Are
you a Tax Time Bomb?
Keep
the IRS Off Your Back
It
happens all the time. I am on an airplane from Denver to Omaha. I strike up a
conversation with the woman next to me. I tell her I'm an attorney primarily in
the tax area. It turns out she is in network marketing. Although my newfound
acquaintance has only been in the business for a couple of years, she is already
making a substantial six-figure income - more money than she has ever made
before.
She
steers the conversation in the all-too-familiar direction, and starts peppering
me with questions: "How can I save on taxes? Should I put my money in a
trust? Take it off shore? Set up a pension plan? Can I write off my
motorboat?"
Before
answering these questions, I have a few of my own for her. "Are you keeping
good records? Do you have an accountant or other tax professional helping you?
Have you ever done a profit-and loss-statement so you know where you stand? Are
you making sufficient estimated tax payments? Are you current with your yearly
tax filings?"
Let
me start with the Six Commandments for keeping the IRS off your back:
1) Hire an Accountant.
I
know what you are thinking as you read this - "Why do I need to pay an
accountant, when I can buy a tax software program for $49?" For starters,
an accountant can help you get organized. He can advise you on the best way to
keep records. An accountant can help you prepare profit-and-loss statements so
that you can see how much money you are making and where your money is going,
and help anticipate how much tax you may owe. He can advise you as to what is
(or is not) deductible for tax purposes, as well as the best way to substantiate
and increase your legitimate deductible expenditures. Most importantly, an
accountant can keep you in tax filing compliance, the one area where most of my
clients get into trouble, just by missing deadlines.
2)
Keep good records.
Without
good records, you have no means to justify your legitimate deductions under the
tax laws. Remember: in an audit, the burden of proof is on you to substantiate
your legitimate tax deductions. Keep a daily calendar of your activities and
receipts for all your business expenses, organized monthly. I know this sounds
like it's more trouble than it's worth. Let me assure you that if you follow my
advice it will be well worth the effort for two reasons:
First,
it will make it that much easier for your tax preparer to go through your
records.
More
importantly, it will allow you to defend yourself should the IRS come
knocking on your door. I have seen, with my own two eyes, what happens in
audit situations where clients' records are sparse or non-existent. It isn't
a pretty sight.
3)
Never Ignore Big brother.
Upon receiving a letter from the IRS, run (do not walk) to a tax professional.
IRS letters run the gamut from the fairly benign inquiry to a serious problem.
(As a quick rule of thumb, a certified letter usually indicates a serious
problem.) For example, it's common for the IRS to lose a tax return or a
payment. If you can quickly satisfy the IRS by sending them a copy, why not take
care of it right away, before it becomes serious? (I actually had a client
ignore a letter in which the IRS was trying to verify a $14,000 overpayment
before refunding it to my client. By the time I became involved - five years
later - it was too late to request the money, as the time period for requesting
the refund had expired!)
Another
possible reason for IRS correspondence may be that the IRS has some questions
regarding a tax return you filed. Let me assure you from experience that
ignoring this type of letter will not make the problem go away. Instead, the IRS
will proceed without you, which could eventually require you to hire someone
like me to fight the government in court, or in collection.
4)
If it Sounds Too Good to Be True, It Probably Is.
Many
clients ask me about putting their money in unincorporated business
organizations, or offshore, or in gold bullion in the cellar, with the idea that
then they won't have to pay taxes. When you hear something like this, there is a
good chance the IRS already knows about this tax dodge. My advice is to seek a
reputable third-party opinion. I know this will cost some money, but it could
save you thousands of dollars in aggravation later.
5)
File Your Tax Returns in a Timely Manner.
The
easiest way to get into trouble with the IRS is not to file your tax returns on
time. Very few people who voluntarily file their tax returns get audited. On the
other hand, my experience is that people who only file the tax returns after the
IRS inquiry are more likely to be scrutinized. I cannot think of a single good
reason to make yourself visible to IRS radar.
6)
Don't Make It Up.
People
tend to panic at tax time when they discover that a huge tax bill awaits. It is
very tempting to start making up numbers. Resist this temptation. While it is
never pleasant to owe the IRS money, submitting an obviously false return could
land you in jail. A corollary is that you should also resist the temptation to
make up false receipts for the IRS to look at if you are audited. I had one
client get criminally charged for doing just this - so, to save $12,000 in
taxes, he ended up paying $25,000 in legal fees!
Now
that I have your attention (I hope), here are some basic tips on how to save
money.
Everyone's
tax situation is unique and here are a few hints:
Keep
good records of all business expenses, substantiating their business
purpose. Nine out of ten tax problems arise from the failure to take this
simple, if occasionally tedious, precaution. The tax law specifically allows
you to deduct necessary and ordinary business expenses incurred in carrying
on a trade or business. Keep a daily record, diary, or planner with all your
business expenses.
Use
one, or at most two, credit cards exclusively for all your business
purposes. This way, you know exactly where to look for all the business
expenditures.
Do
you travel overnight as part of your business? Of course you do. Do your
clothes get dirty as a result? Then the cost of dry-cleaning them is
entirely tax deductible.
Does
your spouse work? If not. You should consider hiring her or him at minimum
wage. Chances are, your spouse is doing plenty for your business already.
Document it. Then setup an insured medical reimbursement plan for
your employees (i.e., your spouse) and dependents (your kids), and deduct
your contributions as a business expense. Note: if the plan is not funded by
insurance, then other IRS rules apply.
Do
you have children? Are they older then six or seven? Then put them to work!
By which I mean, you should consider hiring them for minimum wage (perfectly
legal in a family business). Their first $4,000 or so will be basically
tax-free to the child because of the standard personal tax deduction - and
totally deductible to you! A note here: make sure that your child is
actually performing legitimate, business-related work you can document, if
asked. Yes, stuffing envelopes does count.
Do
you have more than one car? Then
try to use one solely for business purposes. This will take some
self-discipline, but it will allow you get the most tax benefit from one
business vehicle.
If
possible, conduct sales seminars and presentations at home. In this way, the
cost of all food and refreshments (even the leftovers!) will be totally tax
deductible as a business expense.
Of
course, you need to prove, if asked, that this was not just a social bash! I
suggest videotaping all or part of the evening for posterity, or collecting
people's business cards and filing them with your receipts.
Sound
tax planning lets you keep more of your money - and your peace of mind.