DARRIN T. MISH: Good morning and welcome to the IRS Solution Attorney show I’m your host Darrin T. Mish the IRS Solution Attorney, how are you doing Katrina?
KATRINA MADEWELL: Doing great I’m your cohost Katrina Madewell thank you for joining us this morning. If it’s your first time ever joining us I would like to tell you a little bit about the show. So every week Darrin and I show up on Thursday mornings and we talk all about some of the things that you see in the field, these common things that seem normal to you but for the customers that you are representing, it’s the biggest problem that they have in their life. You deal with a lot of non-filers, people that haven’t filed tax returns in eons.
DARRIN T. MISH: Absolutely, so you know for whatever reason that I have dedicated my life to solving people’s IRS problems, but that’s the reason we don’t call the show the IRS problem solver is because we don’t focus on the negative here we focus on the solutions. But today we have been doing this radio show for several months now what about 6 months?
KATRINA MADEWELL: yeah maybe even close to a year, time flies when you are having fun.
DARRIN T. MISH: I have a really special announcement this morning and that is that for the very first time I know that my wife Heather is actually listening and I don’t think she has listened to the show so far and she and our assistant Samantha back in the office are listening this morning so a big shout out to those guys.
KATRINA MADEWELL: Well hi Heather thanks for listening.
DARRIN T. MISH: I’m actually more nervous then I have ever been doing this show.
KATRINA MADEWELL: You will be fine.
DARRIN T. MISH: But you know…
KATRINA MADEWELL: The topic for today though is right on time, so 15 red flags that could trigger an IRS Audit, but I don’t know anybody that is not looking at there tax stuff now.
DARRIN T. MISH: You know back when I used to be a criminal defense attorney I would meet people at cocktail parties and eventually they would ask me what kind of lawyer I was and I say well I do criminal defense and you could kind of see people slither away they were kind of like gross ok but now …
KATRINA MADEWELL: According to Jim they don’t even talk to you everybody avoids you.
DARRIN T. MISH: But no actually now having done IRS problem resolution kind of work for the last 16 years or so almost everybody discreetly says hey can I get one of those business cards because you just never know and that is why the topic of today’s show is so important really. Really anybody who has to file a tax return could be subject to an audit right so that is why we are talking about it.
KATRINA MADEWELL: So what’s number 1 on the list? Is this the biggest thing that you see or is this just number 1 on the list?
DARRIN T. MISH: It just happens to be number 1 on the list. The first one will be home based businesses. You know more than ever people are working from home now and they want to take that home interest deduction or the home business deduction you know they want to figure out the square footage of their home is dedicated to business purposes and they want to figure out the percentage and take off the, deduct the interest.
PAT: I had a home business many years ago and I thought about doing that not only take off a desk I bought for my home office, I got audited because of the desk.
DARRIN T. MISH: Yeah I mean it does happen.
KATRINA MADEWELL: Well don’t home offices trigger an audit like that is the whole point of this one. Cause that is what I heard is that true?
DARRIN T. MISH: I have a theory that they can because it’s heavily abused and a lot of people, remember saying you know pigs get fat and hogs get slaughtered, and so people have a tendency to be kind of hoggish about what they deduct on their home you know for the square footage and what not. I did have an audit on a home business deduction one time and they were deducting, it was like a 3 bedroom home and they were deducting the square footage of 2 bedrooms in the house and I was a little skeptical at first and then I had them take photos of the actual work spaces and that the work spaces were an absolute disaster I mean there was papers everywhere, but it was clear that people were working in that space cause nobody would keep their house like that.
KATRINA MADEWELL: Right paper everywhere
DARRIN T. MISH: Exactly, and when we went to the auditors come it was gee I don’t know if I can allow this that work space is pretty messy and I just kind of laughed and I said well I should send you a picture of my actual office at my office building cause it’s not any better.
KATRINA MADEWELL: So home based business compared to home office deduction are they one and the same?
DARRIN T. MISH: Yeah that’s one and the same is you just have to be careful.
KATRINA MADEWELL: Cause home based business you think about like Mary Kay, the jewelry, and that kind of stuff, and you have people like me that have a real office and a home office but I just don’t take that home office deduction cause I always thought it would trigger just a migraine of an audit.
DARRIN T. MISH: Yeah and there could be distinctions you know you could have a home based business that was more of like a hobby. Give you an example you bring in $5000 worth of income and you are trying to write off $10,000 worth of deductions. I mean you are not going to get away with that very long for very many years before the IRS says hey can we take look at what you are doing here because it looks like you know you are writing off your lifestyle. Happens a lot in the MLM network marketing businesses like you mentioned Mary Kay and I’m not singling those people out.
KATRINA MADEWELL: Well this is just what popped in my head.
DARRIN T. MISH: Right but they you know they have a lot of travel a lot of times they go to a lot of conventions and things like that so you just want to make sure that…They go to the people’s houses usually. Yeah well I mean in terms of there going to have a lot of travel where they go to conventions where they get pumped up and so they can recruit more members and stuff.
