Rounded numbers are probably one of the biggest red flags. This is especially true when you have a sole proprietor who provides their information in a handwritten format at the last minute and right before a filing deadline.

 Individual making a low six figures W-2, and he drives to his office from his residentat at least 70 miles one way. He was given advice to open an office near the company he works for. He bought this big behemoth of a vehicle. I believe it was a large SUV for which he paid $67,000—and expensed the whole thing on the tax return in the year of purchase. In the three years subsequent to the purchase, he had some medical issues, not to mention a pandemic occurred. His marketing was not very good and he did not generate much in gross income (income before expenses). These were all things that were not in his favor. He has produced large tax losses that were reported on his Schedule C. Guess what happened to him? You got it: his return got selected for audit. Not only that, the IRS denied a hundred percent of all of his deductions saying that he didn’t have a legitimate business and he was just trying to expense his commuting mileage.

 This issue is an example of someone normally having a situation they are not used to having. For example, people don’t normally sell their primary residence every year or inherit stocks and bonds from a family member that they have never had before. Let’s take for example the situation when someone sells their primary residence. Now, normally you would not have to report anything if you lived in the house for at least two of the previous five years and you never treated the house as a rental. But sometimes the title company has to report the transaction on a Form 1099-S. Well, a number of things can happen in this situation. First, you might not have received the Form 1099-S. Second, you could have forgotten you received it.

 The IRS expects you will most likely donate about 5%–10% of your income to qualified charitable organizations.

 The American Opportunity Tax Credit is fraught for abuse. The IRS does keep track of how long a child is being claimed for the American Opportunity Tax Credit. So, if it’s claimed for more than four years, because this credit cannot be claimed for any longer than that. graduate school is not eligible and going to raise you up the pile to get selected for an audit.

 when the rental property is vacant, that lost rent is not a deduction. If you didn’t receive the income, you don’t also get to take that as a deduction. Sorry to be the bearer of bad news. You get to take all the costs that you incurred on the property while it is occupied or vacant, but you don’t also get to take the deduction because you didn’t get the income.

 Taxpayers are supposed to keep a contemporaneous written log of their total and business mileage if the use their car as a regular tool for their business. When the logs show rounded numbers that get input on the tax return, IRS are most likely going to want to take a closer look. However, if they keep good enough records on a calendar or some other written log, that they can go and recreate it by using Google Maps to recover at least some of what they believe they are owed. But, please note that the law does say it is supposed to be a contemporaneous written log, which means you are keeping/writing it down as you go. While I recommend that you keep a contemporaneous mileage log, courts have allowed the recreation of it. Just don’t give rounded numbers to your tax pro or put it in the tax software. But it is best to have a contemporaneous written log so you have an actual and better number in the future. If need be, please use an app on your smart phone like MileIQ, which will allow you to swipe right for business and left for personal drive.

This can be a trap for many grandparents out there who claim their grandchildren. It is just one of those inquisitive moments for the IRS. This is also an issue for many boyfriends and girlfriends who want to claim the children of their live-in mate because they are living with them. However, it is debatable whether or not they even meet the criteria to claim them as dependents. In most cases the boyfriend claiming the girlfriend’s children, even though they live with him and even though they are providing more than the 50 percent of the sup- port, generally, cannot be claimed as dependents, as they cannot meet the other tests of the children being a dependent. For the grandparents, the key is to make sure they keep as much documentation as possible to show the child lived with them and that they provided more than 50% of their support. It would also be wonderful to have Form 8332 or some other written signed document indicating that the parents are not going to claim the child.

It is an acceptable practice to use outside help in your home or business, but most people don’t take the time to get the correct Forms, in this case, the Form W-9 from each contractor. They also don’t file the required 1099s to report the monies paid to the contractor. In most instances, if they would at least have filed the 1099s. If you do get audited, the IRS can deny the deduction for not reporting the amount paid on the appropriate 1099. Please be sure that if you pay a person or company more than $600 for services that you provide them a Form 1099. To be safe, just ask each contractor to com- plete a Form W-9. This will provide you the information you need for the 1099 and it will remove all doubt if you are unsure if you need to issue a 1099.

It is not uncommon for salespeople who drive a lot to not be fully reimbursed for their auto mileage.  The IRS sent Taxpayers a correspondence audit notice requesting details on the mileage that they drove and reported on Schedule A. Part of what they asked for was repair receipts from their vehicles, in that period. The repair receipts will usually list the make and model so they know which vehicle they are dealing with and the odometer reading when it was brought in to the repair facility. If that odometer reading doesn’t match within that period, obviously there is going to be some further scrutiny and probably disallowance of that deduction. Just be aware and make sure that if you do keep track of the mileage through odometer readings that those odometer readings match with your repair receipts. This also includes keeping track of those times when a car is taken in for repair or for oil changes or anywhere else where they notate the odometer reading on the receipt.

