Episode 36: Reduce Your Taxes & Your Audit Risk

Announcer: This is The WealthAbility® Show with Tom Wheelwright. Way more money, way less taxes.

Tom Wheelwright: Welcome to The WealthAbility® Show where we're always learning how to make way more money and pay way less taxes. Hi. This is Tom Wheelwright, your host, founder and CEO of WealthAbility®.

Tom Wheelwright: Is your tax preparer increasing your taxes because he or she is afraid of the IRS? Today, you're going to discover how to never be afraid of the IRS and reduce your taxes by thousands of dollars. We're talking about the number one deduction that people forget, that people don't take, and it's likely they don't take it or they don't take the right amount because of their tax preparer. I'm in the tax preparation industry. Okay? I see good tax preparers and I see bad tax preparers, but what drives me crazy is when I see that somebody is not taking the home office deduction because their accountant or tax preparer has said this raises a red flag.

Tom Wheelwright: Let's talk about this red flag. This is such a serious issue. When I speak at seminars, and I speak in front of thousands of people as you know, I frequently ask the question, how many of you have ever been told by your tax preparer not to take a legitimate deduction? Routinely, 80% to 90% of the hands in the audience go up. If I'm talking to entrepreneurs, 80% to 90% of the hands go up. I always ask the follow-up question, for how many of you was that deduction the home office deduction? Most of the hands go back up.

Tom Wheelwright: Here's the truth of the matter, folks. If you handle the home office deduction as the IRS suggests you handle it, there is no place to indicate on the tax return that you have a home office. How is it that this is a red flag? Here's what's happened unfortunately in my industry. Preparers have been trained by people who understood how the IRS works 20 years ago. 20 years ago, was it fair to say that the home office deduction was a red flag? Yes. Even when it's a red flag, I would propose that if your tax preparer is afraid of taking a legitimate deduction, that just means your tax preparer is afraid of the IRS. That's what it means. The home office deduction is a tax deduction that is specifically outlined in the internal revenue code of this is how much is taken, this as how to take it, so it is a completely legitimate deduction.

Tom Wheelwright: Why would people think, why would preparers think this is a red flag? Well, if you file a Schedule C, which means you have a home-based business or a small business and you file a Schedule C. In other words, you're showing your business income and expenses on your personal tax return, your 1040. If you're doing that, then you also have to file a special form that says you have a home office, and you identify the home office deduction and it goes through the whole computation.

Tom Wheelwright: Here's the challenge with that. Why are you filing a Schedule C? Did you know that a Schedule C will increase your audit risk by five times? There's a good reason for it. A Schedule C is easy to manipulate, and there's no proof that you've done things right because there's no balance sheet. There's only a profit and loss or income statement. That's it. You basically only have one side of the equation. Profit and loss is only one side of the equation. Balance sheet is the other side of the equation. If you only have one side of the equation, you can manipulate that all day long. It's like if you have one point, you can draw a line through that as many times you want, as many directions as you want. If you have two points, you can only draw one line through it one way. The two points are the income statement and the balance sheet. The IRS knows that. The IRS goes, well, look, a lot of people manipulate their Schedule C so we're going to audit people more often if they have a Schedule C because we don't believe them.

Tom Wheelwright: Why do you have a Schedule C? Because there are so many alternatives to a schedule C. You could file on a partnership return. You can have it be a partnership. You'd have a limited liability company taxed as a partnership. You could file as an S corporation. You could file it as a C corporation. A Schedule C, frankly, is for lazy people and particularly lazy accountants.

Tom Wheelwright: Look, folks, I love my profession. I'm a CPA. I've been a CPA for almost 40 years. I'm very proud to be a CPA. That said, there are lots and lots of tax preparers, including CPAs who don't understand that there are ways to do a tax return and ways to set you up so that you know … You know if you have an S corporation, there's no place to report on that tax return that you have a home office. All it shows is office expense. That is actually the way the IRS wants you to do it. You reimburse yourself. This is the IRS instructions on the S corporation tax return for a home office. If you have a partnership, it's the same way. You're supposed to be reimbursed for it. It's an office deduction. There's no office expense. There's no place that says home office. There's no calculation form.

Tom Wheelwright: Here's what's going on when you're not taking your home office deduction. You are missing deduction for part of your utilities, for part of your purchase price of your home, for part of your cleaning and maintenance. You may be missing part of it because you couldn't take your tax deduction on your income taxes on your Schedule A because you're not finding the Schedule A anymore. You've got tax deductions that you're missing out on.

Tom Wheelwright: On top of that, think about this. Home office has an impact on other deductions. The biggest one is automobile expense. We all know that the IRS considers a commute to be personal expense. They also say that the very first trip you take during the day is commute, even if you're going to a client, even if you're going to go see a property. That means that that very first trip is nondeductible. The last trip of the day is nondeductible too because you're going from your home to an office, and that may be a client, and then you're coming back home. On the other hand, the IRS also says that if you have a home office and every morning you go into that home office and do your administrative work, and every night you come home to your home office and do your administrative work, answer emails, etc., then your commute is the 30 feet from your kitchen to your home office. That first trip of the day is no longer a commute.

