Archive for category: Audits

In separate reports, Zen99 and the consumer finance web site nerdwallet ranked Los Angeles the best city for freelancers. In 2012, 12% of people in Los Angeles reported themselves as self-employed. Each of these website reports considered housing and health care costs, the percentage of freelancers in an area as factors. Even before the sharing economy began to take off, the entertainment industry and growing tech scene were already strong sources of freelance gigs in L.A.

For freelancers, consultants, actors and other self employed people, life gets complicated come tax time. Digging around for the paperwork to fill out tax forms practically qualify as exercise. Such business people have a nightmare trying to find receipts which is why you should keep track expenses and receipts year round rather than pursuing a paper chase as April 15^th nears.  

Remember when you can’t find receipts, you can’t write off your expenses and therefore you are paying more money to the government instead of keeping it for yourself.

Here are seven don’t – or, deadly sins, for freelances at tax time:

1. Not knowing what they owe.  There are 20 different 1099 forms that get sent out to workers to track freelance gigs.  One of them is the 1099-K, which only has to be sent to you by a company in paper form if you make over $20,000. People think – Great, no paper form, no taxes on that. But that’s a big mistake – you still have to self-report the income.  

2. Not knowing WHEN they owe.  For freelancers who owe more than $1,000 in taxes for a year, tax time comes more often than just April 15^th.  They have to pay taxes quarterly. But then it’s not coming out of paychecks like it does for permanent employees. 

3. Not tracking and writing off the right types of business expenses. Many freelancers fail to realize they can write off part of their cell phone bill as a business expense. Expenses vary by the type of work.  A rideshare driver’s biggest expense will be related to their car, while a web developer’s biggest expense might be their home office. Figuring out what expenses are important to your type of work is important is maximizing your tax savings.

4. Writing off personal expenses.  This goes back to that cell phone.  If you use the same phone for personal and business purposes, don’t be tempted to write the whole bill off. Estimate the amount you use it for your work. The same goes for your vehicle. Don’t go trying to write off miles driven to the beach. 

5. The Double No-No: counting expenses twice.  Speaking of vehicles, most people use the Standard Mileage Rate ($0.56/mile for 2014), which factors in gas, repairs and maintenance and other costs like insurance and depreciation. But if you use this rate, you can’t also expense your gas receipts and repair bills.  

6. Employee AND employer.  Freelancers they play both roles. For regular employees, Federal, State, and payroll taxes are withheld from a paycheck, and distributed on the employee’s behalf. It’s how Social Security and Medicare are funded. The IRS mandates that the employer must pay half of every employee’s payroll tax, and the employee is responsible for the other half.  Independent contractors have to handle both halves.  The IRS does give you a small benefit by letting you deduct the half that you pay yourself as a business expense but don’t believe that because of this a freelancer pays less taxes than the regular wage-working employee.  

7. Not keeping adequate records. The IRS requires you to keep proof of all business receipts, mileage, etc.  If you can’t show these, the IRS could refute the expense and force you to pay back taxes. The good news is there are other ways to prove expenses if you’ve lost the receipt. A bank or credit card statement with the date and location might do the trick. The IRS may be accommodating if you are doing your best but if you’re being a headache, they’re going to be a headache as well.

What the tax man looks for.

It is a statistical fact: Self-employed individuals are much more likely to get audited than regular employees.

A tax auditor is looking for certain things when they audit you and your business. The IRS training manuals note that the auditors are examining you and not just your business tax return. Your lifestyle may be checked against your reported income to see if there is a discrepancy which shows skimming, diversion of funds or deception. For example, that mansion with the truck-mount van parked out front may send up the wrong “economic reality” flag.

Travel and entertainment deductions in a business are usually suspect as some people try to deduct personal entertainment and meal “business” expenses. You must be able to clearly explain the business relationship in a credible fashion. Taking your friends out to the ballpark or taking the family on a vacation to that industry conference may not quite pass the litmus test of an audit. Writing off your legitimate business entertainment expenses requires detailed explanation of the reason for the expense, as well as a receipt.

Your calendar will undoubtedly be scrutinized to make sure there are no glaring gaps between possible work, vehicle or equipment usage and the income reported. As an example: If you are claiming 100% business vehicle usage but your calendars do not confirm the times and locations of service stops, you may be open to an analysis of possible personal use of the vehicle. Entries in a business diary or calendar help to justify an expense to an auditor as long as it appears to be reasonable.

Business credit cards are also highly scrutinized as they have a high potential for misuse (such as use for a personal vacation or personal expenses). Keep these only for legitimate business expenditures (places where company checks won’t do). Too many times a small business owner says that they will “reimburse the business later” for that personal expense put on the business card. That routine just opens you up for closer inspection.

