“Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct and accurately list all amounts and sources of income I received during the tax year. Declaration of preparer (other than taxpayer) is based on all information of which preparer has any knowledge.”
You have probably acknowledged and affirmed this statement many times over the years since it is located directly above your signature on your individual tax return. However, let’s assume for the sake of this article that you are unfamiliar with it and the statute of limitations on your income tax return. Today, we will review these topics as well as the most common areas that can attract increased IRS audit attention.
The statute of limitations on the IRS to assess taxes on a taxpayer generally expires three years from the due date of the return or the date on which it was filed, whichever is later. For this purpose, the tax return is considered filed on the due date of the return if it was filed on or before the due date. For instance, if your 2016 individual income tax return (Form 1040) was filed on March 1, 2017, it is considered to be filed on April 15, 2017; the actual due date. The statute of limitations for the 2016 return expires three years from April 15, 2017, on April 15, 2020. However, if the return omits 25% or more of income the statute of limitations gets extended from three, to six years. The statute for the collection of previously assessed taxes is generally ten years. What this means is that once the IRS assesses a taxpayer is liable for a given year’s tax, it has ten years to pursue the collection. However, the statute of limitations is unlimited if the taxpayer commits tax fraud.
There are several scenarios that could cause the IRS to flag your return. The first is failing to report all of the 1099’s and W-2s you receive. If you have multiple 1099’s and W-2s, be sure to review the statement normally accompanying your tax return to make sure none are missing. If you have so many that you have difficulty organizing and collecting them all (it does happen), you can request a Wage and Income transcript from the IRS at no charge. A paid tax preparer can also request this directly from the IRS if you’ve signed a Power of Attorney authorizing the preparer to communicate on your behalf with the IRS.
Another red flag is taking disproportionately high deductions on Schedule A. You should be able to provide evidence for every expense you deduct. For instance, some people donate more to charity than others, and it may trigger an audit. But if you’ve been contributing to a valid 501(c)(3) entity and you can provide evidence, then there is nothing to worry about.
The next red flag trigger is what is referred to as “hobby losses.” A hobby loss is when you have income and expenses from an activity that produces losses for three consecutive years, and a profit motive is difficult to prove. Sometimes what ends up being considered a hobby loss began with a profit motive, but it then later becomes increasingly clear over time that the endeavor is for some personal pleasure rather than a profit motive. Taxpayers should be careful when going down this road. For instance, let’s say you teach guitar on the side. If you generate gross income of $3,000 and have expenses of $3,200, your deductions are limited to income of $3,000. Also, you’d want to be able to prove that the expenses were for ordinary and reasonable items, such as rent, normal materials and advertising. If your expenses consist of two brand new guitars totaling $3,200, you are playing with fire.
It is common knowledge here in Las Vegas that the casino will issue a W-2G if you win $1,200 or more on a single slot machine payout. For some reason people think that winnings less than $1,200 are not taxable income. Let it be a reminder to you that all income is taxable income unless the IRS says it isn’t. You may not receive a W-2G for your winnings that are less than the $1,200 threshold, but that doesn’t mean it is not taxable.
Keep a log of your gambling losses with as much detail as possible as you can only deduct your losses to the extent of your winnings. Furthermore, you can only deduct losses if you have winnings. Losses are deducted on Schedule A as miscellaneous deductions. Deducting large losses without including your gambling winnings as other income on page 1 of your 1040 will certainly raise a big red flag. Professional gamblers typically report winnings and losses on Schedule C. They are also allowed additional gambling related expenses such as software, research materials, costs of lodging and meals, which are not allowed to be deducted by nonprofessionals. For those of you that are recreational gamblers, be mindful to report these items correctly.
Whether you prepare your own return or you have a tax professional prepare it, you should take time to review the tax return to make sure it is accurate and correct. If your preparer doesn’t offer to review the return before filing, you should ask him or her to go over it. Even honest and hardworking preparers make mistakes, and you might have legitimately forgotten to disclose an event or transaction that impacts taxes. As Benjamin Franklin once said, “an ounce of prevention is worth a pound of cure.”
Donovan Thiessen, CPA has worked with Gerety & Associates, CPAs in Las Vegas, Nevada for 10 years, focusing on trust and estate, and individual and business income taxation. The firm has substantial experience in estate planning and can handle complex transactions. You may reach Donovan at email@example.com and 702.933.2213.
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