IRS Audit Red Flags And How To Avoid Them

February 5, 2014 by

A waving red flag
I just read the January 17, Kiplinger Tax Letter which stated the 2013 individual audit rate was one out of every 104 1040 tax returns and they expect this amount to decrease as the IRS examination resources continue to shrink due to budget cuts. Millionaires seemed to get the most scrutiny, 1 out of every 9, and those with taxable incomes between $200,000 to $1,000,000 had an audit rate of 1 out of 37 and those with taxable incomes under $200,000 were audited 1 out of every 113.

I tried to create a list of obvious red flags that can increase your chances of being audited and possible solutions.

1. Claiming 100% business use of your car especially if there is no other car available for personal use which is an actual question on the return.

2. Deducting disproportionate or large amounts of business travel, meals and entertainment on schedule C of form 1040. I typically form an LLC for my sole proprietor clients and have them file 1120S corporate returns to reduce their chances of being audited.

3. Writing off a large hobby loss from horse or car racing or dog breeding on your schedule C which offsets your other income and decreases your taxes.

4. Deducting rental losses on schedule E of form 1040 by claiming to be a real estate professional where you must show you spend more than 50% of your working time and over 750 hours materially participating in real estate activities. However if you have more than one rental property you should make an election to have all your rental properties treated as one activity.

5. Running a cash business. The IRS is keenly aware of cash businesses such as taxis, restaurants, bars, lawn care, hair salons or car washes. The IRS even has guides for Revenue Agents to use when auditing cash-intensive businesses, telling how to interview owners and noting various indicators of unreported income, which is why you should always hire a tax professional like Gregory J. Spadea to represent you if you are audited.

6. Failing to report foreign bank accounts. This is a huge area of focus with significant penalties possible especially since the IRS has had success getting foreign banks to disclose account owner information.

7. Taking higher than average deductions. The IRS may pull a return for review if the deductions are disproportionately high when compared with the reported income. This is why I always consider the category averages of filed returns with similar income when preparing returns for my clients.

8. Unsupported cash or property charitable contributions deducted on Schedule A of form 1040. I always recommend my clients get a letter from their church or charity if they give more than $250.00 during the tax year.

9. Improper matching of income reported by 1099-B, 1099-C, 1099-INT, 1099-DIV, 1099-K, W-2 or K-1 which is how most correspondence audits are triggered. I normally file an amended return to report the income and deduct the appropriate expenses.

10. Math mistakes on the return, although these can be avoided if you electronically file your return.

11. Claiming a dependency exemption also claimed by another taxpayer such as an ex-spouse, or the dependent themselves. If you do not have physical custody you should ensure the custodial parent signs Form 8332 to release the exemption to you.

12. Not filing your returns which may result in the IRS filing a Substitute for Return based on third party information and not allowing any deductions. I normally file the delinquent returns to take the appropriate deductions and apply for an installment agreement if necessary.

13. Engaging in cash transactions. The IRS gets many reports of cash transactions in excess of $10,000 on form 8300 from banks, casinos, car dealers and other businesses, plus suspicious-activity reports from banks and disclosures of foreign accounts. Understand that the IRS looks at “step transactions” that occur with a short period to build upon transactions that are less than the $10,000 threshold.

14. Telling everyone how you put one over on the IRS. The IRS will look at your Facebook page and your other social media sites or pay whistle-blowers such as your ex-spouse, a disgruntled employee or a competitor, rewards of 15% to 30% of the additional tax collected, including fines, penalties and interest after they audit you.

15. Filing late after the extension period has expired, which also means late filing penalties.

16. Employee Job Expenses. The IRS generally starts with the assumption that if an employer doesn’t reimburse a specific expense made by the employee, that expense may not be a true job expense. So, if you are a W-2 employee, you must meet the following three guidelines: 1) total of all expenses exceeds two percent of your adjusted gross income; 2) the expenses are deemed “ordinary and necessary”; and 3) the expenses were not reimbursed.

