Prepare to see many changes in the tax code in 2010 and 2011, partly due to the costs of providing economic stimulus during 2009. You may be concerned about the possibility of an audit, so here is some information that may help you prepare for this possibility.
Targets and compliance
A new three-year “study” of employment taxes, selected by SIC codes, will affect about 2,000 taxpayers per year. It has been 25 years since the Internal Revenue Service (IRS) has investigated this area, and it will be looking for misclassification of independent contractors who are really employees. The results will be used to help rewrite the audit handbook. Interestingly, a similar S corporation “study” a few years ago has triggered a current increase in S corporation audits.
More taxpayers will now qualify to carry back net operating losses from pass-through entities (such as LLCs and S corporations) for up to five years, with a time extension to include 2008 and 2009. However, the IRS is taking a hard look at losses deducted by S corporation stockholders, and penalties for failure to file or late filing of both S corporation and partnership returns have increased from $89 to $195 per month (for each partner or shareholder) with a maximum of 12 months. This is expected to raise $1.2 billion over the next decade.
The Tax Inspector General estimates a $2 billion revenue shortfall and has begun pressuring auditors who are not assessing enough penalties. Sole proprietors are known for being noncompliant, so Congress is considering a cap on deductible losses and a possible standardized deduction for home offices to improve the revenue stream from these businesses. Sole proprietors should always set up separate business accounts and credit cards, in order to avoid confusion between personal and business accounting.
Audits of high-income/high-wealth individuals (net worth of more than $1 million) have increased by 30 percent, and a new initiative to uncover tax evasion by these filers was announced in October. Instead of reviewing their individual returns, the agency will be looking at all entities in which they have ownership. First to be targeted are organizations with income in the tens of millions of dollars, but this threshold may be reduced in the future.
Correspondence audits are up by 1,000 percent. These are requests for additional documentation related to one or more specific line items; these usually result in minor assessments.
Contrary to popular belief, using the preprinted label on a tax return does not increase your chances of being audited. It simply increases the processing speed of the return. There also is no correlation between taking the automatic extension and being audited.
If you are audited, your CPA may advise you not to be present. Since the auditor may ask dozens of questions, such as, “How much cash do you usually keep in your pocket?” most taxpayers become nervous and reveal unnecessary details. Issuing a power of attorney to your CPA and making yourself available by telephone can save you money.
Nonpayers and nonfilers
A taxpayer who is unable to pay the required tax should still file a return. Willful failure to file a return is a federal crime, and failure to file penalties can cost up to 25 percent of the tax owed. The failure to pay taxes on time also triggers a penalty of up to 25 percent of the unpaid amount, but there is a form available to request an installment plan.
If you belong to an organization that has failed to file returns, a CPA may advise the organization to file only 3 or 4 years’ worth of returns, especially if no taxes are owed. Although you have only two years to claim any refunds, the IRS has three years to assess you for unpaid taxes. There also is a mismatch between the interest the IRS pays on refunds owed and the interest you owe on late payments. Guess which rate is higher.
Refunds, rebates and gifts
Make sure you claim your refunds, and notify the IRS of address changes. There are more than 100,000 taxpayers who are owed more than $124 million in refund checks returned to the IRS because of address errors. The average check is $1,148.
Remember the stimulus checks issued to many citizens during recent years? Issuing those checks was expensive, so the 2009 employment tax tables were changed to reduce individual federal tax withholding instead of issuing more checks. Taxpayers who worked more than one job may incur a repayment obligation because of the overlap in “under withholding” on multiple paychecks.
Money or property received as a gift or inheritance is usually exempt from federal tax, and the donor or estate is responsible for payment of any taxes due. However, the IRS can try to recover any unpaid tax from the donee or the heir. In such cases, recipients should seek professional advice.
Next month, we’ll review some of the changes in the tax code that may benefit you or your company.
NORBERG-JOHNSON is a former subcontractor and past president of two national construction associations. She may be reached at firstname.lastname@example.org.