IRS Audit Red Flags: The Dirty Dozen Here are twelve hot spots on your return that can raise the chances of scrutiny by the IRS.
Ever wonder why some tax returns are audited by the IRS while most are ignored? Well, there's a whole host of reasons to this age-old question. The IRS audits only about 1% of all individual tax returns annually. The agency doesn't have enough personnel and resources to examine each and every tax return filed during a year. So the odds are pretty low that your return will be picked for an audit. And of course, the only reason filers should worry about an audit is if they are cheating on their taxes. However, the chances of you being audited or otherwise hearing from the IRS can increase depending upon various factors, including whether you omitted income, the types of deductions or losses claimed, certain credits taken, foreign asset holdings and math errors, just to name a few. Although there's no sure way to avoid an IRS audit, you should be aware of red flags that could increase your chance of drawing some unwanted attention from the IRS. Here are the 12 most important ones: 1. Failure to report all taxable income. The IRS receives copies of all 1099s and W-2s that you receive during a year, so make sure that you report all required income on your tax return. The IRS computers are pretty good at matching these forms received with the income shown on your return. A mismatch sends up a red flag and causes IRS computers to spit out a bill. If you receive a 1099 for income that isn't yours or the income listed is incorrect, get the issuer to file a corrected form with the IRS. 2. Returns claiming the home-buyer credit. First-time homebuyers and longtime homeowners who claimed the homebuyer credit should be prepared for IRS scrutiny. Make sure you submit proper documentation when taking this credit. First-time homebuyers have to attach a copy of their settlement statement to the return, and longtime homeowners should also attach documents showing prior ownership of a home, including records of property tax and insurance coverage. All claims for this credit are being screened. As of May 2010, more than 260,000 returns had been selected for correspondence audits (examinations done by mail rather than face-to-face) because filers did not attach the necessary documents to their tax returns. And those numbers will continue to grow. Also, the IRS has ways of policing the recapture of the homebuyer credit. Generally, the credit is required to be recaptured if the home is sold within three years for homes brought in 2009 or 2010 and within 15 years for homes bought before 2009. The IRS is checking public real estate databases for sales of homes for which the credit was taken. 3. Claiming large charitable deductions. This comes up again and again because the IRS has found abuse on audit, especially with those taking larger deductions. We all know that charitable contributions are a great write-off and help you to feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared to your income, it raises a red flag. That's because the IRS can tell what the average charitable donation is for a person in your tax bracket. Also, if you don't get an appraisal for donations of valuable property or if you fail to file Form 8283 for donations over $500, the chances of audit increase. Be sure you keep all your supporting documents, including receipts for cash and property contributions made during the year, and abide by the documentation rules. And attach Form 8283 if required. 4. Home office deduction. The IRS is always very interested in this deduction, primarily because it has a pretty high adjustment rate on audit. This is because history has shown that many people who claim a home office don't meet all the requirements for properly taking the deduction, and others may overstate the benefit. If you qualify, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance, and other costs that are properly allocated to the home office. That's a great deal. However, in order to take this write-off, the space must be used exclusively and on a regular basis as your principal place of business. That makes it difficult to claim a guest bedroom or children's playroom as a home office, even if you also use the space to conduct your work. Exclusive use means a specific area of the home is used only for trade or business, not also where the family watches TV at night. Don't be afraid to take the home-office deduction if you're otherwise entitled to it. Risk of audit should not keep you from taking legitimate deductions. If you have it and can prove it, then use it. 5. Business meals, travel and entertainment. Schedule C is a treasure trove of tax deductions for self-employeds. But it's also a gold mine for IRS agents, who know from past experience that self-employeds tend to claim excessive deductions. Most under-reporting of income and overstating of deductions are done by those who are self-employed. And the IRS looks at both higher-grossing sole proprietorships as well as smaller ones. Big deductions for meals, travel and entertainment are always ripe for audit. A large write-off here will set off alarm bells, especially if the amount seems too large for the business. Agents know that many filers slip in personal meals here or fail to satisfy the strict substantiation rules for these expenses. To qualify for meals or entertainment deductions, you must keep detailed records generally documenting the following for each expense: amount, place, persons attending, business purpose and nature of discussion or meeting. Also, receipts are required for expenditures over $75 or any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast. 6. Claiming 100% business use of vehicle Another area that is ripe for IRS review is use of a business vehicle. When you depreciate a car, you have to list on Form 4562 what percentage of its use during the year was for business. Claiming 