17. Too many round numbers on a return, because the IRS thinks you just estimated or made up the amounts deducted.

18. Alimony deductions that don’t agree to alimony income of the recipient. In these cases the IRS requests the divorce decree or settlement agreement that specifies the amount of alimony.

The endless social engineering by Congress with tax deductions, credits, capital gains taxes and income tax rates makes it essential to have your tax return reviewed by your tax professional to determine whether such deductions are permitted and what tax strategies should be employed. Please call Gregory J. Spadea at 610-521-0604 of Spadea & Associates, LLC in Ridley Park, Pennsylvania if you get an audit letter or want help preparing your tax returns.

Filed Under: Tax Law Tagged With: , , , ,

Direct vs. Circumstantial Evidence

January 28, 2014 by

Male Forensic Scientist Holding an Evidence Bag With a Gun Inside
Sometimes my office receives a phone call from a potential client asking me to evaluate their case based on the facts in evidence to see how strong the prosecutor’s case is. I explain the types of evidence including circumstantial and direct evidence.

Circumstantial evidence relies on an inference to connect it to a conclusion of fact. It is not based on personal knowledge of the facts in controversy, but of other facts from which deductions are drawn. These other facts are also called indirect evidence because they are applied to principal facts by linking them through established occurrences. Circumstantial evidence usually accumulates into a collection, so that the pieces then become corroborating evidence. Together, they may more strongly support one particular inference over another. It is important to understand that circumstantial evidence varies in it degree of strength, however the more corroborating evidence there is, the stronger the circumstantial evidence becomes. Circumstantial evidence is especially important in criminal cases where direct evidence is lacking especially if there are no witnesses.

One example of circumstantial evidence is the behavior of a person around the time of an alleged offense. If someone was charged with theft of money and was then seen in a shopping spree purchasing expensive items, the shopping spree might be circumstantial evidence of the individual’s guilt. If a witness actually saw the person take the money that would be an example of direct evidence.

While Direct Evidence is obviously stronger than circumstantial evidence, a jury can still convict someone solely on circumstantial evidence. However, the burden of proof is always on the prosecution to show the defendant is guilty beyond a reasonable doubt. Reasonable doubt does not mean certainty and that allows the prosecution to meet its burden in cases where it cannot actually produce an eyewitness or any direct evidence.

When the prosecutor has no direct evidence he creates a timeline and attempts to place the defendant at the scene of the crime using his cell phone or EZ-Pass. Sometimes the victim’s calendar indicates the person they met with when the crime was committed.

Direct and Circumstantial Evidence are concepts that you need to understand if your case is headed for trial or you are weighing a plea offer from the District Attorney. If you have any questions about these concepts contact Gregory J. Spadea at 610- 521-0604 of Spadea & Associates, LLC in Ridley Park, Pennsylvania.

Filed Under: Criminal Law Tagged With: , , , , ,

How to Avoid Cancellation of Debt Income in Foreclosure

January 17, 2014 by

Taxes, debts and other problems.
Many homeowners under threat of foreclosure attempt a short sale or a deed-in-lieu-of-foreclosure. Their goal is to escape liability for a potential deficiency between the selling price of the distressed property and the amount owed on the original loan. For federal income tax purposes, such a cancellation of debt (COD) is generally considered ordinary income when the lender forgives the mortgage debt. Many distressed homeowners face the risk of not only losing their homes but also owing thousands of dollars in income taxes on the forgiven mortgage debt.

Fortunately, Congress passed the Mortgage Forgiveness Debt Relief Act (MFDRA) of 2007, which relieves COD taxation on debt forgiven on principal residences. Secondary loans on a primary residence also are exempt if forgiven, but only if the money from these loans was used to purchase or improve the property. Advocates should be ready to demonstrate that their client’s property was, in fact, used as a primary residence to qualify for the MFDRA’s relief.