KATRINA MADEWELL: So the second on the list is self-employment taxes. We talked about this one a lot on the show.
DARRIN T. MISH: Yeah it happened quite a bit you know if you are a schedule C filer and a schedule C filer is just somebody who’s self-employed they get a 1099 instead of a W-2 so there is no automatic withholding and one of the killers for being truly self-employed and filing on a schedule C is that you have to pay your self-employment tax. You know I think Pat George here is our producer and I think he probably gets a W-2 so he gets taxes withheld, he gets FICA tax withheld by the station by the company that employees him, and then he matches half of the FICA as well so it’s 7.65% the company pays 7.65% that they employee pays but when you are self-employed you actually have to match both halves with is 15.3% right off the top and so that would be a pretty good argument for incorporating and we don’t really have the time to talk about that on the show today but you do see people who forget to file that schedule SE which stands for self-employment when they file their tax return with their schedule C.
KATRINA MADEWELL: Pat actually has several businesses so I’m sure, are you paying your self-employment tax Pat?
PAT: Oh yeah that’s why every year I have to sell shares of my stock just to pay my taxes.
DARRIN T. MISH: I want to buy some of those shares I think.
KATRINA MADEWELL: I’m curious why self-employed people never I shouldn’t say never but why a lot of self-employed people don’t pay their taxes on time and I think you know for me for being self-employed for so long like now I kind of got it down but a lot of people like their income fluctuates and I think maybe they don’t know but they should still take that 15% and just…
DARRIN T. MISH: Did you just seriously ask that question after doing this show for almost a year? The reason that self-employed people don’t you know pay their taxes on time is because there is no automatic mechanism to make it happen. Back before…..
KATRINA MADEWELL: I know but they know it’s coming is what I’m saying so why not pay it?
DARRIN T. MISH: Because it is a negative thought and so you do it.
PAT: Put it off as long as you can you know you have to pay it then and just do it then.
DARRIN T. MISH: Absolutely
KATRINA MADEWELL: Is it self-discipline I guess as opposed to like your W-2’s so they are just going to take it out.
DARRIN T. MISH: Well let me give you some historical perspective before about 1920 and I do not know if that is the exact date but there was no automatic withholding from paychecks for people that were wage earners so what happened is everybody in America who is liable to pay income tax just got a big bill at the end of the year or April 15th and so obviously there were some compliance problems because and also if it’s not forcibly withheld and you have to pay that big chunk you know once a year then it causes taxpayers to realize how high the tax rate actually is ok.
KATRINA MADEWELL: Oh yeah.
DARRIN T. MISH: So congress decided hey we are going to go ahead and treat you know what 80% of the workforce, 80% of the population just like lemmings and we are going to just go ahead and take it out of there check you know from force withholding on the front end and that way they won’t realize how much money we are actually taking, how much money we are actually spending and how high the tax burden actually is. But there is no real way to do that on the 1099 side because you know the government can’t get in the way of that self-employed person and their customers. So I think that is really the reason why self-employed people have so much trouble is because again like you said it fluctuates and what not so you have to set up some kind of discipline in order to get that done correctly and we talk about real estate agents all the time, they should take out some reasonable percentage out of every closing and remit it to the IRS in the form of an estimated tax payment.
KATRINA MADEWELL: See again I don’t pay myself like everyone else in this business takes a commission, I take a salary.
DARRIN T. MISH: Yeah and that’s and right and you take a salary you have withholdings from your paycheck from your corporation right I think that is a more sophisticated…
KATRINA MADEWELL: Dividends, distributions
KATRINA MADEWELL: But I am like so disciplined I don’t need to write myself a check without doing that online payment.
DARRIN T. MISH: Yeah that’s great I mean that’s the absolutely way it ought to be done but you know it’s kind of rare. I think that online payment is a good point in that I think it’s only been a year or two that the IRS had the ability for taxpayers to just log onto a website and pay by ACH or by credit card like almost every other business had for at least 10 or 15 years.
KATRINA MADEWELL: It makes a difference though.
DARRIN T. MISH: It does it’s actually easier right it’s psychologically perhaps for some people a little bit easier to just go ahead and pay it online then to write that check with all of those zeros on it that you have to send in.
KATRINA MADEWELL: Absolutely I would agree. So the 3rd one on our list is work-related deductions.
DARRIN T. MISH: Yeah and this kind of dovetails into what I was talking about earlier with the travel related stuff. You know if you’re work-related deductions are disproportionate to your income that you are bringing in then you are probably going to get an audit right so if you back to my example if you had a $100,000 in income and you have a $120,000 in work related deductions every year, year after year it’s probably going to be a red flag for the IRS to go ahead and take a look to just see what is going on there.
KATRINA MADEWELL: Oh man I hear the music already it’s about that time ah number 4 just so you will stick around throughout the break is failure to file a tax return it’s a good one.
DARRIN T. MISH: A lot more common than most people know right.
KATRINA MADEWELL: He gets it all the time. Darrin has story after story where people haven’t filed in 20 years and it’s amazing like Disney poof you make it go away.
