10 Secrets You Must
Know to Avoid IRS
Inclusive of Tips to Save Money on Taxes While Lowering Audit Risk
Woody Alpern – CPA/PFS/CTRS
Guest Host – William Cibulas – Attorney at Law
Tip 1 – Don’t Make Careless
Pull IRS Transcripts (Freedom of Information
Act Requires IRS to Disclose Their Cards)
Report Income & Expense Items in Proper
Place On Return
Make Sure Names, Social Security Numbers
and/or EIN(s) Correct and Match for Primary
Filers and ALL Dependants
Attach Proper Year W-2s or Other Required
Tip 2 – Do Not File As a Sole
Proprietor Schedule C
Returns Filed In Calendar year 2007 – 137,849,635. Returns audited in 2007 – 1,391,581 (1%)
Nonbusiness Returns Without EIC<$200,000
Selected nonbusiness returns = .40%
With Schedule E or Form 2106 = 1.30%
Schedule C & Nonbusiness Returns with EIC
<$25,000 = 2%
>$25,000 = 3.50%
Schedule C Returns Without EIC
<$25,000 = 1.20%
$25,000 - $99,999 = 1.90%
$ , $ ,
$100,000 - $199,999 = 3.80%
$200,000 or more = 3.10%
Returns With Income of at least $200,000, But Under $1,000,000
Nonbusiness returns = 2.60%
Schedule C returns = 2.80%
R t I f $1 000 000 M 5 60%
Returns With Income of $1,000,000 or More = 5.60%
Schedule C On Face of Return & Automatically Subject to Self Employment Tax (about an extra 15% tax).
Consider forming LLC or Inc.
Source IRS Data Book, FY 2008, Publication 55b
Tip 3 – Avoid Hobby Loss Rules
Loss for 3 or more out of 5 consecutive years = IRS will challenge as hobby.
T t th i f fit b i d f t
Taxpayer must then prove it is a for profit business under facts &
Facts & Circumstance Test
1. Manner in which taxpayer carries on the activity.
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2. The expertise of taxpayer or advisors.
3. Time and effort spent by taxpayer in carrying on the activity.
4. The expectation that assets used may appreciate in value.
5. Taxpayer’s success in other similar or dissimilar activities.
6. Taxpayer’s history of income/loss with respect to the activity.
7. Amount of occasional profits, if any.
8. l f
Financial status of taxpayer.
9. Elements of personal pleasure or recreation.
Strategy to Win Hobby Argument
Keep thorough and businesslike books (Quickbooks, etc…)
Use a separate business checking account.
Record business and personal use of assets in a log book (such as for a charter
boat or photography equipment).
Use a separate credit card for business
Research market/technology trends used in similar businesses.
Obtain the insurance, registration, certification, proper license, etc., needed
for that type of business.
Maintain a qualified home office with a second telephone listing.
Document periodic evaluations of operations to attempt to improve
D l p a written business plan and update it annually.
Develop ritt n b in pl n nd pd t nn ll
Source – 1040 Quickfinder Handbook for 2009
Tip 4 – Do Not Classify Employees
as Independent Contractors.
Factors the IRS Considers:
1. Behavior control.
2. Financial control (i.e. employees get paid regardless of profit
3. Relationship of the parties (written contract, employee
benefits, temporary or permanent relationship, Integration).
4. Other – less important (right to discharge, worker’s right
to terminate, part-time or full time, work required to be
done on employer’s p g g
premises, setting of hours, setting order
of work sequence).
Be careful with domestic help. This area is under attack.
Relief Provisions Under Section 530
to Fight Employee Classification
Use Section 530 of the Revenue Act of 1978 to treat
worker as an independent contractor for employment
tax purposes if all the following requirements are met:
1. Reporting Consistency (1099s always issued, etc).
2. Substantive Consistency (others performing g
substantially similar work not treated as
employees after December 31, 1977).
3. Reasonable Basis (judicial basis, prior audits,
Ramifications if Reclassified As
Becomes liable for employment taxes that should have
been withheld for workers pay (FICA).
Becomes liable for the employer’s share of FICA taxes.
Becomes liable for federal unemployment taxes.
Becomes liable for penalties and interest for failure to
(a) pay these taxes and (b) file payroll tax returns.
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May have retirement plan retroactively disqualified (all
vested accrued benefits could become fully taxable for
all employees in plan).
Tip 5 - Business Owner’s Must Pay
S-Corporations Paying Owner’s Large Dividends
Particularly Under Attack (Avoids Self Employment
Facts & Circumstance Test to Determine “Reasonable
Salary.com, Indeed.com, Bizstats.com
40% to 50% Unwritten Safe Harbor – Report as
Recent Victory Representing Client - Settled at 20% of
Profits S l Broke D D ti H b H
P fit as Salary – B k Down Duties Hour by Hour
Tip 6 – Home Office Deduction
Huge Red Flag (Low Hanging Fruit
S-Corporations cannot pay rent for Home Office Use of >2% Shareholder.