 Separate spouses can claim head of household if they don’t live together for the last six months of the year. But if they both report the same mailing addresses on the return, are they really separated? Meaning, if they have the same mailing address on the tax return, how can you prove they did not live together? Be aware that if they are truly separated and they are not living together, then they should actually have separate physical and mailing addresses. And then the spouse who claims the head of a household can do so as long as they have been separated for the last six months of the year.

The Form 1099-K was created in 2012. It requires credit card companies to start reporting when a merchant was using them for all of the income. This applies to companies like PayPal, Stripe, and Square, and all of the other credit card companies. They are required to report your credit card gross receipts on Form 1099-K. If a business is using multiple credit card merchant providers, they will get multiple Forms 1099-K-and the IRS will do their normal document matching of these documents with what you report on your tax return. If the gross receipts reported on a Schedule C or an S-Corp does not at least equal or exceed the amount that was reported on the sum of the Forms 1099-K, there is a problem. Usually, for most businesses the sum of the Forms 1099-K exceeds the total gross receipts reported on the tax return. Also, if the sum of the Forms 1099-K equals or is just over the amount of gross receipts reported, then we need to have a discussion on the amount of cash, checks, bartering, virtual currency, etc., received by that business to determine if it is reasonable for that business type. We don’t want this turning into a fraud investigation for unreported income. Nor do we want to see the IRS assess the substantial understatement penalty (aka accuracy related penalty).

Taxpayer was claiming a bunch of expenses that included itemized deductions, claiming some expenses that really weren’t true expenses and just not matching things with the documents he had. It was just a total disaster for this couple. But this is one of those cases of an abusive tax scheme that can easily be avoided. This guy is what we call a “ghosted tax preparer.” He prepares the return but does not put his name on the bottom of the return as a preparer. This is illegal. If someone other than you prepares your tax return, they need to provide their information in the preparer space of that tax return. It does not matter if they are a licensed preparer (attorney, CPA, or EA).

This is a very common issue for people who take distributions from their retirement accounts. It does not matter if you are over 59 ½ or not. If you take a distribution and the amount that is reported as taxable on the Form(s) 1099-R is different than the amount you are reporting on your tax return, then you need to document it now.
Another related issue is that we are only allowed to have one “rollover” of a retirement account per year. A rollover is defined as you taking a distribution where the funds end up in your hands, but you put those funds into another account. This does not include trustee-to-trustee transfers (i.e. bank to bank). For those of you who aren’t aware, the IRS won a court case a number of years ago in which they said they were going to basically follow this rule and that they were able to prove that a taxpayer is en-titled to only one rollover a year. Let’s say they get the distribution from the 401(k) or another IRA. They get the check and liquidate the ac- count. They want to move it to another account at an- other broker or bank. The check is written to the client. They then cash that check, and then within 60 days, they take the fund over to a different retirement account. So as long as they make that transfer from a traditional IRA to traditional IRA or ROTH IRA to ROTH IRA and do it within 60 days, no taxable event has occurred (i.e., rollover). However, the problem is that a 1099-R usually will have a code seven or a code one or a two in box 7. And because the IRS is expecting that to be a taxable event, they are likely to get a document-matching notice. I have had many situations like this. I normally tell clients that when I see this fact pattern, I try to get them to document the withdrawal out from the old account and the deposit into the new account for the day that notice comes. Which is usually about a year after the tax return is filed. For some of these red flags, there’s not much you can do. It is what it is and you are going to get a notice.

 they usually don’t claim all the expenses they are entitled to deduct, and are usually missing depreciation. The other issue is that their rental usually causes an overall tax loss. Why is this an issue? Even if their income is below $100,000, they still have to be actively managing the property and really need to be the person with the most hours on the property. Most people have a property manager who does the bulk of the work and this disqualifies most people from being able to claim the loss currently under the active participation rules.

Losses of any kind are usually an item that stands out on a return and get a second look by the IRS. This is no different. This is where I tell my clients to not only keep good records in terms of the receipts and invoices they get for expenses on the property as well as the mileage log for their trips related to the rental activities, but they should also keep a good calendar of the time they spent on each rental property so that they can prove they were actively participating.