Even if homeowners do not qualify under the Mortgage Forgiveness Debt Relief Act, some common law and statutory exemptions may provide relief. First, indebtedness discharged as part of a bankruptcy is exempt from cancellation of debt (COD) income. Second, a purchase-price exception provides that when an original lender bargains with an original purchaser, a reduction in principal may be deemed an exception to COD income in cases of failing market conditions or reduced property values. If the lender issues you a 1099-C, then you will have to file IRS form 982 with your federal 1040 income tax return to avoid paying tax on the COD income.

If you face foreclosure or get a 1099-C for Forgiveness of Debt Income, please call Gregory J. Spadea at 610-521-0604 in Ridley Park, Pennsylvania.

Filed Under: Tax Law Tagged With: , , , , , ,

How to Handle a Pennsylvania Sales Tax Audit

January 9, 2014 by

Man doing an audit
If your company gets an audit notice from the Commonwealth of Pennsylvania you need to take control of the situation. One of the first steps you should do in a Pennsylvania sales tax audit is to hire a professional that has experience in dealing with the Pennsylvania Department of Revenue. Spadea & Associates, LLC has successfully handled dozens of audits over the past 10 years. We can help you by scheduling the opening conference with the auditor at our offices. Spadea & Associates, LLC will represent your company and handle all communications with the auditor. This ensures that potentially sensitive information won’t be leaked accidentally to the auditor by any of your employees. By having the auditor review the records at our offices and not yours, protects your sensitive information and does not disrupt your workplace. We will also escort the auditor around your workplace when and if he wants to inspect it. We will prepare you for the interview to ensure the audit goes smoothly and does not turn into a fishing expedition. We will provide the auditor with only the specific information they need and not any additional records that may expose a vulnerability or expand the scope of the examination. Spadea & Associates, will ensure the auditor provides the statute or rule to back up their determination of taxation for any items that may be under question.

If you get an audit notice from Pennsylvania please contact Gregory J. Spadea of Spadea & Associates, LLC at 610-521-0604. We are located in Ridley Park, Pennsylvania.

Filed Under: Tax Law Tagged With: , , ,

When Do I Need To Take Required Minimum Distributions (RMD)

December 27, 2013 by

Sad businessman pushing hand truck with taxes.
If you are age 70-1/2 or older by the end of the year (December 31), the IRS requires you to take a required minimum distribution (RMD) from your tax-deferred retirement accounts such as traditional IRAs, SEP IRAs and 401(k) plans no later than New Year’s Eve. If you turned age 70-1/2 this year, you have the option to delay your first RMD until April 1 of the following year, but if you decide to do that, you will have to take two RMD’s in the same year which could increase your income taxes substantially.

If you inherit an IRA from your spouse you can wait until you reach 70-1/2 before taking required minimum distributions.

However, if you inherit an IRA from someone other than your spouse you must determine whether the account owner died before, on, or after his or her required beginning date (RBD):

• If the account owner died before the RBD, you may choose between two ways of calculating the RMDs—the life expectancy method or the five-year method.
• If the account owner died on or after the RBD, you must use the life-expectancy method.

The life-expectancy method requires that you withdraw certain minimum amounts annually according to calculations set forth by the IRS. You can always withdraw more than the required amount if you wish.

The five-year method requires that you receive all assets in the account no later than the end of the fifth year following the year of the account owner’s death. There are no minimum withdrawal requirements. You may withdraw assets at any time, as long you redeem the entire account by the end of the fifth year following the owner’s year of death. This option is only available if the IRA owner passed away before the RBD.

Your RMD is calculated using a “life expectancy” factor taken from IRS life expectancy tables. Non-spouse beneficiaries use the Single Life Expectancy Table, found in IRS Publication 590. If you are one of a group of beneficiaries, your RMD may be calculated using the life expectancy factor of the oldest beneficiary of the group.

If you withdraw less than the required minimum distribution, you will be subject to a federal penalty, which is an excise tax equal to 50% of the amount you should have withdrawn. This penalty is in addition to paying ordinary income tax on the amount you should have withdrawn.

Therefore you should keep a paper trail of all of your RMD distributions. Also keep a copy of any notice your brokerage firm sends you about the RMD for this year. This paper trail will be extremely helpful if you are audited or if you determine in the future that you did not withdraw enough money this year to satisfy the RMD requirement.