KATRINA MADEWELL: You are listening to the IRS Solution Attorney show with Darrin T. Mish I’m your co-host Katrina Madewell we’ll be back in a minute.
KATRINA MADEWELL: You are listening to the IRS Solution Attorney show and if you’re just tuning in with us today’s topic is 15 Flags that could trigger an IRS Audit. Pretty right on time for March.
DARRIN T. MISH: Yep we better hurry up cause we are on like number 4 and we don’t have that much time today so.
KATRINA MADEWELL: Failure to file a tax return.
DARRIN T. MISH: Yeah you know this is actually really common we call them non-filers in the business. My favorite story I’ve shared this many times on the air was a gentleman who came in he was visibly trembling and shaking and came into the office and he wanted some help with a tax problem so we sat down and I asked him what the problem was and he says well I haven’t filed tax returns in a long time, I said ok that’s fine, that’s normal or in my practice at least. How long has it been, he said well a long time, alright I’m used to it hit me with it. He says well 1960 was the last time he had filed a tax return and that’s probably in 2010 or something like that. And so I actually got a big grin on my face and I started laughing, but I wasn’t laughing at him though I was laughing along with him because I knew that he would only need to file the last 6 years returns to be considered current and caught up, and the irony was I was born after 1960. So we got him worked out and it all got settled up and he got to go on with his life but you know actually the failure to file a tax return can trigger an audit, it’s called when the taxpayer doesn’t file a tax return the IRS can repair something called a substitute for a return or an SFR. And what they do is for self-employed people who get 1099’s, this happens quite a bit they just take their 1099, they add up all the 1099’s multiply times tax rate, no deductions and no expenses and they’ve got the income side correct and they go ahead and assess the tax cause the taxpayer and that’s not a good thing.
KATRINA MADEWELL: If they do that can that be amended?
DARRIN T. MISH: You can file, you have the right to file a subsequent original tax return to reduce the liability and we do that quite a bit that’s very common in our practice but that is a type of audit and it’s not the kind of audit that most people want to go through.
KATRINA MADEWELL: So we talked about this one a little bit last week but number 5 is claiming dependents and ex-spouse claims. This is a good one, baby’s momma.
DARRIN T. MISH: Yeah, I was going to say that but…..
KATRINA MADEWELL: I had to take it from you baby momma ….
DARRIN T. MISH: I didn’t think that was all that polite. What happens is when you have a you know a divorce situation or parents that aren’t together there’s actually a race to file your tax return to claim the kids and it doesn’t matter really what the court order says, with who can claim the kids or not. The IRS is going to go ahead and honor the first person who claims the kids….
KATRINA MADEWELL: Which I think is ridiculous because you know there is some just doing that every year.
DARRIN T. MISH: Oh yeah I’m sure there are people that run out there probably January 2nd and file their tax returns just so they can claim the kids. But you know if you both claim the kids then you both are going to get some kind of audit because the 2nd person that claims them is not going to be allowed so….
KATRINA MADEWELL: But they are usually going to be the one with the trouble because they filed 2nd.
DARRIN T. MISH: There is one thing we haven’t touched upon is that there is several kinds of audits, right? So there is the audit that we all really fear and that is the in-office audit right?
Where they either come to your office which is really bad or you go to their office which is almost as bad and you have to bring the big box of documents and the proof and substantiation and stuff but there’s also correspondence audits and that’s what one of the things that we’re touching on today is that like in the case of you know claiming dependents that somebody else has already claimed, you probably not going to get an in-person audit you are going to get a correspondence audit you are going to get a letter that says beep you know do over you know because you claimed this child that you are not entitled to because somebody else already claimed them you owe us x amount of tax do you agree or disagree and then kind of goes on from there.
KATRINA MADEWELL: How does that differ though from a regular audit cause I didn’t even know there was different types of audits.
DARRIN T. MISH: There correspondence audit is usually limited to one issue sometimes 2, it’s very limited to a single issue so it’s a little bit easier to deal with. The hardest audits are the forget the exact term but it’s basically where they do a statistical audit cause they want to see everything, every single thing that you claimed and those are the hardest because..
KATRINA MADEWELL: What triggers that one?
DARRIN T. MISH: It’s purely random and they don’t do them all the time they only do them during certain periods of times so they might have like they do some audits of I’ve actually talked to people that have had these but I’ve never handled one but you just get an audit notice that say, well for purely statistical purposes we are going to see we are going to audit your entire return and we’ll see what’s up and what they do is they do you know thousands of these across the country to see where the problem areas are so they know…
KATRINA MADEWELL: What to fix what to change on there end.
DARRIN T. MISH: What to fix and who to audit you know more often, what types of tax payers for example.
KATRINA MADEWELL: So number 6 on our list for 15 Red Flags that could trigger an audit is medical expenses.
DARRIN T. MISH: Yeah you see this a lot because there is a limit to how much you know how much your medical expenses have to be before you can deduct those on a schedule A and medical expenses are an itemized deduction and I believe they have to exceed 10% of your adjusted gross income, so think about that that is a pretty high number right?
KATRINA MADEWELL: I think so yeah that would be like you went to the hospital from a car accident.