For anyone to be considered materially participating in a rental property, this includes real estate professionals. You must spend at least 100 hours per property in order to claim that loss. If there is somebody else who is working on the property more than you, then they are not going to allow the passive losses. This is easy to pick out for the IRS to look at easy line matching. You can see that the usual going rate to pay for a property manager is about 10 percent of the gross rents. When that amount is 10 percent or more on the commissions or management fee line, then typically the IRS can match those and will obviously want to look at it further. They are looking to disallow the loss. Keep in mind this just means that you cannot deduct the loss currently. The good news is that you get to carry that loss forward to another year.

 When a taxpayer makes a large claim for a refund on an amended return, or Form 1045, or an 1139, or for that matter on the business side for NOLs or credits or Form 843, expect closer scrutiny of these documents. The IRS isn’t going to want to give up any more money than they are required. They are fighting fraudsters as well out there. If somebody who is making $20,000 in income gets a refund of two to three thousand dollars, the IRS is not going to care a whole lot, whereas somebody who is making a half a million dollars, the refund amount could obviously be a much large number. Five and ten thousand dollars (or more) is where   the IRS starts giving a little closer scrutiny.

Also filing of an amended return with large refund and close to the end of the statute of limitations caused tax return to be looked at and scrutinize more closely and to examine the tax returns for the next or past three years.

This should probably be a no-brainer, but cash-based businesses are typically known for not reporting all the cash. They are high-value targets for a full blown audit. As you can understand, restaurants, coffee shops, street vendors, lawn service, vending machines, laundromats, hair salons/barbershops, and many tourist related activities, including cannabis-based businesses, are examples of some cash-based businesses. I recommend that if you have clients who have cash- based businesses, then you need to look at the audit technique guide (ATG) for Cash Intensive Businesses. This ATG shows you how the IRS picks, selects, and audits these types of returns so that you can help your clients best defend it. I don’t ever want to say reverse-audit the return, but get them in a better position in order to not have large changes.

When it comes to S Corporations, the IRS says on your S Corp acceptance letter that the shareholders should pay them-selves reasonable compensation. Reasonable compensation is the amount that someone gets paid in a similar sized and type of business as yours and they wear the same various hats in the business as you (CEO, human resources, cook, cleaner, and chief bottle washer). The biggest thing that most people don’t realize is that there is a line for officer’s compensation on page one of  the Form 1120S. There is also a line for shareholder distributions on page 5 of Form 1120S in the M-2 section. It is easy to see, when there is a large number on the distributions line and a low to no number on the officer’s compensation line, that the IRS can have a field day with an employment tax audit. The audit doesn’t have to be conducted by just the IRS. Keep in mind, as I mentioned earlier, that an employment tax audit can be managed at the state level and the information shared with the IRS. I have had that hap- pen before here in Florida. 

 There has been a new question on the individual tax return that began appearing on tax returns recently. Did they have any virtual currency transactions that occurred? Most people don’t realize it because they are just using the virtual currency as cash. They bought their Bitcoin (or any of the thousands of other virtual currencies) and now they’re buying something with it. The owner of the virtual currency doesn’t look at it like the IRS does. The IRS looks at virtual currency as a capital asset; this is no different than owning stocks, bonds, or mutual funds.

Bitcoin is now the most common of crypto currencies (another name for virtual currency). When it was first presented to me about eight years ago, it was roughly $800 per coin. I had a client who came into me and talked to me about it and I obviously could have made a killing if I had bought some at that time because it soon got up to about $19,000 and even went over $50,000. As you can see, it’s no different than the stock market. I also had a client who recently bought some at a high end and, to his dismay, sold it at the low end. But these transactions still need to be reported on the schedule D or Form 8949. The IRS is coming after the people who use or sell it. The IRS was successful in getting client data from some of the data aggregators that host these transactions, places like Coinbase as well as some others that hold these coins. This is something that you need to be aware of if you own this type of investment. The IRS knows about you. It is not going to look good if you do get audited because you get notices by not reporting the purchaseof that computer you bought with that share of Bitcoin that you used to pay for it.

This is when one spouse claims income, but the other claims a different amount for the deduction or is just claiming the alimony deduction. Starting in 2019 alimony is no longer deductible for new divorces. I have seen many cases over the years where the spouse who is paying the alimony gets whacked because they are doing the separation of assets. They often include the separation of marital assets as part of their alimony deduction. The problem occurs where the spouse who is collecting the alimony is not reporting that on their tax return. Make sure that it is true alimony that is being paid, that it’s meeting the requirements to be called alimony. This is one of the ultimate in red flags when things don’t match. It is no longer an issue for new divorces since it is no longer income or a deduction, but you can still have divorces prior to where they are grandfathered in. They still have to claim the alimony income and the payer of the alimony gets to claim the deduction.