Don’t Take The Chance And Lose Everything You Have Worked For.

Protect yourself. If you are selected for an audit, stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important to that you’ve hired the best lawyer for your particular situation. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Los Angeles, San Diego San Francisco and elsewhere in California are highly skilled in handling tax matters and can effectively represent at all levels with the IRS and State Tax Agencies including criminal tax investigations and attempted prosecutions, undisclosed foreign bank accounts and other foreign assets, and unreported foreign income.

Description: Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. resolve your IRS tax problems to allow you to have a fresh start.

Your business is growing and you are prospering. Business is good. Life is good. Then the unbelievable happens, which turns your world upside down and pushes you into pure panic.

This panic mode is instantly brought on by receipt of an IRS audit letter.

Most of us don’t fear something exploding or catching on fire as much as we fear an IRS audit. Of course, the best way to survive a tax audit and even to come out of it successfully is not to panic, but to prepare.

Take it seriously.

Even though IRS audits are fairly routine events, they should be taken with the utmost of seriousness. In the event you receive an audit letter, you should immediately spring into action to ready yourself for the audit. The IRS usually sets the time and place for the audit. If you try to put it off, any penalties and interest will just become that much bigger. If you choose to represent yourself, you should adjust your schedule to comply with their date. Think of not showing up for an audit the same as not showing up for trial in a courtroom. It is that serious.

The really, really bad news.

If you think there is nothing worse than you getting from the IRS than a standard or routine IRS audit letter – continue reading …

You can be investigated by the IRS through a civil tax audit (which is very serious) or through a criminal investigation (which is even more serious). The criminal investigation arm of the IRS can come bearing badges and guns, as it is an investigation of fraud against the United States government. In any such investigation, the IRS can (and probably will) obtain your bank records and other financial records, both business and personal.

Virtually all small businesses involve close ownership with profits or losses going ultimately to the business owner. This is why the IRS looks closely at your personal accounts. Any instance of depositing unreported income in a bank account will probably show-up in an IRS audit. Small businesses which prepare their own tax returns (as opposed to going through a tax professional such as a CPA) are more likely to be audited.

Why does the IRS exercise extra scrutiny over small businesses?

The IRS especially scrutinizes the self-employed because the agency claims that most tax cheating is done in small businesses. There is some logic to this because, in a self-employed business, there are many more opportunities to blur the difference between business expenses and personal expenses. Also, many self-employed people put the idea of proper record-keeping and the cost of hiring accounting and tax professionals at the bottom of their priority list. It is not uncommon for business owners to concentrate more on the operational side of the business than to properly accounting for the true business expenses and deductions.

It is a statistical fact: Self-employed individuals are much more likely to get audited than regular employees.

What the tax man looks for.

A tax auditor is looking for certain things when they audit you and your business. The IRS training manuals note that the auditors are examining you and not just your business tax return. Your lifestyle may be checked against your reported income to see if there is a discrepancy which shows skimming, diversion of funds or deception. For example, that mansion with the truck-mount van parked out front may send up the wrong “economic reality” flag.

Travel and entertainment deductions in a business are usually suspect as some people try to deduct personal entertainment and meal “business” expenses. You must be able to clearly explain the business relationship in a credible fashion. Taking your friends out to the ballpark or taking the family on a vacation to that industry conference may not quite pass the litmus test of an audit. Writing off your legitimate business entertainment expenses requires detailed explanation of the reason for the expense, as well as a receipt.

Your calendar will undoubtedly be scrutinized to make sure there are no glaring gaps between possible work, vehicle or equipment usage and the income reported. As an example: If you are claiming 100% business vehicle usage but your calendars do not confirm the times and locations of service stops, you may be open to an analysis of possible personal use of the vehicle. Entries in a business diary or calendar help to justify an expense to an auditor as long as it appears to be reasonable.

Business credit cards are also highly scrutinized as they have a high potential for misuse (such as use for a personal vacation or personal expenses). Keep these only for legitimate business expenditures (places where company checks won’t do). Too many times a small business owner says that they will “reimburse the business later” for that personal expense put on the business card. That routine just opens you up for closer inspection.

Don’t Take The Chance And Lose Everything You Have Worked For.

Protect yourself. If you are selected for an audit, stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important to that you’ve hired the best lawyer for your particular situation. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Los Angeles, San Diego San Francisco and elsewhere in California are highly skilled in handling tax matters and can effectively represent at all levels with the IRS and State Tax Agencies including criminal tax investigations and attempted prosecutions, undisclosed foreign bank accounts and other foreign assets, and unreported foreign income.

