Q: Why should I engage a tax preparer?
A: The complexity of the tax code leads more than 60% of Americans to professional tax preparers. Even if commercially available programs facilitate the task, you still need to answer the questions correctly. Are you sure you know the minutiae of the tax laws to answer the questions properly and stay within the law, not to mention to get all the deductions and credits to which you are legitimately entitled? If you are not sure, you need a professional tax preparer.
Moreover, many returns are filed electronically. Even though electronic filing has made mathematical errors less likely, many taxpayers still need assistance. Finally, according to IRS estimates the average taxpayer needs in excess of 24 hours to do his or her tax return, but over 52 hours if a Schedule E for rental properties is filed. Are you sure you want to invest this amount of time, not to mention the $60+ for the tax software?
Q.: What is an Enrolled Agent (EA) and what do they do?
A.: An Enrolled Agent (EA) is a person who has demonstrated competence in the field of taxation and can represent taxpayers before all administrative levels of the Internal Revenue Service. “Enrolled” means licensed by the federal government. “Agent” means authorized to appear in place of the taxpayer at the Internal Revenue Service. EA’s advise clients and prepare tax returns for individuals, partnerships, corporations, estates, trusts and any entities with tax-reporting requirements. Their expertise in the continually changing tax law field enables them to effectively represent taxpayers audited by the IRS.
Q.: I have been paying too much in income taxes. How can I lower my tax liability?
A.: There are several ways you can reduce your tax liability, but most of them require some advance planning. The only exception is the opening of a traditional IRA, which you can establish until April 15 of the current year and make it apply to the prior year. It is best to discuss your particular situation with your tax advisor and examine each of the options listed below to determine which option is the best for you.
- Boost your 401(k) contributions
- Increase the contributions to your flexible spending account (FSA). Discuss with your tax advisor.
- Buy a house or a car
- Increase your charitable contributions
- Pay college bills
- Keep track of your medical expenses
- If you use your car for medical, charitable or unreimbursed employee business expenses, maintain a written record of the mileage
- Sell losing investments.
Q.: I am planning to start my own business. What expenses can I deduct?
A.: If your start-up expenditures actually result in an up-and-running business, you can elect to amortize the costs (that is, deduct them in equal installments) over a period of at least 60 months (normally, 180 months), beginning with the month in which your business opens. This election enables you to eventually deduct both the cost of investigating the creation of the business and the costs of actually creating it. Be aware, however, that only those costs that would be deductible if they were incurred by an existing trade or business are eligible for the election. In addition, you can take an immediate deduction of up to $5,000 and deduct the remainder over the amortization period. There are limitations, however, and this is a complex topic. Consult your tax advisor.
Playing it Safe — Eight items on your return that can raise “red flags” for the IRS:
- Failure to report all taxable income. The IRS receives copies of all 1099s and W-2s that you receive during a year, so make sure that you report all required income on your tax return.
- Returns claiming the home-buyer credit. Make sure you submit proper documentation when taking this credit. First-time homebuyers have to attach a copy of their settlement statement to the return, and longtime homeowners must also attach documents showing prior ownership of a home, including records of property tax and insurance coverage.
- Claiming large charitable deductions. If your charitable deductions are disproportionately large compared to your income, it raises a red flag. That’s because the IRS can tell what the average charitable donation is for a person in your tax bracket.
- Home office deduction. Many people who claim a home office don’t meet all the requirements for properly taking the deduction, and others may overstate the benefit. If you qualify, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance, and other costs that are properly allocated to the home office. In order to take this write-off, however, the space must be used exclusively and on a regular basis as your principal place of business. That makes it difficult to claim a guest bedroom or children’s playroom as a home office, even if you also use the space to conduct your work.
- Business meals, travel and entertainment. Schedule C is a treasure trove of tax deductions for self-employed people. But it’s also a gold mine for IRS agents, who know from past experience that the self-employed tend to claim excessive deductions. Most under-reporting of income and overstating of deductions is done by those who are self-employed.
- Claiming 100% business use of vehicle. When you depreciate a car, you have to list on Form 4562 what percentage of its use during the year was for business. Claiming 100% business use for an automobile on Schedule C is a big red flag. The IRS knows that it’s extremely rare that an individual actually uses a vehicle 100% of the time for business, especially if no other vehicle is available for personal use. Make sure you keep very detailed mileage logs and precise calendar entries for the purpose of every road trip.
- Cash businesses. Small business owners, especially those in cash-intensive businesses — taxi drivers, car washes, bars, hair salons, restaurants and the like — are an easy target for IRS auditors. The agency is well aware that those who primarily receive cash in their business are less likely to accurately report all of their taxable income.
- Taking higher-than-average deductions. If deductions on your return are disproportionately large compared to your income, the IRS audit formulas take this into account when selecting returns for examination. Screeners then pull the most questionable returns for review. But if you’ve got the proper documentation for your deduction, don’t be scared to claim it. There’s no reason to ever pay the IRS more tax than you actually owe.