Full Description

No one wants to be audited by the IRS. Even taxpayers who are certain that their returns were accurate and all of their deductions and other tax write-offs are justifiable are somewhat intimidated by the receipt of notice from the IRS that they have been selected for an audit. Having to offer proof of income, deductions, exemptions and credits, especially if the proof may be missing or inadequate, can be unnerving. Even more unsettling is that the IRS auditor can still disagree with your proof even when you have all your receipts.

Beat an IRS Audit provides readers with everything they need to know to handle an audit. From discussing information on avoiding the audit in the first place, to explaining what steps to take to prepare for one if selected, the entire process is simplified and made understandable.

Table of Contents

Introduction

SECTION I: The Basics of U.S. Income Taxation of Individuals

Chapter One: Income
Who is an Individual?
Income of Individuals
Earnings from Employment
Interest
Rents
Royalties
Dividends
Distributive Share of Partnership Income
Income from Discharge of Indebtedness
Other Section 61 Sources of Gross Income
Gross Income
Income Excluded From Taxation
Gifts and Inheritances
Insurance Proceeds
Recovery of Adjusted Basis from the Sale of an Asset
Gain from a Primary Residence
Assigning Income

Chapter Two: Deductions
Qualifying to Take Business Deductions
The Ordinary and Necessary Requirement
Non-Business Adjustments for Adjusted Gross Income
Deductions Available Only to the Self-Employed
Deductions for Adjusted Gross Income that are Available in General
Deductions from Adjusted Gross Income
Itemized Deductions
Medical and Dental Expenses
Taxes Paid
Itemized Interest Expenses
The Home Mortgage Interest Deduction
Investment Interest
Charitable Contributions
Casualty and Theft Losses
Calculating the Personal Deduction for Casualty and Theft Losses
Miscellaneous Deductions
The General Limitations on Itemized Deductions
The Standard Deduction
Determining Filing Status
Additional Standard Deduction Allowance for the Aged or Blind
The Standard Deduction for Those Claimed as a Dependent by Others
Those Ineligible for the Standard Deduction

Chapter Three: Exemptions
Personal Exemptions
Exemptions for Dependents
The Relationship Test
The Citizenship or Residency Test
The Joint Return Test
The Gross Income Test
The Support Test
Multiple Support Agreements
Children of Divorced or Separated Parents
Audit Aspects of Tax Exemptions

Chapter Four: Federal Income Taxes and Common Tax Credits
Regular Federal Income Taxes
Alternative Minimum Tax
Self-Employment Taxes
Tax Credits

SECTION II: Audit Essentials

Chapter Five: The Audit Process
The Letter Audit
The Office Audit
The Field Audit

Chapter Six: IRS Approaches to Audits
The Bank Deposits Method
Indirect Methods of Establishing Income—Using Earnings to Reconstruct Income
Indirect Methods of Establishing Income—Using Expenditures Plus Increase in Net Worth to Determine Income
The IRS Response to the Cash Hoard Defense

Chapter Seven: Circumstances that are Most Likely to Cause an Audit
Income From Self-employment
Using the Services of Independent Contractors
Owning an Interest in a Partnership or Small Business
A Dealer Showing Investment Income in the Items in Which He or She Deals
Securities Dealers
Real Estate Dealers
Royalty Income
Deducting Business Losses
Combining Activities in Order to Qualify for the Presumption
Proving a Profit Motive When the Presumption Does Not Apply
Taking a Deduction for an In-Home Office
Uses That Must Be Both Exclusive and Regular
Uses That Must Be Regular But Not Exclusive
What Draws Attention From the IRS Toward Home Offices
Engaging in Bartering
Taking Abnormally Large Itemized Deductions
Other Activities that May Trigger an Audit

SECTION III: Responding to Audit Notices and Dealing with Deficiencies

Chapter Eight: Preparing for an Audit and Responding to the Findings
Keeping Proper Records
Auto Expense Records
Records of Business Meals and Entertainment
Supporting Schedule A Deductions
Making Notes During Preparation of Tax Returns
Responding to an Audit Notice

Chapter Nine: Responding to Audit Results and Tax Deficiencies
Dealing with a Tax Deficiency
Consequences of Failure to Pay Taxes
Installment Agreements
Offers In Compromise
Discharging Tax Liability by Filing Bankruptcy

Glossary
Appendix A: IRS Form 656, Offer in Compromise
Appendix B: Payment Plans
Appendix C: IRS Form 2848, Power of Attorney and Declaration of Representative
Index
About the Author

Excerpt

The 5 Tests You Must Meet to Qualify for Tax Exemptions

Excerpted from Beat an IRS Audit by James O. Parker ©2007

In addition to the personal exemption available to taxpayers and their spouses, exemptions may also be taken for dependents. However, they must meet the five dependency tests to qualify the taxpayer to take an exemption for them.

