A big part of my business is helping people who are getting audited by the IRS. What you might find surprising is how many people I wind up helping that paid a “professional” to prepare their tax returns. I use the term professional loosely here because right now, basically anybody with a computer can hang out a sign and say they are a tax professional.
Now the IRS tried to put a stop to that, they set up rules requiring testing and training for anyone getting paid to prepare tax returns. But they lost a court case so now you’re stuck trying to guess if your preparer has even minimal competency.
One of the questions I ask when reviewing an audit return is, “How old is your tax person?” Full disclosure here, I’m also “over a certain age”—let’s just leave it at that. Lots of tax professionals are older. (At the IRS convention in Chicago this summer, we made a game of looking for people who were under 40—not many to be found.) But the dinosaurs are the ones who don’t keep up with the new tax laws.
True story: a woman came into my office because she was being audited and the IRS wanted a few thousand dollars from her. She had had her return done by a “professional” but he didn’t do audits so she found me on the internet. Red Flag 1: if your “professional” won’t represent you on a tax return that he’s prepared then he’s probably not credentialed.
Anyway, I took a look at the return and asked her a few questions. By the time I got to, “How old is your tax preparer?” I already knew the answer. He was a retired CPA. He just did tax returns during the season to keep busy.
I handed back the tax return and told her to pay the money. The tax return had been prepared using 2004 tax rules. Had the return been done in 2004—fine, but since it was her 2010 taxes, everything was different. Here’s the real kicker—had she done her own taxes using Turbo Tax or some other home style software—she wouldn’t have made that mistake. The software questions would have guided her to the right answers and she never would have claimed a deduction that she wasn’t allowed.
There are lots of mature tax preparers (I’m one of them) who keep up their licenses, take update classes and keep up with what’s new in tax law. The tax dinosaurs, on the other hand, are living in the past and can cause more harm than good for their clients. Here are some warning signs that you’ve got a dinosaur:
1. Your preparer won’t e-file your tax return. Any professional tax preparer that prepares over 10 tax returns a year is required to e-file the returns. If you have a “normal” tax return and you still have to mail it—that’s a warning sign that your person is behind the times.
2. Your preparer doesn’t use tax software. I don’t care how brilliant the person is—software is necessary for today’s tax returns. Software isn’t perfect, but it eliminates many mistakes.
You should also beware of preparers who won’t sign your return and don’t have PTIN numbers. That’s not necessarily a dinosaur, that’s more likely fraud—you should run from those guys.
Dinosaurs are extinct. The one time the IRS tried to do the right thing and protect people from the tax dinosaurs, they lost the court case. So you have to protect yourself. Tax dinosaurs should be extinct too.
Note: before you read this post, you should really see “Deducting Employee Business Expenses on Your Tax Return (Part 1)” first to see if you should even consider claiming them.
Okay, so you’ve decided that it makes sense for you to be reporting your job expenses on your tax return. Generally, people who report employee business expenses are in sales; folks who do a lot of driving and a lot of business entertaining. Those are the expenses I’m going to look at today.
Business miles: I have a lot of blog posts about mileage, usually I’m writing about self-employed people, but the rules for claiming mileage are the same for employees. If you are commuting to the office—that’s not a deductible expense. If you’re driving around town meeting clients—that is deductible.
For example: let’s say your average round trip commute is 20 miles every day. The average person commutes to work 250 days out of the year so if your commute is 20 miles a day, you can expect your commuting miles to be 5000 miles a year. That’s 5000 miles you can’t claim as a business expense.
But, let’s say you kept really good records of your business miles. You traveled 17,000 miles on business (including your commute) during the year. That means you drove 12,000 deductible miles and that’s pretty significant. (17,000 – 5,000 is 12,000 miles)
To claim your mileage, you’ll need to know what type of car you drive, and the year, make, and model. Also, when did you start using it for work? The paperwork is going to ask you how many business miles you drove, how many commuting miles, and how many other miles (they mean personal—picking up the kids at school, buying groceries, and stuff like that.)