100% business use for an automobile on Schedule C is red meat for IRS agents. They know that it's extremely rare that an individual actually uses a vehicle 100% of the time for business, especially if no other vehicle is available for personal use. IRS agents are trained to focus on this issue and will closely scrutinize your records. Make sure you keep very detailed mileage logs and precise calendar entries for the purpose of every road trip. Sloppy recordkeeping makes it easy for the revenue agent to disallow your deduction. As a reminder, even if you use the IRS' standard mileage rate to deduct your business vehicle costs, ensure that you are not also claiming actual expenses for maintenance, insurance and other out-of-pocket costs. The IRS has found filer noncompliance in this area as well and will look for this. 7. Claiming a loss for a hobby activity. Your chances of “winning” the audit lottery increase if you have wage income and file a Schedule C with large losses. And, if your Schedule C loss-generating activity sounds like a hobby...horse breeding, car racing, and such...the IRS pays even more attention. It's issued guidelines to its agents on how to sniff out those who improperly deduct hobby losses. Large Schedule C losses are audit bait, but reporting losses from activities in which it looks like you might be having a good time is just asking for IRS scrutiny. Tax laws don't allow you to deduct hobby losses on Schedule C; however, you do have to report any income earned from your hobbies. In order to claim a hobby loss, your activity must be entered into and conducted with the reasonable expectation of making a profit. If your activity generates profit three out of every five years (or two out of seven years for horse breeding), the law presumes you're in business to make a profit, unless the IRS establishes to the contrary. If audited, the IRS is going to make you prove you have a legitimate business and not a hobby. So, make sure you run your activity in a business-like manner and can provide supporting documents for all expenses. 8. Cash businesses. Small business owners, especially those in cash-intensive businesses...taxi drivers, car washes, bars, hair salons, restaurants and the like...are an easy target for IRS auditors. The agency is well aware that those who primarily receive cash in their business are less likely to accurately report all of their taxable income. The IRS wants to narrow the tax gap, and history has shown that cash-based businesses are a good source of audit adjustments. It has a new guide for agents to use when auditing cash intensive businesses, telling how to interview owners and noting various indicators of unreported income. 9. Failure to report a foreign bank account. The IRS is intensely interested in people with offshore accounts, especially those in tax havens. U.S. tax authorities have had some recent success in trying to get foreign banks (such as UBS in Switzerland) to disclose information on U.S. account holders. Also, the IRS had a voluntary compliance program where people came in and reported their foreign bank accounts and foreign assets in exchange for lesser penalties than they would have otherwise been subject to. The IRS has learned a lot from these probes. Failure to report a foreign bank account can lead to severe penalties, and the IRS has made this issue a top priority. Make sure that if you have any such accounts, you properly report them when you file your return. Keep in mind, though, that if you have never previously reported the foreign bank account on your return, and you decide to do so for the first time in 2010, that might also look suspicious to the IRS. 10. Engaging in currency transactions. The IRS gets many reports of cash transactions in excess of $10,000 involving banks, casinos, car dealers and other businesses, plus suspicious activity reports from banks and disclosures of foreign accounts. A recent report by Treasury inspectors concluded that these currency transaction reports are a valuable source of audit leads for sniffing out unreported income. The IRS agrees and it will make greater use of these forms in its audit process. So if you are a person who makes large cash purchases or deposits, be prepared for IRS scrutiny. Also, beware that banks and other institutions file reports on suspicious activities that appear to avoid the currency transaction rules (such as persons depositing $9,500 cash one day and an additional $9,500 cash two days later). 11. Math errors. One of the biggest reasons that people receive a letter from the IRS is because of mathematical mistakes they make on their tax returns. If you make an error in your favor, you are going to hear from the tax man, and there is a greater risk of the IRS pulling the whole return for audit. So take time to ensure all your calculations are correct. Even though math errors may not lead to a full-blown audit, it's always best to remain under the radar of IRS computers. 12. Taking higher-than-average deductions. If deductions on your return are disproportionately large compared to your income, the IRS audit formulas take this into account when selecting returns for examination. Screeners then pull the most questionable returns for review. But if you've got the proper documentation for your deduction, don't be scared to claim it. There's no reason to ever pay the IRS more tax than you actually owe.
Treasuries and mortgages doing better early this morning. At 8:30 weekly jobless claims saw a decline of 6K filings from last week, however last week's claims were revised from 282K to 394K. Continuing claims were down 51K to 3.714 mil but as with the claims continuing claims were revised from 3.721 mil last week to 4.22 mil in the revision. The 4 wk average also increased to 394,250 frm 391.000 based on the revisions. The claims report today is data collected after the BLS gathered the data for tomorrow's monthly employment report.