If a taxpayer makes a donation of a non-cash item in excess of $5,000, they must attach a signed appraisal to their tax return. You can attach that as part of a PDF attachment to your e-filed return. But, expect that there is going to be a closer look taken into this deduction especially if the deduction is well more than $5,000. Some of your wealthier companies and individuals will donate land to the school board for them to build a new school. They get tax deductible charitable contributions for that donation. Not long ago I had a case whereby a client bought some real estate that included a bunch of ceramic stone statues. They wanted to donate them to an art gallery after having a written appraisal prepared. It came out that the collective value of these items was $110,000. As long as they have received the written appraisal, then yes, they can take a tax deduction for this donation. Again, the additional point here is to be aware that this is the type of deduction that is going to receive some close scrutiny from the IRS. 

If you are legitimately running a business and if you have the necessary documentation to prove that, then you need to have the papers and intent to prove it. If this is you, you need to study the hobby loss rules. There are nine factors to consider to make sure you are operating a business and not a hobby. You need to look at the court cases that are out there in regard to your situation and they are in your favor. If you can document and have the support to prove your legitimate business, then by all means claim the loss. Just because you had three years of consecutive losses doesn’t mean that you cannot legitimately claim the expenses and take the loss. But you need to know that this is a situation that makes you a higher profile target for an IRS audit unless you are doing everything to make sure that you are a legitimate business and not engaged in a hobby.

Casinos only report the amounts provided on a Form W-2G. This usually means that you are also not claiming the losses incurred at the casino. Most regular gamblers create an “account” at the casino. The casino tracks their activity at the various slot machines and gaming tables throughout their visit each day they are there as long as they use their member card. If you happen to be a professional gambler, then you really need to document everything. This is no different than the hobby rules. Now, you can understand that the IRS is not really going to believe you when you say that you are a professional gambler. Many people think they are a professional gambler. A professional gambler wins a majority of the time and makes a profit more often than not.
Professional gamblers should be sure to document the hours they spend being a professional gambler as well as the time they are honing their trade and actually doing their trade. They need to document all their winnings, all their losses as well as the expenses they incur being a professional gambler, because this is another issue that will likely receive closer scrutiny from our friends at the IRS.

Despite what I said earlier about amended returns and how the IRS says that simply filing one does not make it an instant IRS audit target, if a taxpayer files an amended tax return as a refund claim within 60 days of the ending of the ASED period, expect the IRS to take a closer look at that return. Now, even if you file it on April 15 three years later-which is still a timely filing–that doesn’t mean that the IRS doesn’t have time to challenge it. They have technically 60 days to review it. However, if you have ever dealt with anything concerning the IRS, you know that 60 days is nowhere near long enough for them to actually get into looking at the return, let alone being able to make some determination on it. I had a client do this recently. He had someone prepare an amended return and file it within the 60-day period before the end of the ASED period. The IRS calls this a Delta Statute, which means that they can’t assess any additional tax once it has passed that extra 60-day time frame. However, they can deny the claim for refund. This client had this person prepare the Form 1040X for 2016. He filed the return within 60 days of the end of the ASED period claiming a refund of the full tax paid. Unfortunately, there were many, many things wrong with this return. I cannot even believe that it was done by a professional tax preparer. We are still in process of the audit on this return, but I am expecting that he is not going to get any of that refund. He had document-matching problems among other things. There was a 1099-S filed on the him that was not reported on the return, which is what I believe caused the return to be looked at by a Revenue Agent. There were items on Schedule C that should have been reported on Schedule E (rental) and a host of many other errors. To be honest with you, he was just better off not filing this amended return claim because it will hurt him more than it will help him. Why do I say that? Well, this simple amended return is now causing the tax returns for  the next three years to be audited, primarily since two of them have not been filed and are late. But the moral of the story here is this: be careful in this type of situation. Not that it is wrong, but as always, make sure you dot the I’s and cross the T’s!

This should hopefully go without saying, but some things just need to be said. This can range from cash-based businesses and the document matching. Even simple little things like the 1099s for HAs (Health Savings Accounts). People have the HAS accounts and they take distributions and the IRS treats that as income unless you prove otherwise. That is part of the document matching. You don’t report the HSA distribution on Form 8889 and mark that the distribution was used for qualified medical; if you do so, then it is regarded as income. Expect a CP2000 notice in your future. This is also a case where you need to refer to the cash-based business audit technique guide. It actually shows ways that the IRS can and should be looking to find unreported income. This goes beyond document matching. This revolves around whether or not you have reported all of the cash sales as well as the credit card and check sales.

