Surviving the Annual IRS Terror - Part 2
By Richard B. Barger, ABC, APR
15 times. Rita and I have been audited some 15 times. Why is the IRS watching out for me? Well, I'm no accountant, no lawyer (Thank goodness!), no tax advisor. But I know that I have three characteristics that increase my likelihood of being audited.
Office in home
Large deductions in relation to income
Somewhere along the line, despite the fact that Congress contemplates that Rich Barger or someone like him may actually operate an independent business from his residence, the IRS has, in their infant wisdom, decided that they should make this business form as undesirable as possible. If they aren't the original inventors of obstacles, they certainly have had the full week's course on creatively implementing them. (To read a really serious, honest-to-goodness rant about the fu@#ing IRS, go to my Biting Commentary, "Here's to the Newer, Friendlier IRS.") At any rate, being aggressive increases my likelihood of being audited only slightly. I'm probably going to be singled out anyway. So, I might as well try to save all the money I can. Last week, in Part 1, I mentioned that I keep incredibly detailed records, that I am aggressive with deductions, and that I look at audits as a cost of doing business, a cost of keeping my own money. No Profit Doesn't Have to Equal No Deductions The IRS tries to convince people that they must make a profit three years out of five in order to be considered a business. It ain't in statute; it's only an easy rule of thumb for everyone to use. There is no legal requirement that a business must make a profit to be a business, only that it be attempting to make a profit. (I'm not sure what the legal terminology is, but that's the general idea: attempting.) There are lots of characteristics that go into making a business a business, and profit is only one of them. Some years, because of the generous deductions Congress has, in its wisdom, written into statute, my business showed no profit -- on my tax return. If Congress thinks I should be taking all those deductions, who am I to argue? The IRS likes for you to do things their way, to make life easy for them. In an audit, they will argue about what is "required." But although the requirements of law (statute) are enforceable, what the IRS has chosen to require by their own regulation, rule, policy, procedure, or written or oral "opinion," ruling, or interpretation may not be. These are arguable and, often, just a matter of who blinks first. (Although, I admit, sometimes the blinking is done on the steps of Tax Court.) It May Be Easier to Deduct More Space Than Less The "office in home" deduction is getting tighter: You have to be able to demonstrate that, basically, the space is used regularly and exclusively for business purposes. In a strange way, that makes it easier to deduct three rooms and a bathroom than it does a corner of a bedroom or family room. The IRS may argue the non-exclusive nature of a dual-purpose room, but they can't successfully make the same argument when the entire room is demonstrably devoted solely to business purposes. You could walk into any of several rooms in my home office and it would be perfectly clear that they have only a business purpose, that any damn fool -- even an IRS auditor -- could see that they were not personal living space. The office I'm in right now has two desks, four computers and computer tables, five monitors, two printers, five full-sized file cabinets, and a $7000 photocopier. You think it's used for personal purposes? Hell, I have a total of 63 drawers of file space! Try cramming that into a corner of a bedroom. If you ever have business visitors, you naturally must maintain your office premises. So, once you have determined that, say, 37.2 percent of your residence is devoted exclusively to business use, then it is reasonable to argue that 37.2 percent of yard maintenance, painting the house, certain inside repairs, etc., also are deductible. If IBM can deduct mowing the grass and repairing the sidewalk, you can, too. You may be able to deduct 100 percent of expenses related to the exclusive office areas. Insurance and property taxes would be 37.2 percent deductible (except that any specific "business premises" or "business liability" insurance probably would be 100 percent). Get the idea? Isn't Almost Every Trip a Business Trip? Then there's mileage. Don't deduct visits to your mother. Beyond that, you'll find that many -- most? -- of your trips are to see either 1) a client (or supplier), 2) a former client (or supplier), or 3) a prospective client (or supplier). Pick up business cards. Note locations, mileages, who you visited with, and the topic. Records, records, records. If you go to a business supply store or the Wholesale Club or a shopping center or a Home Depot for some item for the business, log the trip and the purchase and deduct it. Even if they didn't have what you were looking for, if the trip was for a business item, deduct the mileage and the parking. Keep contemporaneous records of mileage. If you take someone out for a meal, note the individual, the company, and the business purpose on the back of the receipt. If you visit the home or office of a colleague, note the business purpose and deduct the mileage and parking. Everything adds up. Plus, if you make a habit of this -- every trip is listed, every time -- the IRS can't say you just "invented" deductions. Consistent record-keeping is the key. My Favorite Auditor Story You remember that auditor I mentioned last week, the one who couldn't make heads or tails of my records, the one who said my documentation was "too detailed"? We got her fired! That's right, they sent her ass right back to the processing center, from whence she came. Now, if you're thinking ahead, you say, "But wait! That just means they brought in another auditor, who began the whole thing from scratch. You just stretched out what otherwise was already a painful process." Well, yes … and no. They did indeed bring in another auditor, who took what had by then accumulated to a four-inch-thick file of papers, forms, and documentation. Documentation on top of documentation. Indeed, that was the problem with the first auditor: She kept asking for stuff, but, once we supplied it, she had no idea what to do with it. Anyway, every time the new guy asked us for something, fortunately, because the previous auditor had made us supply the World's Fair of documents, we could honestly say, "We've already provided that. It's in the file." And we did so, again and again. We got the impression that he never went to the trouble to go through much of the original auditor's accumulated, disorganized crap, and he never asked us for anything new, so we came through the audit just fine. Your Mileage May Vary Not for a second do I assume that all of these tips will work for you. But maybe one or two of them will give you ideas or will alert you to an area where you might keep your records in a little different fashion, or maybe you'll consider an approach that you'd never thought of before. If you believe you're following my lead and you screw up, too bad. I'm not going to accompany you to the audit and I'm not going to visit you in Leavenworth. But if you find something useful here, talk it over with a competent tax advisor or attorney. And then, go for it. It's your money, not theirs!
Editorial comment: I detest the fact that our country has designed a system that requires struggling small businesses to jump through all these hoops when we could be doing something productive for the economy. However, that's the system in place; those are the rules they've established. So it's up to us to implement them in the way that best helps us survive. Oh, for a VAT and abolishment of the IRS forever!