Good Record-keeping: The Front Line of Audit Defense

Even if your tax return doesn’t raise any red flags, there is always a small chance that it will be randomly selected by the IRS for examination. Therefore, it is a good idea to keep good tax records. You should hold onto all of your tax-related documents–anything that supports what you report on your tax return–for at least 3 years after you file a return. You might want to keep your records longer, but the IRS generally has only 3 years to audit a tax return, unless suspicion of tax fraud is involved. This 3-year period begins on the day you file your tax return. But if you file early, the period begins on the day of the actual tax deadline.

Records are an essential part of tax planning and preparing for the possibility of audit. Of course, even if you are never the victim of an audit, there are still good reasons to keep your tax records in order. Congress has been known to retroactively introduce a tax break from time to time, and you may need to produce documentation in order to claim it on an amended return. Or you may need to file an amended return to claim a tax credit that you missed when you were preparing your original return. In that case, you have 3 years to file an amended return and get a new refund check. But after 3 years, any unclaimed refund is forfeited.

Here are some examples of tax-related documents you should keep in your records:

•     Pay stubs
•     Old tax returns
•     Tax information forms (W-2′s and 1099′s, etc.)
•     Mortgage statements
•     Receipts from charities
•     Receipts (or statements) from childcare facilities
•     Credit card statements
•     Canceled checks
•     Medical bills
•     Vehicle mileage logs
•     Self-employment business records
•     Gambling journal

If you are worried about becoming a hoarder because of the stacks of paper you have collected, you can always just scan your documents and save the digital files. But remember to back up your computer regularly!

Audit Defense No. 2: File Electronically (efile)

When you file your tax return online, you can drastically reduce your chances of being audited. A lot of red flags are raised by mistakes in calculation or by errors of omission. When you prepare your tax return online, the tax software will check your return for omissions and errors before you efile. According to the IRS itself, efiled returns have only a 1% error rate–compared to a 20% error rate for paper returns!

Potential Audit Red Flags

Certain things reported on an income tax return have been seen to increase the chances of examination by the IRS:

•     Itemized deductions (above the average amount for your income level)
•     Schedule C self-employment losses
•     Large home office deductions
•     Large charitable deductions
•     Rental losses
•     Casualty losses
•     Drastic increases in income from the prior year
•     Income over $100,000

The Biggest Red Flag for Audits

Unreported income is the one thing that is most likely to lead to an audit. During processing, the IRS will match the figures on your tax return with all of the W-2s, 1099s, and other information that has been reported to them. The IRS is very good at ferreting out unreported income, and they will audit your return, or at least send you a nice letter asking for clarification (a CP-2000 notice). Remember that the IRS has 3 years to audit any return without suspicion of outright tax fraud.

Audit Defense No. 3: Your Right to Appeal

I know it might be hard to believe, but even the IRS can make a mistake from time to time. That is why you have the right to appeal the results of an audit. If you disagree with the IRS “adjustment” (new tax bill) after a flawed audit, you can file an appeal. This kicks into motion the process known as “audit reconsideration”. Audit reconsideration will be a lot easier if you have the documents to substantiate your case. If you ever have to file an appeal, you will find good tax records to be your greatest ally.

Who’s Afraid of the Big Bad Audit?

So, if you ever find an audit notice in your mailbox, don’t panic! With good tax records at your disposal, you can face the challenge head on. Don’t be afraid to present your case and to file an appeal if you need to. Just don’t forget to breathe!

Paul works and writes for efile.com, a company that provides an online platform for tax return preparation and secure efiling. They aspire to be a less expensive and more user-friendly alternative to the big online tax companies, with all of the same capabilities and more benefits.

And I do not want, and I will not accept, a deal in which I am asked to do nothing, in fact, I’m able to keep hundreds of thousands of dollars in additional income that I don’t need, while a parent out there who is struggling to figure out how to send their kid to college suddenly finds that they’ve got a couple thousand dollars less in grants or student loans.

This is the usual class warfare talk that we are so used to hearing from both sides.  I am not a big fan of either political side – I think they are both partially to blame for the financial mess our country is in – but I was really taken aback by President Obama’s comments.  As a moderate income earner, I would not directly feel the impact of taxing those that make more than I since it would not affect my paycheck; however, I do not agree with this philosophy alone to lessen the debt our country owes.  That is great that the President does not need hundreds of dollars in additional income (maybe he could personally donate this additional income to the IRS) but who is to say that someone else that makes a similar salary does not need this money.  Maybe they are using it to send their children to college or saving up to start a business.  Just because the President does not need this money doesn’t mean that someone else feels the same way.