DARRIN T. MISH: So if you earned $75,000 a year that mean’s your out of pocket medical expenses had to exceed $7500 before you can itemize those and put them on your tax return and that’s relatively rare so often what you’ll see is you will see people that take you know what the hospital billed them the insurance paid some of that and things like that so..
KATRINA MADEWELL: So that’s what they are looking for is to see what you actually paid
DARRIN T. MISH: Yeah trying to see what is actually deductible.
KATRINA MADEWELL: Alright so number 7 on our list is omitting income, that never happens, never happens omitting income?
DARRIN T. MISH: If I had a nickel for every time a person said I forgot to put a 1099 on my tax return
KATRINA MADEWELL: They send them late we’ve talked about that.
DARRIN T. MISH: They do, they do but if you have some sort for calculating your income, system can be really simple like every you know all cash and checks get deposited into checking account and then you can add up those at the end of the year if you have some kind of rudimentary system you shouldn’t have a problem with this but it happens a lot where people you know the 1099 they didn’t get it they lost it they forgot about it whatever but if the, we talked about this in the past, and that is that the IRS is going to match what’s on your tax return to the information returns that they receive on the other end so that the W-2’s and the 1098’s and the 1099’s and all of those things they are going to match the computer’s going to automatically match that so if you are a self-employed person and you’re reporting $50,000 income on a Schedule C and the 1099’s equal $60,000 in income you are going to get audited 100% of the time every single time so this is one of those that you just can’t…
KATRINA MADEWELL: Plus playing with fire there going to get the information so you might as well make sure that it is right.
DARRIN T. MISH: Yeah I mean there is no you’re not going to get away with that one you could probably get away from overstating expenses a lot easier then understating income that is reported to the IRS.
KATRINA MADEWELL: Right, right because they already have the numbers. Number 8 is charitable donations, thinking those deductions right, the charitable donation deductions.
DARRIN T. MISH: Yeah these rules got tightened up in the last several years and that now we didn’t used to have to prove our charitable donations, for example you could just put cash in the collection you know basket at church and you could kind of just make up that number but in the last say decade the IRS has really tightened us up until then you are going to get those receipts, you know those statements at the end of the year from all your charitable organizations. One other area that I see that causes some audits is the donations to Salvation Army and Goodwill and things like that.
KATRINA MADEWELL: Yeah that is what I was going to say because they don’t usually put anything on that we talked about that.
DARRIN T. MISH: Yeah so you are going to want to if you are going to donate those items first of all I think you should donate those items that you are not going to use I think it just makes a lot of sense it’s just the right thing to do but if you are going to write that stuff off, you’re going to want to write down on the receipt every single thing that you donated so one dress shirt value $6, for example one sofa value whatever $65 whatever it is.
KATRINA MADEWELL: You can look up on their website and get an idea what something like that sells for.
DARRIN T. MISH: Yeah there’s lots and lots of websites that can help you understand like the items that you donate what they are worth and I actually think that I mean this is kind of strange but taking everybody has a you know a camera in their pocket nowadays just take a picture what you donated especially if they are big items you know a bag of clothes I don’t know if you are going to take pictures but if you are going to donate it..
KATRINA MADEWELL: You’re donating a bunch of stuff…
DARRIN T. MISH: A car, a boat, a sofa, a dresser, a bunch of furniture things like that you should take photos because you just never know and it’s easy to…
KATRINA MADEWELL: It’s always better to have more documentation than not enough.
DARRIN T. MISH: Yeah my nightmare is when somebody comes into the office and they want audit representation and I look at the audit paperwork and help them narrow it down the issues ok these are the things that the IRS wants to look at and then I say so tell me about your documents and almost without fail I hear the fire, flood, hurricane story. You know, oh I don’t have any records to substantiate that stuff because they are gone.
KATRINA MADEWELL: So what happens in that case?
DARRIN T. MISH: Well I don’t take I don’t take a lot of those cases because I only represent people that have realistic expectations right, so if that’s if that’s the story and they say I really don’t owe any money and I want you to fight this all the way to the supreme court, you hear that a lot, you got to give me some bullets for the gun and documents and proof. Substantiation are the bullets so if you don’t give me bullets for the gun I’m not going in to get my head kicked in because it’s not a fun scenario and you’re not going to be happy later as a client.
KATRINA MADEWELL: Is there any rules though or anything like let’s say they did have a house fire and they can legitimately prove that insurance claim is there any rules within the IRS that would help them?
DARRIN T. MISH: Yeah there are let’s talk about that after the break and things that can be substantiated even if you don’t have the documentation.
KATRINA MADEWELL: Sounds great you are listening to the IRS Solution Attorney show today’s topic is 15 Red Flags that could trigger an IRS Audit if we have time at the end of the break we will take your calls 888-404-1010 it will be the latter part of the show 888-404-1010 we will be back in a minute…
KATRINA MADEWELL: Welcome back you are listening to the IRS Solution Attorney show with Mr. Darrin T. Mish, I’m your co-host Katrina Madewell today’s topic is 15 Red Flags that could trigger an IRS Audit.