If you do not report all the taxable income, it can come back to bite you later. I have heard of people not reporting all of their income in order to not pay too much tax and then wanting to get a loan or mortgage. The bank says, “We cannot lend you money on that income,” to which the customer says, “Oh, no. We make a lot more income than that and it should not be a problem for your people to run the numbers.” Say what? Did they just admit tax fraud verbally in front of another human being? Did you know that there is such a thing as whistleblower statutes? A whistleblower can rat you out and not only that, they can get paid a commission based on a percentage of the tax that the IRS collects from you. Please don’t go there. Report all of your income and I promise you that you will sleep better at night.

  This is the case usually when ex-wife will claim the child when it is ex-husband turn. What usually happens is the first one there wins. It isn’t right. When that happens, even though it is baby daddy’s turn, not baby mama’s, in order for baby daddy to end up claiming the child he is going to have to file his tax return on paper and takes between six to nine months to clear up.

If you are separated, getting divorced or already divorced, and you have kids, talk to your attorney about  having a Form 8332 completed. This form helps you determine who claims what child in what year. It is your best get-out-of-jail-free card because with this form your tax return cannot get messed up. Keep in mind that this problem can affect the additional child tax credit (ACTC), earned income credit (EIC), dependent care credit, and any other issues that revolve the dependency exemption. If you are able to claim the child, then it is so much easier and nicer if you can e-file their return, not to mention that you will get your refund much sooner. This is just one of those problems that, unfortunately, some times you don’t know about it until you e-file the return.

This can be paired with Chapter 23. Section 183 of the Internal Revenue Code, is titled Activities Not Engaged For-Profit. This is also known as the Hobby Loss Rules. The basic gist of this is that you cannot have a loss from your business for three out of five years without having a profit motive. So, what is a profit motive? The IRS has created nine factors that can help determine if there is a profit motive in the business activity. While no one factor is determina- tive or overriding, meeting the criteria for multiple factors will totally help your case. The nine factors are:

• You carry on the activity in a businesslike manner
• The time and effort you put into the activity indicate you intend to make it profitable,
• You depend on the income for your livelihood
• Your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business)
• You change your methods of operation in an at- tempt to improve profitability,
• You (or your advisors) have the knowledge needed to carry on the activity as a successful business.
• You were successful in making a profit in similar activities in the past
• The activity makes a profit in some years, and
• You can expect to make a future profit from the

appreciation of the assets used in the activity. The best thing to do to help yourself is to review these nine factors and do what you can to document your activities to make sure that you meet as many of these factors as you can. The more the documentation shows that you are operating your business for a profit motive, the better off you are should the IRS come knocking on your door.

At the end of the day, the business activity is what it is. If you have a loss for consecutive years, just make sure you are operating as a profit motive and you have the documentation to prove it. Then do what you can to not show a loss in future years.

 Most businesses cannot operate without incurring expenses for business meals and travel-related costs. A deductible meal is when two people consume food, drinks, or both together and they have some business-related

discussion before, during, or after that meal. Meals and travel-related expenses need to be substantiated with receipts, not just with credit card and bank statements. Most people just think, “Oh, it’s on my credit card statement and that should be enough.” A credit card statement does provide some documentation, but please note, that doesn’t always say where you were, how much you spent or what you bought. But the law in this area does require that you maintain certain records specifically when it comes to meals and travel-related expenses. Make sure you are not claiming every little lunch you have at a McDonald’s, Burger King, Dunkin’ Donuts, or Taco Bell. That is not deductible. Re-

member, you must generally have more than one person with you (unless you are traveling out of town) and must be discussing business before, during, or after the meal. When it comes to travel expenses, you can deduct expenses related to items like hotels, airfare, rental cars, taxis, parking, and public transportation. If you want to be creative, you could look at taking a partial vacation on the government’s dime. For example, if I went to a conference and it happens to be in Hawaii, there is nothing to say if my wife is in volved in the business that I couldn’t take her and my family with me. The airfare and the hotel expense for my wife and me would be deductible. Well, the hotel portion related to the conference would be anyway. I would just not deduct the hotel costs related to the personal portion of my trip.