I am all for reworking the tax code to close some loopholes but I feel we need compromise on both sides.  I have heard some say the rich should pay more in taxes because they can afford to.   Have we ever thought that some are rich because they chose to make changes in their lives so they could become rich?  I look at how Tracy and I live our lives.  I know many people that have nicer things then we do because they spend their entire paychecks and do not plan for their futures.  These same people tell me they have no money to invest for their future – they actually do but make the choice to spend it now rather than save.  On the other side, Tracy and I choose to not buy everything we want, drive older cars and cut costs anyway we can so we have money to invest for our retirements.  So, at this point in time, some people have a lot more things than we do and spend money in ways that we do not.

Let’s fast-forward thirty years.  If all goes as planned, Tracy and I should have invested enough so that we will be able to retire as millionaires (if the stock market continues to perform as it has for the past 100 years) whereas some of our friends that spend money now rather than save won’t have anything except Social Security to live off of.  At this point in time, we would be considered the “evil rich” because we have a lot of money saved.  Some would even argue we should pay a larger portion of capital gains taxes.  I think this logic is so wrong.  We have made a choice to save for our Golden Years and have put off buying things so we are prepared for retirement.  It is unfortunate that others did not have the discipline to do the same but I feel it would be a mistake to penalize us for our planning just because others, that had the same opportunity we did, made the choice to do something different.

Do you think the rich should be forced to pay more?

Photo credit: US Army Africa

What Can I Do If I Cannot File My Return On Time?

If you are unable to file your tax return by the due date – this year’s deadline is Monday, April 18th – you should file an extension with the IRS. This is a fairly simple task process and can be accomplished in one of several different ways:

1. Print out IRS Form 4868, complete it and mail it into the IRS.
2. Use IRS e-file to file your extension online. You will need to either have your tax preparer file for you through his e-file program or use a tax preparation software program, such as TurboTax or TaxCut.
3. Pay Your Taxes. If you need to file an extension and owe the IRS money, you should pay at least 90 percent of what you owe with a debit or credit card. To do so, you will need to call the IRS directly or make a payment through an IRS-approved service provider.

While filing for an extension is a great option for those who cannot get their income tax returns in on time, it is important to note that obtaining an extension does not enable you to pay your tax bill late. When you file for an extension, in order to avoid late payment and interest fees, you should make sure to send the IRS at least 90 percent of what you owe. If you cannot pay 90 percent of what you owe, you should still file for an extension and pay as much as you are able to, because the failure-to-file penalty is far stiffer than the failure-to-pay penalty.

What If I Cannot Pay My Tax Bill

The overwhelming nature of tax season can make simply not filing your return and avoiding your tax bill a tempting but dangerous option. Procrastinating will ultimately lead to a more costly and stressful outcome. There are quite a few alternatives available to you are unable to pay your tax bill, including:

1. Find the Funds. Do you have a savings account from which you can take out the money, or a family member who can afford to lend you the funds? Can you request a personal loan from your bank? Another option, although highly discouraged, is to charge your tax bill to a credit card. Be careful with this last option since credit card interest rates can be high, so work as fast as possible to pay it off.
2. Set Up an Installment Agreement with the IRS. As long as you owe less than $25,000, it is possible to obtain an Installment Agreement from the IRS by simply visiting the IRS website and filling out an agreement form. If you owe more than $25,000, you can still try to obtain an installment plan but will need to fill out an IRS Collection Information Statement before gaining approval, and the IRS may require you to liquidate some assets in order to reach the $25,000 or less dollar liability level.
3. Ask the IRS for an Extension to Pay. If you know that you will be able to get the funds you owe within a short period of time of after the deadline passes, you can ask the IRS for an extension to pay. In this situation, you will typically be granted an additional 30-120 days to make payment. This is your best option if you are sure that you will have the funds to pay your bill in full within the given timeframe. You will still incur a failure to pay penalty (as with option 2 above) but you will avoid an installment agreement setup fee.
4. Request an Offer in Compromise. It is important to note that these are rarely approved, and in order to receive one you will need to prove that you have no means to pay your bill regardless of whether or not you set up an installment plan. This is for special and extreme circumstances only.

Avoiding filing your income tax return is not a viable option. Not filing your taxes or paying your taxes leads to some of the highest penalties that the IRS gives out. The penalty for not filing your tax is 5 percent compounded monthly on any tax balance owed while the penalty for not paying is .5 percent a month on any unpaid balance. The IRS will catch up with you and the interest and penalty fees will be high – not to mention that delinquent taxes can destroy your credit – and the IRS can and will do what it takes to get the money, including seizing your assets.

