February 2012

February 2012: What You Need To Know About - Getting Your Taxes Done Right

Author: Lew Wessel | Photographer: Photography by Anne

Pop quiz: Which professional does South Carolina require to attain the most number of continuing professional education hours every year?
a) Medical doctor
b) Lawyer
c) Certified Public Accountant
d) Insurance agent
e) Magazine editor

If you answered (e), you are Maggie Washo or an admirer of hers. The correct answer, however, is ©, because we CPA’s are more valued by society than any other professional (just my theory)and because the tax laws and audit standards are a constantly moving target and really do require 40 hours of classes every year just to keep up.

This is why I attended the 18-hour 2011 Clemson University Income Tax Workshop in December. The 200+ tax professionals present learned many things in those two days of classes, not the least important of which is the fact that IRS and South Carolina Department of Revenue audit activity is significantly increasing. As well it needs to, considering the deficits we are running at all government levels. What this means to you, the taxpayer, is that it is more important than ever to get your taxes done right. Here are some items on individual tax returns that are most abused along with some tips to get you audit ready:

The Auto Expense Deduction on many tax returns would make even J.K. Rowling’s editor do a double take. In too many cases, the deduction on the return is mostly pure fiction (I’ll avoid the word “fraud”). Here are the basics: a deduction is allowed for the legitimate use of your automobile in your “business.” This includes all the costs of owning and maintaining the auto, including gas, repairs, auto-loan interest, depreciation, etc. In lieu of compiling all this data, the IRS allows a per-mile deduction plus additional expenses for parking and tolls. In 2011, this per mile deduction is $.51 through July 31 and $.555 from August 1 to December 31. The most egregious problem with this deduction is that it’s often not warranted at all or grossly overstated, because the taxpayer’s non-deductible personal miles, which include the miles commuting from home to office, are included as business use. For example, if a medical professional’s work routine is to drive to and from his/her office and walk from there to the hospital when needed, the total business miles are zero.

A second common mistake is not meeting the record-keeping requirement of this deduction. In order to take this deduction on the tax return, you must keep a contemporaneous record of each business trip, noting origin, destination, purpose, etc. No record, no deduction, even if it’s all true. Needless to say, most taxpayers don’t meet this requirement and they are sitting ducks for an audit adjustment. Note: there are some mobile phone apps that sync up with your car’s Bluetooth and then download each trip to an Excel file on your computer; check it out!

On the flip side, most people miss legitimate mileage deductions for miles driven for medical reasons (e.g. to and from the doctor’s office) and charitable pursuits (e.g. miles to and from working as a volunteer at the Bargain Box). These can really add up, with medical miles deductible at .19 per mile (.235 from July 1, 2011) and charitable miles at .14 per mile. Again, you’ve got to keep contemporaneous records.

The Charitable Contribution Deduction is another common problem on individual tax returns. Deductions are only allowed for cash or property contributions to organizations specifically defined by the Internal Revenue Code and, in most cases, specifically sanctioned by the IRS under code section 501©(3). In addition, the deduction is only allowed for the amount that truly represents a charitable donation. So… no deduction is allowed for gifts to political candidates or campaigns (remember this in 2012!!); no deduction is allowed for gifts to individuals, no matter how worthy or needy they happen to be; no deduction is allowed for the part of a contribution that gets you a round of golf at Harbour Town, a dinner at Frankie Bones, etc. This last issue, it seems to me, is the most commonly abused, with taxpayers listing the full amount they paid for a charity event when only a fraction of it actually represents a true donation. Charities holding such events are required to provide you documentation with the correct deductible amount, so look for it when preparing your return.

Speaking of record-keeping, you must substantiate every donation with a cancelled check, receipt or the equivalent, and any donation of $250 or more has to be proven with a written acknowledgement from the donee organization. In the olden days, a taxpayer could simply tell the IRS auditor that they put $10 a week in the church collection plate; this no longer works.

The Home Office Deduction is often overlooked and equally often overused. This is a tough deduction to take because, as a point of fact, it is only allowed for a space within your home that is used exclusively for business. If you are audited, you will probably need to convince the IRS agent that you never wrote so much as one personal check from your home office. Seems unfair, since the same rule doesn’t apply to a non-home office, but it’s the IRS’s response to a badly abused deduction. I’m not trying to dissuade you from taking this deduction if legitimate; I just want you to be aware of the rules.

The Non-Reporting of Income is another common problem that has plagued the IRS and practitioners forever. Here’s the rule: whatever “income” you make, in whatever form, from whatever source, is generally reportable and taxable; e.g. a cash tip to a waiter must be included on his/her tax return even though it’s in cash and won’t be reported on a 1099 or W-2. There are a couple of neat exceptions to this rule… ask your accountant. Happily, not all the money you receive is “income.” For example, true gifts from friends and family and inheritances are not taxable to the recipient, no matter how large

The Under-Reporting of Income is also something the auditors will be looking for, particularly when it comes to capital gains and the overstating of “basis” (usually the cost of asset). Due to significant abuse in this area, brokerage firms are now required to include basis and other information on your 2011 1099-B (mutual funds will be added in 2012). Make sure your tax return numbers match up!

South Carolina Use Tax reporting is an interesting issue. This is the amount of sales tax you would have paid to SC on purchases made out-of-state or through the Internet. This line on the SC1040 tax return has been pretty much ignored in the past by South Carolina taxpayers. However, at the Clemson conference, we tax professionals were informed by state officials that it is going to be an audit focal point in the future. I would advise you to make a good faith estimate when preparing your 2011 return.

As you prepare your tax return or the tax organizer for your professional, make sure you have a document (e.g. W-2, 1099, etc.) or hand-prepared schedule to back up every line on the return. These records should be kept for at least as long as your tax return is “open” (generally three years from the date of filing or due date, whichever is later), but I would recommend seven years just to be safe (isn’t this why you have an attic?).

What you do on your tax return is between you and your conscience and, if audited, the IRS and perhaps a judge and jury if you really go wild. For tax professionals, however, the behavioral guidelines are contained in IRS Circular 230: Regulations Governing Practice before the Internal Revenue Service. Failure to follow these guidelines can have career-ending consequences.

Cutting right to the chase, the tax professional preparing your return is, gratefully, not an agent of the IRS and can pretty much rely on the information you provide him/her without the need to audit your books. Nevertheless, the tax professional is not permitted to ignore actual information or knowledge, nor suspend disbelief, nor take a “frivolous” position on your tax return. When the tax professional signs your return, he/she better be comfortable that every number listed and every tax position taken on the return has a reasonable basis. If you think your tax pro is being a little too picky with you this busy season, please understand that he/she has good reason to be cautious.

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