Do not lie about the mileage! It is the most audited piece of any tax return. Keep a log, use MapQuest, and learn to read your odometer. Don’t make stuff up. Most people over estimate their business mileage.
Use our FREE mileage log on our downloads tab: http://robergtaxsolutions.com/free-downloads/. This is FREE to disburse amongst your family or friends.
Business entertaining: The business lunch. Just because you happen to have a receipt for eating a meal in a restaurant doesn’t make it a legitimate business expense. If you learn nothing else from this post, learn to write on your receipt. Who did you eat with and what was the meeting about? It doesn’t have to be fancy: Fred—networking, Marge—advertising, Peggy—sales call. Enough to jog your memory if you get asked.
Dinner with your spouse is not a deductible business expense even if you’re talking business. Don’t be naive. The receipt for the fancy restaurant with the $200 dinner dated February 14th sure as heck better be well substantiated for business if you want to float that one by the IRS. Same goes for the McDonald’s Play Place, how many people really are conducting business there? (Okay, full disclosure, I’ve got a business client who does hold business meetings at McDonald’s—it works with balancing family duties, but the meetings are well documented.)
Remember, most business meals are in the 50% category; meaning that if you had $1,000 worth of business meals it only counts as a $500 deduction on your tax return.
Employee business expenses are a popular target for IRS audits. It doesn’t mean you shouldn’t claim them though, it just means that you need to be extra careful. Make sure you document everything. Write on your receipts, keep a log book, hold onto your proof and you’ll be just fine with your deductions.
Do you claim auto expenses for your business on your taxes? If the answer is no, you should probably skip this blog post. If the answer is yes, this is exactly the post you want to be reading.
I do a lot of audit work. Lots of audit work. Every audit that I’ve ever worked on where the taxpayer claimed mileage the IRS asked to look at the mileage log. Every single one! Small business owners are more likely to get audited than wage earners and most small business owners claim mileage. So—if you’re a small business owner, you need a mileage log.
So here is your new mileage log. All you have to do is fill it in with the miles and the appointments. It’s all set up and formatted as an Excel spreadsheet. There’s even room for other auto expenses in case you’re using your actual costs instead of mileage.
Did you know that you have to keep track of your miles even if you are claiming your actual expenses? It’s true. Often, people come to me with their auto receipts and I can’t do anything for them without their mileage. Whether you claim mileage or actual expenses, you must have a mileage log.
In order to do your mileage log correctly, you’ll need your odometer reading from the beginning of the year and from the end of the year. I like to take my readings on New Year’s Day during the Rose Bowl Parade. I started 2012 out with 81 miles on my car (I got a new car at the end of 2011.) Now I’m up to 8903. I should reach 9700 by the end of the year. Of those miles, about 5,000 of them are for business.
If I’m claiming straight mileage, I would take the 5000 miles times the 55.5 cents per mile that I’m allowed to claim for a deduction of $2,775.
If I’m claiming actual expenses, then I’d take the 5,000 business miles I drove and divide that by the 9610 actual miles I drove during the year to get the percentage of my expenses that I could deduct. 5,000 divided by 9610 = 51.98%. So I’d total up all my gas and maintenance expenses and figure the depreciation and multiply that all by 51.98% to get the right dollar amount.
So you see, you can’t claim your actual expenses without having the mileage to figure the percentage.
This mileage log was prepared by Michael Siebert in my office. We looked at a bunch of other logs; some were too complicated and some didn’t have everything you needed. This one’s right about in the middle and it covers what the IRS really wants to know. There’s a separate page for every month, but all you really need to turn in to your tax preparer is the summary page.
Feel free to use it. Copy it. Give it to friends. It’s okay. We left the year off so that you can use it for multiple years if necessary. We’d like you to use it when you have us do your taxes, but if you use someone else’s, that’s okay. You can always use our mileage log. The point is that it is very important to have a mileage log for your taxes that we don’t care who uses it. It’s free. We’re not even asking you to sign up for anything.
If you’re claiming auto expenses on your tax return this year, you need to use a mileage log. If you don’t already have one, here’s one for you.
