I HAVE NEVER BEEN ABLE to figure out why people make financial decisions based on what they hear from strangers in grocery lines, at bars, at Starbucks, or from what they see in cute pictures on Facebook, while ignoring their own financial advisors. This is especially true for really radical advice about ways to cut your taxes dramatically. Why aren’t you getting your information from someone who can see your entire financial picture and give you advice based on your particular situation—not just on one piece of the picture or on urban myths?
Did you know that tax professionals around the country talk to each other? Yup. We are connected in closed groups on LinkedIn, Facebook, and other social media outlets where we share stories about your exploits. Of course, no one actually names any of our clients. We just tell our stories. Sometimes we laugh, sometimes we cry. Often we ask each other for advice. The truth is, even though you come to us after you’re in trouble, we really, truly want to help you.
That’s exactly why I created TaxMama.com more than a decade ago. After having spent years as a troubleshooter for people with tax problems, I decided to try to help prevent the problems from ever happening in the first place by creating a free, safe place for you to ask your questions. You really, truly are welcome to come to TaxMama.com. Simply click on “Ask a Question.” I, or another member of Team TaxMama, will give you an answer for free. (Please don’t email us your questions—you won’t get an answer. Period.) We won’t compute your calculations or do the work for you. That would be impossible to do without a full-blown consultation, anyway. We will point you to the information you need. We will give you guidance on what to discuss with your tax professional. After all, if you don’t know what to ask about or where to start in a consultation, it’s a waste of time, isn’t it?
OK, let’s start the No-No’s with the nightmare stuff. Have patience and work your way down to the routine things you never want to do.
Tip #225:
Don’t play audit roulette. The odds are with the house (the IRS). It’s really tempting to claim a large deduction for something that you didn’t spend. Or to overvalue something that you sold so the profits are lower. Or to avoid reporting income that you got in cash or without a W-2 or 1099. After all, who’s going to know? You’re right. There are times you can get away with falsifying the information on your tax return—for a while. But the problem with this is that, as with winning when you gamble, it gets addictive. You get away with it once, looking over your shoulder all year . . . maybe for two years. No one comes after you. So let’s try it again. The second time you do it and nothing happens, you’re not quite as nervous. So you keep doing it. Sooner or later you will get caught. Yup. The IRS has better and better methods of cross-referencing information in your tax return with where you live, your lifestyle, your spending, and even your social media posts. The very deductions that you take tell the IRS when you are living above your reported means. Or, when you keep getting away with it, it’s tempting to brag to a friend. Great friend. Uh huh. Your friend turns you in. People snitching on (former) friends, lovers, spouses, and neighbors are a big source of leads for the IRS. When the IRS does audit, and you have scammed them for several years, the IRS will start auditing previous years and give the information to your state(s).
Tip #226:
If you are going to play audit roulette, be smart. Keep your fake tax reductions to below 25 percent. That way, the IRS may only audit you for up to three years. (Your state may have an extra year or two, though.) When you underreport more than 25 percent of your income or tax liability, your exposure to audit is for at least six years. If the IRS can prove you were not just mistakenly underreporting but filing fraudulent tax returns, they may audit you as far back as they please. No limits. Not fun. This can even lead to criminal penalties and jail time.
Tip #227:
Don’t fall prey to amateur tax geniuses. Friends who know everything and push tax advice on you will get you into trouble and you will end up coming to a tax professional quaking in terror. Why? The IRS is auditing that genius—and everyone with whom they shared their wisdom. You will end up paying a tax professional who will try to smooth over the truth and convince the IRS not to charge you penalties or bring criminal charges. There is nothing we can do about the taxes you will owe for doing something that was clearly not sensible. But the penalties and the interest on those penalties can run to the thousands of dollars. We can help prevent, reduce, or reverse those for you.
Tip #228:
Avoid the refund mills, those tax preparers in your community that have a reputation for generating really high refunds. How do you think that person is able to generate refunds that are so much higher than everyone else? Do they look smarter than your current tax professional? Do they even have a degree in accounting or taxation? Do they have an excellent reputation for integrity, known throughout the community as an expert? Heck no! Many of them are fly-by-night operators who will be long gone by the time the IRS comes to you asking for their money back. These kind folks not only rip the IRS off, they steal from you. Many of them give you one version of your tax return but file a different version. Their version has a higher refund. They have the part of the refund that you don’t know about being deposited directly to their bank accounts. You will have to pay all that money to the IRS even though you didn’t know it was happening.