Description: Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. resolve your IRS tax problems to allow you to have a fresh start.

So where a business has been treating its workers as independent contractors and there is a concern that the IRS in an audit would not respect this arrangement, what can the business do?

The business should consider entering into the IRS’ Voluntary Classification Settlement Program (VCSP). The VCSP is a voluntary program that provides an opportunity for taxpayers to reclassify their workers as employees for employment tax purposes for future tax periods with partial relief from federal employment taxes. To participate in this voluntary program, the taxpayer must meet certain eligibility requirements and apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.

What is the eligibility for this program?

The VCSP is available for taxpayers who want to voluntarily change the prospective classification of their workers. The program applies to taxpayers who are currently treating their workers (or a class or group of workers) as independent contractors or other nonemployees and want to prospectively treat the workers as employees.

A taxpayer must have consistently treated the workers to be reclassified as independent contractors or other nonemployees, including having filed all required Forms 1099 for the workers to be reclassified under the VCSP for the previous three years to participate.

Additionally, the taxpayer cannot currently be under employment tax audit by the IRS [income tax audit is OK] and the taxpayer cannot be currently under audit concerning the classification of the workers by the Department of Labor or by a state government agency.

If the IRS or the Department of Labor has previously audited a taxpayer concerning the classification of the workers, the taxpayer will be eligible only if the taxpayer has complied with the results of that audit and is not currently contesting the classification in court.

So for a business that qualifies for VCSP what are they looking at for penalties?

A taxpayer participating in the VCSP will agree to prospectively treat the class or classes of workers as employees for future tax periods. In exchange, the taxpayer will:

• Pay 10% of the employment tax liability that would have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of section 3509(a) of the Internal Revenue Code;
• Not be liable for any interest and penalties on the amount; and
• Not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified under the VCSP for prior years.

The VCSP is a valuable program that a business owner should consider.

Protect yourself. If you are selected for an audit, stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important to that you’ve hired the best lawyer for your particular situation. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Los Angeles, San Diego San Francisco and elsewhere in California are highly skilled in handling tax matters and can effectively represent at all levels with the IRS and State Tax Agencies including criminal tax investigations and attempted prosecutions, undisclosed foreign bank accounts and other foreign assets, and unreported foreign income.

Description: Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. resolve your IRS tax problems to allow you to have a fresh start.

If the IRS asked to examine your business’ Federal Tax returns, would you survive the audit? For Jade Phuong who operates a nail salon, it was a nightmare that came very close to ending her business.

Before the IRS turned her world upside down, Jade already had beaten the odds as a small-business owner. Her nail salon had been operating more than eight years, a considerable accomplishment considering that most small businesses fail in less than three years. Living at home with her mother, Jade saved enough money to open her nail salon fresh out of nail school at age 25.

Despite a rocky start, Jade was able to build up her business and after a couple of years was able to enjoy a good living from her nail salon. In fact things were going so well that when a space almost twice the size of her current location opened just two doors down, she decided to move to the bigger space and expand into the tanning business by installing six tanning beds in the new space. Jade was feeling good, everything was going great. She bought her first house and moved into it. Jade finally attained the American dream.

Then two weeks later she got the letter from the IRS.

The Longest Year

The letter from the Internal Revenue Service was innocuous enough – mixed in with the salon’s mail, it looked just like any other piece of business correspondence.

When Jade realized that it was indeed from the IRS, she felt a twinge of concern, but not panic. As a business, Jade would periodically get notifications and letters from the IRS or the State but this letter was different. Jade opened the letter and read the words, “Your Federal tax returns for the selected tax years have been assigned to me for examination.” The vague sense of unease Jade originally felt was now panic in full bloom.

Jade immediately got on the telephone with her accountant and told him of the letter she received. She even faxed him a copy so he could see it for himself. Sure enough Jade’s last three years of business income tax returns were selected for examination.

Her accountant said don’t worry as he felt confident that this was just a random audit and that Jade’s recordkeeping and reporting to the IRS was done by the book. So the accountant told Jade to contact the IRS agent and arrange for him to come to the business and meet her and look at the business’ books and records.

And so Jade contacted the IRS agent and scheduled a meeting at the salon.

The IRS agent came to the salon and he was business-like, but very pleasant – the agent seemed like someone you could talk to. Apparently the IRS agent very much wanted Jade to think this audit wasn’t a big deal so Jade would open up to the agent.