If you need any help calculating the RMD or have questions about how you can reduce your tax on the RMD, please call Gregory J. Spadea of Spadea & Associates, LLC at 610-521-0604, located in Ridley Park, Pennsylvania.

Filed Under: Tax Law Tagged With: , , , , , , ,

Qualifying for Delaware County Veterans Court

December 4, 2013 by

Proud saluting male army soldier
In 2011, Delaware County created Veterans Court. The Court seeks to address the increasing number of veterans entering the criminal justice system after serving our country. Many Veterans suffer from the wounds of combat, including Post-Traumatic Stress Disorder (PTSD). The Delaware County Veterans Court’s mission is to provide substance abuse and mental health treatment to the men and women who served our country while balancing the interest of the community in punishing, rehabilitating and deterring these defendants from committing future crimes. In a collaborative effort with the Office of the District Attorney, Defense counsel, and the Veterans Administration, the Delaware County Veterans Court seeks to provide defendants with treatment and services needed to return to being productive and law-abiding citizens.

To qualify for veterans benefits a veteran must have received an Honorable discharge but they can still enter the Veterans Court Program regardless of the character of their discharge. The veterans must agree not to take any narcotics including prescribed narcotics while enrolled in the program. The veteran agrees to supervised probation and treatment for 18 months and upon successful completion the criminal charges will be dismissed.

A veteran may not be eligible for the Veterans Court Program if he/she has any of the offenses listed below as either an open charge, prior adult conviction or prior juvenile
adjudication. Also, the veteran is ineligible for a charge of Attempt, Solicitation and or Conspiracy to Commit the listed offenses below.

1. Offenses involving children such as interference with custody, concealment of a child’s whereabouts, endangering a child’s welfare and corruption of minors where the crime is of a sexual nature.

2. Other offenses including escape, stalking, impersonating a public servant, contraband, and promoting juvenile prostitution.

3. Pennsylvania motor vehicle violations including driving under the influence for the third or Subsequent Tier 3 offenses within 10 years or a crash involving serious bodily injury, homicide by vehicle, aggravated assault by vehicle, aggravated assault by vehicle while driving under the influence, accidents involving death or personal injury resulting in serious bodily injury or death, accidents involving death or person injury while not properly licensed resulting in serious bodily injury or death, falsification of identification number, dealing in vehicles with falsified numbers, dealing in titles for stolen vehicles, false application for certificate of title registration, altered, forged or counterfeit documents, fleeing or attempting to elude police officer when graded as a felony of the 3rd degree, indecent assault, incest, indecent exposure if the veteran knows or should know victim is under 16 years old.

4. Theft offenses including any theft where value is equal or greater than $10,000, deceptive business practices where theft value is equal or greater than $10,000, or victim is sixty years of age or older, theft by extortion, burglary, however a veteran is still eligible if offense is burglary of a non-residence and no one else is present.

5. Weapon offenses and explosives including possessing, manufacturing, selling or transferring firearms, or carrying explosives on conveyances.

6. Crimes of Violence including murder, voluntary manslaughter, involuntary manslaughter, aggravated Assault, kidnapping, arson, intimidation or retaliation against victims or witnesses, and drug delivery resulting in death.

7. Sexual offenses including rape, sexual assault, involuntary deviate sexual intercourse, and aggravated indecent assault.

If you are a veteran charged with a crime contact Gregory J. Spadea of Spadea & Associates, LLC in Ridley Park, Pennsylvania at 610-521-0604.

Filed Under: Criminal Law Tagged With: , , , ,

Internal Revenue Code Section 1031 Exchange Requirements and Benefits

November 26, 2013 by

Blue man carrying the words tax on his back
Internal Revenue Code Section 1031 enables property owners to defer capital gains on the sale of business use or investment property provided another business use or investment property is acquired in the same transaction. A 1031 exchange allows investors to accomplish many investment goals, such as acquiring property with greater income potential, relocation of an investment property and diversification.

