TAX TIME REMINDERS
One tax deadline is behind us, and now it is time to file those annoyingly ridiculous personal income tax returns. Here are some friendly reminders before you sign that tax return under penalties of perjury.
The deadline to file your personal income tax return this year is Wednesday, April 15th. If you cannot file your return by that date, you are required to file for an extension to file and make a good faith estimate of the amount of tax that you will owe when you eventually file your return. If you fail to make a good faith estimate of the tax that you will eventually owe, you run the possibility of the IRS assessing you with a failure to file penalty as well as a failure to pay penalty. Failure to make the good faith estimated tax payment with your extension can render your extension void and of no effect. Failure to file penalties are equal to 5% per month capped at 25% of the tax due. Failure to pay penalties are equal to .5% per month capped at 25% of the tax due.
Married persons that file a joint return need to be careful and review their return. By filing a joint return, each spouse is jointly and severally liable for the entire tax shown on the return or adjusted on audit. The IRS does not automatically split the liability in half and pursue each spouse for their share. The IRS pursues the spouse from which it is easiest to collect the outstanding tax. Further, if you are married and decide to file a return separate from your spouse by filing married filing separate, you need to be careful in reporting your income. In California, a community property state, the income you are required to report on a return separate from your spouse is all your separate property income and one-half of your community income and one-half of your spouse’s community income. If you find yourself in an unfortunate divorce situation, it may be possible to avoid the imposition of the community property laws with respect to the reporting of income through the innocent spouse procedures. However, make sure you are properly advised before going down this path with the IRS or FTB.
In hiring someone to prepare your return, make sure you review the work they do in the preparation of your return. You are the one signing the return and will be liable for any resulting tax, interest, and possibly penalties. Return preparers are not auditors of your return and may not inquire with you regarding the propriety of what you are reporting. If you have any questions or concerns, discuss the issue with your return preparer or seek additional assistance from a tax professional. There are certain issues that are more likely to trigger an income tax audit.
Small businesses that engage in cash intensive businesses are more likely to be audited. This is even more so when net income from said business is less than $100,000. The IRS has determined that these returns have a greater possibility of adjustment. Accordingly, make sure your records are up to date and you have those receipts to substantiate all expenses on audit.
Similarly to the previous issue, the next target of an audit is someone that is reporting higher than average deductions. The IRS loves to attack meals and entertainment, car and truck expenses, and any other deduction that looks out of the ordinary on a return. This should not prevent you from reporting all your legitimate expenses, just make sure you have the substantiation for them when questioned.
Another frequent subject of an audit is a business/activity that regularly reports losses. The IRS may contest these “businesses” as hobbies not engage in for profit which will result in the loss being limited to the amount of the income. In fact, the IRS may require the income be reported as other income and the expenses on Schedule A as an expense for the production of income subject to the itemized deduction limitations and alternative minimum tax limitations. A business is presumed to be engaged in to make a profit if it is profitable three out of five years. If you run a loss more than two years out of five, that does not mean you will automatically lose on audit. You will just have to prove that you have engaged in the activity to make a profit which is a factually intensive process.
Lastly, another issue that can trigger an audit is the reporting of rental income losses claiming to be a real estate professional. For most people, rental losses are passive losses and only deductible to the extent of passive income. For a special category taxpayer that qualifies as a real estate professional, rental losses can be offset against ordinary income. However, the requirements to be a real estate professional can be difficult to meet and often more difficult to substantiate. If you deduct rental losses as a real estate professional, make sure you consult with your tax professional as to what you will need to show on audit to prevail on the issue.
There are many things that can trigger an audit. The key to surviving an audit is substantiation, recordkeeping, and having a tax opinion if you are involved in a technical legal issue. Do not take your responsibility of filing an accurate return lightly. The costs of an audit can be dramatic. Be careful out there.
– Jason W. Harrel is a Partner at Calone & Harrel Law Group, LLP who concentrates his practice in all manners of Taxation, Real Estate Transactions, Corporate, Partnership and Limited Liability Company law matters. He is a certified specialist in Taxation. Mr. Harrel may be reached at 209-952-4545 or jwh@caloneandharrel.com