But you may know the expression “Pigs get fat, hogs get slaughtered.” It is better to be a pig than a hog. If you end up trying to be a hog and take more deductions than you probably should, then you could be in a world of hurt if the IRS finds out. You are going to end up having to potentially pay the piper at some later point in time. When it comes to meals and travel expenses, just make sure you take good notes on the receipts and invoices and keep them (even if it is electronically) so you have them in the event the IRS pulls your lucky number.

The expenses for club dues, entertainment, and political dues/contributions are now all non-deductible items. There was a time when club dues and entertainment were allowable business expenses. Unfortunately, over the years, Congress has decided these expenses are no longer allowable. If you have these expenses in your financial records, then you need to make sure that they are not taken as tax deductible on your tax return. These particular expenses are an area that the IRS will look for on almost every client who gets selected for audit. They are always looking for expenses that they can disallow. You know, those are costs that were being claimed that are not legitimate deductions under the tax code. They will be looking at expense categories that could include items such as club

dues, entertainment or political contributions. Make sure that you look at accounts, for example, like charitable contributions, dues and subscriptions, meals, travel, and any other account that is similar to the non- deductible categories we are discussing in this chapter.

Back in 2010, Congress passed the Affordable Care Act. This allowed everyone to obtain health insurance that could not be obtained elsewhere. Starting in 2013, it became a requirement to have health insurance. If you did not have health insurance, then you would be penalized. I always have said that I care that my clients have health insurance. I just never thought I would care enough for

their tax return. If you get your health insurance from healthcare.gov (i.e., the government marketplace), then depending on  your income level, you are eligible for a subsidy that will help you reduce your monthly health insurance premium. The premiums and subsidy you receive are then reported on Form 1095-A. This form is to be input as part of your tax return. The tax return is the reconciliation of whether you got too much or not enough subsidy. The subsidy is based on your annual income at the time you applied for the health insurance. If you reported

your income too low, then you may owe some of this subsidy back. If you reported it too high, then you may be entitled to an additional refund (actually it is called the premium tax credit). If you don’t report the receipt of the health insurance subsidy on your tax return for the respective year, then the processing of your tax return will be delayed. The IRS will hold your tax return until you submit a Form 8962 along with the copy of the Form 1095-A. Once they receive these documents, they can complete the processing of your return. This means that if you are due a refund, it could reduce your refund or add to it depending on which way it goes. One question you may ask is, “Why wouldn’t the IRS have this information already since this is reported on a form that they should have in their database?” That would be a good question. Yes, it is reported to the IRS and

usually done so electronically by the end of March, but it takes the IRS’s systems until as early as the end of May to as late as the middle of July to get posted to your Wage and Income transcript account. The moral to the story: just make sure you report the Form 1095-A on your tax return if it applies. If you do, you will get one less notice in your life, get your refund quicker, and sleep better at night.

 They are out there, unfortunately. Abusive tax preparers will put extra expenses on your schedule A, C, E, or F. They will make up deductions that even sometimes you didn’t even know they were there. They show the taxpayer one return with the extra deductions and then the preparer will prepare another return with the extra deductions to claim the difference in the refund. Unfortunately, it is the taxpayer who gets whacked in these situations. If the IRS figures it out, and many times they do, the taxpayer not only owes the extra tax, but the tax preparer will usually go to prison and have to pay restitution. Normally, the taxpayer will usually not pay much in the way of penalties and interest, but you will have to prove you did not get the money and that you did not know about the scam. Unfortunately, there are some good people that get caught in that net that end up having to pay some taxes unbeknownst to them. If this seems to you like one of those cases where it seems too good to be true, then it probably is. Don’t be afraid to get a second opinion if something sounds fishy.

 If you are not aware, marijuana is still illegal at least at the federal level. It is true that many states allow it to be sold for medical and recreational purposes. But since it is an illegal business for federal purposes, there are limitations on what the law allows for these businesses to deduct on their business tax returns. Cannabis businesses can only deduct the cost of their inventory and nothing else. Nothing. Nada. Zilch. Of course, there are people out there who are always trying to come up with schemes and ways to be able to deduct their expenses or do something like capitalizing their expenses into their inventory under Internal Revenue Code (IRC) Section 263A. Unfortunately, for every case I have seen where someone attempts to challenge this, they lose. The problem for many of them is the cash-basis nature of the accounting. These businesses are unbanked, which means that most banks won’t even take them as a customer and allow them to have a bank account. These businesses are making very good money as far as I understand it, but because they primarily deal in cash, some tax professionals might be careful (or leery) in taking on such a client. Check with your professional liability insurance and make sure you know what you are doing. If this is your business, then until Congress makes marijuana a legal substance, you unfortunately have no choice but to pay for all of the normal expenses a business would have, which is to say you won’t be able to deduct them on your tax return. Just be sure to file your tax return, both business and personal. If you don’t do that, it will just cost you that much more later. Unfortunately, we have to play by the rules.

