Tax News

How to Avoid a Tax Audit

Avoid tax AuditWhile there is no guaranteed method of avoiding audits, there are things to steer clear of that could trigger an IRS audit. The Senate recently approved nearly $80 billion in IRS funding, with $45.6 billion for enforcement, which could lead to more audits.  Here are some things that the IRS has historically viewed as “red flags,” which could increase the chances of an audit for taxpayers. 

Reporting a Business Loss  

The IRS will surely be more inclined to audit a taxpayer who reports a net business loss, even if the loss is small. Reporting losses year after year will only increase IRS interest in your tax returns. Remember, it is mandatory to report all earnings in a tax year. However, it might be helpful to reconsider which expenses should be deducted from your tax return. Reporting even a small profit could reduce the chance of being audited by the IRS.  

Being Vague About Expenses 

When it comes to expenses, the more detail the better. This is especially true when categorizing them on your return. Try to avoid listing expenses under “Other Expenses” as this will lead to more scrutiny from the IRS. It may even be helpful to provide supplemental documentation explaining why certain expenses drastically increased or decreased for that year. Doing so can give potential auditors a valid explanation for such occurrences and possibly avoid a tax audit. Additionally, rounding dollar amounts are red flags for the IRS. You should always use exact dollar amounts on your tax return. 

Filing Late 

Some taxpayers believe that filing late can actually decrease the risk of being audited. However, filing on time, as well as paying on time, can help establish a history of IRS compliance. This will be far more beneficial in the long run.  

Claiming Excessive Deductions 

It is best to avoid any excessive expenses. For example, deducting the cost of your breakfast and lunch each workday may not be acceptable to the IRS. Excessive deductions for your donations to charitable organizations can also increase the chances of being audited. Inflating business expenses can result in being audited, especially if you try to claim large amounts for business entertainment or claim a vehicle that is used for only business purposes 100 percent of the time. Now that home offices are more common, it’s important to only claim the home office deduction for the portion of your home that is used exclusively for business purposes. When claiming this deduction, you will need to figure out how much square footage in your home is dedicated to your business. For tax year 2022, the rate for the simplified square footage calculation is $5 per square foot, with a maximum of 300 square feet or $1,500. 

Keeping Poor Records

Even the simplest tax situations require adequate records. If your finances are more complicated, then detailed records are necessary. Some taxpayers may feel inclined to estimate their expenses because they did not save receipts or documents, which the IRS views as a red flag. It’s important to make sure you have detailed records for the past three tax years at minimum. Having items like your previous tax returns, medical bills, business receipts, real estate documents, and investment statements can help substantiate your claims and avoid an IRS audit.

Choosing the Wrong Filing Status

Your filing status (single, married filing jointly, married filing separately or head of household) determines how you treat many tax decisions, such as what forms you’ll fill out, which deductions and credits you’ll take and how much you will pay (or save) in taxes. Select the wrong status, and it will trigger a cascade of mistakes–maybe even an audit. On top of that, if you decide to file jointly with your spouse, this means you’re responsible for any errors or deliberate falsehoods on your partner’s return, so make sure that you’re comfortable with what it says.

Tax Relief for Those Being Audited 

The chances of being audited are low, but those chances increase when the IRS notices any of the above red flags. The audit process can be very stressful. It is a tedious process that requires collecting information regarding your income, expenses, and itemized deductions. Failing an audit can result in a huge, unexpected tax bill. It’s best to seek assistance from experts who can help you avoid an IRS audit. Give us a call at 800-536-0734 for a free consultation with one of our knowledgeable tax professionals. 

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Real Estate Investments & Tax Implications

real estate investments tax implications

Real estate investments can be very complex, especially when it comes to tax reporting. However, there are general tax implications for common scenarios. Here, we will discuss some of these benefits. 

