Let’s say you own a small business. You think you’re successful. You’re a pillar of your community. Or, you’re self-employed and doing well. Or, you just can’t resist putting money into overseas investment vehicles.
The folks at the Internal Revenue Service want to get to know you much better. Not because they’re mean. (Well, maybe some auditors are.)
The larger reason is that some of you underreport your income. And according to the agency’s just-released 2010 game plan, they’re coming to get ya!
There is a gap between what taxpayers should pay every April 15 and what they actually pay. It comes to about $345 billion a year, Chris Wagner, the commissioner of the IRS’ Small Business and Self-Employed Operating Division, told a recent conference.
About 44% comes from small-business underreporting, he added.
His division, which is responsible for 41 million self-employed workers and 9 million small businesses with assets of less than $10 million, is investing heavily in personnel. By the end of 2009, the division expects to have hired 4,000 more people, including 1,100 revenue agents and 1,100 revenue officers. Revenue agents investigate possible criminal violations; revenue officers conduct noncriminal investigations and collections. The agency expects to hire at the same level in 2010. And those folks are all after your money.
Wagner reported that IRS auditors will zero in on filers of Schedule C, the prime form used by self-employed people. Auditors will concentrate on deductions for meals and entertainment, and for travel, auto use and home office expenses.
How you can defend yourself
Now, don’t panic. Don’t get mad. You’re honest, right?
Well, here’s the secret word on how to deal with the IRS: preparation. Preparation means substantiation. If you have your receipts and checks in order, you have nothing to fear. Here’s what to do:
- Meals and entertainment. A meal or tickets to entertain clients that cost $75 or more must be backed up with a piece of paper. Any expense under $75 can be substantiated with an entry in your day planner or diary. In both cases, you need the date, the restaurant or entertainment facility name, the address, the amount paid, the person or people you were with, and the business discussion. If there’s no business relationship or connection to your expense, you get no deduction. The tax pros call it the business “nexus.”
- Travel. Here you’ll need copies of your bills and checks to prove they were paid. You’ll also need to establish the business nexus for the expense.
- Auto use. This is easy. The IRS wants a contemporaneous record of the business miles and the total miles you put on your vehicle. Only the business miles, or the business percentage based on total miles driven, are allowed. Many of my clients keep a pocket tape recorder to record the miles driven and their purpose. They later transcribe the tapes and record the miles. Handing the transcripts and the tapes to an auditor usually eliminates the auto use issue.
- Home office. This also should be easy. Diagram your office and have someone take a picture of you in it holding up the local newspaper with the date as clear as possible. Better still, display a copy of The Wall Street Journal to help justify your deduction of The Journal as an investment expense.
Remember, you can be audited up to three years after you file. So a 2009 return filed on time may be audited through April 15, 2013. You may have moved in the interim. Or perhaps you decided to discontinue your home office. In either case, the picture with the date establishes that you did have an office in 2009.
Watch out for the “regular and exclusive” use rule. If you use your office as anything other than an office, you lose your home office deductions.
If you’re asked if the computer in your home office is used 50% for business and 50% for personal use, or 90% business and 10% personal, the only right answer — if you want to keep the home office deduction — is 100% for business.
I also recommend that you have a sign-up book to establish that customers or clients have come to your home office.
A problem: What you don’t tell them
In every self-employed or small-business audit I’ve had in the last three years, the IRS has gone after unreported income.
The auditor is going to ask for all your bank statements, checking, savings and investment accounts. The IRS position is that every deposit is income.
We all know that’s ridiculous; even the IRS knows it is ridiculous. Deposits can be transfers between accounts, gifts, bequests, loans, etc.
But the IRS wants you to prove that it’s not income. Otherwise, it may tax the deposit.
Personally, I keep a record of every check I deposit. I note whom it’s from, and, if it’s not income, why it isn’t. That’s a lot easier to do when I get the check than if I have to reconstruct it two years later in the middle of an audit.
About your account in Switzerland . . .
The IRS has begun aggressively tracking down taxpayers who try to hide their wealth overseas. The IRS is also going after the promoters who push these schemes. (See “The hazards of hiding money overseas.”)
If you have a financial interest or signature authority over a bank, securities or other financial account outside the United States, you may be required to report that account under the Foreign Bank Account Reporting Act, or FBAR.
FBAR reporting normally applies only to accounts with at least $10,000. But President Barack Obama’s tax plan for 2010 contains a provision that creates a rebuttable presumption that all foreign bank accounts contain $10,000 and must be reported, unless you can affirmatively show that the account has less than $10,000. Once again, the burden is being shifted to you.
The feds are looking for unreported income. Reporting the account is an invitation to be audited. But not reporting an account that should be reported is even worse.
The civil penalty for willfully or knowingly failing to file an FBAR account is up to the greater of $100,000 or 50% of the value of the account at the time of the violation. You can also be hit with criminal fines up to $500,000 or 10 years in prison, or both, for willful failure. Knowingly failing to file the form can cost you $10,000 or five years in prison, or both.
So, yes, the IRS is coming to get ya. You’ve been warned, so get prepared — now