Don’t believe me? Think this is farfetched and TaxMama is exaggerating to scare you? Drop by the IRS’s Criminal Investigation website. Click on the link to “Examples of Abusive Return Preparer Investigations” (https://www.irs.gov/uac/Abusive-Return-Preparer-Criminal-Investigation-%28CI%29).
Tip #229:
Speaking of penalties, don’t waste your money getting saddled with tax penalties. Not only are they annoying and irritating, but you have to pay interest on the penalties. Practically all the time, if you are conscious of your responsibilities, you will have no reason to get a penalty. Of course, if you consort with tax wildcatters, watch out!
What are some of the regular penalties (https://www.irs.gov/uac/Newsroom/Eight-Facts-on-Late-Filing-and-Late-Payment-Penalties)?
What are the biggies?
These are just the civil penalties. You don’t even want to begin to get involved with the criminal penalties.
Tip #230:
Don’t pay IRS penalties. If you find yourself facing large IRS penalties, get the penalties waived. Unless you’re a tax criminal or a habitual tax delinquent, there are often ways to get the IRS to forgive penalties. For folks who’ve never gotten hit with penalties before and suddenly face really large penalties, there is a special provision for you. It is called the First Time Penalty Abatement (FTA). You will find the details on the IRS website (https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Penalty-Relief-Due-to-First-Time-Penalty-Abatement-or-Other-Administrative-Waiver). Here are the three main qualifications to convince the IRS to waive your penalties:
Tip #231:
If you owe a small penalty for something like not paying enough estimated taxes or withholding, just pay that penalty. Save the FTA for the big mistakes. Sometimes, with the complexity of the tax laws, even the most diligent Tax Vigilante will get hit.
Tip #232:
Don’t disclose your Social Security Number (SSN) when not absolutely necessary. Naturally, you need to provide it to your employer, your medical care providers, and your bank. But really, unless you are in business, think twice, OK, three times, before giving it to anyone else. Do not have that number printed on your checks. And do not carry anything in your purse or wallet with your SSN. In my research for a MarketWatch.com article several years ago, I learned two disturbing sources of Social Security numbers theft:
Tip #233:
Don’t become a victim of Stolen Identity Refund Fraud (SIRF). According to an August 2015 report, Treasury Inspector General for Tax Administration (TIGTA; https://www.treasury.gov/tigta/auditreports/2015reports/201540026fr.pdf), approximately 1.1 million fraudulent tax returns were filed in 2011 that showed evidence of identity theft. Their words: “That have the same characteristics as IRS-confirmed identity theft tax returns.” As a result, the IRS has started a campaign to make you aware of the issues, to solicit your help to stop this widespread fraud, and to help you become more active about protecting yourself. The campaign is called “Taxes. Security. Together.” Get the details from the new IRS Publication 4524 (https://www.irs.gov/Individuals/Taxes-Security-Together). While most of the recommendations are common sense, it seems people are far too trusting and don’t bother with precautions. Please don’t think you are immune. You are not.
Tip #234:
Don’t give out any information over the telephone to anyone who calls you about any identity, bank account, or tax or financial details. Even if (especially if) they seem to know a lot about you, do not answer or confirm their information. The best thing to do if the call is not from someone you actually know is to just hang up. If you feel that it might be a legitimate call, call the organization they claimed to be from and ask them if there are outstanding debts or medical or insurance issues. Please, please, please, tell your parents and other elderly friends to hang up, as well. Help them avoid being victimized. Remember, you cannot be bullied if you hang up.