Next up this morning, the March Chicago purchasing managers index, expected at 70.0 frm 71.2 in Feb, was 70.6. The new orders component at 74.5 frm 75.9, the employment index at 65.6 frm 59.8 the highest read since Dec 1983 and the prices pd for materials at 83.4 frm 81.2, the highest since July 2008. Employment and prices are more evidence that the economy is improving along with inflation concerns. However, there was little reaction to the report, treasuries and mortgages held steady with small price gains and the stock market unchanged.
Finally today, Feb factory orders were expected to be up 0.4%, were down 0.1% and Jan revised to +3.3% frm 3.1%.
In Europe inflation data was stronger than expected; in the 17-nation euro region inflation increased to 2.6% in March from 2.4% in February, European Union estimates showed today. That’s the fastest pace since October 2008, and exceeds the ECB’s 2.0% limit for a fourth month. Economists had forecast inflation to hold steady. Next week the ECB will meet to discuss increasing its base lending rate, the inflation data today further increases the chance ECB will increase rates. Following moves in China, Brazil, Russia and India base lending rates are moving higher. In the US so far, the Fed still holds that inflation is not an immediate problem and plans to continue the easing move of buying $600B of treasuries. Whether or not inflation is about to click in, the bond market will face a huge hill to climb keeping long term rates including mortgages at or below the present levels. Fed officials are increasingly more divided on ending QE 2 sooner and less buying than originally intended; Bernanke however appears to be holding with completing the entire $600B buying that will conclude at the end of June.
After all the data this morning the rate markets holding better than we would have thought given the strong Chicago PM index and inflation increase out of Europe. The stock market holding unchanged. Technically the 10 yr held 3.50% on Tuesday giving traders a little opportunity but overall the bond market still holds a bearish outlook for rates. The rest of the session will be setting up for tomorrow's employment report with estimates still for an increase of 200K jobs and the unemployment rate unchanged at 8.9%. If floating stay close today; normally we do not like having a market position into employment as it is too volatile.
Last Week in Review: Our thoughts continue to go out to people suffering in both Japan and the Middle East. Read on to learn how world events impacted the markets.
Forecast for the Week: The volatility is sure to continue, as will the barrage of news, including several reports that will tell us how our economic recovery is faring.
View: Have a home equity line of credit? Know if it is impacting your credit score unfairly? Check out important details below!
"It’s a small world after all..." That notion was especially evident last week, with both the news in Japan and the Middle East impacting our markets. Here’s what happened, and what the impact was on home loan rates.
The first thing to understand is the concept of "safe haven trading." At times of global unrest and uncertainty, like with last week’s nuclear crisis in Japan and the ongoing fighting in Libya, Traders will park their money in "safe" investments like our Bonds. And since Bonds such as Mortgage Backed Securities (MBS) are tied to home loan rates, when Bond pricing improves, our home loan rates can improve... which is what we saw last week.
But it’s also important to understand how incredibly volatile this situation is. A "safe haven trade" is just that... a trade, which is short-term. Should events around the world become more stable, this safe haven trade can unwind very quickly... with Bond prices and home loan rates worsening as a result. This is similar to how the market reacted at the end of last week, when Libya declared a cease fire to fighting after the United Nations declared a no-fly zone.
Another thing to note is that Bonds and home loan rates are facing some additional headwinds that could hamper their improvement. First, if Japan sells some of their Treasury holdings to help finance the recovery and reconstruction, like they did in 1995 after the Kobe earthquake, this could spur a sell-off in Bonds overall, which would cause Bonds and home loan rates to worsen.
Second, we cannot overlook the impact of inflation... which is the arch enemy of Bonds and home loan rates... both here and overseas. Not only is China struggling with inflation even though they have raised rates and tightened lending requirements multiple times over the past few months, but last week both our Producer Price Index (which measures inflation at the wholesale level) and our Consumer Price Index were hotter than expected.
The bottom line: If inflation is allowed to grow, it can be very difficult to rein in and control... and this will hinder improvement in home loan rates. And, if the situations in Japan and the Middle East stabilize or improve, we could see further unwinding of the "safe-haven" buying of US Bonds... which will also hinder improvement in home loan rates.
If you have been thinking about purchasing or refinancing a home, call or email me to learn more about how you can benefit. Or forward this newsletter on to someone you know who may benefit from today’s historically low rates.
Continuing developments in world events are sure to impact the markets this week, but there are some important US economic reports to look for, too, including:
Remember: Weak economic news normally causes money to flow out of Stocks and into Bonds, helping Bonds and home loan rates improve, while strong economic news normally has the opposite result.
