In reality, if you read the entire article, you’ll find that the odds of triggering an IRS audit are pretty much right in line with what I said in my article. What this other news article points out is that there are ways for the IRS to contact you that aren’t really audits. If you include these not-audits in the count of actual audits, then you get, not surprisingly, a much higher number of audits. In particular, the article focuses on ominous letters that IRS sends out to taxpayers, which are very much not audits. In fact, the letters cited in the article are about as far from an audit as you can get.

One of the letters informs taxpayers of a math error in their tax returns. This is not an audit. This is a notice that you messed up your math and therefore need to pay your taxes based upon the correct math. This scenario in no way results in anyone questioning your deductions or asking you to prove anything on your tax return with financial records. An audit is a re-examination of your tax return, not a request for you to fix a math error. Assuming you use tax software and take the 2011 standard deduction, there is a small chance of filing a return with a math error in it.

Another of the letters mentions the electronic system the IRS has to match reported data with the amounts listed on a tax return. I did allude in my post to the fact that the IRS matches information reported directly to it by your employer and other financial relationships with the amounts you actually report on your income tax forms. I even mentioned that this is an are where only a fool tries any funny business. Again, the result of this scenario is a letter in which the IRS in no way re-examines your return except to change the results of your calculations based upon the numbers that are reported to the Internal Revenue Service directly. This is not an audit either.

The point of my article about the low chances of being audited was not to encourage people to cheat on their taxes, nor to suggest that anyone cheat because the risk of audit is so low. Rather, I hoped to make filing income taxes a little less tense. People get so worked up about getting audited that they don’t take tax deductions or credits that they qualify for, for risk of being audited. That isn’t smart personal finance strategy, but neither is cheating.

Go into doing your taxes realizing that they can be a bit complicated, although there are tax prep software packages that help, but there is no need to walk around in fear of a potential audit. It might happen, but chances are it won’t. Just don’t freak out about it for no reason.

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Higher Tax Audit Chances? originally published at Finance Gourmet

Odds of Being Audited

According to IRS statistics, the chances of being audited by the IRS is about one in 100, or one percent. A deeper look, however, reveals the the IRS audits certain tax returns much more often than other returns. IRS audit statistics suggest that high-income taxpayers and those who own small businesses are more likely to be audited that middle and low income taxpayers who earn the majority of their income from wages and salary or brokerage-style investments.

The reasons certain groups get audited more than others are two-fold. First, and foremost, there is more money to be gained by auditing higher income taxpayers. For example, consider a middle income wage earner, who is married filing jointly, bringing down a salary of $70,000 with no other income. Taking the standard deduction for 2011, of $11,600 for married couples filing joint, that leaves $58,400 of taxable income.

Do the math and that taxpayer isn’t going to pay any more than around $7,500 and likely much less if there are any kids. Assuming that our fearless taxpayer files his income taxes and fudges a child care credit or student loan interest deduction, he might shave a few hundred bucks off his total. If he is caught and audited, then the IRS can recover that and penalties and interest (particularly if it is proven to be fraudulent). Either way, the sum total of collection by that IRS audit won’t be more than a $1,000. That’s hardly worth the time and effort.

Don’t get me wrong, the IRS can and does audit returns like this all the time, primarily to avoid the appearance of “never” auditing certain kinds of tax returns. All it takes is one person getting audited to scare-straight dozens of their friends and acquaintances. However, at the end of the day, this taxpayer isn’t really “worth” the cost of an audit.

Who Gets Audited By the IRS?

A high-income taxpayer on the other hand can generate a significant tax recovery. When someone’s total tax liability is $5,000, even a big cheater won’t owe too much extra if audited. However, when someone’s total tax liability is $25,000, $50,000 or more, a successful audit might recover $10,000 or more, especially if there are penalties and interest involved.

The other reason higher earning taxpayers get audited more often is that they have more ways to cheat. Someone who earns a salary and takes the standard deduction has very little room to be sneaky. After all, their salary is reported to the IRS as well as the taxpayer. Trying to cheat on that number is flat-out stupid, considering a computer will crosscheck each and every one of those.

On the other hand, higher salaried taxpayers tend to itemize their deductions. Many of those tax deductions, such as mortgage interest are also reported to the IRS and thus not likely to be underreported. However, there are plenty of deductions that can be exaggerated very easily. Catching these things is the bread and butter of audits.

For the same reason, small business owners are frequent audit targets. There are many deductions for small business owners and other than the requirement to keep receipts and records, many are completely undocumented directly to the IRS. The 2011 Section 179 tax deduction alone is worth up to $250,000 this year. That’s some real money worth collecting.

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IRS Audit Odds originally published at Finance Gourmet

Check here to learn how to deduct mortgage interest on your taxes.

Make Mortgage Payment Early to Deduct More

One of the biggest tax deductions that is available to ordinary taxpayers is the mortgage interest deduction. Simply put, the 2011 mortgage interest deduction is the ability to deduct whatever amount you pay in mortgage interest from your income taxes. There are several rules and exclusions, but they don’t apply to most taxpayers unless you have more than $1 million in mortgages or several houses. This is one of those tax deductions with no income limits.  You do need to itemize your deductions in order to claim the mortgage interest deduction. For many people, the amount of their mortgage interest deduction determines whether it is best to itemize or claim the 2011 standard deduction amount.