Real Estate Tax Write-Offs 

The most obvious tax implication for real estate investments are the write-offs that can help reduce rental income. Typically, you can deduct any expense directly related to managing and maintaining the property. This can include: 

  • Property insurance and taxes 
  • Mortgage insurance 
  • Property management expenses 
  • Expenses for maintenance and repairs 
  • Advertising fees 
  • Office space 
  • Equipment used for operating your real estate business 
  • Legal fees 
  • Travel expenses  

Accurate and detailed records should be kept in case the IRS requires substantiation. 

Real Estate Depreciation 

Like many physical assets, real estate investments assume normal wear and tear. You can deduct the cost of depreciation on your taxes each year, which will allow you to lower your tax liability. According to the IRS, the standard expected life of a property is 27.5 years for residential properties and 39 years for commercial properties. This means you can take the value of the property, less the value of the land it resides on, and divide it by the expected life term to calculate the amount of depreciation cost per year.  

Capital Gains 

Many real estate investors purchase properties with the expectations of eventually selling them later. Being aware of the tax implications that result from the sale of a property is just as important as those that result from owning one. A capital gains tax can have drastic effects on your tax liability. 

For example, you can realize a short-term capital gain if you earn a profit on an asset within a year of owning it. The gain is considered regular income. If the profit is large enough, it can move into the next tax bracket, creating a larger tax bill. 

On the other hand, you can realize a long-term capital gain if you earn a profit on the sale of property held for one year or more. These gains have much lower tax rates than standard income tax rates, which means you will get to keep more of the profit. Additionally, if your income is low enough, you may not be required to pay any taxes on the profit.  

Tax Help for Real Estate Investors 

It’s always best to get the advice of a reliable tax preparer or professional during tax time, especially if you have complex investments like real estate. Not knowing the correct way to report income, losses or deductions can result in IRS auditing, penalties and fees. If you need tax help, give Optima a call at 800-536-0734 for a free consultation with one of our knowledgeable agents. 

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Is My Side Business a Hobby or Small Business?

hobby or small business

The desire or need for extra income has become increasingly prevalent. Side gigs have been a popular method of supplementing earnings but with this comes more reporting during tax time. When is a side business treated as a business in the tax world, and when is it treated as a hobby? 

Small Businesses 

The IRS considers an activity a business if it’s “carried on with the reasonable expectation of earning a profit.” If you consider your activity a business, then you can deduct certain expenses on Schedule C. During the beginning stages of your activity, you may incur several “startup” costs like tools, materials, equipment, etc. that you can deduct during tax season. You may even be able to deduct the loss against your regular income. Some expenses are also limited in how they can be deducted, so it’s best to check with a tax preparer for clarification. 

Hobbies and the Hobby Loss Rule 

If your side activity doesn’t qualify as a business, it can be treated as a hobby. As of 2018, the IRS does not allow hobby expenses to be deducted from hobby income.  

Internal Revenue Code Section 183: Activities Not Engaged in for Profit officially lays out a guide to determine if you are running a business or engaging in a hobby. 

  1. Does the time and effort put into the activity indicate an intention to make a profit? 
  2. Do you depend on income from the activity? 
  3. If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business? 
  4. Have you changed methods of operation to improve profitability? 
  5. Do you have the knowledge needed to carry on the activity as a successful business? 
  6. Have you made a profit in similar activities in the past? 
  7. Does the activity make a profit in some years? 
  8. Do you expect to make a profit in the future from the appreciation of assets used in the activity? 

If you answered yes to several of these questions, it’s likely the IRS will view your activity as a business. You can also use the profitability test to determine if your activity is a business. Typically, the IRS will determine this by looking at your business activity to see if you earned a profit in three of the last five years, including the current tax year. If you did in fact earn a profit, the IRS will consider it a for-profit business.  

Tax Relief for Hobbyists and Business Owners 

It is the responsibility of the taxpayer to know if they are operating a business or engaging in a hobby. Claiming ignorance will not be an acceptable excuse for underreporting income with the IRS. Keeping detailed records of income and expenses related to hobbies and businesses is essential to remaining compliant with tax law. If you need tax help, give us a call at 800-536-0734 for a free consultation. 

