1 January 2016

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 January 1, 2016
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Individual Tax Return Form 1040 Audit Flags

Income & Expenses Not In Balance:

1.Total income on the return is less than your deductions, especially itemized deductions of Schedule A amount; this is the radar area creating automatic questions and possible examination.  This is a red flag for the standard of living that does not match the life style. This could trigger other audit questions on the individual return.  If the expenses are more that the income then better to have good supporting documents how did you support living expenses during the year.

Schedule A Acquisition Mortgage and Home Equity Loans:

1.The limit on the principal home acquisition loan is 1,000,000 and 100,000 for the home equity loan.  If you are deducting more than the above limits then creating red flags.  The amount above these limits has to be calculated to reflect accurate proportion of mortgage and equity interest on the Schedule A.

2.NEW Modified Form 1098 for 2016 – A Major Change Impacts Many:  A major red flag and future audit issue with matching the new information of the new Form 1098 will show items that IRS might not have them before.  These new items on the boxes are-Box 2: Outstanding mortgage principal as of 1/1/2016 Box 3: Mortgage origination date Box 5: Mortgage Insurance Premiums Box 7, 8, 9: Address information of property securing the mortgage.  These new information will help practitioners and IRS with additional tools to know that the loan is acquisition loan or equity debt loan.  If the amount of loan has exceeded the acquisition loan amount which will limits the mortgage interest deductions for the taxpayer.  If loan refinanced it can also qualify as acquisition loan or debt, if it does not exceed the amount of the old acquisition loan just before the refinancing.  Nature of acquisition loan is that it could be deducted against both regular and the AMT.

Form 1095-A Health Insurance Marketplace

1.Be aware of issues with 1095-A at the end of tax year.  This form shows the coverages for the family members and the months were covered.   And the amount of subsidy for which months received.  With the tax returns Form 8962 Premium Tax Credit (PTC) is reported to IRS.  If your income or the members of family changed and obtained their own insurance or had income and going to file by herself or himself at the end of the year inform your insurance provider for further future financial problems.  If the changes were not reported when a family member status changed then at the end of year income of that person if is your dependent it will be part of the calculation of PTC.  If the family member is going to file tax return with his or her own exemption then it will impact on your tax return.  Be aware of high penalties for not having health insurance.

Charitable Deductions

1.Higher than average deductions of cash charitable deductions relative to the income level could create red flags. Make sure that the charity organization is recognized by the IRS and have a valid non-profit organizational status.  Make sure to receive receipt when giving cash donation. On the non-cash donations extreme caution should be used. What the charity organization provides to you most of times is not the real fair market value of the donated item.  Keep a good record such as pictures when providing to charity.

Schedule C:

1.Home Office Deductions-IRS allows home office deductions but they have to be reasonable and not overstated. Unreasonable percentage of deductions for home use of business such as utilities, mortgage interest, property tax, or rent causes red flag. Home office use has to meet the rules of IRS exclusive use test such as a use in a regular basis as the principal trade place of business or for the meeting the customers or clients.

2.100% use of auto expense in business also creates red flags.  The percentage use of auto has to be reasonable percentage between business and personal use either actual expenses such as gas, repairs, insurance, deprecation, or when the auto is leased for business.  Auto mileage is a basis for the percentage of business and personal usage, keep log if possible.

3.Below average net income also creates questions and red flags.  Based on government collections there are some averages for each industry in professional services or retails or wholesales or others.

4.Higher meals and entertainment deductions relative to income and above average of industry.

5.Continues losses in business three out of five years.  From government point of view you are there to make money and profit motive is the basis of business.  If it is a hobby then it is not belonging to schedule C and it has to be treated in different schedule as hobby activity rules and not business motive.  Hobby losses are limited to the extent of income and not more that income.

Stock Market Activities:

1.The brokerage firms report the gross proceeds and from 2011 the cost basis to IRS through the matching concept from third party government would know the stock activities.  Make sure to keep accurate stock market activities and provide them to your tax preparer that you will receive by end of each January for the previous year activities.  Be aware of wash sales many ignore them and be surprised when income tax returns prepared at the end of year and loss the wash sales portion as deduction.

Passive Activities Reporting:

1.If you have rental properties this is a passive activity.  The loss is limited to maximum of $25,000 if your adjusted gross income below $150,000.  It will phase out up to $150,000 of income.  If you are anactive participant in this property.  If you are material participant and a real estate professional with certain amount of time during the year spend in real estate activates then your loss is not limited to $25,000.  There are certain rules that have to be met.

The above information is for the educational and general informational purposes only.  These are not tax or legal advises.  For any specific matters you have to consult with your tax, legal, and financial advisor.

S Corporation Reasonable Salary Compensation of Officer

IRS is auditing S corporations for not having a reasonable amount of compensation for the officers and active shareholders.  The reason being is that with the pass through income from K-1 to the shareholder income no self-employed tax is paid on the ordinary income.  Self-employed tax (social security rate 6.2% or $7,347 for employer and 6.2% or $7,347 for employee for the maximum amount of maximum $118,500 for year 2016) the Medicare rate of 2.9% remains the same with no limit which 1.45% is for employer and 1.45% for a single and head of household earner under the thresholds of $200,000, for couples under $250,000, for married filing separately under $125,000.  A 0.9% Medicare surtax on earned income kicks in for higher incomers from January 1, 2013.  For earners over the above thresholds the effective Medicare tax rate will be 3.8% not the 2.9% rate as extra 0.9%.

Please take this tax issue very serious since there is some time before the year-end now.  If you have someone doing your payroll service contacts with them and if you are not sure about the reasonableness of amount call me to help you soon and do not delay.  If you do not take any reasonable salary then all the distribution and net earnings will be subject to self-employed tax for salary purposes.  Which for the year 2015 is 15.30% for the year 2016 for the under threshold figures stated above.  The Medicare rate for the employee and employer remain at 1.45% for each or total of 2.9% of taxable gross income with no limit, a 0.9% Medicate surtax on earned income of above the threshold or 3.8%. The amount of 15.30% will be increased to 16.20% for the higher incomers exceed the above thresholds.

Due to very sensitive nature of this issue from IRS point of view, I as tax expert outlined this summary article to help you to prevent costly audit and penalties that might be involved.

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