AUGMENT YOUR AUDIT AWARENESS

by Andrew D. Schwartz, CPA

Looks like the IRS is stepping up their auditing efforts.  As predicted in an article posted on FindAGoodCPA.com three years ago, Are You At Risk of Being Audited, I sadly noted that the IRS had planned to increase the number of tax returns they will be examining.

To quote myself from three years ago, "The IRS has acknowledged that the Service can't 'audit its way out of the tax gap.'  Even so, audits remain an important compliance tool...[and you should] expect the IRS to rely on audits as a deterrent against non-compliance with the current tax laws." 

This past summer and fall, my firm assisted a handful of clients who were being audited by the IRS.  The most noticeable trend was that many of these examinations were handled as "desk audits".  Instead of meeting face to face with an IRS agent, our clients were asked to compile certain records, and then submit their documentation through the mail for examination.  (Makes you wonder if the IRS is offshoring these audits to India. Just kidding, of course.  Or am I?)

Based on our limited sample of audited taxpayers, it appears the IRS is currently focusing their auditing efforts on medical expenses, charitable donations, and employee business expenses.  Let's take a look at the documentation the IRS requests in connection with these audits:

Medical and Dental Expenses

• Send copies of cancelled checks, receipts or statements for all medical savings accounts, medical and dental expenses (including medical insurance) showing the person for whom each expense was incurred, along with any insurance or employment reimbursement records.  Send a copy of your medical insurance handbook or policy describing the benefits and reimbursement policy and verification of premium costs.

• For prescription drug expenses, send copies of statements or receipts showing the prescription numbers, names of drugs, costs and date purchased.

• For other expenses, (including capital improvements, equipment, transportation and lodging) send proof of payment and statements to show costs and medical requirement.

Charitable Donations

• Send copies of cancelled checks and receipts for contributions to charitable organizations.

• If the contribution was other than money, send the name and address of the charitable organization and the description of the items contributed.  If the appraisal is required by Form 8283, Non-Cash Charitable Contributions, send a copy of the appraisal showing the fair market value of each item on its contribution date.  In addition, send evidence of its original cost.

• If you claimed expenses for attending a convention or similar activity, provide a statement showing you were an official representative of the organization.  Also provide the organization's reimbursement policy, expense receipts and an itinerary or agenda for the activity.

Miscellaneous Itemized Deductions and Employee Business Expenses

Please provide an explanation, receipts and records to substantiate any amounts that you entered on Schedule A lines 20, 21, and 22.  For the amounts claimed on Form 2106 or Form 2106-EZ, please submit the following:

• A copy of your employer's reimbursement policy or a letter from the employer explaining what expenses are reimbursed.  The letter should also indicate whether it is an "accountable" or "non-accountable" reimbursement plan.

• If your employer does not have a reimbursement policy, please provide a letter from your employer indicating what expense(s), if any, are reimbursed or that no reimbursement is authorized.

• A statement as to whether or not reimbursement is included on your W-2, and, if so, where on the W-2 the reimbursement is reported.

• A copy of any receipts for any expenses claimed greater than $75.

• Receipts for any lodging expenses claimed.

• Copies of logs, diaries or other records showing all expenses incurred, job locations and dates you were at each location.  For meals and entertainment, these records should detail the business purpose and the business relationship.

• Verification of total mileage on the Vehicle(s).  This can be from two repair receipts, inspection slips or any other records showing total mileage for the year.

• For uniforms, equipment and tools: send a statement from your employer stating whether or not the expense was reimbursed.  Provide your employer's description of the reimbursement policy and the amount you were reimbursed.  Send copies of cancelled checks and receipts verifying expenses.

• For education expenses: send a statement from your employer explaining whether you needed to incur the expense in order to keep your job, salary or status.  Explain in writing how the education helped you maintain the skills needed in your job and how much reimbursement you received.  Send copies of receipts and cancelled checks to verify the amount you spent for books, transportation, and other educational expenses.

• For legal, taxes, and investment counsel fees: send copies of cancelled checks, receipts, and statements showing the amount paid and the purpose of the expense.

Oy Vey

What can I say but "Oy Vey"?  After reading through that list of documentation that the IRS might request from you, you really need to set up some type of system to keep your receipts and other evidence of the deductions you claim on your tax return each year.