Must treat as expense reimbursement.
In general, to qualify for home office, the area in the home must be used
regularly and exclusively:
1. As the principal place of business (including administrative use);
2. As a place to meet clients in the normal course of business or
In connection with the business if it is a separate structure not attached
to the taxpayer’s personal residence (this separate structure doesn’t
have to meet test 1 & 2 above, i.e. flower shop that has separate
structure green house located on same property as primary house).
NOTE: In a very recent IRS audit where we represented a client, the IRS
Revenue Officer insisted on coming to the home to determine if the
above tests were met and actually measured the home office space to
the t fh ffi taken li t’ t
compare th percentage of home office use t k on our client’s tax
Tip 7 – NOL Carrybacks and Amended
Returns (Scrutinized Carefully by IRS)
NOLs incurred in 2010 can be carried back 2 years or carried forward.
Form 1045 is filed to compute carryback, and will require detailed support
usually as much as an amended return. Expect to receive an IRS notice
requesting further information, or notifying you to supply support, or
notifying you of an audit.
Form 1045 MUST be filed within one year after the end of the year in which
an NOL arose.
Form 1045 usually processed faster then an amended return (90 days from
Form 1040X is filed for an amended return.
Form 1040X amended returns are taking about 16 weeks to get processed,
and are being flagged regularly for audits.
Form 1040X claim for refund must be filed within 3 years after the date
original return was filed, or within two years after the date the tax was paid,
whichever is later.
Tip 8 – IRS Looking Carefully at Employee
Expense Reimbursements & Fringe Benefits
Form 2106 is used for employees to report unreimbursed employee business expenses (subject to
2% AGI phase out).out)
Form 2106 expenses, documentation, detailed receipts, VERY DETAILED AUTO LOG,
required. Unreimbursed auto expenses really being scrutinized.
Form 2106 – use per diem allowances rather then actual – less scrutinized (i.e. auto mileage per
diem, meals, travel and lodging per diem, etc).
Fringe Benefits – Employee fringe benefit receive tax favored treatment depending if they meet
non discrimination rules or qualify otherwise. Business deducts but employee doesn’t have to
include in income.
Fringe benefit for employee owner – double bonus. His business deducts by he doesn’t have to
include in income
Fringe Benefits subject to nondiscrimination rules (cafeteria plans, self insured medical
reimbursement plans, dependent care assistance plan, educational assistance, employee discounts,
meals provided at employer operated eating facilities, no additional cost services, group term life
O h excludable f i
Other l d bl fringe b fi i l d working condition f i
benefits include: ki b fi (company care), De
di i fringe benefit ( ) D
Minimis (holiday gifts, office snacks, occasional parties, occasional tickets), on premises athletic
facilities, transportation benefits (transit pass, parking, smartcards), Moving Expense
Reimbursements, Retirement Planning Services, Employee Achievement Awards, Meals and
lodging (while away from home – remember, use per diems).
Tip 9 – Family Income Shifting –
IRS is scrutinizing this area because any child
(someone under 18) pays tax at their tax rate on
all earned income
Child can now possibly qualify for IRA, ROTH
or Retirment Plan.
Shifts wealth to child for estate tax purposes.
Documentation is key.
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Paying reasonable compensation is key. y
Tip 10 – Audit Strategies
If audited, make sure your documentation is incredibly organized, accurate complete, etc.
You may not want to argue smaller items. Win the bigger battles.battles
Auditor has extreme discretion so treat them with total respect and professional courtesy.
Don’t joke around with auditor. Due to recent attack on Austin, Texas IRS building, any comments made to
an IRS employee that could be interpreted as a threat against the employee will be taken seriously and
Do not over argue your point even if you are technically right. In other words, be a good listener and let the
IRS auditor do most of the speaking. Many times they will over look items and say things that are in your
favor. If needed, subtlety and with respect state a tax position you believe you are correct on but in a way that
is more asking the auditor and say you value their opinion on it. Stroke their egos! This has worked amazingly
well for me over the years.
If a return was examined for the same items in either of the two previous years, and no change was proposed,
contact the IRS immediately and the examination will likely be discontinued per policy 7605(b) stating that
no taxpayer shall be subjected to “unnecessary examination.”
Don’t be afraid of IRS appeals. In fact, we have found we get much more to go our way on appeals.
Remember, the function of the Appeals Division of the IRS is to settle cases in order to reduce the number of
cases proceeding to court (the IRS doesn’t want to go to Tax Court).
Be h t h ki t th
B EXTREMELY CAREFUL what you say when speaking to the IRS by phone. They may appear to be
b h Th t b
your friend, but everything you say can be used against you and may be recorded (I’ve even heard that when
they have you on hold, and you hear the hold music, they are tapping you to see if you say anything while on
If you have a professional representative handle your audit, DO NOT attend the audit with them. You may
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say something wrong by accident. Also gives your representative the ability to say they have to check with you
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for certain decisions giving more time to think about tricky items.