DARRIN T. MISH: So before the break we were talking about things that that could be proven even if they weren’t…
KATRINA MADEWELL: Well we were talking about like if someone got a notice to get audited and they said they can you help you me and oh I had a house fire, I don’t have anything…
DARRIN T. MISH: That’s right so yeah
KATRINA MADEWELL: My question was does the IRS take exception to that but if you could prove look I’ve got an insurance claim my house really did burn down or I had a flood I really have nothing…
ARRIN T. MISH: Yeah but in that case I don’t think you are going to have a dispute with the IRS that you know the flood actually happened or that the fire actually happened but you still run in the problem of ok how do we substantiate these deductions that you take, that you took, you don’t get just a free pass oh sorry that’s terrible your house is burned down we are just going to go with it, you know let the audit go, no that’s not how it works. I wish it did that would be great.
KATRINA MADEWELL: Well that is why I was asking if there is a provision in the law that allowed for that.
DARRIN T. MISH: I think it would encourage arson but.
KATRINA MADEWELL: You could have a very legitimate point on that one Darrin.
DARRIN T. MISH: Audit notice equals you know house fire..
KATRINA MADEWELL: See I have way to much paper already so it all gets mailed off in that little blue envelope every month.
DARRIN T. MISH: Yeah exactly so what happens is there is a rule called the Cohan rule, I’m saying that for a case that was decided back in the 30’s and basically it stands for the proposition that if you have expenses or deductions that are obviously part of your business or enterprise that you are engaged in then you may be given some reasonable allowance even if you can’t substantiate them so let me give you an example: At my office you know I have a standalone office building and the utilities are not included and I obviously write off the electricity bill right because without electricity what happens?
KATRINA MADEWELL: You can’t turn on the computer.
DARRIN T. MISH: Yes we are sitting in the dark and if you are really hot or really cold and in a conference room and we can’t get anything done you know everybody would have to use pen and paper and it just wouldn’t work. Obviously electricity for most businesses is going to be an expense that you are not going to have to prove with any high degree of certainty happen because it’s kind of obvious that it happened. A real estate agent is going to be entitled to some mileage because you’re going to have some showings you’re going to have some driving, you’re probably not going to get what you claimed but you are going to get something.
KATRINA MADEWELL: The only consistency from one year to the next?
DARRIN T. MISH: Maybe that could be a pretty good argument but not necessarily.
KATRINA MADEWELL: It’s all in the logistics I’m sure right?
DARRIN T. MISH: Yeah there is a lot of details that go on here and so we are going to have at that point the argument of well was it the electric bill you know $300 a month or was it $500 a month
KATRINA MADEWELL: Right
DARRIN T. MISH: So the IRS is probably always going to come down on the lower end and the taxpayer is going to want to come out on the higher end.
KATRINA MADEWELL: Of course, and that is where you come in the middle I suppose.
DARRIN T. MISH: Yeah and we try and get it worked out
KATRINA MADEWELL: So number 9 is no health insurance, we talked about this with those lovely penalties.
DARRIN T. MISH: Yeah this is one of the newer things I mean this is only been a few years where you can actually get penalized if you don’t have health care for the entire year.
KATRINA MADEWELL: So this now triggers and audit? Really?
DARRIN T. MISH: You could get a correspondence audit for sure if you don’t check the correct box on the tax return this is the first year where you have to check the box I believe and if you don’t have the correct documentation I think it is a 1095 is the form that you get from your insurance company nowadays that says that you had coverage for the entire year and I just love the name…
KATRINA MADEWELL: I don’t think we got that.
DARRIN T. MISH: I love the name that the government came up with it was kind of Orwellian they call it a shared responsibility payment.
KATRINA MADEWELL: I can never remember that.
DARRIN T. MISH: I will never forget the very first time that I saw a client’s you know basically their penalty notice from the IRS and it said shared responsibility payment actually had to go ask somebody what the heck that was cause I had never seen one but it’s becoming more and more common.
KATRINA MADEWELL: Why wouldn’t they name it something that would actually make sense like no insurance penalty you know?
DARRIN T. MISH: Health care penalty would make sense.
KATRINA MADEWELL: Anything that makes sense other than shared responsibility. Number 10 is child support, how in the heck is that something that could trigger an audit?
DARRIN T. MISH: Well they are not deductible so you see people deduct them you know from their tax returns…
KATRINA MADEWELL: Really?
DARRIN T. MISH: And they are not deductible so…
KATRINA MADEWELL: Yeah you just get to deduct the kid.
DARRIN T. MISH: Right. That’s if you win the race to file, but really the actual answer is that you should go by the you know the court order in the divorce and the family law issued and whatever the judge declared in that case.
KATRINA MADEWELL: So number 11 is divorce settlements, that’s tax deductible? Divorce settlements?
DARRIN T. MISH: Well…
KATRINA MADEWELL: Is that like we split the house or we split the car or we split something?
