Your receipts are important: save them

Deduction opportunities abound for people who know the importance of saving their receipts and keeping proper documentation. Make sure you’re taking the right steps to make qualified deductions during filing season.

When it comes to taking qualified deductions on your federal tax return, three things must happen:

  • Recognize that an expense might be deductible on your tax return.
  • Keep a record of the expense in an organized fashion.
  • Obtain the proper (and timely) documentation to support your deduction.

This might be obvious to most people, but here are some typical areas where taxpayers often fall short. In the long run, these items could end up costing you plenty during tax filing season, and trigger IRS audits.

  1. Cash donations to charity. To deduct and support your deduction to a qualified charity you must have valid support. Donations of cash are no longer deductible if they are not supported by a canceled check or written acknowledgement from the charity.

A donation deduction of $250 or more needs to be supported by documentation created at the time of the donation. A canceled check and bank statement are not sufficient. If you get audited, having the charity issue documentation after the fact may not be enough.

  1. Non-cash contributions. You need documentation for these donations as well. This includes a detailed list of items donated, the condition of the items and their estimated fair market values. While this level of detail is not required for small donations, keeping good records and taking photos is a good practice.
  2. Investment purchases and sales. If you bought or sold an investment you will need to know your cost basis. Today’s regulations require brokers to report to the IRS the cost basis of investment sales. Review your broker accounts and correct any errors. It’s very difficult to defend yourself in an audit when records reported to the IRS are in error.
  3. Copies of divorce decrees, alimony and child support agreements. There are often conflicts between two taxpayers taking the same child as a deduction. Do you have the necessary proof to defend your position? The same is true with alimony and child support. Keep these documents in a safe place and be ready to use them if necessary.
  4. Copies of financial transactions. Keep copies of documents from any major financial transaction. This includes real estate settlement statements, refinancing documents and any records of major purchases. These documents are necessary to ensure your cost basis in the property is properly recorded. The documents will also help identify any tax-related items like mortgage insurance, property taxes and possible sales tax paid.
  5. Mileage logs. Lack of tracking deductible miles is probably one of the most commonly overlooked documentation requirements. Properly recording charitable, medical and business miles can really add up to a large deduction. If the record is not available, the IRS is quick to disallow your deduction.

If you are not sure whether a document is needed, retain it. Then you can always retrieve it if needed.

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You’re getting audited – here’s what to do

So you’ve been contacted by the IRS — or you’re worried you will be. Find out the first steps you should take to be prepared if you’re audited.

Most of us will never be audited. But when it does happen, it might feel a little scary. The truth of the matter is IRS auditors do audits every day. They know what to look for and can ask questions that you may easily answer incorrectly. Here’s how you can be more prepared if it happens to you:

  • Respond to the IRS in a timely manner. Do not let it get to a point that a face-to-face examination is required.
  • Ask for help. Do this right away. Too many clients think the problem is easy to resolve, but inadvertently say the wrong thing or open another audit issue inadvertently.
  • Know what is being asked. Clearly understanding the core question can simplify the solution. Why is the auditor asking to see your 1099s? Is it regarding a form you don’t have? Is the auditor asking about your small business profits because he/she thinks your business is a hobby?
  • Understand how the auditor has been trained. The IRS has certain areas in which it focuses training for its auditors. These are published in Audit Technique Guides (ATGs) and are available for review on the IRS website. The ATGs can be helpful in identifying areas for potential audits, as well as help you understand what the IRS likes to question.

Even if there’s only a small chance that you’ll be audited in your lifetime, it can be helpful to know how you can prepare for it if it happens to you.

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Fair market value (FMV): What is it and how to defend it

The price that property would sell for on the open market — fair market value (FMV) — often seems like it’s open to interpretation. Here’s how to defend your FMV determination if it’s questioned.

So what is fair market value (FMV)? According to the IRS, it’s the price that property would sell for on the open market. This is the price that would be agreed on between a willing buyer and a willing seller. Neither would be required to act, and both would have reasonable knowledge of the relevant facts.

This is the standard the IRS uses to determine if an item sold or donated by you is valued correctly for income tax purposes. It is also a definition that is so broad that it is wide open to interpretation.

Understand when FMV is used

Fair market value is used whenever an item is bought, sold or donated and has tax consequences. The most common examples are:

  • Buying or selling your home, other real estate, personal property or business property
  • Establishing values of other business assets like inventory
  • Valuing charitable donations of personal goods and property like automobiles
  • Valuing bartering of services, business ownership transfers or assets in an estate of a deceased taxpayer

 

Know how to defend your FMV determination

If the IRS decides your FMV opinion is wrong, you are not only subject to more tax, but also penalties. Here are a few tips to help defend your FMV in case of an audit.

Properly document donations. Fair market value of non-cash charitable donations is an area that can easily be challenged by the IRS. Ensure your donated items are in good or better condition. Properly document the items donated and keep copies of published valuations from charities like the Salvation Army. Don’t forget to ask for a receipt confirming your donations.

Get an appraisal. If you sell a major asset such as a small business, collections, art or capital asset, make sure you get an independent appraisal of the property first. While still open to interpretation by the IRS, this appraisal can be a solid basis for defending any differences between your valuation and the IRS.

Keep pricing proof for similar items and transactions. This is especially important if you barter goods and services. If you have a copy of an advertisement for a similar item to the one you sold, it can readily support your FMV claim.

Take photos and keep detailed records. The condition of an item is often a key consideration in establishing FMV. It is fair to assume an item has wear and tear when you sell or donate it. Visual documentation can be used to support your claimed amount. And keeping copies of invoices for major purchases is also a good idea.

With proper planning, establishing FMV of an item can be done in a reasonably defendable way if ever challenged.

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