Once you have decided what to do about your tax bill, start planning better for next year. You certainly don’t want to find yourself in this situation again.

This guest post was provided by Matt Robinson. Matt is a tax professional and tax writer. He provides valuable tax tips, news, guidance and more on his tax advice blog. His website also gives detailed do-it-yourself information on resolving tax liens, tax levies, IRS penalties and many other tax problems.

Photo credit: MoneyBlogNewz

Tip 1- Know which records to keep.

Before you can streamline your record keeping, you must first know what documents you will need when you file your 2010 tax return. With so many changes to tax laws, this can become a confusing yet not impossible task.  The following documents should be kept for use when you file your next tax return.

• Proof of income – The IRS wants to know exactly how much money you make each year, therefore it stands to reason that you want to keep records on all earnings.  This includes payroll records, 1099s, investment records, spousal support and any other taxable income.
• Deductions - There are certain expenses that can help you lower your tax liability which reduces the amount of taxes you are responsible for paying.  These deductions are important in that they either lower what you will owe the IRS if you have a tax bill or increase the amount of money you will receive back in the form of a tax return.  Common deductions include but are not limited to charitable donations, interest paid on your mortgage, tuition expenses, business expenses (for the self-employed), child care expenses and spousal or child support payments.  Keep any receipts that may be used to support a tax deduction.

Tip 2- Keep important documents organized

While it is important to keep all of these documents, it is also recommended you do so in an orderly fashion.  Whether you intend on filing your tax return on your own or if you hire a tax professional, having your records organized will expedite the process and save time for everyone involved. Keeping and organizing physical records is necessary in the event you find yourself facing an audit after filing your tax return. You may also decide to keep electronic records by using spreadsheets or software that helps you organize your records. Here is how you can get started.

• Establish one place where you will keep all of your physical documentation. This can be accomplished with a very basic filing system. Label your main folder Tax Documents 2010.
• Make a checklist that includes all of the documents that you will need when you file your tax return, this way you will know which documents you need to keep.
• Create a separate file for each of the following: income and earnings, interest statements or other documentation from your bank or financial institution, personal expenses or deductions, business expenses and deductions, and any receipts or documentation that may be used to support tax credits.

These are the very basic files you would need to organize your taxes. The more complicated your situation in regards to taxes, the more files you may have to add to track and organize necessary documentation.

When the time comes to file your income tax return you will have all of the necessary documentation to either complete your return on your own or hand it over to a tax professional. Once your tax return is filed, take all the information you have saved throughout the year and place it inside one large envelope to be saved for future reference. Organizing your tax records as you go is the easiest way to avoid losing documentation that could cost you money in the long run.

This article is provided by Back Taxes Help LLC, a company designed to help you with various IRS tax problems. For self-help tax information or tax professional help, please visit BackTaxesHelp.com

So, what do you do if you owe the IRS money?  Certainly, don’t panic.  The important thing to do is to stay level headed.  There are plenty of options you can consider in making sure the IRS gets their money.  But you’ll want to act fast to get your plan in order and rid yourself of the debt as soon as possible.

What to do if you know you’re going to owe money to the IRS

Avoid tax penalties

First, don’t hesitate to file.  Even if you know you’re going to owe income taxes this year, you’ll want to go ahead and file by April 15^th.  According to an article at SmartMoney.com, you’ll have to pay a 5% per month penalty.  The failure to file penalty will be charged until it reaches 25% or more of what you owe!  SmartMoney provides   the below example:

If your unpaid balance on April 15 is $8,000, you’ll rack up monthly failure-to-file penalties of $400 until you “max out” at $2,000. After that, you’ll be charged interest until you settle your account (as mentioned, the current monthly rate is 0.833%).

Filing extensions

You might consider filing an extension using form 4868, but keep in mind, an extension of time to file is not an extension of time to pay.  Penalties and interest will still accumulate on your debt.  According to the IRS, interest is generally 1/2 % to 1% for each month or part of the month the tax is not paid.

Options if you can’t pay your income taxes

Bottom line, if you can’t pay your income taxes, it’s time to explore your options.  Keep in mind, owing the IRS is a form of debt.  You’ll want to take action to get the IRS paid off fast!  Here are some ideas to consider in no specific order.

1.  Savings

Can you draw on your personal savings to pay the tax bill?  An unexpected tax bill is reason enough to pull money from your emergency savings fund and pay it off immediately.  However, I wouldn’t recommend leaving less than $1000 in your savings account.  If you’re already under this amount, you might consider some of the other options listed or even an installment agreement discussed below.

