Tax credits (tax dollars not spent) are, as noted in the introduction to this section, better than tax deductions. A $100 tax credit, after all, reduces your tax liability by a full $100, while a $100 deduction reduces your liability by only 15 percent or 28 percent of that $100 ... depending upon your tax bracket. It makes sense, then to take advantage of any and all tax credits you may have coming.
Here are some tax credits often overlooked
Credits for the elderly and disabled . If you are 65 or older by the end of the tax year, or under 65 and retired on permanent and total disability, and meet certain criteria, you may qualify for a tax credit. Check with your tax preparer or the local IRS service office for more information, since the formula for determining eligibility is complicated and involves such factors as adjusted gross income, untaxed Social Security benefits, etc.
Child-care credit .
This credit is based on a
sliding scale with parents with adjusted gross income of less than $10,000 receiving the greatest benefit (a tax credit of up to 30 percent of child-care costs, up to $720 for one child and $1,440 for two or more children). A family with an adjusted gross income of $28,000 or more, on the other hand, may claim a credit of up to 20 percent of total child-care costs, up to a maximum of $480 for one child and $960 for two or more children.
Credit for care of another family member.
You may also claim the same credit for the care of your husband or wife who is physically or mentally incapable of self-care or for the care of a member of your household incapable of self-care whom you claim as a dependent or whom you would claim as a dependent were it not for the fact that he or she earned income of more than $2,000 in the tax year.
Earned income credit.
This frequently overlooked credit is available to low-income workers who have a child living with them for more than half the year.
Overpayment to Social Security. If you work for two or more employers in a year and earn more than $48,000, you may have had too much Social Security tax deducted from your income. To check, find the total amount of FICA tax withheld (add the figures on your W-2 earnings statements) and subtract the maximum contribution ($3.604.80). Any excess can be claimed as a credit and reduces your tax liability dollar for dollar.
Some other credits, not well known, are credits available to you if you are the original owner of a diesel car, if you own a company that hires some disadvantaged workers, and even, in some cases, if you pay income taxes to a U.S. possession or any of certain foreign countries.
There are six basic ways taxpayers are selected for audits. Knowing how the selection process works may help you avoid so-called "red flags" that can trigger an audit. You need to remember, though, that being tapped doesn't mean the government suspects you of wrongdoing ... and also remember that a certain number of taxpayers are selected for audits each year purely at random.
Here are the half-dozen audit-selection methods
The Discriminate Function System. This is a method by which the IRS has programmed average deductions for each income bracket into its big computer in Martinsburg, WV. If the deductions on your return are especially high compared with most others in your bracket, you could be selected for an audit.
The Taxpayer Compliance Measurement Program. In order to determine the average numbers used in method No 1 above, the IRS randomly selects tax returns and goes over them with the finest of fine-toothed combs. If you're unlucky enough to be selected for this kind of audit, expect to spend two or three days justifying deductions and answering questions.
Matching information on documents. Thanks to computers, The IRS can (with ever-increasing ease and an speed) match your W-2 form with your employer's, partnership returns, interest-reporting forms submitted by banks, etc. Restaurants even report on their total business which allows the IRS to estimate tip income for waiters and waitresses. If you haven't reported income as required, there's now an almost 100 percent probability that the government is going to find out.
Targeted group projects. The IRS gives even closer scrutiny to the returns of particular groups than it does to those of most salaried workers: Self-employed individuals,for example, are targeted, as are waiters and taxi drivers. If a taxpayer in one of these groups takes unusual deductions or reports little or no income from tips, the likelihood of an audit is increased.
Discrepancies. Again, computers are at work. In this instance, though, the computers are looking for discre
pancies within
returns. An apparent discrepancy might be, for example the listing of a deduction for mortgage interest with no listing for real estate taxes or perhaps sizable medical expenses along with deductions for medical insurance payments.
Tips from informants. If you've made an enemy who suspects you of tax cheating, that enemy might decide to give the IRS a tip (a situation that's made even more sticky by the IRS agency's policy, in some cases, of rewarding the tipster with up to 10 percent of the additional tax recovered). Reporting cheats
Just about two out of every 100 tax returns are audited, so your chances of escaping an audit year after year are pretty good unless you raise one of the so-called "red flags" listed below:
Deductions excessively high relative to
earnings. A return that shows $400,000 of total income and $30,000 of deductions is questionable and almost sure to warrant an audit. Don't go overboard with deductions; but don't force yourself to pay more taxes just because you're afraid. If you found it necessary to incur some exceptional deductible expenses in a given year, attach a note to your return explaining the circumstances.
