Trucking & Taxes – October 2023

As we have all seen, the Internal Revenue Service is hiring more and more agents. Also, IRS audit rates are increasing.

The Inflation Reduction Act gave the IRS $80 billion in funds, with the majority of that going to increased enforcement. The IRS is hiring 80,000 new agents, but it won’t happen overnight.

It will take the IRS time to hire experienced examiners and train them to audit complicated tax returns. Of course, most of the enforcement effects from the agency’s additional funding won’t impact taxpayers for at least a couple of years.

Audit rates in recent years have been significantly less than 1% of all individual tax returns. But low audit rates do not mean it is open season for cheating. The chance for an audit can increase significantly due to factors such as income, tax breaks you claim, the complexity of your return, math errors and whether you are engaged in business.

Are there sure ways to avoid audits?  No, but there are red flags to avoid. Following are some flags that could lead to an audit:

Failing to report all income

Leaving off income is a sure way to get the computer to pull your return for unreported income. The IRS gets all W-2s and 1099s you receive, as well as interest. If you fail to report, IRS crosschecking will find it.

Not filing

This may not lead to an audit, but it will get the agency’s attention. The IRS will even file a return for you to its benefit, without all your deductions. It’s not always diligent in doing this but is prioritizing it more. The IRS primarily focuses on individuals who make over $100,000 and don’t file.

Hobby losses

If you have multiple years of losses on Schedule C or run a business that seems like a hobby and have lots of income from other sources, you may set yourself up for an audit. The IRS is on the lookout for taxpayers who year after year report large losses from hobby-like activities to help offset other income. The hobby-loss rules are frequently litigated in the tax court.

And guess what? The IRS usually prevails in court, partly because it tends to settle cases it doesn’t believe it can win. It is possible to win a case like this, however, if you have proof of running a legitimate business.

Claiming rental losses

The passive-loss rules can and do usually prevent the deduction of rental real estate losses, but there are two important exceptions.

First, if you must actively participate in the renting of your property, you can deduct up to $25,000 of loss against your other income. That $25,000 allowance phases out as adjusted gross income exceeds $100,000 and disappears entirely once your AGI reaches $150,000.

The second exception applies to real estate professionals who spend more than 50% of their working hours and over 750 hours each year materially participating in real estate. In that scenario, you can write off rental losses.

But know that the IRS actively scrutinizes large rental losses, especially those written off by taxpayers claiming to be real estate pros. And especially in cases of landlords whose day jobs are not in real estate, agents look to verify that filers worked the necessary hours. So keep track of your activities on your rental properties.

Gambling winnings and losses

When playing cards, slots, roulette or betting on dogs or horses, one thing you can count on is that the IRS wants its cut. Even those gambling for enjoyment must report winnings as other income on the 1040 form.

Professional gamblers show their winnings on Schedule C. Failure to report gambling winnings can draw IRS attention, especially if the casino or other venue reported the amounts on Form W-2G.

Claiming large gambling losses is risky, as well. You can deduct these only to the extent that you report gambling winnings. Reporting large losses may also draw scrutiny concerning whether you truly gamble for a living.

Recreational gamblers also must itemize. The IRS looks at returns that report large losses on Schedule A but don’t include winnings in income.

Running a business

Schedule C is a form where self-employed individuals can claim an abundance of deductions.

This form is also a treasure trove for IRS agents who believe the self-employed claim excessive deductions and don’t report all income.

For Schedule C filers, the IRS looks at both higher-grossing sole proprietorships and smaller ones. Those reporting at least $100,000 of gross receipts on Schedule C have a higher audit risk, as do cash-intensive businesses. Another red flag is when business owners report large losses on Schedule C, especially if those losses offset income reported on the return.

In addition, claiming 100% business use of a vehicle is a prime audit red flag. IRS agents know that it’s rare for someone to actually use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use.

The IRS also targets heavy SUVs and large trucks used for business, especially those bought late in the year, since this timing makes vehicles eligible for more favorable depreciation and write-offs. Make sure you keep a detailed mileage log, as well as a calendar entry on the nature of every road trip.

Bad or no bookkeeping can set you up for a very bad audit, as well. Develop a habit of keeping detailed records of transactions just in case you are an unlucky business owner selected for an audit.

Virtual currency or digital asset transactions

The tax rules treat cryptocurrencies as property, and the IRS is on the hunt for taxpayers who sell, trade or deal in bitcoin and other virtual currency and digital assets. With its extra funding, it will be using all available tools to discover unreported transactions. These efforts include mailing letters to people believed to have virtual currency accounts. LL