2.  Sell something

While it may be hard to part with something you value, it may be a good idea to sell a more expensive car or recreational item such as a boat or motorcycle to pay off your debt.  Remember, being in debt is serious, especially when you owe the IRS.  Don’t play games.

3.  Pay some of the debt

You may not be able to pay the entire balance in full, but pay what you can since what you owe is subject to interest.  Again, if you set up an installment or payment agreement the government will charge you between 1/2 % to 1% for each month or part of the month the tax is not paid.

4.  Offer in Compromise

An offer in compromise (OIC) is an agreement between you and the IRS that settles your tax liabilities for less than the full amount owed. Keep in mind, an offer in compromise is generally not accepted if the IRS believes the liability can be paid in full or through a payment agreement.

5.  Family and friends

While this may not work some people, others may be able to ask family or friends to help get them over this hump in the road.  My personal recommendation here is to pay family and friends back as soon as possible and never ask for the loan without a sure way to repay or ability to make payments each month.

6.  Other loans

Taking out another loan to pay the IRS would be a last resort option in my opinion.  You probably won’t be able to beat the interest rate the IRS offers with a personal loan from your bank, or even a home equity loan.   And I certainly wouldn’t use a credit card if that’s something you’re thinking about.  Still, having all the options on the table for consideration will help you choose the right approach for your situation.

7.  Installment or payment agreement

What is an installment agreement?  An installment or payment agreement is an agreement with the IRS to pay your taxes in payments over time.

How do you set up an installment agreement to pay your income taxes?

If you have $25,000 or less in combined tax, penalties, and interest you are eligible to request an installment payment plan.  According to the IRS, you can call the number on your tax bill or use the Online Payment Agreement (OPA).  You can also complete a fill-in request by using form 9465.

Once you submit the request, you will receive a written notification telling you whether or not the terms of your installment agreement have been accepted, or if some modification is necessary.  According to SmartMoney you can submit your own terms and the approval is generally automatic if you owe $25,000 or less.

What if you owe more than $25,000?  According to the IRS, you may still be eligible.  But, you’ll need to also complete form 433F.

Will you still get tax refunds if you have an installment agreement?

As a side note, any refund due to you in a future year will be applied to the amount you owe.  The IRS automatically applies the refund to the taxes owed.  If the amount of your refund doesn’t pay off the tax debt, your installment agreement will continue until the terms are met.

Final thoughts

Quite often I’ve heard Dave Ramsey mention you don’t want to owe the IRS.  Get them paid off as soon as possible so that you can get on with your life!  If you move to an installment agreement, do what you can to pay extra payments each month to minimize interest charges.  Also, after figuring out your approach to pay, make sure you plan appropriately for the current tax year.  The last thing you want to do is increase your debt by owing more when you file taxes again next year.  If you’re having trouble planning, consider finding a tax professional or CPA to help.  Work with this person to minimize a tax refund as well as owing any money.

What do you think about these options?

In a recent article at SmartMoney.com, Jami Makan discusses three great ideas for lessening the financial burden of getting your taxes prepared.

1. Look for group discounts for family members.  Also keep an eye out for referral offers and special coupons being presented on social networking sites such as Linked In.
2. Do some of the work yourself online and then have it reviewed in person.  Some companies are offering considerable discounts from what you would pay by having the work done by a pro.
3. Avoid the tax time rush.  Work with tax preparers to get your taxes done earlier for a discount, or some will even provide a discount if you have them done after April 15^th.  Of course you’ll have to file an extension.

And now, on with the personal finance blog post links and roundup…

Personal Finance Links

I hope you’ll take a few minutes out of your day to explore these interesting and helpful posts from other personal finance blogs.

• Bible Money Matters: PT Money provided a guest post this week on the top 10 tax credits to take advantage of.  Personally, I like the first time home buyer tax credit this year available to new and existing home buyers!
• Wise Bread: An interesting post that provides 7 ways to cut your food bill without clipping a single coupon.  Personally, we are coupon clippers because we play the grocery game.  But this post provides some good suggestions to help save money on what can be one of the biggest budget busters!  My favorite tip?  I like the weekly food run.  All those little trips typically add up to spending more than what you would with just one trip.
• Free Money Finance: Everyone wants to impress their boss, right?  Well, do what your boss wants you to do!  J  You’re guaranteed to improve your performance if you exhibit the behaviors mentioned in this post.  They may seem obvious, but many people don’t do them.  I like the behavior of streamlining processes to save money and time.  Some processes can just bog us down and keep the company and people from being productive!
• Thrive Blog: Looking for some ways to save money on your cell?  I didn’t know about OverMyMinute.com.  What a cool service!  Or, avoid calling information.  I was just dinged over $10 on my latest bill between my wife and me calling to get phone numbers.  Agh!
• The Simple Dollar: The title of this post, “Why Work”, caught my eye this week.  This is an inspiring post exploring why we work, what keeps us from doing what we really enjoy and how to bridge the gap to do what you love.  As an aside, I believe we can glorify God in whatever we choose to do as long as it’s ethical and moral.