Overstated losses from some casualty. You need to use the IRS work sheet and work carefully if you're claiming a casualty loss. Follow the rules.
Unjustified Medical deductions. Many taxpayers forget that medical expenses, to be deductible, must exceed 7.5 percent of adjusted gross income.
Unproven charitable gifts. If you do not include, with your return, a statement showing the date of each contribution, fair market value and the name of the charity blessed with your gift, your return will be pulled and the chances of an audit will increase.
Large-loss tax shelters. These are frowned upon by the IRS. Shelters now must be income producing and not set up solely for tax purposes. The best thing to do is to stay away from shelters unless you're willing to get, and pay for, professional advice.
Inclusion of Schedule C. All self-employed individuals must include a Schedule C with their returns. Unfortunately, this schedule in and of itself is an audit red flag.
Business expenses too high relative to earnings. Be particularly careful to keep travel and entertainment deductions reasonable.
In-home office expenses. These now must meet tough guidelines and often will cause a return to be pulled for audit.
Simple and foolish mistakes. A sloppy, error-filled return will be kicked out of the IRS computer, thus increasing the chance of an audit. Avoid simple mistakes.
If you receive a letter informing you that you're going to be audited, here's what you should do:
Make sure you're completely familiar with the return you filed. Get your file copy and study it carefully. Generally, the IRS agent will question only those items checked on a form letter you receive notifying you of the audit. Study those items most carefully.
If the revenue service is asking for proof justifying some deductions, make sure you have that proof. This could include paid bills, receipts, canceled checks or paycheck stubs showing deductions.
If there's an item of proof you can't find, don't give up. The agent may accept what's known as "secondary" proof. If, for example, you claim a deduction for installing attic installation in your house but don't have a receipt, the agent may accept a letter from the contractor who installed the installation. Also, the agent may take your word on some deductions if you show you are well prepared with proof on other items.
UNDER NO CIRCUMSTANCES ignore the letter. If the timing is bad, telephone the IRS, several days before your scheduled audit and reschedule.
Remember during the audit that the agent is only doing his or her job. Don't become angry and threatening. You don't want an enemy sitting across from you.
On the other hand, don't grovel. Don't volunteer information. Just answer questions simply, honestly and fairly.
If the agent asks for proof of a deduction you don't have but which you know you can easily obtain, let him know. It's better to come back again than to agree to a liability you don't owe.
If you and the agent agree on all issues, you'll be told how much additional tax you owe and be asked to sign an agreement form. ONCE YOU SIGN, YOU'VE LOST YOUR RIGHT TO APPEAL, so study the form and be sure you agree with all figures.
After agreement is reached, you'll receive, in the mail, a bill for additional tax (if due). If you can't pay all at once, ask the IRS to set up a payment plan.
If you feel, during the audit, that you're not being treated fairly, you have the right to ask for a hearing at the appellate level. At the appellate level, experts say, the chances of compromise increase.
If you are still convinced of the rightness of your position and are dissatisfied with the hearing at the appellate level, you may appeal your case to the United States Tax Court. If the amount in question is under $10,000, you can have a hearing under the so-called "Small Tax Case" procedures wherein you act as your own representative but give up your right of appeal.
If, however, those procedures aren't applicable and you are still dissatisfied after appearing in Tax Court, your next step is to take your case to the U.S. Court of Appeals.
As hard as it may be to believe, there are even times when it makes sense to ASK for an audit. Here are those times:
In the case of a death, when an heir or heirs are waiting to take over the after-tax assets of an estate. The sooner the IRS gets around to examining the deceased individual's financial affairs, the better.
In any case when a business is closed down, since key managers and company accountants may leave town or even disappear. An audit or examination at a later date could prove costly, cumbersome or impossible.
Use Form 4810 in asking for a prompt tax assessment, or in a letter, make plain that you are asking for a prompt assessment under Code Section 6501 (d). The IRS then has 18 months to comply with your request, as opposed to the normal three year span allowed for tax assessment.
Say you have a less than $10,000 disagreement with the IRS and you've decided to take the matter to the Small Case Division of the Tax Court. How do you prepare? What should you expect?
