IRS & Audits

Each year it seems the most popular questions is “How does the IRS determine what returns get audited?” It is rumored that only 12 key IRS employee’s know the exact detailed about how the IRS makes this determination. This is suspect at best. Among the accounting and tax profession there is an agreement that there are certain aspects of a return that will trigger an audit. • An unusual sum of money claimed for a deduction, ie. $35,000 for business entertainment expenses • Relative size of deduction vs income, ie $8,000 in travel expenses and $10,000 in income • The nature of the deduction as compared to the taxpayer’s occupation, ie a large business entertainment deduction for a professor • Reporting a deduction in a manner that improperly benefits, ie deducting meals and entertainment (that are subject to restrictions) as a business advertising expense • Contradictions between deductible items, ie a deduction for mortgage interest but no deduction for real estate taxes • Large charitable contributions, ie $50,000 in charitable contributions - even though your income may support this type of deduction it is a trigger for an audit. Make sure to have receipts for ALL contributions Although the exact variations from the norm that actually trigger an audit have never been made public knowledge so the bottom is line is - who knows. As I have alway told my clients - never fear an audit if you are doing the right thing. It may be inconvenient but it should never cause you to shake in your boots.

Mortgage Interest

Mortgage interest can only be deducted if it is your primary or secondary home. A third home (or more) is not eligible unless it is an investment property or business property. HELOC’s are no longer deductible unless they are strictly used for the improvement of your home. They are not deductible if used for personal debt (ie credit card, to buy a new car, etc.)

Mortgage Insurance Premiums (MIP)

This provision has expired and was not extended.

Hardship Distributions

This is a withdrawal from your elective deferral account made because of immediate and heavy financial need, and is limited to the amount necessary to satisfy that financial need. A retirement plan may, but is not required to, provide for hardship distributions. There are very specific standard set by the IRS for this type of withdrawal. This withdrawal is included in gross income unless they consist of ROTH contributions. in addition, the withdrawal may be subject to a 10% penalty for early withdrawal. The withdrawal cannot be re-paid to the plan as it is not a loan. It also cannot be rolled over into an IRA or other qualified plan. Be careful when making a decision to elect a distribution as a hardship.

Tuition and Special Schools

You can deduct as a qualified medical expense the cost of tuition and special schools designed to relieve physical disabilities. Example: Schools that teach sign language, lip reading or Braille. A disable persona can deduct the cost of lodging and meals when they travel to get the training.

Disability Tax Points

Disability payments made by certain payers are tax free income. Included are: • Department of Veteran Affairs Payments • Workers Compensation payments related to physical injury or illness • Damages awarded for physical injury or illness • Compensation payments for permanent loss of some bodily function Note: Social Security disability payments are taxed just like regular Social Security payments, based on the income level of the recipient. Plese note that Arizona does not tax Social Security Benefits even though the Federal pay tax a portion.