Recognizing Red Flags: Signs That Could Trigger an IRS Audit

 Dealing with taxes can often be a complex and confusing process, and the last thing anyone wants is to face an audit from the Internal Revenue Service (IRS). While audits are relatively rare, it's essential to be aware of potential red flags that increase the likelihood of being selected for closer scrutiny.

In this article, we'll discuss some common red flags that could trigger an IRS audit and steps you can take to minimize your risk.

1. Discrepancies and Mismatches:
   One of the most significant red flags for an IRS audit is discrepancies or mismatches in your tax return. The IRS receives copies of various tax-related forms, such as W-2s, 1099s, and 1098s, from employers, financial institutions, and other sources. Failing to report income that the IRS has on record can raise suspicions and trigger an audit. It's crucial to double-check your return for accuracy and ensure that all reported income matches the forms the IRS receives.
2. High Income:
   Individuals with high incomes are more likely to be audited simply because their potential tax liability is higher. However, this doesn't mean that high earners are automatically targeted. The IRS uses a computerized scoring system to determine audit potential, and while a high income might raise your score, other factors also come into play.
3. Excessive Deductions:
   Claiming an unusually high number of deductions, especially in comparison to your income level, can attract the IRS's attention. While you're entitled to claim deductions you're eligible for, be prepared to provide proper documentation to support your claims. If your deductions seem out of proportion, you might face an audit.
4. Home Office Deductions:
   Home office deduction can be a legitimate way to reduce taxable income for self-employed individuals or those with a home-based business. However, it's also a red flag for the IRS due to the potential for abuse. Ensure you meet the specific criteria for claiming a home office deduction and maintain accurate records of your expenses.
5. Business Losses:
   Consistently reporting business losses on Schedule C might raise concerns for the IRS. While many legitimate businesses incur losses, excessive or continuous losses without a clear improvement plan could lead the IRS to question the legitimacy of your business activities.
6. Cash Transactions:
   Large cash transactions, particularly those exceeding $10,000, can trigger an IRS audit. The IRS is concerned about money laundering and unreported income from cash transactions. Financial institutions must report such transactions, so it is essential to ensure that your reported income matches your financial activities.
7. Cryptocurrency Transactions:
   With the rise of cryptocurrencies, the IRS has increased its focus on ensuring accurate reporting of cryptocurrency transactions. Failure to report cryptocurrency gains can lead to an audit, so keeping accurate records of all crypto-related activities is crucial.

While these red flags can increase the likelihood of an IRS audit, it's essential to remember that being flagged doesn't necessarily mean you've done something wrong. The IRS uses a complex scoring system that considers multiple factors before selecting returns for audit.

To minimize your risk, ensure accuracy in your tax return, keep meticulous records, and be prepared to provide documentation to support your claims. If you're ever faced with an audit, it's advisable to consult a tax professional who can guide you through the process and help you navigate the situation with confidence.

Have questions?  Contact Alliance Financial & Income Tax for assistance.

 

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Moving Out of State? Learn All the Tax Implications First

 

With so many people working remotely these days, thinking about moving to another state has become common — perhaps for better weather or to be closer to family. Business owners might contemplate selling their business as part of an out-of-state move. Many retirees also consider moving to a state with a lower cost of living to stretch their retirement savings. Consider taxes before packing up your things if you're harboring such notions.

What Taxes Apply?

Moving to a state with no personal income tax may seem like a no-brainer, but you must consider all taxes that can potentially apply to state residents. In addition to income taxes, these may include property taxes, sales taxes, and estate or inheritance taxes.

If the states you're considering have an income tax, look at what types of income they tax. Some states, for example, don't tax wages but do tax interest and dividends. Some states offer tax breaks for pension payments, retirement plan distributions, and Social Security payments.

What Are the Domicile Requirements?

If you move permanently to a new state and want to escape taxes in the state you came from, it's crucial to establish a legal domicile in the new location. Generally, your domicile is a fixed and permanent home location where you plan to return, even after periods of residing elsewhere.

Each state has its own rules regarding domicile. You don't want to wind up in a worst-case scenario: Two states could claim you owe state income taxes if you established a domicile in the new state but didn't successfully terminate the domicile in the old one. Additionally, if you die without clearly establishing domicile in just one state, the old and new states may claim that your estate owes income taxes and any state estate tax due.