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Converting Your Home to a Rental Property

converting home to rental property

Real estate has long been considered one of the greatest long-term investments. Further, with the trend of minimalist living, many are turning their primary residences into rental properties. While turning your home to a rental property comes with passive income and tax benefits, it’s important to note the tax implications as well.

Benefits of Converting Your Primary Residence to a Rental Property 

Passive income is just one of the benefits of converting your home into rental property, but there are plenty of others. 

Tax Deductions 

Deducting the expenses related to your rental property can decrease the income reported on your tax return. Every property is different, but the most common expenses you can deduct include: 

  • Cleaning and maintenance 
  • Property taxes 
  • Commission fees 
  • Repairs  
  • Insurance 
  • Mortgage interest 

Depreciation Expenses 

The IRS allows you to depreciate your rental property over a 27.5-year period in order to account for things like wear and tear and deterioration. Taxpayers can do this by taking the value of their home at the time of conversion, less the land value, and then dividing it by 27.5 years to calculate the annual depreciation expense. If your depreciation expense is greater than your rental income in a given year, no taxes are owed on the income.  

Tax Impact of Selling a Rental Property 

While the benefits sound nice, it is critical to understand the tax implications that come with not only owning a rental property, but also those that accompany selling one.  

Capital Gains 

In the selling process, timing is everything because it will determine the amount of capital gains tax paid, if any. Capital gains tax is tax owed on the profit earned on an asset upon selling it. It can be found by a simple calculation: 

Final Sale Price – (Asset’s Original Cost + Expenses Incurred) 

The IRS Section 121 exclusion allows taxpayers to exclude up to $250,000 of the gain from the sale of your rental property. The amount increases to $500,000 if married filing jointly. To qualify, the taxpayer must own and use the property as their primary residence for two of the past five years. If a taxpayer sells their residence during a time of using the property as their primary residence for only one of the past five years, they would no longer be eligible for the Section 121 exclusion. In this case, the taxpayer would need to report the gain of the sale in their taxable income.  

Tax Debt Relief for Rental Property Owners 

Tax implications revolving real estate can be extremely tricky. It’s important to make sure you are keeping track of all rental property expenses and income to ensure accurate reporting during tax time. If you need tax help, give us a call at 800-536-0734 for a free consultation. 

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Biden Announces Student Loan Forgiveness Plan

student loan forgiveness

President Biden has announced his three-part student loan forgiveness plan that aims to provide relief to student loan borrowers, especially those belonging to low and mid-income levels.  

Part I: Student Loan Forgiveness for Eligible Borrowers 

Borrowers with individual incomes less than $125,000, or $250,000 for married couples, are eligible for student loan forgiveness up to $20,000. The Department of Education will cancel up to $20,000 in student loan debt to borrowers who received a Pell Grant and had loans held by the Department of Education. Those who did not receive a Pell Grant will receive up to $10,000 in debt cancellation. Since this plan will not benefit high-income households, the Biden administration has extended the pause on loan repayments once more until January 2023.  

Part II: Manageable Loan System for All Borrowers  

The Department of Education proposed a new repayment plan that will replace the current income-driven plan in place. It will prevent low-income borrowers from committing to monthly payments of more than 5% of their discretionary income, a drop from the current 10%. This would lead to an average savings of $1,000 per year for both current and future borrowers.  

In addition, they will expand on the recent improvements to the Public Service Loan Forgiveness (PSLF) program. More than 175,000 public servants have had $10 billion in student loans canceled and the Department of Education expects these numbers to increase. Public servants include nonprofit workers, military members, and officials working in federal, state, local, or tribe level governments.  

Part III: Reduced Cost of College  

Earlier this year, President Biden approved the largest increase to Pell Grants since 2009, a bill that doubled the size of the maximum Pell Grant to $6,895. In addition to making tuition costs more manageable, the Biden administration has also taken steps to hold colleges accountable for keeping reasonable tuition costs, as well as ensuring students are receiving the value for their investments in higher education.  