I have not run into many day traders over the course of my career. Sure, I have worked with them from time to time over the years. The main thing I have to say about people in this industry: they have to watch the market like a hawk. They can literally lose hundreds if not thousands of dollars in an hour if they are not paying attention to the market fluctuations. A good day trader will have dual Internet service connections to their home or office so that if one goes down, they are still always up and running. There are other safe-guards that they need to put into place, so they may have a bit more in some expenses than the usual home office. There is nothing wrong with them claiming these extra expenses, as they have a very good and legitimate business purpose. You just need to make sure that if this is you, you are dotting your I’s and crossing your T’s. Here is the overall problem. Everyone, including the day trader is required to report all stock sale gains and losses as capital gains and losses. If it ends up being an overall loss, then you are limited to $3,000 a year. If they make the Mark-to-Market Election under IRC 475, they can deduct any losses as ordinary losses. This allows them to offset other income reported on their tax return. Ultimately what this does is that it treats all of the securities held in the day trader’s inventory at December 31st as being sold on that day and now they use the new value as their basis for the next transaction. The good news is that the ordinary tax treatment and wash sale rules do not apply. Now here is the trick to elect this for the current year (i.e., the year that you are now reading this book): this election must be filed on the return that is due by April 15th of this year (or attached to the extension you file). That means if you want to do this for 2021, then it would need to be filed by April 15th of that year. Fortunately, if you missed this date, there are late relief procedures that allow you to possibly get it effective timely for the current year, but you need to have reasonable cause (i.e., a really good and compelling excuse). If you are a day trader, please talk with a tax professional to make sure that this election is good for you in our situation.

There are many U.S. citizens who live in foreign countries. There are also many foreigners who live here in the United States as resident aliens. They are all required to report not only their taxable income (and pay any necesary taxes on that income) but also report their foreign bank accounts and certain transactions if they are over certain thresholds.

There are hefty penalties for these if they don’t report this properly to the U.S. government. Now, if you find out that you need to file one of these forms, there is a procedure that is called a quiet filing that can be done. The key is that as long as you report the income generated from that account or activity in the foreign country on a tax return and paid tax on it, you should be good. I have seen this many times from postings by other tax professionals. They have what appear to be foreigners who are U.S. citizens. In many instances they are people who live in country such as Israel or Germany or even England. They were born in the United States to foreign parents. Their parents eventually take them back to their home countries while they are still young. As far as they know, they have been a citizen of the foreign country for their entire lives. They never returned to the United States and did not realize they were considered U.S. citizens. Now, to be clear: this is a child who has lived their entire life in their foreign country. They were not living here in the United States, but technically they are U.S. citizens as well, as they can be dual citizens of both countries. Their parents didn’t realize that they have a filing requirement, as they no longer needed to file a tax return since they do not have a U.S. source of income and are considered nonresident aliens. Their kids are now dual citizens. The kids did not know that they have a filing requirement not only for a Form 1040 but also for potential FBAR situations.

Please understand that the penalties are very stiff and this is an issue that the IRS can make into a criminal case  if they want to, and they do. If you own a bank account (or have signatory authority of a bank account), and that account has its highest balance of the year that is more than $10,000, you are required to file an FBAR return. Please note that this includes the sum of the highest balances of multiple accounts as well. For a FATCA filing on Form 8938, you need to potentially report any foreign financial account maintained by a foreign financial institution or other financial asset held for investment. There are thresholds here for reporting depending on whether you are living in the United States or living in another country. Please note that the due date of the FBAR form is the same as the Form 1040. If you extend your federal return, you will also extend the FBAR form as well. But be aware that the FBAR is a separate tax return filing from the 1040, whereas the FATCA filing is part of the Form 1040 filing. Make sure that you file these forms if they are applicable or suffer the consequences.

 A U.S. citizen who works out of the country for more than 330 days in a 365-day period can claim an exclusion of a certain amount of their earned income plus their housing costs for which they typically get paid or reimbursed. While this is a legitimate deduction, expect that the IRS will take closer scrutiny on this. If you miss the 330-day period by even one day, you do not get to take this exclusion. Expect that the IRS is going to want to look at their travel log, which is typically their passport. Just keep in mind that again, this is a situation where the IRS can have a key to the database of other government agencies. In this case, this would be the U.S. State Department. They will have record of all of your comings and goings, in and out of the United States. They are going to make sure that you were truly out of the country for those 330 days in a 12-month period. This is easy for someone to mess it up. If you misjudge the days you came back in one year and then leave to early the next year, you could lose the entire earned income exclusion. By the way, the exclusion for 2021 is $108,700 per person.  As with everything else, keep a good calendar log of your time in the United States and in the foreign country not to mention your housing/lodging expenses while in that country.