The first step to establishing domicile is to buy or lease a home in the new state and, generally, to sell your previous home (or rent it out at market rates to an unrelated party). Then, change your mailing address on bank and investment accounts, insurance policies and other essential documents. Getting a driver's license in the new state and registering your vehicle there also helps. So does registering to vote there and becoming involved with local organizations and activities. Take these and other steps as soon as possible after moving.

Remember that there may be rules about the number of days spent in the state. You may have to do more than take the steps above to show you're domiciled in the new state.

How Might State Taxes Affect a Business Sale?

Business owners tend to focus on the federal tax implications of a sale, while they may ignore state taxes. Now that federal tax rates are lower than they've been in the past, state taxes may take on added significance. Suppose you're contemplating relocating or retiring to another state. In that case, it may make sense to consider moving before you sell the business — especially if the new state has low, or even no, income tax.

To successfully negotiate the sale of a business, it's critical to understand all the tax implications. Armed with this knowledge, you can assess the impact of moving to another state on your net proceeds from the sale and whether it would be better to sell the business before or after you move.

Need Help?

When looking into whether the grass is greener in another state, research and contact the office for help, avoiding unpleasant tax surprises.

Mike Mead, EA, CTC
Alliance Financial & Income Tax 
807 NW Vesper Street
Blue Springs, MO. 64015 
P - 816-220-2001 x201  
F - 816-220-2012 
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Tax Implications to Be Aware of After a Job Loss

Despite the generally robust job market, some people are still losing their jobs. If you’re laid off or terminated from employment, taxes are probably the last thing on your mind. However, you may face tax implications due to your changed personal and professional circumstances. Depending on your situation, these can be complex and require you to make decisions that may affect your tax picture this year and in the future.

Unemployment and Severance Pay

Unemployment compensation, as are payments for any accumulated vacation or sick time, is taxable for federal tax purposes. Although severance pay is also taxable and subject to federal income tax withholding, some elements of a severance package may be specially treated. For example:

• If you sell stock acquired by way of an incentive stock option, part or all of your gain may be taxed at lower long-term capital gains rates rather than at ordinary income tax rates, depending on whether you meet a special dual holding period.
• If you received (or will receive) what’s commonly referred to as a “golden parachute payment,” you may be subject to an excise tax equal to 20% of the portion of the payment that’s treated as an “excess parachute payment” under complex rules. In addition, the excess parachute payment also is subject to ordinary income tax.
• The value of job placement assistance you receive from your former employer usually is tax-free. However, the assistance is taxable if you had a choice between receiving cash or outplacement help.

Health Insurance

Under the COBRA rules, employers offering group health coverage must provide continuation coverage to most terminated employees and their families. While the cost of COBRA coverage may be expensive, the cost of any premium you pay for insurance that covers medical care is a medical expense, which is deductible if you itemize deductions and to the extent that your total medical expenses exceed 7.5 percent of your adjusted gross income.

If your ex-employer pays for some of your medical coverage for a period of time following termination, you won't be taxed on the value of this benefit.

Retirement Plans

Employees whose employment is terminated may also need tax planning help to determine the best option for amounts they’ve accumulated in retirement plans sponsored by their former employers. For most employees, a tax-free rollover to an IRA is the best move if the terms of the plan allow a pre-retirement payout.

Suppose the distribution from the retirement plan includes employer securities in a lump sum. In that case, the distribution is taxed under the lump-sum rules except that “net unrealized appreciation” in the value of the stock isn’t taxed until the securities are sold or otherwise disposed of in a later transaction.

Suppose you’re under the age of 59½ and must make withdrawals from your company plan or IRA to supplement your income. In that case, there may be an additional 10% penalty tax (on top of an ordinary income tax due), unless you qualify for an exception.

Further, any loans you’ve taken from your employer’s retirement plan, such as a 401(k)-plan loan, may be required to be repaid immediately or within a specified period. If such a loan isn’t repaid, it may be treated as if the loan is in default. If the balance of the loan isn’t repaid within the required period, it typically will be treated as a taxable deemed distribution.

Next Steps

While taxes aren’t the most critical concern after a job loss, they are still important to consider. Contact the office for help charting the best tax course for you during this transition period.