The meeting lasted two and a half hours and the agent asked a lot of questions:  When did we open? How are we set up? Who set up the business organization? Do we write off our car? What kinds of benefits do we give workers? Where do we buy our boutique items?

After leaving the salon that day, the IRS agent went to the office of Jade’s accountant, where the agent spent six hours reviewing the business’ corporate records, check registers, bank deposit slips, car mileage logs, and other papers. The agent returned to the accountant’s office for three additional days.

The examination of Jade’s records was exhaustive and comprehensive but the accountant was confident that the agent would be able to agree with just about everything as reported on the tax returns. The accountant even told this to Jade and further added that he would be very surprised if the proposed liability was more than $1,000.

“You’re joking … Right?”

And a few weeks thereafter, the IRS agent issued a letter. What the agent concluded in that letter about Jade’s business was a shocker. Jade had been classifying her workers as independent contractors. The IRS agent felt they should be classified as employees and under this classification Jade would now owe the IRS $85,000.

Jade was confident that her setup was legal and legitimate because before she even opened the nail salon’s doors, she had consulted and paid a CPA to help her write the business plan and set up the business, including how to classify her workers. The CPA set up Jade’s nail technicians as independent contractors. The CPA said he represented a lot of beauty salons, and he said that’s how all the salons were classifying their workers.

But the IRS agent did not agree.

In a nutshell, the IRS agent based his determination on five factors:

1. Realization of Profit or Loss…There was no element of risk for the nail technicians because they did not bear any of the financial burdens of the nail salon, such as rent, utilities, and insurance.

2. Significant Investment … None of the nail technicians had any significant financial investment in the shop. All the investment was by Jade.

3. Integration … The services of the nail technicians were fully integrated into the business operations – meaning that without the services of the nail technicians, Jade could not have continued business operations as a successful nail salon.

4. Payment by Hour, Week, and Month … Upon completion of each customer serviced, the nail technicians then turned over the total received to the Jade. The nail technicians could not retain these payments from customers.

5. Set Hours of Work … The business did not require the nail technicians to work set hours, but Jade allocated the hours the nail technicians would be available.

Well this was not acceptable to Jade so she hired a tax attorney to appeal this determination and fight the IRS.

Despite the IRS agent’s assertion that the workers should be treated as employees, Jade had some good facts favorable to her entitling her to treat the workers as independent contractors.

For one thing, a few years earlier she received a form letter from the State requesting that she complete a questionnaire about her workers and return it to the State. She completed the questionnaire and soon after received a letter from the State confirming that her workers were independent contractors.

In the questionnaire Jade noted that the nail technicians set their own hours. They didn’t get any benefits from the business. Everyone paid their own taxes and they knew they were responsible to pay for their own taxes.

Despite building a case to support classification of the workers as independent contractors, the position of the Appeals Officer at the IRS Office Of Appeals was that Jade still maintained enough control over the workers that they should be treated as employees.

Now this determination could be appealed to the U.S. Tax Court but to fight the IRS in court meant as much as $25,000 in legal fees, plus the $85,000 for the three years if Jade lost. But there was another option for Jade.

If Jade were to agree to convert her workers to employees and now start taking out taxes, provide worker’s compensation and liability insurances, and pay the employer’s share of their future earnings in Social Security taxes, and supply them completely, the IRS would substantially lower the liability for the prior years. In Jade’s case the liability would now drop below $20,000.

Jade said at this point I have got to go with this option. So she made the changeover and paid the $20,000 to IRS. Turns out only two nail technicians left due to the changeover in worker status.

Older and Wiser

Things are looking good again to Jade who says the nail business is stronger than it’s ever been. She has increased her business, which has increased her income. She also recently upgraded her tanning salon with all new stand-up beds. Just like when she first opened, it’s the tanning beds that are pulling the salon through in the slow times.

She also has eliminated some things, like entertainment expenses and she started buying product in bulk to cut down costs. After the switch in worker status to employees, Jade raised service prices by about 5% to help cover the now higher costs of doing business. To her surprise, it didn’t hurt business at all. It was Jade’s first price increase in nine years anyway, so it was time. Jade does not know of one client who left as a result of these changes.

Jade’s story serves as a good lesson to anyone operating a business or looking to start a business which is that you need to know the rules and follow them. Don’t think that you are immune from the IRS questioning your business.

Starting in 2015, businesses with at least 50 full-time employees must offer affordable health insurance to all employees or substantial penalties will be imposed. If independent contractors are converted to employee status, this may result in a company having more than 50 full-time employees. Also, the IRS is starting a project to conduct 6,000 random audits over a period of three years with worker classification/misclassification as a key focus. The IRS anticipates that when the project is completed, it will pursue employment tax referrals from state agencies that deal with the classification of workers for both workman’s compensation and unemployment purposes.

