marketing or those who advise you. If you're learning and actively applying what you learn to your Internet Marketing activities and have a good "handle" on this?you qualify.

2. Time and Effort the Taxpayer puts into 'running the business'. They just want to make sure you're running a real business, not just engaging in a hobby. How much "time and effort" is enough? The United States Federal Tax Court has ruled that "45 minutes a day, 4 to 5 days a week" qualifies.

I can't see anyone who is in Internet Marketing with a profit motive not qualifying here!

3. The Manner in Which the Taxpayer Carries On the Business Activity. This one is common sense. Do you conduct your business mostly on the telephone, over the Internet and in-home presentations (these are good), or mostly at the golf course, during lunches and at the pub (not so good). Just treat your business like a business.

4. Is the Primary Purpose of your activity to 'Produce a Profit," or to 'Produce Tax Write-offs'? The best way to Pass the profit-motive test, is to have a Business Plan, and That Business Plan should include a table of Income and Expense projections, clearly showing profitability at some point in the future. Note that you are not required to actually produce a profit in order to qualify for home-business tax deductions -- just to show that you have the intent to produce a profit.
If you are doing all this then there is no reason for your business to be considered a "hobby".

Myth: You must make a profit within 5 years to be considered a "business" and file Home-Business taxes.

Truth: That's a generalization. Yes, the government would like to see you make a profit within 5 years but you are not penalized for not doing so. If you are following the above 4 rules and conducting yourself as a business you have nothing to worry about. You are a business and some businesses are not profitable for a number of years.

Myth: Learning how to reduce you taxes is hard and complicated.

Truth: Average Small Business Owners have plenty of tax reduction strategies at their disposal. You just have to know what they are and how to use them.
Once you learn what deductions are allowed you will know what figures your Tax Preparer/Accountant needs and you can configure your accounting accordingly.

Myth: Accounting and tax documentation for the Home-Business is not for the do-it-yourselfer.

Truth: All Small Business Owners can easily keep their own books using any number of software programs. It is not necessary to have an accountant.

No, you will not have to learn accounting. You will just need to be able to "categorize" and record expenses and sales.

Documentation for the government is very easy if you use a pocket calendar and keep your receipts.

In just 5-10 minutes a day you can have records that will withstand any government scrutiny.

About The Author
Karin Workman is a 30-year veteran Home-Based Business Owner who specializes in Tax Preparation for Home-Based Businesses. Karin also wrote the Hot New Ecourse: "Reap the Rewards!" Designed to help you save tax dollars and put more money into YOUR pocket. The course is Free exclusively at: http://reaptherewards.businessoppsunlimited.com/

Navigating The Internet Sales Tax Laws

QUESTION:
I have been contacted by my local city government to say that my business is scheduled to be audited to determine if I owe any sales tax from items purchased on the Internet. Can they really make me pay this tax? I thought you could buy things online tax free? -- Katie R.

ANSWER:
I hate to burst your internet bubble, Katie, but they are within their rights to audit your business and demand payment of sales tax on items purchased on the Web.

Internet sales taxation has been a topic of contention even before Amazon sold its first book and Priceline booked its first flight.

One of the more controversial points is that no one, including our own government, seems to have a clue how to implement a fair and logical Internet taxation process.

With over 7,500 different local, county and state taxation systems in the United States, you can understand the controversy. In 1998, Congress did what it usually does when faced with a potentially explosive issue like Internet tax collection -- it decided to put off making a decision. Congress enacted a three-year moratorium on the collection of taxes to give an appointed advisory board time to come up with an acceptable solution.That moratorium ended last year and opened the door for municipalities to begin collecting sales tax on their own.

Here in Alabama the sales tax collection department is airing radio spots asking Alabamians to step up to - and toss dollars into - the proverbial collection plate. The commercial kindly suggests that if I have purchased anything from an online retailer, I am honor-bound to proclaim such purchases and submit the appropriate sales tax to the collection department right away. They thank me in advance for my cooperation.

So, Katie, when the auditor shows up at your door the best thing you can do is smile politely and be totally forthcoming. The sales tax that you pay is a small price for the convenience of shopping online.

Now where did I put all those Amazon.com receipts?