DARRIN T. MISH: This happens a lot where you should go ahead and use a stereotypical husband paying alimony to wife right? The husband might try to write off the alimony. Seems like something you should be able to write off cause it’s an expense and you know it seems like a burden to pay the alimony but no no no you don’t get to write the alimony off the person receiving the alimony has to report that alimony as an income…
KATRINA MADEWELL: That seems a little off doesn’t it?
DARRIN T. MISH: Well hey talk to Congress there the people that pass these crazy laws.
KATRINA MADEWELL: So number 12 on our list is Rental losses that triggers an audit?
DARRIN T. MISH: Well sure it could if you have you know what you see quite often is you have people who have a second home that is in like a vacation sort of lo-cal like Florida for example and it’s near the beach for example and it doesn’t ever get rented out because really they are declaring it a rental. They are using it as a second home as a vacation destination and they rent it out just a few days a year in order to cause a Schedule E so they can get the depreciation and the different repair expense and things like that and yeah for sure if you are not renting the house out on a regular basis it may very well trigger an audit if you know consistently showing losses year after year.
KATRINA MADEWELL: But how does Air B&B play a role in that?
DARRIN T. MISH: Well you know with these new websites where you can kind of rent out, I don’t know that much about it I want to try it.
KATRINA MADEWELL: Air B&B is like I want to rent a room in my house and you can come stay with me almost like a bed and breakfast which just in my house.
DARRIN T. MISH: Yeah I mean with the advents of these travel sites where you are renting out your house or part of your house for just nights or weeks at a time you kind of in this hybrid situation where is that a real rental or not? Is that really your house or is it a rental what is that in so the problem isn’t in just having Schedule E and reporting income is where you are generating what look to be artificial losses from that rental activity. Does that make sense?
KATRINA MADEWELL: Yeah it does.
DARRIN T. MISH: Because you know especially higher income people want to generate losses because they want to offset their legitimate income.
PAT: What if you have squatters next door and they come and take a bath in your hot tub?
KATRINA MADEWELL: Where do you get this stuff Pat?
PAT: Well I have a crazy neighborhood.
KATRINA MADEWELL: Random.
DARRIN T. MISH: Did that actually happened?
PAT: All the time I mean every morning there are squatters in my hot tub. Can you write that off?
DARRIN T. MISH: I wouldn’t know how to calculate the write off if it was a theft or casualty loss like if they did damage, yes you can write that off.
PAT: Can’t you do it by numbers with how many cause there is 3 or 4 sometimes.
KATRINA MADEWELL: That may bring up another whole point with me that Darrin doesn’t like to talk about with me I bring it up way to often.
DARRIN T. MISH: I think what we to do in that case Pat is we need to put a big No Trespassing sign in the backyard so that when they do show up you can call the police and get them thrown in jail.
KATRINA MADEWELL: Lock on the hot tub.
KATRINA MADEWELL: Just some thoughts.
DARRIN T. MISH: Yeah like a locking cover would be good or don’t do this, but I’m sure it would be funny like corrosive liquid inside the hot tub that would be kind of interesting.
KATRINA MADEWELL: It sounds like a lawsuit Darrin you’re an attorney.
DARRIN T. MISH: Or just don’t don’t clean it for a while.
KATRINA MADEWELL: Make it nasty.
DARRIN T. MISH: Yeah so that actually it looks fine but there is all kinds of…
PAT: I tried that, they didn’t mind that.
KATRINA MADEWELL: Ewww I’m not even going to talk about what could be in there. We are going to move along to number 13 which is commuting expenses.
DARRIN T. MISH: All right this is super super common I see it all the time. You can’t actually write off your commuting expenses. Your drive from home to the office is not deductible your drive from the office to home is not deductible.
KATRINA MADEWELL: You are talking about W-2 employees or in general?
DARRIN T. MISH: It’s for anybody, it’s not deductible so I have an office that has a fixed location and I have a home that is a fixed location from the drive from home to the office not deductible. If I drive from the office to the court house that’s deductible and then there’s kind of a cool rule if I drive from the courthouse to home on that day or any day then that is actually deductible but your normal commuting from home to work or work to home is not deductible.
KATRINA MADEWELL: So in the case of somebody like me real estate agents where we don’t really need to leave unless we have to show property deductible?
DARRIN T. MISH: That is a little bit different. I would say that in a real estate agents sort of example that the drive from home to the broker’s office probably not deductible that’s probably more along the lines of commuting so you probably have weekly sales meeting that you are supposed to go to?
KATRINA MADEWELL: No I don’t. I have an office that’s my office in Ludes that is 3 miles away.
DARRIN T. MISH: Ok so I would say that is probably not deductible but if you go show a house and you are in Ludes and you show a house in Tarpon Springs well for sure that that is obviously not commuting that is deductible cause you don’t have a real fixed location like most people do.
KATRINA MADEWELL: Right…
PAT: What about magazines?
KATRINA MADEWELL: Magazines?
PAT: You know like magazines like my wife is a hairdresser and she gets these magazines that tell you how to do all that. Can you write those off?
KATRINA MADEWELL: Why wouldn’t you?