The Relationship Test
In order for a taxpayer to be entitled to take an exemption for someone as his or her dependent, that party must have either lived with him or her as a member of the party’s household for the entire tax year or must be related to the taxpayer to the degree specified in I.R.C. §152. Those who are considered to be relatives of a taxpayer under the provisions of Section 152 are children, stepchildren, grandchildren, and great-grandchildren; brothers and sisters, including half brothers and sisters and stepbrothers and stepsisters; parents, stepparents, grandparents, and great-grandparents; aunts and uncles; nieces and nephews; parents and siblings of a spouse; and, sons-in-law and daughters-in-law. Any of the relationships created by marriage are not terminated by divorce or by the death of the taxpayer’s blood relative.

The Citizenship or Residency Test
A person for whom a taxpayer wishes to take an exemption as a dependent must be a citizen or resident of the U.S., or a resident of Canada or Mexico. As long as the party meets this requirement for some part of the calendar year in which the taxpayer’s tax year begins, the requirement of the test is considered met for the year.

The Joint Return Test
Generally, if a taxpayer is otherwise entitled to take an exemption for a dependent, but the dependent is married and files a joint return, the taxpayer will not be allowed to take the exemption. The lone exception to this provision is the situation in which a party’s married dependent files a joint return with his or her spouse in order to claim a refund of taxes withheld from earnings, but would otherwise have such low earnings that no taxes would have been due for either of them if they had filed separate returns.

The Gross Income Test
In order to be entitled to take an exemption for a dependent, the dependent person cannot have gross income in excess of the amount of the exemption deduction. However, a parent is allowed to claim an exemption for his or her dependent child, regardless of how much the child earns, as long as that child is either under the age of 19 at the end of the year, or under the age of 24 at year’s end and a full-time student for at least five calendar months during the calendar year. Even though parents may be allowed to take an exemption for dependent children with incomes of their own, the result will be that the children will not be allowed to take an exemption for themselves on their own returns.

The Support Test
To qualify to take an exemption deduction for a dependent, a taxpayer who is otherwise qualified to take the exemption must usually provide more than half of the support for that person. However, there are two exceptions to this rule.

Multiple Support Agreements
If two or more otherwise qualified people together provide over 50% of a party’s support, but no individual person provides the party with over half of his or her total support, any otherwise qualified person who provides over 10% of the party’s support may claim the exemption for the dependent, as long as every other qualified party who provided over 10% of the dependent’s support signs a Form 2120, which is a Multiple Support Declaration, stating that they will not claim the exemption for the dependent. An executed Form 2120 from each otherwise qualified party who is not taking an exemption for someone that they provided over 10% of their support to must be included with the tax return of the taxpayer who does claim an exemption for the dependent. Taxpayers should keep a copy of each Form 2120 for their own records, as well.

Children of Divorced or Separated Parents
Normally, if a child’s parents are divorced, legally separated under a written separation agreement, or they lived apart for the last six months of the calendar year, the parent who had custody of the child for the larger part of the year will be considered to have
provided over half of the child’s support and will be entitled to claim the child as a dependent for tax purposes. This rule will not apply if the noncustodial parent can show that he or she actually provided over half of the child’s support for the year. If there is a
divorce decree or a decree of separate maintenance that states which party will be entitled to claim an exemption for a couple’s dependent child, the decree will govern.

Audit Aspects of Tax Exemptions
There are a couple of situations in which exemptions can trigger an audit. The first is when more than one person claims the same person as a dependant for an exemption. In order to be allowed to take an exemption for a dependent, a taxpayer must supply the IRS
with the claimed dependent’s Social Security number and describe the relationship between the parties. The IRS automatically cross-references Social Security numbers to detect situations in which more than one taxpayer has claimed a person as their dependent. When this occurs, the IRS will contact the parties involved to make a determination as to whom, if anyone, is entitled to claim the exemption.

The second occurs when the taxpayer is in a relatively high tax bracket. Taxpayers with relatively large incomes must reduce their allowance for exemptions. Taxpayers whose incomes exceed a statutorily set threshold amount must reduce their exemptions deductions by 2% for every segment of $2,500 that their income exceeds the threshold amount, up to a maximum of 100%. The threshold amounts are adjusted for inflation each year and reflected in a worksheet, provided in the Form 1040 instructions, for calculating the exemption deduction phaseout. If a taxpayer fails to make the required adjustment, the IRS will recalculate the taxpayer’s tax liability and notify him or her of the recalculation and resulting tax deficiency.

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