Small Business Q&A is written by veteran entrepreneur and syndicated columnist, Tim Knox. Tim's latest books include "Small Business Success Secrets" and "The 30 Day Blueprint For Success!" Related Links: http://www.smallbusinessqa.com/ http://www.dropshipwholesale.net/

How To Claim CHILD TAX CREDIT The Right Way And Add An Extra $2,000 To Your Refund

The U.S. Department of Agriculture estimates that it costs nearly $15,000.00 a year for a middle-class family to raise a child born in 2002 to age 17 (without adjustment for inflation). In recognition of this cots, you can claim a tax credit each year until your child reaches the ago of 17. The credit is currently up to $1,000.00 per child. This credit is in addition to the dependency exemption for the child.

You may claim a tax credit of up to $1,000.00 in 2004 for each child under the age of 17. If the credit you are entitled to claim is more than your tax liability, you may be entitled to a refund under certain conditions.

Generally, the credit is refundable to the extent of 10 percent of earned income over $10,750.00 in 2004.

Conditions:
To claim the credit, you must meet two conditions.

1. You must have a qualifying child.
2. Your income must be below a set amount.

QUALIFYING CHILD.
You can claim the credit only for a "Qualifying Child." This is a child who is under age 17 at the end of the year and whom you claim as a dependent.

The child need not be your own child ? he or she can be a stepchild, grandchild, great-grandchild, sibling, stepbrother, stepsister, or a descendant of any of these.

For example, if you support your 16 year old sister and claim her as a dependent on your return, she is a qualifying child. An adopted child is a qualifying child as long as the child has been placed with you by an authorized agency for legal adoption, even if the adoption is not yet final.

MAGI LIMIT.
You must have modified adjusted gross income (MAGI) below a set amount. The credit you are otherwise entitled to claim is reduced or eliminated if your MAGI exceeds a set amount. MAGI for purposes of the child tax credit means AGI increased by the foreign earned income exclusion, the foreign housing exclusion or deduction, or the possessions exclusion for American Samoa residents.

The credit amount is reduced by $50.00 for each $1,000.00 of MAGI or a fraction thereof over the MAGI limit for your filing status. The phaseout begins if MAGI exceeds the following limits:

1. Married filing jointly $110,000.00 2. Head of household $75,000.00 3. Unmarried (single) $75,000.00 4. Qualifying widow(er) $75,000.00 5. Married filing separately $55,000.00

Example: In 2004 you are a head of household with two qualifying children. Your MAGI is $90,000.00. Your credit amount of $2,000 ($1,000 x 2) is reduced by $750 ($90,000 - $75,000 = $15,000 MAGI over the limit) = 15 x 50 = $750. Your credit is $1,250.00 ($2,000 - $750).

HOW TO CLAIM THE CREDIT AND GET A BIGGER REFUND.
If the credit you are entitled to claim is more than your tax liability, you can receive the excess amount as a "refund." The refund is limited to 10 percent of your taxable earned income (such as wages, salary, tips, commissions, bonuses, and net earnings from self-employment) over $10,750 in 2004. If your earned income is not over $10,750, you may still qualify for the additional credit if you have three or more children.

If you have three or more children for whom you are claiming the credit, you may qualify for a larger refund, called the additional child tax credit.

QUICK TIP.
If you know you will become entitled to claim the credit (e.g. you are expecting the birth of a child in 2004), you may wish to adjust your withholding so that you don't have too much income tax withheld from your paycheck. Increase your withholding allowances so that less income tax is withheld from your pay by filing a new from W-4, Employee's withholding allowance certificate, with your employer.

The child tax credit is scheduled to decline to $700 per child in 2005 and then increase to $800 in 2009, and $1,000 in 2010 and later years.

You figure the credit on a worksheet included in the instruction for your return. You claim the credit in the "Tax and Credits" section of Form 1040 or the "Tax, Credits, and Payments" section of form 1040A; you cannot claim the credit if you file form 1040EZ

If you are eligible for the additional child tax credit, you figure this on Form 8812, Additional Child Tax Credit.

Mr. Patel is a widely recognized and well respected authority on Personal Income Tax matters (Single Parents, Married Families, Small Business Owners). He put his Harvard MBA on hold to start his own Accounting firm and help everyday people just like you from all walks of life to cut your tax bill in half (by at least $1,250 - $7,500). His firm has 50+ years of experience helping everyday people just like you from all walks of life. He can help you file you Income Tax Return and put a guaranteed bigger refund back in your pocket TODAY regardless of where you live in America. Patel Financial Services has served diverse clients from all backgrounds from ALL OVER AMERICA; all the way from Maine and Florida to California and Texas. To sign up for his newsletter titled "The Wealth Builder & The Tax Cutter" visit his website at http://www.Patelfinancialservices.com or send a blank email to Subscribe@patelfinancialservice.com with the word "Subscribe" in the subject line.