For instance, even though I deal with the IRS all the time, if I am not expecting a call from them and someone calls me saying they are from the IRS, I won’t discuss my client. I ask them their name, employee ID number, campus/location, and group number. I do get their phone number. Then I call the IRS directly. I do some research within my sources to determine if this person or phone number is legitimate. Hint: Google the phone number you were given to see if it is an IRS phone number. That saves time. If that doesn’t work, you will need to call the IRS’s main phone number, 1-800-829-1040. Tell the caller that you will call them back in a couple of days. If they tell you it’s urgent and that you’re about to be levied . . . beware. You would have gotten mail from the IRS if there were a levy notice. Another place you can call or visit is your local IRS office, where they have what’s called Taxpayer Assistance Centers. Visit the IRS website and click on your state on this IRS map to get information (https://www.irs.gov/uac/Contact-Your-Local-IRS-Office-1).
Tip #235:
Never send money to anyone who calls you on the phone. If someone calls and tells you that you owe money to the IRS, the state, or on any outstanding bill, call that entity to ensure that you do owe the money and that the balance is correct. You can reach the IRS at 1-800-TAX-1040 (1-800-829-1040). Send your money directly to the IRS, state, or your creditor, not to someone who calls you and threatens you—especially if they want cash, money order, debit card, or cashiers’ checks. First of all, the IRS doesn’t make calls like that. Second, they never ask for cash, money order, debit card, or cashiers’ checks. There are some very aggressive callers who may threaten you with police action or even harm (https://www.irs.gov/uac/Newsroom/Scam-Phone-Calls-Continue%3B-IRS-Identifies-Five-Easy-Ways-to-Spot-Suspicious-Calls). Truly, the easiest way to deal with them is to hang up. Many of my clients have gotten these calls but were smart enough to call me before sending money. I have at least one of these on my answering machine. Do not call them back and think you’re going to play with them. If they are close enough to you to collect cash, they are close enough to do physical harm. If you do feel they are nearby and will harm you, call the police immediately.
People have actually given these scammers money. They have collected about $20 million according to TIGTA’s recent estimate. The average amount people are bullied into giving them is $5,000. The highest payment reported is, believe it or not, half a million dollars!
Tip #236:
The last big scam: the IRS and the US Tax Code is unconstitutional. Puh-leeeze! If that were true, do you think anyone would still be paying taxes at all? Give me a break. Yet lots of smart people fall for the scam. The IRS has devoted an entire section of their website to help you understand the issues and why the “Tax Protester” movement is totally off base. The IRS puts these actions under the label of “Frivolous Arguments” (https://www.irs.gov/Tax-Professionals/The-Truth-About-Frivolous-Tax-Arguments-Introduction). This behavior earns criminal penalties, prosecution, and jail time (https://www.irs.gov/Tax-Professionals/The-Truth-About-Frivolous-Tax-Arguments-Section-III).
I was once privileged to spend about three hours with the new IRS District Director in Los Angeles, Steven Jensen, interviewing him for an article in the Los Angeles Daily News. Our conversation ranged across many topics. This was one of them. I pointed out to him that these tax protesters generally cited specific Tax Code sections or sections in the US Code of Federal Regulations (CFR). Jensen asked if I had ever looked them up. The answer was no. So he proceeded to prove that their citations were generally meaningless. They made up cases and code sections to make their argument appear to have weight. But when you look them up, they are not even related to the point at all.
Even famous people fall for this. How many celebrities can you name? No, Richard Hatch of Survivor fame wasn’t really a tax protester (http://www.newsmax.com/FastFeatures/survivor-star-richard-hatch/2011/05/05/id/395272). He just didn’t bother to pay taxes on more than $1 million worth of income.
Wesley Snipes did jail time (http://www.newsmax.com/Hirsen/wesley-snipes-tax-evasion/2008/04/28/id/323538). Al Capone wasn’t caught by “The Untouchables” but by the IRS and served jail time (https://www.irs.gov/uac/Historical-Documents-relating-to-Alphonse-%28Al%29-Capone,-Chicago). Joseph Andrew Stack III didn’t do any jail time (http://www.newsmax.com/Headline/austin-attack-media-tea/2010/02/18/id/350266). Why? He slammed his airplane into an IRS building in Austin, Texas, and died.