This is one of the most misunderstood deductions we have in the tax code. Claiming this deduction by itself does not generally get a return selected for audit. Although there is a special rule if you have two offices, you have to be doing different tasks in both offices. One is for meeting clients and the other is for doing administrative work; you should not be doing the other work in the other office. Meaning, don’t meet with clients in the home office and don’t do the bulk of your admin or marketing work in the outside office. In order for your home office to be used exclusively for business purposes, it must be an exclusive business-use space. Please make sure it does not have a bed, a sofa sleeper, a crib, kids toys/books/supplies or anything else that the space might be construed to be a non-work space. I say this because the IRS takes a strict view of looking at the home office deduction. However, please do not listen to those tax pros who say not to claim this deduction because it is a red flag. Do yourself a favor: if you qualify, you are entitled to claim the deduction. Please keep good records and be sure to claim the home office deduction.

Claiming any of these credits can result in a closer scrutiny by the IRS. These credits are rampant with fraud. There is a reason why they are holding tax preparers responsible for keeping documentation to prove they know the taxpayer qualifies for the respective credit. You really need to make sure that you qualify for these credits. Make sure you know what the criteria for each credit is. For example, claiming the credit for the ODC and CTC is a very specific test. If you provide more than 50% of the support of the dependent, then they cannot qualify as their own dependent. No matter what you do and it can be considered fraud claim so otherwise. Congress instituted new rules in 2010 where the IRS said when you are filing a return with a refund and you are claiming any or all of these credits, they will not release that refund until after February 15th, Since tax season opens usually around the last Monday in January, that is almost three weeks later. This allows the IRS to match up SSNs, DOB, and any other data point they can to disallow the credit. Of course, if you qualify for the respective credit, then claim it. As with everything else, make sure that you have the appropriate documentation to claim the respective credit.

It means you have little income with big deductions or vice versa. The other mismatch is that Taxpayers has other large losses from K-1s and rental properties. This continued into the years where he did not have any other large income sources. This begs the question, how can he afford to fund these losses when he has no earned income?. But the IRS does not see that, since they take each tax year independent of each other, at least at first glance. You just need to make sure you can document how you are paying for these expenses, especially if there are large deductions. Make sure you are keeping good records of all of the taxable and non-taxable income sources. It could be money coming out of a savings account or CD. There could be stock sales in a brokerage account. If you sell a stock for $100,000, this will give you cash (net of broker fees) of roughly $100,000, even though the gain (or loss) could be much less than that. They could have borrowed the money from themselves, the bank, or even a family member. It could even have come from a number of sources that might not make it taxable. You need to do your due diligence to document the income as well as expenses and make sure that that this is not one of those areas where the IRS may want to give your tax return more analysis.

Math errors are typically a byproduct of those do-it-yourself filers, especially when they prepare it by themselves on paper. Unfortunately, from time to time I will find that their math goes against them and not in their favor. Typically, the IRS will send you a notice, and most of the time the IRS is correcting your return because of the just simple math errors, not an unreported income situation.

Taxpayers were selected for a further scrutiny because they received a Form 1099-S and did not report the sale of theirs home on tax return. Nor did they report it on the amended return as well. Most people are under the impression that the gain on their primary residence is not taxable. Of course, it can be exempt from taxes, but you have to meet the criteria (used the home as your primary residence for two of the preceding five years, and never used as a rental or other business purposes except home office), and you could not use the exclusion in the previous two years and the gross sales price of the home not exceeds the $250k for single/HOH/MFS, or $500k for MFJ, then you have to report it on your tax return (and you get a Form 1099-S) even if you meet the above criteria and there is no taxable gain. Second, if you don’t meet the criteria, but you have what is deemed an unforeseen circumstance, then you may still qualify for a partial exclusion. An unforeseen circumstance is something like a job transfer or death in the family that causes you to sell the home within the two-year period. If you get the Form 1099-S, please be sure to include the sale on Schedule D of your tax return. If rented the property out at some point in time of your ownership, then you have a completely different calculation involved, which means you ought to seek out the help of a tax professional.