DARRIN T. MISH: For sure those are more along the lines of professional periodicals but I will give you an example I get a lot of those professional sort of trade magazines and those are written off, but you know that magazines that end up in my lobby and waiting area so that you got fishing and sport fishing and yachting and marlin magazines. I don’t write those off those are not I don’t write them off because I don’t thing I think that is a little aggressive, I think that you could make an argument…
KATRINA MADEWELL: So even if you never look at those and you’re purely getting them for your clients you don’t write those off?
DARRIN T. MISH: I literally never look at them I don’t have time I wish I did. I have stacks of really nice good magazines about things that I am interested in in the lobby now that I think about it there is not many that appeal to the feminine side of people so I might have to fix that, I might need to fix that.
KATRINA MADEWELL: Yeah we’ll have Heather chime in there on that one. Number 14 is stock sales.
DARRIN T. MISH: Yeah this is kind of a challenging thing to explain on the radio but remember when you sell stock you have to pay the tax on the capital gain so how do you calculate the gain?
KATRINA MADEWELL: So if you buy a stock for $5 or let’s do $100 you buy it for $100 and you sell it for $125?
DARRIN T. MISH: Well then you have to pay tax on the $25 gain so you have to keep track of that you know in excruciating detail too and most people don’t buy $100 shares of Microsoft at $100 and then sell 100 shares of Microsoft at $125. What do they do? Well they buy 100 shares they sell 35 then they buy another 75 and then they sell 85 and I mean it’s kind of all over the place so you are going to want to make sure you have really good records so that you can calculate what’s called the Basis, the Basis in this instance is the purchase price of the thing of the stock so that you can calculate that and pay only the tax on the gain.
KATRINA MADEWELL: That sounds extremely complex like that could be a whole other job for somebody.
DARRIN T. MISH: Well yeah you actually when you get in the next trigger on here is day trading..
KATRINA MADEWELL: Number 15 Day trading that’s a business?
DARRIN T. MISH: Kind of dovetails real nicely is that what these guys do is they buy a 1000 shares of something on a particular day and they are going to try and be in and out of it on a particular day, this kind of lends me to that really good story that we have of the gentleman that had 22 million dollars due to day trading activity and think we probably ought to get to that one on the other side of this break that’s coming up..
KATRINA MADEWELL: We will we got a few more minutes don’t we? Yeah, we have a few more minutes, we had a question though so let’s answer that real quick before we move on Barry wants to know he says “What does a flat tax mean? I hear politicians talking about it all the time and I’m wondering if you could shed some light on what it is thanks love your show can’t wait to catch it.” Flat tax?
DARRIN T. MISH: I think the flat tax he is referring to everybody paying the same rate so if the flat tax was 15% then it would just be 15% across the board for everybody no matter what their income is.
KATRINA MADEWELL: And ironically we did actually did have a question from Jared which is a day trader and we will have to answer that one after the break. You are listening to IRS Solution Attorney show with Mr. Darrin T. Mish, I’m your co-host Katrina Madewell today’s topic 15 Flags that could trigger an Audit so watch out if you missed this show it’s over on ITunes and everywhere else on the podcast so catch the whole thing we will be back in a minute….
DARRIN T. MISH: Welcome back to the IRS Solution Attorney show I’m your host the IRS Solution Attorney Darrin T. Mish.
KATRINA MADEWELL: And I’m your co-host Katrina Madewell thanks so much for sticking with us hopefully you brought some value to your tax return filing this year of the 15 Things that can Trigger an Audit. Jared’s question was right on time with number 15 and what his question is “I’m a day trader and I’ve been doing my taxes myself for a while now, now that I’m starting to make a lot more money at it after listening to your show I’m thinking I need to have a professional prepare them for me this year. Can you recommend someone in Tampa who can help me with this, getting an audit is the last thing that I want to happen”?
DARRIN T. MISH: Well I can’t believe I got that softball question yeah you can call us at 888-get-mish that’s 888-438-6474 but Jared what you need to worry about in day trading is you really need to match those purchases to the sales, especially if you are dealing with the same stock over and over or if you are not doing perfectly even trades. So let’s say if you are buying 1000 shares of GM and then you are selling 200 shares and you are keeping 800 shares and then the next day you buy 375 shares and then you sell 600 shares what happens is it turns into a mess you literally need an excel spreadsheet or something like that to match the purchases to the sales and you have to be able to calculate the basis on everything and remember the shares of the same kind of stock for the same company are fungible. How do you like that word? Fungible means there the same they are like grain there are like corn in a corn silo, you can’t really tell which you know which grain came from farmer John’ s field or which came from farmer Bob’s field so it creates problems where you have to be able to show and calculate what the basis is and this leads me to one of my favorite stories was a day trader came into the office one time and he, the IRS had prepared a substitute for return and they had generated about a 23 million dollar tax bill, we went back and matched all those trades for several years it took over 40 hours of accounting and bookkeeping time and in the end we ended up generating a $50,000 refund for that client so 22 million is what they owed and $50,000 is what they got back after we were done with them so that was pretty good result.
PAT: What’s that word called?