As you can see in the chart below, Bonds and home loan rates improved due to the turmoil around the world, but they were unable to improve above a key technical level. I’ll be watching to see which way the markets move this week.
Home Equity Lines of Credit and Your Credit Score
What You Need to Know and Do
Credit reports have always been important, but they’ve grown even more important in recent years. Now more than ever, you need to make sure you understand what’s on your credit report - and you need to know what steps you can take to improve your score.
For example, did you know that a Home Equity Line of Credit (HELOC) can impact your credit score quite dramatically... and sometimes unfairly... depending on how it is reported?
Here’s What You Need to Know... and Do!
First, you need to know that HELOC’s are commonly reported by the three credit bureaus as revolving accounts. In reality however, they do not fall under the typical revolving terms, even though they are set up in the same way as a revolving account. That’s because HELOC’s are secured by an asset.
Here’s the Good News...
The Fair Credit Reporting act requires reporting agencies to report true and accurate information. So when a HELOC is reported as a revolving account, you can actually send a letter to the three credit bureaus asking them to change the type of account from "Revolving" to "Line of Credit" or "Other."
This way, the account will not be rated by the scoring system using the "Balance to Limit" ratio scenario - which can drop a credit score by as much as 75 points if the HELOC is maxed out to the limit of the available credit line.
A Final Word of Advice
If you do decide to send a letter, you should send it as a Certified Letter, along with a copy of the HELOC agreement. You may have to send the letters more than once, but persistence is the key to accomplishing a positive result with the bureaus.
This article was adapted from information provided by national credit expert Linda Ferrari, author of "THE BIG SCORE: Getting It and Keeping It, Buying Power for Life." Learn more and check out her credit resources at www.lindaferrari.com
Economic Calendar for the Week of March 21-25, 2011
Remember, as a general rule, weaker than expected economic data is good for rates, while positive data causes rates to rise.
Economic Calendar for the Week of March 21 - March 25
The potential of a nuke meltdown increased overnight sending all investors running to cash. The Tokyo stock market with the Nikkei 225 (NKY) index posting its biggest two-day drop since 1987, while commodities slid and Treasuries jumped. Europe's equity markets all lower, in the US in pre-market trade at 8:30 had the DJIA down 278, crude oil down $3.85 and gold off $30.00. Conflicting reports that are steaming moment to moment out of Japan; earlier last night the Prime Minister was cautioning that a meltdown was increasing quickly, asking people to leave the area, tape up windows and/or stay inside. At 8:30 this morning Tokyo Electric Power Co. engineers at a nuclear plant restored water to safe levels, helping drive down radiation after residents within 30 kilometers (19 miles) were ordered inside to avoid contamination. “The radiation levels are above normal, but at most only about one-10th of a chest X-ray and are not harmful to the health,” the government said in a separate statement today.
Whether or not there will be a serious meltdown is an obvious concern but markets are beginning to realize that Japan's economy will be impaired for years in the process of re-building. The impact of one of the largest economies in the world being dragged down is still not fully understood by markets or the Fed. The Fed is meeting today in the scheduled FOMC meeting, talk already about the potential of another easing move resulting from the crisis. The Bank of Japan infused $183B into the financial system yesterday and another $83B today to support the system.
Yesterday the US markets appeared to have not taken the Japanese situation as seriously as we would have thought; the DJIA fell just 51 points while the Treasuries and mortgages hardly moved. Today with increased fears of a nuclear meltdown all markets are being impacted. Crude oil continues to fall on the idea that Japan's need for oil will decline as its economy grinds to almost a halt. Longer term however, crude will eventually increase as markets realize Japan won't have nuclear power for years to come. Gold also is declining, no one wants to hold anything but cash now; all commodities are lower this morning. The news out of Japan is conflicting, there is little understanding now as to the eventual impact for the global economies; today it is a run to cover many market positions.
More not so good news; German investor confidence unexpectedly fell for the first time in five months in March. Its confidence index of investor and analyst expectations, which aims to predict developments six months in advance, declined to 14.1 from 15.7 in February. Economists had expected a gain to 15.9.
The troubles in the Mideast have been put in the back seat with Japan now the main focus; nevertheless things are not improving in the region. Troops from the Gulf Cooperation Council, including Saudi Arabia, crossed into Bahrain yesterday, the first cross-border intervention since a wave of popular uprisings swept through parts of the Arab world. Shiite protesters and Bahraini forces escalated Sunday, with more than 100 people injured as demonstrators demanded democracy through elections from their Sunni monarch.
