What to Do When You Are Being Audited and Your Records are a Mess

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How to terrify just about anyone: Tell them their taxes are being audited.

Even worse: When their books and records are a mess. (Or maybe even non-existent.)

Every number could be scrutinized. That means documentation must be produced to support the amount of each expense and the business purpose of the item.

Some of us are meticulous in our documentation, but if you are like most taxpayers, you have pockets of misplaced or destroyed data. Even worse, you may be in a situation where documentation was completely destroyed by a fire or flood. If you don’t have documentation, does that mean your deductions are automatically disallowed? Not necessarily. Continue reading

COVID-19 Coronavirus Stimulus Check Scams

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Coronavirus stimulus check scams have already started. This is shameful, but not entirely unexpected.

U.S. taxpayers will be receiving payments of up to $1,200 per adult and $500 per child, with reductions for special circumstances. To receive a payment, you must have a social security number. Nonresident aliens, people without a social security number, and adult dependents (ex. your college student who is claimed as a dependent on your tax return) are not eligible.

To receive the full $1,200 you must have income less than $75,000 per year (single) or $150,000 (married). Those with income of $75,000 to $98,000 (single) or $150,000 to $198,000 (married) will receive a reduced amount. Those receiving social security retirement or disability payments WILL get a stimulus check, as well as veterans and those who are unemployed

The $500 per child is only available for a child under the age of 17 who is claimed as a dependent on your income tax return. Continue reading

Don’t Cash Out Your 401(k) in Divorce

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It is common for divorcing spouses to cash out retirement funds at divorce time. And it seems to make sense at the time. There are expensive lawyers and all sorts of expenses to establish a new residence. Support payments may be delayed or non-existent. A retirement fund seems like great solution. It’s a pile of money that you weren’t going to use for a long time, and you have financial needs now.

But it should be the absolute last resort, because it’s so costly in both the short term and long term.

Retirement accounts like 401(k)s and IRAs create a tax deduction now (when money is contributed to it), and then taxes are paid when the funds are withdrawn at retirement time. The government wants us to keep the money in those accounts until we retire, so there are disincentives to withdraw the money early. If you take an early distribution from a retirement account, you’re going to pay income taxes on the money you withdraw, plus a 10% federal penalty for early withdrawal, plus any penalties your state may impose. I tell people to count on losing about 50% of the money they withdraw to taxes and penalties. Continue reading

IRS Audit Rates Keep Falling

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Accounting Today had an awesome article about IRS audits and the recent trends. The good news for taxpayers is that audit rates are down overall. In 2010 the audit rate was 0.9%, or 1.735 million tax returns. Last year it was only 0.5%, or 991,000 tax returns.

There is even better news with some of the specifics:

  • Most audits are done by mail. The IRS asks for information and the taxpayer sends in the responsive documents. The number of field audits (an IRS auditor working directly with a taxpayer to address issues) keeps dropping, and last year the numbers were at an all-time low. Field audits are done for complex tax situations, and less than 250,000 were done last year.
  • S-corporation or partnership tax returns have a very low audit rate at 0.22%. That’s less than half the overall audit rate of 0.5%
  • If you make more than $1 million a year, your likelihood of audit is higher. 3% of taxpayers making more than $1 million were audited last year, but that’s down from the 12% who were audited in 2011.
  • Criminal investigation cases are down 58% in the last five years. During the same period, the number of revenue agents (field auditors) and criminal investigators has dropped by about 25%. So it’s only natural that prosecutions have gone down too.

As Accounting Today notes, the IRS has always used the fear of audits to get people to voluntarily report all of their income and pay the taxes they owe. With audits down, that fear might not be so great anymore. However, the IRS uses other non-audit tools (such as letters that notify taxpayers of discrepancies and taxes due) which still create fear in taxpayers, and may therefore encourage compliance.

Analyzing Tax Returns in Divorces

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Income tax returns are an important piece of financial information in a divorce or child support case. There is so much information that can be obtained from the tax returns, and if we have several years of data, we can make comparisons from year-to-year. In the video below, Tracy talks about the financial data she analyzes on the income tax returns and what these items may tell us about the financial situation of the family.

Bank Deposits Method to Find Unreported Income

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When the Internal Revenue Services suspects that a taxpayer has unreported income, the agents can use one of several methods to uncover that income. These methods can also be used to help calculate hidden income in a divorce or child support case. One such method used to determine unreported income is the bank deposits method, in which the forensic accountant analyzes bank deposits. In the video below, Tracy explains how this is done.

Surviving an Income Tax Audit

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Income tax audits are intimidating whether you are being audited personally or as a business owner. There is a right way and a wrong way to handle an audit by a state or federal taxing authority. It is easy to dig a hole for yourself, but awfully hard to get out of that hole.

Whether you attempt to handle an audit on your own, or opt to involve a professional who is experienced in these matters, there are some things you should know as you embark on your journey. I don’t ever suggest that a taxpayer submit to an audit alone. It is very helpful to have an experienced professional along for the ride. Not only can the accountant or attorney help you complete records requests, she or he can also act as a buffer between the taxpayer and the IRS.

The process of an audit is often one big negotiation. It is a give and take between both sides. Ultimately, both sides want the case closed, and the faster we can get to that point, the better. (Preferably with the least amount of pain for everyone involved.) Continue reading

Getting Business Tax Returns During Divorce

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When one or both spouses have an ownership interest in a business, it is critical to get both income tax returns and financial statements for the entity. It is impossible to fairly evaluate the business and the income from it without both of these.

Many times we meet resistance from the spouse during discovery. It is common to hear “we already gave you the financial statements, why do you need the tax returns too,” or vice versa. Both are important because they provide different information. Occasionally the two will have identical information, but the vast majority of the time there will be different numbers and different levels of detail. We want as much information as possible on the business, so both are critical. Continue reading

Rules For Getting Through a Tax Audit

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Tax audits are scary, especially if you’ve got unusual income or deductions. The assumption is that at the end of the process, you’re going to owe the government money.

You can help yourself in the audit process, however, by following 4 simple rules:

  1. Shut up – You may think you’re helping by talking and volunteering information. You’re not. Even truthful answers can hurt you when talking to an auditor. The goal during an audit is to provide information but NOT raise additional issues or questions. There are right and wrong answers to the auditor’s questions, and the taxpayer often does not know the difference.
  2. Hire a professional – A competent professional will know those right and wrong answers. She knows how to be consistent in answer and not contradict information already provided. She knows what documents will support the position you’re taking in the audit, and she can give the best explanations. Let her answer questions for you.
  3. Prepare your documents – If you’ve done a good job of keeping records, this will be easy. Start pulling together documents right away, but don’t turn anything over until your attorney or CPA has gone through them. Do NOT volunteer extra data or documents to the auditor. Give him only what he needs to answer the questions that were asked.
  4. Do not let the auditor on site – Whether you work from home or in an office, you do not want the auditor there. They could overhear something or see something they shouldn’t. All meetings with the auditor should take place at your attorney’s or accountant’s office. It is much easier to control the documents and the flow of information this way.