Assuming every eligible borrower takes advantage of this plan, it will completely cancel student loans for nearly 20 million borrowers, as well as partially cancel student loan debt for 43 million others.  

Tax Debt Relief for Student Loan Borrowers 

The debt relief in Biden’s Student Loan Forgiveness Plan will not be treated as taxable income for the federal income tax purposes. However, borrowers should remain mindful of available tax breaks and filing requirements. If you need tax help, give us a call at 800-536-0734 for a free consultation today.  

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Inflation Reduction Act Part IV: More Audits, More Tax Collection

inflation reduction act

We know that an increased budget for enforcement will lead to more audits. More audits mean more tax collection. The question that remains to be answered is exactly how much federal tax revenue the IRS expects to collect with the new Inflation Reduction Act

How much taxes will be collected with the Inflation Reduction Act? 

The Congressional Budget Office recently released a report that estimated the budgetary effects of the Inflation Reduction Act. They expect increased collections of about $203 billion over the next decade. This would raise federal revenue by almost $125 billion during that 10-year period after taking into account the $80 billion cost of the act.  

Why is tougher enforcement necessary? 

According to the IRS, most taxpayers pay their federal taxes willingly and on time. However, that still leaves nearly $400 billion in uncollected tax payments. They believe that tougher enforcement can help close the tax gap. In other words, stricter enforcement will help lessen the difference between the amount of taxes that is collected, and the amount taxpayers owe.  

IRS enforcement, audits in particular, has been less frequent in the last decade. In fact, audit rates have dropped for all levels of income between 2010 and 2019. In fact, a tax return was three times more likely to be audited in 2010 than in 2019. However, this is not due to the IRS becoming more lenient or forgiving. The issue centers around staffing levels and funding. The IRS is expecting the new funding from the Inflation Reduction Act to help balance staffing levels in order to be able to collect more tax revenue.  

Are you prepared for increased tax collection? 

With increased IRS tax collection approaching, it’s important to be prepared. It’s never too late to seek tax debt relief. Get protected from the stress and burdens that come with IRS tax collection. Give us a call at 800-536-0734 for a free consultation. 

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Inflation Reduction Act Part III: More Auditors, More Audits

inflation reduction act

More than half of the $80 billion Inflation Reduction Act will be spent on IRS enforcement, including activities that aim to collect back taxes, conduct criminal investigations, monitor digital assets, obtain legal support and hire thousands of new IRS auditors. 

How many auditors will the IRS hire? 

The IRS is looking to hire nearly 87,000 employees over the next 10 years, a major increase from its current 80,000 employees. A majority of the new hires will help bring IRS staffing levels back up to par to maintain efficiency. As of now, it remains to be seen exactly how many of the new hires will be responsible for auditing since the bill does not set any requirements for staffing. It will be up to the IRS to determine the number of enforcement agents that are hired, in addition to all other positions within the agency.  

Who will be audited? 

More auditors mean more audits, so understandably taxpayers are wondering if they will be impacted. The U.S. Treasury Department has said that the low and middle-class, as well as small businesses, will not be the focus of the upcoming increased enforcement activity. In addition, the Biden Administration has called for the IRS to focus its auditing efforts on high-income taxpayers and large corporations that earn more than $400,000 per year. The bill itself includes language that states the goal of the Inflation Reduction Act is not to increase taxes for any individual or entity earning less than $400,000 per year.  

Are you prepared for an audit? 

With increased IRS enforcement activity approaching, it’s important to be prepared. It’s never to late to seek tax debt relief. Let Optima’s team of experts help you get protected from the stress and burdens that come with IRS enforcement. Give us a call at 800-536-0734 for a free consultation. 

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An Update on Student Loan Forgiveness

student loan forgiveness

Student loan debt is still on the rise and new developments regarding student loan repayment and forgiveness have unfolded recently. President Biden will announce his plan for student loan forgiveness and repayment by the end of August 2022.  

