The government has a
responsibility to collect taxes to maintain our highways and roads,
provide schools and facilities for our children and elderly, and keep
our communities safe from crime. We pay our fair share of taxes to
protect our freedoms and maintain our way of life, but there's no
reason to pay more taxes than you have to unless you want to.
Maintaining good
books and records is a chore for many people. Without it, a taxpayer
can undergo a costly and challenging examination by the IRS. By
properly utilizing the provisions of the Code and Treasury
Regulations, one can eliminate excess tax liability. The IRS can
reasonably determine, through a model, a percentage corresponding to
each expenditure relative to the gross income reported for any
business or individual. This is called a DIF Score. The higher the
particular expense item, the higher the DIF score. Since the IRS
examines two to three percent of the returns filed, most of the ones
examined will carry the highest DIF scores.
Keeping adequate
records is one way to help prevent a costly audit. Without it, there
is nothing to substantiate a taxpayer's deductions. At the beginning
of an audit, the examiner normally does a test check for a few months
of expenses against their gross income. The typical focus is travel
and entertainment expenditures for the self-employed, corporations,
partnerships, and joint ventures. The auditor will look at a general
ledger or a spreadsheet of the monthly expenditures to see if it
appears reasonable or out of line.
To get a sense of
what is being audited, let's perform one on a window washer named
Willy. Willy derives substantially all his income as a wage earner
but works part-time washing windows. He reports $1000 of income on a
Schedule C form. Willy has two vehicles and utilizes a pick-up truck
for the business for which he claims a 56 percent business usage. On
his Schedule C, he claims $13,000 of depreciation for his new
vehicle, $3,000 of automobile expenses, and another $900 for other
expenses. The usage of the vehicle breaks out to 2,431 business
miles and 1,910 of commuting miles to come up with the 56 percent
business usage. Unfortunately for Willy, there are no logs showing
time and place, and miles driven for each trip that produced his
$1000 income. It would have been more reasonable for the taxpayer to
utilize the standard mileage rate to determine a vehicle expense of
$1374. This equivalent to 2431 miles x .565 cents per mile.
Depending on the type of industry, the expense for automobiles is
expected to range from 5 to 20 percent of the income reported. In
this example, Willy is at risk of having a possible IRS examination.
To
better understand what is required for record keeping I recommend
reading Chapter 5 from IRS Publication 463:
http://www.irs.gov/publications/p463/ch05.html#en_US_2013_publink100034066
Within
this chapter, you will find out what records are needed to prove
expenses and what qualifies as adequate records. In addition to logs,
statements, and account books, you should also maintain and keep
documentary evidence such as receipts to support expenses. A good tax
preparer will review and help qualify to an extent what is an
adequate record to protect the taxpayer. This type of judgment is
not provided with tax preparation software and is well worth the
extra fee of an experienced tax preparer. Accuracy-related penalties
resulting from the use of tax preparation software is increasing due
to usage. Cases involving accuracy-related penalties are now being
pursued by the IRS. No matter what choice you make, please make sure
that your preparer or software vendor can provide representation
during an audit.
For
the full IRS publication on Travel, Entertainment, Gift, and Car
Expenses see
About the author
As a former Internal Revenue Agent (International), now retired, I have experience with audits, tax research, court cases, Internal Revenue Code and regulations, and tax treaties. I'm currently a consultant to NAP Tax Service Inc in Orlando, FL. If you have questions and would like a consultation, please feel free to contact me at eataxexpert at gmail.com or call me at (863) 274-3829.
Disclaimer:
Much
effort has been made to provide current and accurate tax information
in this blog. Please use careful judgment before acting on any tax decisions
based on any provided information. This blog is not a replacement for
seeking professional advice based on your unique individual needs.