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FUNDING YOUR CHILD'S COLLEGE TUITION BILL TODAY

by Richard S. Schwartz, CPA, CVA

For most people, three of the largest expenses they will incur in their lifetime are buying a house, saving for retirement, and paying for a child's college education.  Buying a home is generally done via a mortgage to make it affordable for the everyday person.  Saving for retirement is also done over a period of many years, usually via an employer sponsored retirement plan such as a 401(k) or 403(b) plan or via IRA’s.  Similarly, one also has the option to save for a child’s college education utilizing a long term plan as well.

The IRS allows individuals to save for a child’s education via a tax- free plan called a Section 529 Plan.  Each state sponsors their own plan in connection with an investment company such as Fidelity, Vanguard, or Schwab among others. 

Individuals generally choose a plan based upon the investment objectives and track record of each specific state plan.  For instance, you may live in Massachusetts (the MA sponsored plan is managed by Fidelity Investments), but can choose to use another state’s college savings plan.  While many states do offer an incentive to their residents to use their own state sponsored plan by offering a tax deduction on their state income tax return, other states, including MA, do not offer such a tax break. 

529 Plans are usually categorized as either prepaid plans or savings plans. 

•  Prepaid Plans allow individuals to prepay, or “lock in” all or part of the costs of an in-state public college in today’s dollars for their children, grandchildren, etc.  These plans may also be converted for use at an out-of state college or a private college.  (More info on a national prepaid plan is available at www.independent529plan.org.)

• Savings Plans allow individuals to make contributions into a pre-set portfolio of mutual funds for their children, grandchildren etc.  The goal of these funds is long-term growth in the value of the portfolio.  These accounts will fluctuate in value based upon the underlying investment portfolio of the plan. 

For both plans, contribution limits are subject to tax free gifting rules.  For 2010, you and your spouse can jointly gift up to $26,000 per year per child without gift tax consequences.  However, special rules allow taxpayers to front-load five years of gifts into one year for education planning, allowing you and your spouse to jointly gift up to $130,000 into the plan in any one year during a five year time period.  Please note that you will need to file a gift tax return if you're married and contribute more than $26k on behalf of one child in any calendar year.

The primary advantages of 529 Plans are as follows:

• Although the contributions to the plan are not tax deductible on your federal tax return, the plan’s earnings grow tax-deferred.

• Distributions used for tuition and other qualified expenses are tax-free to you and the beneficiary (child).

• Control of the funds remains with the donor (parent or grandparent, etc.)  Contributing to a section 529 plan is a revocable gift – thus, the donor can take the funds back (subject to taxes and a penalty of 10% on the earnings) or reassign the funds to another child's 529 account.

• The plans investments are professionally managed, utilizing the expertise of investment portfolio managers of national investment companies.

• Individuals can instruct the plan to automatically invest the funds monthly/periodically via an electronic funds transfer from your checking account to the plan in order to take advantage of the benefits of dollar cost averaging for investment purposes.

In summary, we are all well aware of the already exorbitant and continually growing costs associated with attending a college or university.  For this reason, you need to start saving for a child's college education as soon as you can, hopefully while your child is relatively young. 

As part of your planning process, as with any investment decision, you should consult an expert and/or do your research.  Start by contacting the various investment companies’ toll free customer service phone numbers to discuss your questions with their representatives, or visit their websites and read through their literature; both avenues provide a wealth of knowledge of general information for Section 529 Plans as well as specific information pertaining to their own plan(s).  Another great resource is the website www.savingforcollege.com which provides an abundance of useful information on Section 529 Plans and also maintains rankings of the performance of the different state sponsored plans.

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2009 & 2010 TAX FACTS

• For 2009, the standard deduction for a single individual is $5,700 and for a married couple is $14,400. A person will benefit by itemizing once allowable deductions exceed the applicable standard deduction. Itemized deductions include state and local income taxes (or sales taxes), real estate taxes, mortgage interest, charitable contributions, and unreimbursed employee business expenses.
• For 2009, the personal exemption is $3,650. Individuals will claim a personal deduction for themselves, their spouse, and their dependents. 
  
• The maximum earnings subject to social security taxes is $106,800 for 2009 and 2010.
  
• The standard mileage rate is $.50 per business mile as of January 1, 2010, down from $.55 per mile for 2009.
  
• The maximum annual contribution into a 401(k) plan or a 403(b) plan is $16,500 in 2010. And if you'll be 50 or older by December 31st, you can contribute an extra $5,500 into your 401(k) or 403(b) account this year.
• The maximum annual contribution to your IRA is $5,000 for 2009 and 2010.  And if you turn 50 by December 31st, you can contribute an extra $1,000 that year.  You have until April 15, 2010 to make your 2009 IRA contributions. 

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