Tip #237:
Don’t assume the IRS will understand. TaxMama’s other mantra: disclose, disclose, disclose. Whenever you have anything complicated or confusing in your tax return, explain it in detail. If you had to estimate something, include an explanation of why you don’t have the actual amount and what source of information you used to come up with your estimate. If you needed to do a computation, include the detailed worksheet. Include information about account numbers and other specific information. When you provide details like this, it limits the IRS’s audit powers to three years instead of six. Use the Form 8275 Disclosure Statement and add your attachments (https://www.irs.gov/pub/irs-access/f8275_accessible.pdf). If it turns out that you made some wrong assumptions, the full disclosure could eliminate penalties. If you relied on the advice of a tax professional, that surely will help eliminate penalties.
Good news: we are done with the nastiness. Let’s get on with normal Tax No-No’s!
Whenever you have a Net Operating Loss (NOL), don’t file your tax return without first deciding whether or not to waive NOL carryback (https://www.irs.gov/publications/p536). This is a very common mistake, or oversight. Not making a decision about this can be extremely costly and could lead to audits. The average person doesn’t realize this is necessary. In fact, in the rush to file on time, many tax professionals overlook this decision as well. It will be up to you to bring it up and ask about this if you see a negative AGI on your tax return. What the heck is TaxMama talking about? Good question.
The way the Internal Revenue Code is written, when you have a NOL (say in 2015), you are required to carry that loss back to your tax return two years earlier (to 2013). Once you use up that loss, you carry what’s left to the tax return one year before the NOL year (to 2014). If there is still anything left, you carry it to the tax return for the year after the NOL year (to 2016). No doubt, our legislators thought that making this an automatic requirement would be helpful to taxpayers. But most people don’t understand it and rarely use this provision. Because this requirement isn’t understood, and because it is ignored, most people just take that loss and use it to reduce the next year’s taxable income (2016). And this is what causes the audit. Since that’s the wrong year, the IRS knows that when they audit they are guaranteed to generate additional taxes. So what’s a good taxpayer to do? Let’s look at the next tips, shall we?
Tip #239:
Don’t carry the loss back. Waive your right to the carryback. If you could carry that loss back for two years and get refunds fairly quickly, why wouldn’t you want to do it? Or why shouldn’t you? Here are some reasons taxpayers may not want to file backward:
Tip #240:
Don’t forget to include the “election statement” in your tax return in the year the NOL is created. What statement? The statement must be attached to your timely filed tax return, including extensions. It must read something like this: “I am choosing to waive the carryback period for tax year 20XX under section 172(b)(3).” This tells the IRS that you will be using the loss in future years only.
Your tax software has this built in for you to use. You just have to know where to find it. If you cannot find the checkbox for it, call tech support and ask them. Otherwise, file your tax return on paper and include that election. Feel free to use my wording.
Oops, you forgot to make the election, or didn’t know. Can you still fix it? No worries . . . uh, well, no worries if it is less than six months since you filed the tax return. Here’s what you do. The IRS explains it beautifully: “If you filed your original return on time but did not file the statement with it, you can make this choice on an amended return filed within six months of the due date of the return (excluding extensions). Attach a statement to your amended return and write, ‘Filed pursuant to section 301.9100-2’ at the top of the statement” (https://www.irs.gov/publications/p536/ar02.html).
Tip #242:
Supposing you do want to use the carryback, don’t forget to file Form 1045 before the end of the year. Most people, when they think about filing an amended personal tax return, think about Form 1040X. But when it comes to NOLs, there is a special form, Form 1045, Application for Tentative Refund (https://www.irs.gov/pub/irs-access/f1045_accessible.pdf). This form is special for several reasons:
Tip #243:
Don’t deduct costs related to pets, no matter how strongly you feel that they are part of your family. The IRS doesn’t accept them as dependents. Yet. Huh? Why yet? Believe it or not, in 2009, Representative Thaddeus McCotter, who represented a Detroit-area district, introduced the HAPPY (Humanity and Pets Partnered through the Years) Act (http://www.newsmax.com/InsideCover/mccotter-pets-taxes/2009/08/25/id/334603). It was designed to authorize a deduction of up to $3,500 a year for “qualified pet care expenses,” including veterinary care. Of course, it was not successful. But expect more of this thinking as the population ages.