Read on:
First, get all the forms you need by contacting the Clerk of Court, U.S. Tax Court, 400 Second St. N.W., Washington, D.C. 20217. You'll be sent a petition form, a form for designating the location of the trial, and a booklet explaining how the Division works, as well as a list of Cities it visits.
You must file the petition, along with a $60 filing fee (subject to change), within 90 days of the date you were notified of your deficiency. This time limit is absolute. AS in all IRS matters, use certified mail, return receipt requested.
In your petition, clearly state your disagreement, including your reasons for disagreeing. You don't have to be a legal whiz, just write clearly and concisely. A copy of this petition will be sent to the IRS and you'll probably be contacted by the Service soon afterward. Many cases are settled at this stage of the proceedings.
If no settlement is reached, a trial date will be set. You should be notified about two months in advance. Be prepared to wait for trial though, since, depending upon the case-load, it can take from seven to 10 months for a trial date to be set after your petition is filed.
At trial, you can call witnesses, argue your case orally or in writing, submit evidence you may have and personally testify. Documentary evidence is particularly important so bring as much paperwork as is founded.
Decisions of the Small Case Division are final and neither side can appeal. Furthermore, you can't use prior decisions as precedent and, in fact, your case can't be used as a precedent, even in another case involving yourself.
In rare instances, a Small Case Division case may be transferred to the regular Tax Court. This usually happens in cases where new or unusual legal issues are raised or in which the court wishes to establish some binding precedent.
Private ruling ... what they are and how they work
Investors who are putting a lot of money at risk in a venture often are concerned about the tax consequences of their investment. Few, though, know they can query the IRS to determine those tax consequences before making any investment.
The IRS will provide, under certain circumstances, what is known as a "private letter ruling" -- a written statement from the IRS national office outlining the effects of a given transaction. The "letter," though, is not free -- there is a fee ranging from $50 to a high of $1,000.
Here are some cases when you would be well advised to ask for a private ruling:
You are considering an exchange of property, with the exchange based on a lack of tax consequences.
You wish to make a donation to a government entity but only if the donation is considered a deductible charitable donation.
You wish to pass control of a family-owned business to your children by allowing them to redeem company shares from you but want to make sure the transaction receives favorable capital gains treatment.
You need to determine the need to withhold Social Security taxes from employees working for you in unusual capacities or under unusual circumstances.
There is no standard form, so you must send a letter to the internal Revenue Service, Associate Chief Counsel (Technical), ATTn: CC:IND:S, Room 6545, 1111 Washington Ave. N.W., Washington, DC 20224.
for expeditious handling of your request, contact the IRS by telephone -- at 202-566-4773 -- before sending your letter and state the general area of the ruling request. You'll be given a code number to include with your request, used to direct the paper work to the responsible individual.
Also:
Detail the proposed transaction, omitting no details.
Include in your request the names, addresses and taxpayer identification number (or Social Security numbers) of all parties to the transaction.
State the business reasons for the transaction, if any.
State clearly what ruling you are seeking.
File any arguments supporting your request with legal authorities.
Make clear that the issue is not in litigation.
If you expect an adverse ruling, ask in your letter, for an opportunity to meet with officials to state your case in person.
Attach copies of all relevant documents to your letter.
Declare that all facts are true and that you sign under the penalty of perjury. Have your signature witnessed by a notary.
Request that all confidential information be removed from the published ruling.
What happens
Within about three weeks, you'll be contacted by an agent to discuss your request. If the agent says it is slated for approval, you'll get a favorable letter, usually within six months. If the agent says the request will be disapproved, you can withdraw it and proceed with the transaction; no request will have officially been made in the eyes of the revenue service. If the agent is not sure about the fate of the request, you may be able to amend it to obtain a favorable ruling. If this first discussion with an agent ends with major issues unresolved, you can request a hearing in person. If the hearing ends with the IRS still looking negatively at the proposed transaction, withdraw your request.
NO RULING IS BETTER THAN A NEGATIVE RULING
When NOT to seek a private ruling
If you're pretty sure the ruling will be unfavorable to you, as noted above, no ruling is better than a negative ruling. Without a ruling, if you proceed with the transaction, there's always a chance your return will go unaudited. If, on the otherhand, you receive an unfavorable ruling, the chances of an audit are high, and an audit may disclose other tax problems you'd rather not have disclosed.