Some of the requirements of a successful 1031 exchange are as follows:

• A qualified intermediary is required to facilitate the exchange. The qualified intermediary acquires, holds and conveys both properties, controls the sale proceeds and guides the exchanger through the exchange process.
• The exchanger must not have actual or constructive receipt of the sale proceeds, including deposit monies.
• Once the relinquished property is conveyed to a buyer, the exchanger has 45 days to identify replacement property and a total of 180 days to acquire it.
• To maximize the tax-deferral, replacement property of equal or greater value and equity must be acquired. In the event of a trade down in value or equity, the exchanger is taxed on the amount of the trade down.
• Title to the replacement property must be held in the same name as the relinquished property.

In addition to the investment objectives already mentioned, a 1031 exchange is a great estate planning tool. The fact that one may complete exchange after exchange and continue to rollover the gain allows the gain to be deferred indefinitely. Upon the death of the exchanger, the heirs inherit the property with a stepped-up tax basis thus eliminating all deferred gain.

While real estate exchanges account for a majority of 1031 exchanges, you can exchange any type of asset held for business use or investment, including tangible and intangible assets. A few examples include airplanes, construction equipment, rental car fleets, artwork, patents, race horses, distribution rights and livestock. When exchanging personal property, “like-kind” replacement property must be acquired which means something within the same asset class. When exchanging, in addition to deferring the capital gains, you also defer the depreciation recapture. For business owners who took bonus depreciation in recent years, this is especially beneficial and helps keep valuable capital invested in the business.

Business owners have long utilized 1031 exchanges to help grow their business. They can also help a business relocate to a better location or a more efficient facility or expand into several locations as well as replace equipment and vehicles. Additionally, exchanges can provide an exit strategy for retiring business owners by exchanging business related real property for other incoming producing real estate or even a future vacation home or primary residence.

If you are considering selling real property held for business use or investment purposes, be sure to contact Gregory J. Spadea of Spadea & Associates, LLC at 610-521-0604 to discuss how you might benefit from a 1031 tax-deferred exchange.

Filed Under: Tax Law Tagged With: , , , , ,

Checklist for Setting Up Your Business After Forming A Corporation

November 25, 2013 by

Clipboard with checklist
After we form a Corporation for your business the next steps are to:

1. Open the New Corporation business checking account using the Articles of Incorporation and the EIN. When you open the business bank account get the following:

a. Just put your Corporate name on the business checks not your address;
b. Put “Void After 60 Days” under the dollar line on the checks and start with number 1001;
c. Get overdraft protection for your business account;
d. Get your monthly statements and check imagines in the mail or print them out or save them every month to your computer or server.
e. Get copy of your signature card. (Per Uniform Commercial Code Article 3)
f. Get a business debit card that you can use to make business purchases or take draws.

2. Then fill in a W-9 with your corporate name and EIN and give it any one that paid you over $600 so they do not issue you a 1099-Misc. under your SSN for the current tax year.

3. You should hire a payroll company to pay you once per month and set up direct deposit and pay yourself at least $12,000 in 2014 so you can maximize your Simple IRA employee contribution for 2013. I would recommend Precise Payroll at 302-530-8410. Remember if you are the only shareholder employee you do not need Workmans’ Compensation Insurance.

4. To maximize your retirement you have until October 1 to open a Simple IRA and then you have until April 15, of the following year to make a $12,000 employee contribution and your Corporation can make a 3% of your pay employer contribution. If you can afford to, you should also fund a ROTH IRA or a nondeductible IRA by contributing $5,500 by April 15, of the following year assuming you met the AGI limits and you re under 50 years old. If you can afford to make additional contributions for retirement I can recommend a financial planner.

5. Instead of a Simple IRA you can also consider a 401K and make an employee contribution of $17,500 and have your employer match 10% of that.