DARRIN T. MISH: Fungible
PAT: Fungible I think that is what I find in my hot tub.
DARRIN T. MISH: I think that is fungi that you find in the hot tub.
KATRINA MADEWELL: Eww Pat if you have a question we might have a moment to answer it 888-404-1010, 888-404-1010.
DARRIN T. MISH: So yeah it’s really important that on the day trading and on the stock sales that you have the ability to match the sales to the purchases. It’s about that time isn’t it?
KATRINA MADEWELL: That’s the IRS train wreck of the week you just heard.
DARRIN T. MISH: So in this particular case what had happened was an older lady came into the office and she had a pretty good size tax liability spread out over several years. When I asked her what caused you to owe the tax money, very common question I ask clients because I if I sometimes I can go back and kind of fix the problem at the source, she told me well I had a big 1099 C for cancellation of debt in this particular tax year. I said really that is interesting so how did that come about and she said well I don’t really know I had a you know a first mortgage on my house and I had a second mortgage or a home equity line of credit, can’t remember which it was, and she said just out of the blue, I think it was Bank of America, just wrote it off and I got a 1099 C and when I prepared my tax return I had to pay the tax on that cancellation of debt which is kind of crazy but that is what the law is and so she is like so now I owe 29 grand for that tax year. I thought about it and I asked her a few more questions and we were able to identify that she actually qualified for an exemption for paying the tax on that 1099 C cancellation of debt called qualified principle residence. So we went ahead and amended the tax return and we took that tax off and it reduced her tax bill by $26,000 and the IRS actually rejected the amended return. So now what? Most taxpayers at this point go that didn’t work you know we lose and we are going to have to pay the bill well I didn’t like that answer for this particular tax payer so what I did is I went ahead and I appealed, I went to the tax payer advocate and I just did a do over basically I explained in simpler terms this time what the situation was and after about a year and a half, just this past week, we got the news from the IRS that they had written off the $26,000 of excess tax that she really wasn’t liable for and we were able to get that wrapped up for her and so…
KATRINA MADEWELL: So the cancellation of debt did she have a short sale or was it one of the one’s where they wrote off the second?
DARRIN T. MISH: I think she was probably behind, substantially behind, on that second and it seems like there’s a trend right now with the lending institutions there just going ahead and writing those things off.
KATRINA MADEWELL: Well there was a group awhile back and they were something that passed for like a couple of the big name banks, I know this because we experienced it on short sales with they are like oh no I got qualified in this group where the banks just basically wrote it off so they don’t have to pay for it anymore.
DARRIN T. MISH: Kind of sounds like another sweetheart deal for the bank right? I mean they get to write it off they get to write off these bad debts off their balance sheets so they look stronger right but then who gets stuck in the end the same person that gets stuck in the end every single time the tax payer is going to get stuck you know and some of these cases just due to like ignorance of knowing what they are obligations are there going to go ahead and pay tax on that cancellation of debt and the IRS is not going to come out of there way and say hey wait wait wait that was actually qualified principle residence you know debt that you don’t have to pay a tax on.
KATRINA MADEWELL: So how long did that case actually take?
DARRIN T. MISH: That case took about 18 months I mean when he came into the office I was thinking to myself ok this is this is almost as slam dunk as they come this is going to take 3 to 6 months most of that is going to be just waiting time but the IRS was kind of stubborn in this one it took them quite a while to you know eventually come around to my way of thinking.
KATRINA MADEWELL: Do they always let you do a do over or you just have to explain that the right way and see if you can get it?
DARRIN T. MISH: Well, no, they don’t always let you do a do over in my philosophy in dealing with the IRS is I have to explain things extremely in an extremely simple manner. If a child, if one of my kids can understand my argument then I have a good chance of winning if it’s overly complex nobody at the government is going to listen nobody is going to read that stuff nobody can actually put any real thought into it, it has to be a slam dunk, very simple argument and if you can do that then you can win. And that is actually harder than it sounds you know it’s easy to keep things complex it’s much more difficult to you know explain things in simple way that people can understand that you win no matter what.
KATRINA MADEWELL: Well it makes sense to me the simpler the better and so that tax liability was like 20 something thousand?
DARRIN T. MISH: It was like $29,000 and we got it knocked down to about $3000 at the end.
KATRINA MADEWELL: What’s the average time cause I thought they all took a while after doing the show with you but you’re saying that some of them can be knocked out in 3 or 4 months?
DARRIN T. MISH: Yeah if it is a simple issue like an amended return, amended returns only going to probably take somewhere between 2 and 6 months for the IRS to go ahead and accept it and process it. In this case since they denied the amended return and you don’t have a right to an accepted amended return by the way everybody thinks you do but absolutely you do not have a right to an amended return that’s why it’s important to get that tax return filed correctly the first time if at all possible.
KATRINA MADEWELL: Well we had some much fun with you today the whole topic was 15 Red Flags that can trigger an Audit. If you missed it catch the whole thing on a podcast. This is the IRS Solution Attorney show I’m your co-host Katrina Madewell and Mr. Darrin Mish.
DARRIN T. MISH: We’re out!