One Money Design Around the Web

This week I discussed how much to save for retirement in my article at Bible Money Matters.  I’ve decided not to join the panic about retirement savings. Read my post to learn why!

Personal Finance Blog Carnivals

What is a personal finance blog carnival?  If you’re interested in learning more, here is a great definition from BlogCarnival.com:

Blog Carnivals typically collect together links pointing to blog articles on a particular topic. A Blog Carnival is like a magazine. It has a title, a topic, editors, contributors, and an audience. Editions of the carnival typically come out on a regular basis. Each edition is a special blog article that consists of links to all the contributions that have been submitted, often with the editor’s opinions or remarks.

The benefits for the reader include reading a wide variety of content about personal finance.  A further benefit is the ability to interact with the writer or other readers in the comments.

One Money Design was recently featured in Carnival of Personal Finance #244: The Fiscally Irresponsible TV Characters Edition

According to the IRS, the amount of tax your employer withholds depends on a few things:

1. The income you earn.  The more income you earn, obviously, the higher your tax liability.
2. The information you’re providing in the form you turn into your employer.

What is the W-4 form and the purpose of withholding allowances?

The W-4 is a form you complete for your employer that’s used to determine how much income tax to withhold from your paycheck.

The form collects three types of information according to the IRS:  1) whether or not you want to withhold money at the single or married rate; 2) the total amount of withholding allowances you want to claim; 3) any additional amount you would like withheld.  The more withholding allowances you specify on the W-4, the fewer taxes withheld.

When to make changes to your withholding allowances

If you’re like our family, we’ve had a lot of life changes in recent years that have resulted in a need to modify our W-4.  I think this may be typical for a young family.  J

We’ve received some fairly large returns in the past and would rather have the extra money to manage towards our financial goals each month.  So, after receiving some of these hefty income tax refunds we’ve submitted new W-4’s specifying an increased number of withholding allowances.

The IRS provides some guidance on when to update your W-4.  Basically, as with our family, you’ll want to revisit your withholding allowances for major changes in life such as marital status, birth of a child or perhaps the purchase of a home.  Also keep in mind, any changes related to exemptions, adjustments, deductions, or credits you become eligible for will require you to revisit your withholding allowances.

Your W-4 can be updated at any point in time through the tax year.

Adjusting your withholding allowances

If you want an easy way to determine your allowances, you can use the IRS tax withholding calculator.  The hardest part about the calculator is making sure you have the right information handy.  So, here are a few tips the IRS provides before using the program:

• Have your most recent pay stubs handy.
• Have your most recent income tax return handy.
• Estimate values if necessary, remembering that the results can only be as accurate as the input you provide.

The calculator will take you through 5 different steps or pages requesting information.  Again, as long as you have the information handy the process is quite easy and answering the questions shouldn’t take more than 10 minutes.  For your convenience, I’ve provided a summary of each step below:

Step 1: General information is requested in this step.  You’ll need to provide the filing status for your 2010 income tax return (married, single, etc.) and specify as to whether or not someone claim you as a dependent?

Step 2: Enter any child tax credits and other credits you’re eligible to receive.

Step 3: Enter income and withholding information.  This is where you’ll need your pay stub to help you determine how much in taxes have already been withheld to date so that it’s not counted twice.

Step 4: Enter any adjustments to salary such as a contribution to an IRA or education loan interest you may be paying this year.

Step 5: Finally, enter any deductions.  This is where you can enter your itemized deductions or select the standard deduction.

Based on all the information you submit, the calculator will tell you your anticipated income tax for 2010.  The results will also tell you how much tax you’ll have withheld for the year and whether or not you’ll have an overpayment or if you will underpay your income taxes.

Now, here’s the best part.  The calculator provides you direction as to how many allowances you should consider submitting on your W-4.  With this information you can print off a new W-4 (see link below), complete the information (including your new amount of allowances) and submit to your employer’s human resources department.

This being said, keep in mind I’m not a tax professional.  If you’re concerned at all you may over or under pay taxes (even after using the calculator), please consult with a tax professional!

Have you increased or decreased your withholding allowances in the past?  What did you find helpful or confusing in this process you can share to help other readers?

Helpful links to help you adjust your witholding allowances

• W-4 form
• Withholding Calculator
• More about Tax Withholding