You should never take cash out of the ATM using your business bank account. Never.
If you never have and never will take ATM cash out of your business account, you’re done here. Go read a different post, I’m not worried about you. If you still think it’s okay to make a cash ATM withdrawal from your business account, keep reading. Imagine you’re routinely getting whacked upside the head with a rolled up newspaper about every two minutes until you learn this lesson.
Why not use the business account for the ATM?
1. It’s a blazing red flag to the IRS that you’re doing something naughty. Even if everything you do related to your ATM withdrawals is 100% legitimate, to the IRS it says, “I’ve been a scumbag! Make me pay more taxes!” It’s really not a message you want to convey.
2. It’s bad bookkeeping practice. You have income and expenses. You take money in and you spend it. You need to account for how you spend it. An ATM cash withdrawal doesn’t give you the paper trail you need for your expenses. Even if you’re good about keeping those receipts (and believe me, you’d be the exception) you’re still stuck with issue number 1 – blazing red flag to the IRS.
But I own the business and it’s my money, why can’t I just make a withdrawal? Good question. Let’s say you’re just a plain sole proprietor, nothing fancy. You’re absolutely right; that’s your money and you’re entitled to use it as you see fit. If you’re keeping a separate bank account for your business, then you should write a check from your business to you for your “draw”. That’s legit and it gives you a paper trail. Whenever you take money from your ATM, it is considered as going to you and you’ll be taxed as that being your profit.
Here’s an example: Fred takes $200 a month out of his business account to pay some contract laborers. He occasionally hires some kids from the local football team to help him with his moving company. He pays the boys in cash and has never paid any one boy more than $600 so he hasn’t had to issue a 1099 (1099s must be issued if you pay $600 or more.) Fred gets audited by the IRS. He’s claimed $2400 in expenses for contract labor. That’s the $200 a month cash he’s paid to the boys on the football team to help him with some moving projects. What the IRS sees is $2400 in ATM cash paid directly to Fred and they charge him $1200 in taxes and penalties for under-reported income. Fred will have a very difficult time fighting this. It’s possible that he can fight and win, but why be in that position in the first place?
Let’s move it up a notch, what if Fred has an LLC-a limited liability company? Let’s say Fred takes an ATM withdrawal from his business account so he can take his wife out to dinner. Once again, its Fred’s money and he has that right. But now Fred is treating his business account as a personal account. This messes up his “limited liability” status. If you don’t keep a strict line between your business account and your personal account, you risk losing your limited liability protection. This makes it even more important for Fred not to use his business ATM card for cash if he has an LLC.
How’s your head? Been smacked enough times? Bottom line: never make an ATM cash withdrawal from your business bank account. If you want to pay yourself, write yourself a check. If your business needs to use cash, set up a petty cash account and fund it by writing a check for petty cash. A clean paper trail will keep the IRS off your back and that means money in your pocket.
Every year people ask me, “What can I do to prevent being audited by the IRS?” The honest answer is, “Absolutely nothing.” Because in fact, everyone is audited every year. You just don’t know it. Every year, your tax return is run through a computerized audit. First there is the search for missing documents—such as an unfiled W2 form or interest statement. Then there’s the DIF score, it’s a process where the IRS basically checks “what’s normal” for expenses for taxpayers in various income brackets.
When a return is tagged by the computer, then a human being takes a look at it. A return that gets snagged by the computer may still not be audited if it makes sense to the human. If the human still has a question, then an audit letter goes out.
Even people who don’t file tax returns are audited. The IRS runs the documents about your income even if you don’t file a return. If they determine that you’ve earned enough income to file, rest assured, you’ll get a letter about it.
Now I bet you’re wondering, “How do I get my hands on those DIF scores so that I can keep my return from being pulled for audit?” Yeah, I’d like a copy of those too. Unfortunately, the IRS doesn’t publish them. That would be like showing your hand in a poker game.
In the meantime, your best defense is hanging on to your records. Now that tax season is over, make sure that you’ve put all those papers someplace safe. Hopefully, you won’t need them.