How To Audit Proof Your Tax Return Forever A Recent Close Encounter Of The Irs Kind Getting Tax Credits For Saving Energy Self Employed Tax Strategies Make Your Accountant Your Best Friend Employer Cash Incentives To Employees For Hybrids
Congress has passed legislation that is supposed to result in a more “sensitive” Internal Revenue Service. You know, not such a lean, mean, tax-collecting machine.
Hmmm .. . . What do you think?
A few months ago, one of my clients (let’s call him Mr. Jones) got one of those IRS “love letters” requesting more information about his return, and the IRS wanted to meet with Mr. Jones in person to discuss the situation.
Mr. Jones (a local small business owner) was required to show up at the local IRS office with all his records. The IRS was questioning the legitimacy of several business deductions — and so the IRS was doing what it is allowed by law to do — demand that the taxpayer prove that those deductions were valid.
Turns out that Mr. Jones lost the audit and ended up owing the IRS a significant amount of money — the additional tax, plus penalty and interest for late payment of that tax. Why did Mr. Jones’ lose the audit? Mr. Jones made two “classic” taxpayer mistakes:
MISTAKE #1: “NO RECEIPT, NO DEDUCTION”
Mr. Jones lost several deductions simply because he didn’t have the proper documentation to prove the deductions.
What do I mean by “documentation”?
Well, if the IRS requires you to substantiate a deduction on your tax return, you must be able to provide written proof that the deduction really happened. The easiest way to prove a deduction is to hang on to:
a) The receipt or invoice, and
b) Proof of payment, which can be a canceled check, cash receipt, or credit card statement.
Mr. Jones reported numerous deductions for which he simply didn’t have the documentation. No receipts, no canceled checks, no nothing. Turns out that Mr. Jones was one of those “cash guys”. Maybe you know what kind of guy I’m talking about — he never wrote a check in his life, just carried a wad of cash around in his pocket. He paid for everything with cash, and never kept any of his receipts.
Every year he’d sit down with his wife and “remember” how much he spent on different things. No way to prove any of this, of course. He just had a “feel” for how much cash he had spent, and he had run his business for so many years that he just “knew” how much it cost to purchase certain things.
Well, this is the kind of taxpayer that the IRS loves! It really is true — if you can’t prove that you paid for something (with receipts, invoices, canceled checks, etc.), then you run the risk of losing that deduction in the event of an audit.
One of the most common questions I am asked by clients is this: “I know I paid for something, but I don’t have a receipt. Should I still report the deduction.”
My response is usually this: “You only need a receipt if you get audited.”
At first, people don’t know if I am joking or not. Well, I do make that comment with my tongue planted firmly in cheek, but there really is a lot of truth to it. If you don’t have the documentation to prove a deduction, you can still report the deduction (if you want), because you only have to prove the deduction if you get audited.
But if you do get audited, knowing that there are undocumented deductions on the return, be prepared to lose the deduction. Fair enough?
And here’s the other major mistake that Mr. Jones made:
MISTAKE #2: BOGUS DEDUCTIONS
It turns out that Mr. Jones wasn’t completely honest with me about some of his deductions. He reported deductions that simply were not real deductions. Here’s one example: Mr. Jones owned several rental houses. These rental houses, of course, required maintenance and repair work. Many times Mr. Jones would do the work himself rather than pay someone else to do the work.
Well, Mr. Jones would estimate what he would have had to pay someone else to do the work that he did himself, and then he would report that amount as a deduction, even though he didn’t actually pay anybody to do the work.
In other words, Mr. Jones deducted the value of his time — which is non-deductible.
This is an important point — you can never legitimately deduct the value of your time for work you did. You have to actually pay someone else to do the labor.
If you ever get a letter from the IRS demanding additional information, you’ll have nothing to worry about if you do exactly the opposite of what Mr. Jones did. If you can properly document your deductions and assuming you have no bogus information, you’ll pass the audit with flying colors.
Homeowners looking to cut their tax bills may want to rethink their water heaters. A recently signed law allows people to take as much as a $300 tax credit if they install a tankless water heater in their house.
The new tax credit is meant to encourage U.S. residents to better manage their energy consumption through the use of more efficient technology. Switching to such technology carries the added benefit of reducing utility bills overall even after the tax credit has expired.
In the case of water heaters, that means using models that offer a continuous supply of hot water while reducing energy use.
For instance, Bradford White EverHot tankless water heaters use efficient technology to provide hot water instantly. The water heaters use a series of modulating gas burners that only operate when there’s a demand for hot water. The Energy Factor (EF) of the heaters ranges from 0.82 to 0.87-comfortably above the new energy bill’s minimum tax credit-qualifying requirement of 0.80.
“Tankless water-heating technology may not be the best choice in all water-heating applications,” said Bruce Carnevale, vice president of sales at Bradford White Corporation. “However, recent improvements in tankless water heating designs have made them an important option to the energy-conscious consumer. One of the barriers to consumer acceptance of tankless water heaters has been their high initial cost, relative to traditional tank-type water heaters. But the $300 tax credit will help to reduce the cost differential.”
Additional tax incentives exist for homebuilders who utilize the new technologies and also for commercial applications, whether the building is new or under renovation. The tax credit will run through Dec. 31, 2007.
Self-employed individuals always cringe at the amount of taxes the pay to the IRS and state. Here are tax strategies for self-employed individuals that reduce those tax amounts.