Tom Wheelwright: Well, for most of us, that first and last trip of the day, that's 50% of our driving. We've doubled our automobile expense because we have a home office. We can't claim that home office unless we claim the home office deduction because we're saying we don't have a home office if we don't claim a home office deduction. We actually need to claim the home office in order to get the automobile deduction as much as we're entitled to, to increase the amount we're entitled to.

Tom Wheelwright: Here's what's more. Some of you are taking the home office deduction. Are you taking the right amount? Could you increase your home office deduction? The IRS actually gives us two different ways. Well, actually three. There are three different ways to determine your home office deduction. They actually have a very simplified rule, which almost never maximizes your deduction. You can look at it, but I'm telling ya, it almost never gets the most deduction. You can take a square footage of your home office compared to the rest of your home. That's what most people do who actually take the home office deduction.

Tom Wheelwright: The IRS also gives another alternative however. If your rooms, like in my house, the rooms in my house are pretty much all the same size, they're pretty close to the same size. They say you can actually take number of rooms. If you have 10 rooms in your home and you have one room that is your home office because it's used exclusively for business, whether your real estate business or your other business, then that's 10%. Are you maximizing your home office deduction? This is the question for your repair. Remember, it's really your preparer who's doing this. The reason that you're listening to this podcast is because you want to understand how to minimize your taxes and maximize your cash flow. That's what you're trying to do. Well, sometimes, you're not sure, does my prepare know what they're doing?

Tom Wheelwright: This is actually why we created The WealthAbility® network of tax professionals and other accounting professionals. Because what we've discovered is that there's really not a lot of good training out there for the small firms; small firm being 20 and under. We've taken it on ourselves to educate really what is 80% of professional accountants are in small firms of under 20, and they're not getting served. That's what The WealthAbility® network is all about, is serving that group. Let's say that you have an accountant who you go, “I really like my accountant. They clearly need some training.” Send them to us. Go to wealthability.com. Have them sign up for a consultation. Get on the phone with them. We are happy to help your accountant. We're happy to help you, but we're really even more happy to help your accountant because our mission is to reduce your taxes and increase your cash flow. The best way to do that, the person who has the most impact on that is your accountant, your CPA, your tax advisor, your tax preparer. We want to help them out.

Tom Wheelwright: Things like the home office, we think, well, this is a little … It's not that much. You add in the automobile deduction and it could be $5,000 to $10,000 a year easily. Think about if you had an additional $10,000 deduction. Let's say you're in the 30% tax bracket. That's $3,000. Your choice. You can give that to the government or you can put that in your pocket. It's your choice. It's simply a matter of getting the financial education. It's simply a matter of working with your tax advisor on a regular basis and making sure that you understand the law and they understand the law and understanding that, guess what? This big red flag doesn't have to be a red flag.

Tom Wheelwright: If you have a Schedule C, I'm sorry, but shame on your tax preparer for you having a Schedule C. I don't care if you're not making much money. I get filing an S corporation return, a partnership return is an extra step and costs a little bit of money. I got to tell you though, what's it worth for you to be able to sleep at night knowing that the IRS is much less likely to come knocking on your door? There is nobody, I mean maybe the grim reaper, but nobody else that we fear more or that we want to talk to less than the IRS. They know that. What we want to do is when we prepare tax returns, we want to make sure we're doing things in a way, and when we set up our entities and when we set up our businesses, when we set up our real estate, all of our investments that we do it in such a way to minimize the chance that the IRS comes knocking on our door. The IRS knows we're going to do that. The IRS is fine with it.

Tom Wheelwright: Frankly, they would much rather … The reason they don't audit S corporations as much is because they would much rather you have an S corporation. This is an incentive. Think about this. Not getting audited is an incentive to do what the government wants you to do. They want you to be an S corporation because they want to see both sides of the equation. They want to see the income statement and the balance sheet, or they want you to be a partnership, or they want you to be a C corporation. They don't want you to be a Schedule C. It makes their job harder. They don't trust you. They really can't trust the numbers. They have to prove out those numbers. It's much more work. They give you a reward basically, for example, not having to report a separate form for the home office if you file those returns that they would rather have you be those entities.

Tom Wheelwright: The point is you have the choice of how you set up your business. You have the choice of how you set up your real estate and your investments. You get to choose. The IRS doesn't get to choose that for you. You get to choose. Why not choose something that will reduce your audit risk and reduce your taxes at the same time? To me, that's a logical choice because everything we do, we want to increase your cash flow so you make way more money and pay way less taxes. We'll see you next time.

Announcer: You've been listening to The WealthAbility® Show with Tom Wheelwright. Way more money, way less taxes. To learn more, go to wealthability.com.