Tip #244:
Don’t overlook allowable deduction for service pets. Seeing eye dogs, hearing dogs, and other service pets’ costs are fully deductible as medical expenses. Naturally, you need a prescription from your doctor. The pet must be specially trained to help you with your particular medical need. You can find more information about service animals at Assistance Dogs International (http://www.assistancedogsinternational.org/about-us/types-of-assistance-dogs/service-dog). They are overseen by the Americans with Disabilities Act (ADA). You can find their FAQs on the ADA site (http://www.ada.gov/archive/animal.htm).
Don’t deduct your swimming pool or hot tub energy costs when applying for the residential energy credit on Form 5695. The rules say, “Costs allocable to a swimming pool, hot tub, or any other energy storage medium which has a function other than the function of such storage do not qualify for the residential energy efficiency credit” (https://www.irs.gov/pub/irs-pdf/i5695.pdf).
Tip #246:
Don’t deduct the cost of over the counter drugs or certain non-Western medicines. They are not deductible in Flexible Spending Accounts, Health Savings Arrangements, or itemized deductions on Schedule A. Nowhere. People argue and try. However, there is one exception: when the over-the-counter drugs are prescribed by a doctor (in writing) for the treatment of a specific condition. Certain non-Western or nontraditional medical practitioners are recognized by the IRS. You will find them in IRS Publication 502 (https://www.irs.gov/publications/p502). Keep a copy of the prescription. Get a new copy every year. Have the doctor’s office write a letter, each year, explaining why these over-the-counter drugs are prescribed instead of behind-the-counter drugs. Here are the IRS’s FAQs about this issue (https://www.irs.gov/uac/Affordable-Care-Act:-Questions-and-Answers-on-Over-the-Counter-Medicines-and-Drugs). Regardless of other limitations, insulin is always deductible, whether purchased over or behind the counter.
Here are some nondeductible drugs, even with prescriptions: laetrile, medical marijuana, and other drugs bought outside the US that are not approved by the FDA. Incidentally, in the latest budget bill, Congress quietly stopped all prosecution for businesses selling medical marijuana in states where that is legal.
Tip #247:
You may not deduct the cost of cosmetic surgery if the surgery is for purely personal reasons (https://www.irs.gov/publications/p502/ar02.html). However, if there is a medical reason for the cost, you may claim the deduction. What is the best way to prove there is a medical reason? If your health insurance company provides all or partial reimbursement, there’s a good chance there is a medical reason for the procedure. Still, it’s a good idea to get a copy of the prescription or doctor’s paperwork showing the medical need for the surgery. Common acceptable reasons include reconstructive surgery after an accident (a fire), an earlier surgery (like breast removal), or a birth defect (cleft palate). Sometimes the medical reason might be psychological—severe depression, perhaps even threatening suicide, because of a visible defect.
Tip #248:
Don’t withdraw money from your 401(k) or other retirement plan to pay for education, your first house, or other exclusions. You may have heard that there are a few expenses that are exempt from the early withdrawal penalty, but that only applies if the money is drawn from an IRA—not from any other retirement account (see Tip #194).
Tip #249:
Never deduct commuting mileage (https://www.irs.gov/publications/p463/ch04.html). This is the mileage from home to your office or your job, a trip you take regularly. (I found this out, early in my career, the hard way. During an audit. It was embarrassing, but we had a good laugh.) However, if you drive from home to an alternate work location, or to class, or training, and so on, that is not commuting. You may also track the mileages from the office to those other locations, or to a second job. This rule applies equally to people with jobs and business.
Tip #250:
Paying off a loan is not a deduction, no matter how big that loan is. A long time ago I had an angry discussion with a client who was also my roommate. She had borrowed about $50,000 to buy Nautilus® equipment for her gym. We took a depreciation deduction for all that equipment either in the first year, or over the first five years, that she was in operation. One day, a new boyfriend came along and paid off her loan. He insisted that she must get a deduction for that payment. Despite explaining patiently three or four times, and even providing detailed worksheets about how the numbers worked, he didn’t believe me. They stalked out of my office in fury. I haven’t heard from them since. Over the years, I have had similar discussions with other clients. All the rest understood the concept after a while. I hope you do, too. If there are deductions to be had, the deductions were used when the loan was first obtained and the assets were purchased. If it was a business loan, the interest was deducted each year as the payments were made. But the payoff? No deduction. The journal entry on the books would be:
Tip #251:
You may not claim a deduction for the cost of fees relating to loan modification documents and or IRA transfers. When it comes to loan modifications, if the loan is on a home, you might be able to add it and the other costs to the basis (tax cost) of the home. There is no deduction at all for fees related to student loans and other loans. For investment loans, you may take a deduction under Miscellaneous Itemized Deductions and reduce the cost by 2 percent of your adjusted gross income.