The good news is being self-employed is one of the best tax strategies out there. Unlike a salaried employee, the full scope of tax credits and deductions available in the tax code are now available to you. The key, of course, is understanding the available deductions and organizing your business in a manner that allows you to maximize the write-offs.
The number one tax strategy for self-employed individuals is to keep receipts for every business expense and write them off. Practically anything can be deducted, so do it. Acceptable expenses include cell phone usage, business mileage, office supplies, home office deductions including part of mortgage or rent and so on. If you’ve filed a tax return while self-employed, you are probably already aware of this so lets move on to more specific tax strategies for self-employed individuals.
Maximizing you non-capital losses can result in major tax savings. If your expenses exceed your income for a year, you obviously will not have to pay taxes for that year. What most people don’t realize, however, is that such losses can be carried forward for seven years and deducted against future income. Alternatively, the same losses can be carried backward three years to recover past taxes paid. The end result of this situation is you can turn a bad business year into an income generator by applying the losses to taxes in other years which effectively wipes out your tax bill for those years.
Another tax strategy is to look at your side businesses. If you have one business, you’ll often have a second one that is tailored to making some money off a personal interest. While you are in it mostly because you like it, you may not realize it qualifies as a business and can help you reduce your taxes. Let’s assume you are primarily a self-employed consultant, but also write travel articles on the side. You may view the travel articles as a hobby, but it is in fact a business. If you’ve sold or even tried to sell any of your articles to a publication, all of your expenses related to travel writing can be deducted from your taxable income. This includes trips and so on. These, deductions can significantly reduce your taxable income from the consulting business. Make sure to get a grasp of your overall business efforts, even if you don’t really consider them to be a business.
Consider employing your children to save on taxes. A child under 18 that works for you does not have to pay FICA and so on. If the total wages for the year are under $4,250, they will pay no taxes and you can write off this amount as a legitimate business expense. Of course, the child needs to actually be doing a legitimate business task, but filing and similar manual tasks certainly will qualify.
Tax strategies for the self-employed are plentiful. If you are self-employed, consider getting professional help. A good professional will save you thousands upon thousands of dollars in taxes, more than making up for their fees. Oh, you can also deduct their fees!
Many people just assume their accountant will cut their taxes as much as possible. To get the biggest benefit from them, you need to be a bit more proactive.
Make Your Accountant Your Best Friend
Accountants tend to come in two types. The first is a reactive accountant, one that waits for you to send in your financial information and then prepares your taxes. The second asks you to come in and fill in annoying questionnaires about your life and so on. You want to go with this second accountant.
To truly save money on your taxes, you want a proactive accountant. A proactive accountant recognizes that the best way to cut tax bills is to plan ahead. They do not want to see you in April when it is time to prepare last years taxes. Instead, they want to see you in January every year to have a lengthy discussion about your finances, changes you foresee in your life that year and your plans for the future. Once they have this information, they can give you definitive direction on steps to take to cut down on your taxes.
Despite what you may have heard, accountants are just as human as you and I. If you don’t make any effort to get your tax strategy sorted out, they probably will not either. If they give you advice and you don’t follow it, you have no one to blame but yourself. To get the biggest benefit you must avoid procrastination. They are going to save you thousands, if not tens of thousands, of dollars, so do your part.
So, how do you find a proactive accountant? You can look around the net or ask friends. You will never really know what you have, however, until you meet with one. When you do, you need to ask them what steps they will take to handle your taxes. If they make no mention of a review of your finances for the purpose of making recommendations, it is time to move to the next one.
To get the biggest benefit from your tax professional, you need two things. First, find a proactive one. Second, follow their directives immediately.
Many companies offer their employees cash incentives to undertake certain actions such as buying a hybrid car. It is important to remember that such situations have tax consequences
Employer Cash Incentives To Employees For Hybrids
Purchasing a hybrid vehicle makes sense on many fronts. It is a financial windfall given tax credits provided under the Energy Policy Act of 2005. Driving a hybrid has the additional financial advantage that one uses less gas, thus saving on fuel prices. Finally, hybrids are much easier on the environment given the fact they produce less pollution than traditional fossil fuel vehicles.
As is often the case, businesses tend to take action to promote socially positive steps before the federal government. Whether it is promoting healthier lifestyles or, in this case, a more green lifestyle, businesses almost always lead the way. The situation with hybrid cars is no different.
Many businesses are providing financial incentives to employees that purchase hybrid vehicles. These incentives can be significant. They often are offered in the form of cash payments, contributions to retirement plans and even stock options. As you might image, employees are taking advantage of the situation.
There is, however, one cautionary not for both businesses and employees when it comes to incentives for hybrids. The act of transferring wealth to the employees is considered a taxable event. Simply put, the employees must claim the amount of the incentive as income when reporting taxes. The employer is responsible for reporting said income as part of the reported W-2 wages and the employee must pay the relevant taxes.
There is one exception to this taxable income rule. If the employer is actually producing the product in question, then no taxable event occurs. In the case of the hybrid incentives, this exception would obviously only apply to employees of vehicle manufactures actually building the hybrids, to wit, Honda, Toyota, Ford, GM and so on.
The decision by many companies to offer incentives to motivate employees to purchase hybrids is laudable. It is important, however, that both employers and employees understand the tax consequences..
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