Enforcement and collection of taxes are but two of the responsibilities the Internal Revenue Service is charged with, and often the most daunting to taxpayers. While your tax audit risk may be low (0.70% of all individual returns filed in 2016 were selected for examination), be aware that of all the audits conducted by the IRS in Fiscal Year 2016, 70.7 percent were conducted by correspondence. Given the budgetary constraints the Internal Revenue Service will be forced to operate under, they will rely more and more on artificial intelligence to identify and select returns for examination and send automated correspondence letters to unsuspecting taxpayers.
However, if you are a taxpayer who files a Schedule C, Profit or Loss from Business, with their Individual Income Tax Return, your odds of additional scrutiny go up. Tax professionals have long known that Schedule C is one of the most likely forms of a tax return to be selected for examination. If your return is ever selected, either by correspondence and/or field examination, the burden of proof remains with the taxpayer to prove entries, deductions and statements made on the tax return. The taxpayer must be able to substantiate certain elements of expenses in order to deduct them. Taxpayers must maintain adequate records to prove expenses and/or have sufficient evidence that will support a tax return assertion(s). As the saying goes, “The IRS will believe everything you say, so long as it is wrapped in proof.”
Most transactions in business create a paper trail and will assist the realtor (entrepreneur) in supporting their income and deductions. Aside from doing this, they may also find answers to questions like “should realtors hire virtual assistants?“. For realtors, the most important income document they receive is their 1099-MISC, Miscellaneous Income, from their employer. It is highly advisable to reconcile the amount shown on the form to the amounts received throughout the year, either by maintaining a cash receipts journal, adding all the deposits received from your bank statement, or maintaining an electronic bookkeeping system.
Expenses are the costs you incur to carry on your trade or business. Documentation for expenses usually comes in the form of cancelled checks, cash register tapes, vendor account statements, credit card receipts and statements, invoices, etc. For many types of expenses (mileage, travel & entertainment, gifts) the IRS requires “contemporaneous” records – meaning the tax record(s) is(are) created as the expense(s) or the event that creates the expense(s) occurs. Here too, a log of expenses should be kept. Whichever system you use to keep records, whether you keep a series of folders containing receipts, maintain an expense journal or have an electronic bookkeeping system, this is your tax audit defense system.
Assets, such as machinery (automobiles) and furniture, that you own and use in your business, are properties that are not fully deductible (expensed) in the year of purchase, but you must maintain records to compute and support any depreciation expense claimed during the tax year, and gain or loss claimed upon disposition. Documentation for assets include:
• Purchase invoices
• Expenses of preparing the asset for use
• Depreciation schedules
• Sales contracts (for disposition of assets)
• Cancelled checks
• Documents notating the impairment of an asset due to casualty and/or theft and resulting deduction\
From a tax perspective, the most important part of running your business is maintaining separate business checking and credit card accounts. These accounts should be reconciled monthly as they serve as the primary evidence source for your income and deductions on your tax return. Failing to keep separate accounts could lead an IRS Field Auditor to conclude, upon examination, all deposits as income, when in fact that may not be the case.
Realtors by far have the most difficulty in keeping up with their business tax compliance. It isn’t that they are inherently bad people, but, it is the nature of their business. And the IRS doesn’t make it any easier with their arcane system of paying estimated taxes. Realtors can go weeks and months without earning a dime and suddenly when a commission is earned and paid, the money is usually spoken for by paying for living necessities. What is required here is a slight change of perspective and a short phone call to one’s tax professional. When a commission is received, taxes should be part of the “living necessities” paid by allocating a percentage of the earned net commission towards taxes, so a large balance is not due come April 15th. The IRS will not penalize anyone for paying their taxes a little early, but they will penalize you for paying them late.
For those interested realtors who want more information on this topic, I am offering a whitepaper, “101+ Realtor Deductions,” free for the asking. Please call 914.712.6919.
Ron Friedman, principal of Ron Friedman, CPA CTRS has over fifteen years of tax and accounting experience, most notably in IRS tax resolution matters. He can be reached at ron@ronfriedmancpa.com or 914.830.4369.