Tip #252:
Don’t claim a deduction for the annual IRA fees or transfer fees unless you paid the fees with money outside the account. Most people let the fees come from the funds inside the IRA. That means you are reducing your investment each year. It’s wiser to pay the costs with money out of your pocket. The fees are relatively low. If you are able to use Miscellaneous Deductions, you will be able to deduct the fees. If not, your IRA will grow just that little bit more.
Tip #253:
Don’t let the IRS audit you year after year. It’s actually their own rule about “Repeat Examinations.” If a return was examined for the same items in either of the two previous years and no change was proposed to the tax liability, contact the IRS immediately and the examination will likely be discontinued. This policy is in accordance with IRC section 7605(b) of the Internal Revenue Code, which states that no taxpayer shall be subjected to “unnecessary examinations” (https://www.law.cornell.edu/uscode/text/26/7605). So what do you do if they invite you back to the dance again? If it’s for the same issues—and the IRS found nothing the first time—just call them up and politely explain that they need to cancel the audit. Please, do be polite. Being rude, arrogant, and pushy will only get you into trouble. After all, Martha Stewart didn’t go to jail because of a small amount of insider training profits. She went to jail because was rude to the investigators and brushed them off. They had power. They used it. Had she cooperated, most likely she would have simply been embarrassed, slapped on the wrist, and fined.
Tip #254:
Do not rely on the IRS instructions, written or verbal. There is an excellent article by attorney Robert W. Wood on Forbes.com (http://www.forbes.com/sites/robertwood/2015/11/11/amazingly-irs-says-you-cant-rely-on-irs-instructions). Wood provides a long list of taxpayers who relied on the IRS’s instructions and lost in court. If you’re going to take a position on a tax issue that you think is a little borderline or aggressive, get a written opinion from an Enrolled Agent, Certified Public Accountant, or an attorney. That will give you standing. The IRS’s public information will not.
Tip #255:
Don’t leave your tax refunds on the table. You only have three years to file a tax return after the end of the tax year. If you don’t file . . . whoosh! They money is gone. Every year, the IRS posts its announcement about unclaimed refunds (https://www.irs.gov/uac/Does-the-IRS-Have-Money-Waiting-For-You%3F). Millions of dollars go unclaimed. In 2015, the IRS announced that there was about $1 billion sitting there, waiting for you. Sure, it’s nice to make a large donation to the coffers of the US Treasury. But . . . you don’t even get a donation deduction for this. And do you really want your government officials just wasting your tax refund? Heck no! File on time and waste that money yourself.
Tip #256:
Don’t leave assets unclaimed. Visit the unclaimed property sites in the states where you or your family have ever lived. Start at the USA.gov (https://www.usa.gov/unclaimed-money) site to look up your states—that way you know that you are dealing the real states’ websites, not someplace bogus. (Warning: If someone calls you or sends you an email saying they have found assets for you, do not give them any money or information. If they refuse to provide you with details, visit the unclaimed property sites yourself. There is a lot of fraud out there.) You would be surprised what family members may have left behind in bank accounts, insurance policies, wages, security deposits, and so on. After the entities lose touch with the account owners, they are required to turn the assets or money over to the state. I found several thousand dollars that belonged to my deceased aunt.
Tip #257:
Never fall for a “too good to be true” tax preparer or investment offer. If it looks too good to be true, it probably is. Sure, you like to believe in Santa Claus, Peter Pan, and fairy tales. The fantasy world is a delightful escape and I go there often. But when you enter that world, please leave your money and your tax returns behind.