Student Loan Payment Pause 

Student loan payments are currently paused but are set to begin again on September 1, 2022. While student loan payments have been paused several times since the Cares Act passed in March 2020, it seems the pause may be extended again past the August 31st deadline.  

Student Loan Forgiveness 

On the other hand, President Biden may announce a decision on student loan forgiveness. There has been some speculation that Biden plans to cancel as much as $10,000 for more than 40 million federal student borrowers. Included loans are the Federal Family Education Loan Program (FFELP), Perkins Loans, Grad PLUS Loans, and Parent PLUS Loans, many of which have not been included in recent student loan forgiveness initiatives.  

Student Loan Forgiveness: Limited Waiver 

A limited waiver was instituted in October 2021, allowing student borrowers to count student loan payments that were once considered ineligible toward student loan forgiveness. Ineligible payments include late payments, partial payments and payments made under the incorrect payment plan. This one-time exception is due to expire after October 31, 2022, but President Biden has named an extension of the waiver as another permanent means of student loan forgiveness.  

Republican Student Loan Forgiveness and Repayment Plan 

Three Republican members of Congress introduced a new bill that serves as an alternative to President Biden’s potential plan for student loan forgiveness. The plan does not include any major loan cancellation and seeks to end the Public Service Loan Forgiveness program that is set to begin in July 2023, as well as the student loan payment pause. The bill also introduces a new Income-Based Repayment (IBR) plan that would replace the current income-driven repayment plans in place and eliminate capitalization of student loan interest. Finally, the bill would include a provision that limits student loan interest to 10 years, which can save borrowers thousands of dollars.  

Tax Debt Relief for Student Borrowers 

While the idea of student loan forgiveness seems attractive to many, nothing is set in stone yet and borrowers should continue to plan for repayment. Additionally, borrowers should remain mindful of available tax breaks and filing requirements. If you need tax help, give us a call at 800-536-0734 for a free consultation today. 

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How Filing for an Extension Affects Your Taxes

With a massive increase in taxpayers filing for an extension, what does this mean for people who owe? How does the extension deadline work? Hosts CEO David King and Lead Tax Attorney Philip Hwang discuss these details and more in this week’s episode.

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Tax Tips for Remote Workers

remote workers

There has been a surge in remote work since 2020, qualifying employees for certain tax deductions.

Tax Deductions for Remote Workers

Generally, your home office must be used for the sole purpose of your work to qualify for deductions on your tax return. Expenses such as internet, phone bills, and similar items could also be for personal use. Items you might consider deducting would be a computer purchase for the sole use of your job, a special phone line, other equipment and materials required for your work, or maintenance for the upkeep of said equipment.

Another qualifying factor for a home office would be a space that is utilized specifically for meeting with clients. If your work requires you to have a physical space to host meetings, store inventory, or to conduct business that is not virtual, you may qualify for deductions when you file.

Leased Office Space for Remote Workers

As a self-employed or remote worker, you may have a separate space for your work. However, a leased office, or a workstation located on premises that is not your home would not qualify as a home office. The IRS will see this as an optional work environment.

Records and Receipts for Remote Workers

No matter your work location, it is imperative that you document and keep track of all records pertaining to work-related purchases. Receipts and records are the only tangible evidence of your expenses that can qualify you for deductions. You must know the exact dollar amount of your expenses; estimations of round, even numbers will often flag your return.

Too many round numbers for your expenses could trigger an audit.

Simplified and Direct Deductions: What’s the difference?

The simplified method for home office deductions is done by expensing $5 per square foot of your office, up to 300 square feet max. This method can qualify up to $1,500 in deductions.

The direct method requires you to track all your expenses and maintenance costs for your home office. This method allows you to qualify for a bigger deduction.

Tax Debt Relief for Remote Workers

Whether you work from home or in an office, Optima assists self-employed and W-2 workers with tax liabilities. Give us a call at 800-536-0734 for a free consultation today.

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