6. You should get the following insurance under your new Corporate name:

a. Professional liability or Errors and Omissions insurance.
b. You should also register your business vehicle registration in your Corporate name and inform your auto insurer to update your policy and add full tort coverage.
c. You should also get a personal umbrella of at least $ 1,000,000 if not more depending on your personal net worth.
d. You should also get disability insurance and pay the premiums out of your personal bank account so if you have to file a claim the proceeds will be tax free. I would recommend Tim Harris of Nationwide at 610-565-1910 to get quotes for a, b, c and d.
e. Health Insurance, I recommend you contact Donna McCabe at 610-832-3740.

7. You should sign up for a business visa or master card that either pays you cash back or pays you rewards like Pentagon Federal Credit Union 800-247-5626, or Chase Ink 800-882-6751. You should use the card to make all your business purchases so when you receive the yearend detailed statement that will list all your business expenses by category, it will simplify your record keeping.

8. You should use Microsoft Outlook or Google Calendars to schedule your appointments and track your mileage, meals, entertainment and cash expenses. Also keep receipts so you can total your cash expenses at year end. You should use Quickbooks to do monthly profit and loss statements to calculate your quarterly estimated tax payments. I recommend Kathy Shippee to help you set up Quickbooks at 267-228-4818.

9. If you want to accept credit cards using your smart phone sign up for Square, which has no monthly fees and charges about 3% per transaction.

10. If you hire someone else to reconcile your bank statements and or make deposits make sure they are bonded to prevent fraud. You should also review your annual profit and loss statement and tax returns with your tax preparer looking for any unusual increases in expenses. Finally you should review the cancelled checks every month from the business account to ensure there are no missing checks or suspicious transactions.

11. If you rent or own commercial space consider switching to Direct Energy at 888-734-0741, which will charge you a fixed rate of 8.79 cents per kWh for electricity which includes transmission charges and gross receipts tax. Compare that rate to PECO’s rate.

12. If you pay anyone who is not a corporation more than $600 during the tax year get them to fill in a W-9, before you pay them so can issue them a 1099-Misc.

By doing all the above steps you will follow the three rules that every entrepreneur has which are to:

1. Pay the least amount of taxes legally by following rules 2 and 3 below;

2. Maximize your retirement contributions by fully funding both a Simple and Roth or nondeductible IRA;

3. Practice good corporate governance by not paying personal expenses from the business checking account and keeping good business records and using your business credit cards for all your business purchases. Making sure you have the proper amount of insurance listed in paragraph 6 above.

Feel free to contact Gregory Spadea at Spadea & Associates, LLC in Ridley Park at 610-521-0604 if you have any questions.

Filed Under: Business Law Tagged With: , , , ,

Amortizing Intangible Assets When You Buy A Business

November 11, 2013 by

Intangible assets business diagram
When you buy the assets or the stock of business you may acquire intangible assets such as goodwill if you pay more than the net value of the underlying tangible assets. Under the Internal Revenue Code Section 197 you must amortize these intangible assets over 15 years. Common examples of intangible assets include the following:

  1. goodwill;
  2. going concern value;
  3. workforce in place including its composition and terms and conditions (contractual or otherwise) of its employment;
  4. business books and records, proprietary operating systems, or any other information base including client lists or other information with respect to current or prospective customers;
  5. supplier based intangibles such as the existence of favorable distribution relationships or favorable contracts;
  6. any patent, copyright, formula, process, design or knowhow;
  7. any government license or permit;
  8. any covenant not to compete entered into in connection with an acquisition of an interest in a trade or business; and
  9. any franchise, trademark, or trade name.

After you purchase the company you must allocate the premium paid in excess of the net tangible asset values to the appropriate intangible asset listed above. However, if you can show that the useful life of the intangible asset is less than 15 years you can use that period to amortize the asset. An example would be a covenant not to compete contract with payments made over 5 years. In that example you can amortize the cost of the covenant over the five year contract period as payments are made instead the 15 year statutory period.

If you are considering buying the assets or stock of a company and you need a sales agreement or help calculating the value of the intangible assets please call Gregory J. Spadea of Spadea & Associates, LLC at 610-521-0604 in Ridley Park, Pennsylvania.

Filed Under: Business Law Tagged With: , , , , ,

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