Economic news here in the US this morning has been pushed to the side; the Mar NY Empire State manufacturing data this morning at 8:30 showed the overall index up to 17.5 frm 15.43, a little better than expected but with Japan it is already out-dated news. The sub components; new orders fell to an index read of 5.81 frm 11.80 in Feb, the employment component increased to 9.09 frm 3.61 and prices pd for materials increased to 53.25 from 45.78 (any index read over zero is considered expansion.
At 10:00 the Mar NAHB housing market index hit at 17, up 1 point from the past five months and was as expected.
Later this afternoon the FOMC meeting will conclude with the usual short policy statement. The Fed is unlikely to have much comment in the statement regarding the current economic crisis that is escalating out of Japan. Expect a lot of debate in the coming days over whether or not the Fed may have to initiate another easing move of some kind. It is too soon for any definitive decisions, the Fed will wait for more news and analysis on the impact on the US economy before committing to any additional easing.
Everything happening now in the world is supportive to US treasuries and therefore mortgage markets. Early this morning the 10 yr note yield fell to 3.23% down from 3.37% at the close yesterday. By 9:30 the 10 yr rate had increased to 3.26%. The equity markets are trading lower today with investors and traders scrambling to market neutral positions or simply selling. Yesterday the equity market opened soft with the DJIA off 140 points but by the end of the session the DJIA ended down just 51 points; today may be a lot different pending continual news coming out of Japan on their nuke problem. This morning the DJIA opened down 185, the 10 yr +30/32 at 3.26% -11 bp and mortgage prices up 19/32 (.59 bp); within five minutes of the open the DJIA traded down 293 on a news flash Japan suffered another 6.0 earthquake.
It is all happening rapidly this morning, no one wants to wait to see facts, the markets are highly volatile and emotional at the beginning of the day. Today may be exceptionally volatile as the news unfolds. Already in the first 30 minutes of trading in equities the indexes are well off their lows and the bond and mortgage markets have backed off their best levels so far.
Good Morning!
Treasuries and mortgages opened a little better this morning with the key stock indexes lower. The world still focused on Japan's earthquakes and Tsunami. There are now three nuke plants in jeopardy of a meltdown and the Tokyo stock market was hammered hard last night, the largest loss in 2 yrs, down 6.0%. Crude oil continues its decline on continued belief demand will decline in Japan. There are no economic reports scheduled today, the calendar has data points mid-week however. This week is marked by tomorrow's FOMC meeting with the short policy statement out at 2:15 Tuesday afternoon. This Week's Economic calendar: Tuesday; 8:30 am Empire State manufacturing index (17.0 frm 15.43 in Feb) Feb import and export prices (N/A) 10:00 am NAHB housing market index (17 frm 16) 2:15 pm FOMC policy statement Wednesday; 7:00 am weekly MBA mortgage applications 8:30 am Feb housing starts and permits (starts -4.4%, permits +2.0%) Feb PPI (+0.6%; core +0.2%) Q4 current account balance (-$110.0B) Thursday; 8:30 am weekly jobless claims -10K to 387K; con't claims 3.750 mil frm 3.771 mil) Feb CPI (+0.4%; core +0.1%) 9:15 am Feb industrial production (+0.6%) Feb capacity utilization (76.5% frm 76.1%) 10:00 am Feb leading economic indicators (+0.9%) Mar Philadelphia Fed business index (28.0 frm 35.9 in Feb) The DJIA opened down 65 at 9:30, the 10 yr note +10/32 at 3.36% -3 bp and holding below 3.40% since last Thursday. Technically the l0 yr note and mortgage markets are breaking some resistance levels. Japan's woes are filtering around the world; crude lower on the belief demand in Japan will decline, emerging market equity markets rallying on re-building boom that will be huge in Japan. Most all attention now is on Japan's problems but the Mideast is still out there with continued protests in a number of states in the region while Qaddafi is waging war with protesters in the oil region and ports. In Europe a week ago comments from the ECB that it would be considering increasing interest rates next month to head off increasing inflation; now that looks less likely, England didn't increase rates and there are voices calling for the ECB to hold rates low to keep recovery moving forward and less concern over inflation increasing. The rest of the day today for the bond and mortgage markets will be dependent on how equity markets trade; so far the key indexes are weaker but not much. Tomorrow's FOMC meeting should keep investors and traders from major moves. The Fed will keep interest rates at their present levels, talk about concerns over inflation, still worry over the strength of the US recovery with slow improvement in employment and no signs of recovery in the housing sector.
"Friends of Kids with Cancer" Charity Event Sponsored in part by Envoy Mortgage
Greg Iverson-Envoy Mortgage
Gary Bussard-Branch Manager STL Envoy Mortgage
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