Don’t Take The Chance And Lose Everything You Have Worked For.

Protect yourself. If you are selected for an audit, stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important to that you’ve hired the best lawyer for your particular situation. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Los Angeles, San Diego San Francisco and elsewhere in California are highly skilled in handling tax matters and can effectively represent at all levels with the IRS and State Tax Agencies including criminal tax investigations and attempted prosecutions, undisclosed foreign bank accounts and other foreign assets, and unreported foreign income.

Description: Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. resolve your IRS tax problems to allow you to have a fresh start.

From travel expenses to paying wages to family members, there’s no limit to what people will try to write off at tax time for the sake of their business. But where do you draw the line? Which write-offs you’re trying to write off go too far?

Tax Write-Off: Travel Expenses

Here’s a write-off that sometimes is difficult deciding just where to draw the line. Can you deduct the cost of going to see a Cirque du Soleil show in Las Vegas if you’re treating your client? The answer is yes, as long as you can justify it as a business expense. And what if your spouse goes along on the trip? As long as they’re a partner or employee of your business and attended conventions or meetings on the trip you took together, then his or her travel and 50% of his or her meals are also deductible.

• Key Issue: You can deduct travel expenses, and 50% of related meals and entertainment, if the travel is reasonably related to your business.

• How to Do It Right: The more accurate your records are, the more likely they’ll be accepted and validated by the IRS if you become involved in an audit situation. On your next business trip grab an envelope from the stationary drawer of your hotel room and put all your receipts from that trip in it. Label the envelope with a name and date to help you remember that trip and document it should it be questioned later.

Tax Write-Off: Cell Phone Bill

If you use a cell phone as part of your business, this could be a big deduction for you. So don’t make the mistake of mixing business with pleasure by sneaking too many personal calls onto your cell phone bill.

• Key Issue: Because of the way a cell phone can be used and many phones and features are bundled into single plans, this expense has come under much scrutiny, so people need to keep good records and keep their actual cell phone bill so they can demonstrate what portion relates to cell phone use and that a majority of the calls were business calls.

• How to Do It Right: Take a look at your cell phone bill to make sure you receive an itemized report. Because cell phones are considered listed property, you need to keep detailed records of their use. In the case of a land line, it’s a good idea to have a separate phone number for your business since the IRS won’t let you allocate the cost of a single phone in your home to your home office.

Tax Write-Off: Home Office

Home office deductions used to be a big red flag for an audit back in the 1990’s. These days, you just need to use the deduction with caution. A good rule of thumb to follow is that anything that’s unusual and disproportionate to your level of income is something the IRS will check out.

• Key Issue: Home office space is the exact square footage area in your home dedicated exclusively to the running of your business.

• How to Do It Right: Get an accurate floor plan of your residence and the exact square footage of the space exclusively used for business. Once you figure out the percentage of your home office compared to your overall home, then you can go back to your heating bills, electric bills and all other bills that go to supporting your home, and figure out the amount you can deduct for running your business.

Tax Write-Off: Home Office Computer

It’s not a good idea to mix your business world with your personal life so you should not use your home office computer for personal tasks if you can help it.

• Key Issue: If there is the only computer in your house, you will have to calculate the percentage of total time you use it for business purposes.

• How to Do It Right: Ideally, your best option is to purchase a laptop or tablet and dedicate it to being your personal computer. You then use your desktop computer solely for business. This way you can avoid any messy situations come audit time.

Tax Write-Off: Rent

Wondering if you can still take the home office deduction if you’re a renter? The answer is yes. But you need to know the right way to go about it.

• Key Issue: Home office space is the exact square footage area in your home dedicated exclusively to the running of your business.

• How to Do It Right: Get an accurate floor plan of your residence and the exact square footage of the space exclusively used for business. Once you figure out the percentage of your home office compared to your overall home, then you can go back to your heating bills, electric bills and all other bills that go to supporting your home, and figure out the amount you can deduct for running your business.

What Should You Do?

Protect yourself. If you are selected for an audit, stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important to that you’ve hired the best lawyer for your particular situation. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Los Angeles, San Diego San Francisco and elsewhere in California are highly skilled in handling tax matters and can effectively represent at all levels with the IRS and State Tax Agencies including criminal tax investigations and attempted prosecutions, undisclosed foreign bank accounts and other foreign assets, and unreported foreign income.

Description: Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. resolve your IRS tax problems to allow you to have a fresh start.