In a normal year, you make 12 mortgage payments. Add up the total amount of interest paid, and that is how much you get to deduct. Your mortgage company will actually do it for you because they are required to submit a 1099-INT to both you and the IRS. This means the IRS knows how much money you actually paid on your mortgage, so this isn’t a good place to get creative. You can find the 2011 1099-INT forms on the IRS website. (Update: The 2011 1099-INT forms are now also available.)

However, as with most tax deductions, you get to claim the amount amount you pay during the year regardless of when it is actually due. Thus, if you pay your January mortgage payment in December, you get to deduct it on this year’s taxes. That means you get to deduct the amount of interest paid on 13 payments instead of just 12.

For example, let’s assume for the ease of math that you pay $1,000 per month in interest on your mortgage. (Keep in mind that only the interest part of your payment is deductible. The amount that goes to principal and the escrow payment is NOT deductible.) If you made all the payments at the regular time during 2011, then your 2011 mortgage interest deduction would be $12,000.

That’s not too shabby. But, if you pay your January 2012 payment during December 2011, then you have made 13 payments during the 2011 tax year instead of 12. That means that on your 2011 taxes you can deduct $13,000 instead of just $12,000. That extra $1,000 deduction can be very valuable especially at higher tax brackets. In the 30 percent tax bracket, making your payment just a few days early saves $300 on your taxes.

The Catch to Paying Your Mortgage Early

There is, of course, a catch to using the tax trick of paying off your mortgage early.

By making your January 2012 payment in 2011, you have eliminated one of the payments you would normally make during 2012. That means that you can only deduct 11 mortgage payments worth of interest in 2012 because the January payment was not made during 2012, it was paid in 2011.

In our example above, by paying the January 2012 payment early, you got to deduct $13,000 in 2011. But, that means you will only be able to deduct $11,000 on your 2012 taxes. There is a way around this. If you make your January 2013 payment during December 2012, then you can deduct the full-year of interest of $12,000. However, there is no way to get that extra deduction again until you bite the bullet and take only 11 months worth of interest payments as your mortgage deduction in some year.

Mortgage Interest Deduction Audits

Here is the mistake that many taxpayers accidentally make.

In 2011, they read about this really great idea to make their January mortgage payment early in order to get a bigger interest deduction. So, they pay 13 months worth of payments during 2011 and they deduct 13 months worth of interest. So far, so good.

However, in 2012, they forget that they did that. The mortgage company sends them a 1099-INT that shows a full 12 months of interest payments for 2012 and they deduct the full 12 months of interest, even though they can only legally deduct 11. Then, are those who try and use the trick again in 2012 by paying their mortgage early and deducting 13 months of interest when they only qualify for 12 months of interest payments.

Remember those 1099-INT forms that the mortgage company sends to both you and the IRS?

That is how you get caught. The IRS computers run the numbers on the forms against the numbers you claim and sometime in 2013 or 2014, a letter shows up in the mail saying that a routine examination of your return has discovered a possible error. If you are really unlucky, your return will get flagged for a full-scale audit. Typically, however, you’ll just be subject to an “information audit” where the IRS will require you to provide documents to support your deductions.

It won’t take long for cancelled checks and mortgage statements to reveal that you claimed too many deductions in 2012 and owe back taxes and interest on the amount. Theoretically, if the IRS can prove you did it on purpose, you can also be on the hook for fraud and additional penalties, but this kind of mistake happens all the time and non-accountants routinely fall victim so they probably won’t go after you for that.

How To Maximize Tax Deductions by Paying Mortgage Early

Paying your mortgage early to increase your mortgage deduction amount in 2011 works best for people who either have income that varies from year to year, or people who know that they are going to get hit with a big tax bill and will adjust for it on their 2012 taxes.

If your income varies because you earn commissions, own your own business, or you get bonuses that are different sizes each year, then you want to pay your mortgage early in a year where your income will be high. Even if it is high the next year, you can pay early again and keep your full-year interest deduction. Eventually, when you have an off year or your bonus is smaller than usual, you can not pay early and only deduct 11 months of payments. This “reloads” this tax deduction increase trick for another year when your income is higher.

For people who get an unexpected windfall during the year that may result in a higher tax bill, that extra $300 deduction will give you some extra room when filing in 2012 for your 2011 taxes. Just be sure to adjust your withholding for 2012 so that you don’t come up short again.

Paying your mortgage early is a good end of year tax tip. However, be sure you fully understand what you are doing and how it affects your future taxes. If you pay early this year, you have to pay early for every other year until you are ready to take the smaller 11-month size deduction.

Subscribe to the Finance Gourmet Feed to get all of our coming 2011 end of year tax tips.

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Mortgage Tax Deduction End of Year originally published at Finance Gourmet

Standard Deduction 2012

The 2012 standard deduction is the amount that taxpayers will use to file their taxes before April 15, 2013. For taxes to be filed before April 15, 2012, taxpayers need to use the standard deduction 2011 amount set in the fall of 2010.

The amount of the standard deduction for 2012 for taxpayers who are married filing jointly is $11,900. This amount is up $300 from the 2011 standard deduction amount of $11,600. For taxpayers who are filing single, or who are married filing separately, the 2012 standard deduction is $5,950 which is an increase of $150. For those taxpayers who file as head of household, the standard deduction in 2012 is $8,700.

Various other tax credits and income tax deductions are also indexed for inflation. For the 2012 tax year, the maximum earned income tax credit, or EITC, increased to $5,891, which is up form the 2011 maximum of $5,751. Accordingly, the maximum income limit for the EITC increased from $49,078 in 2011 to $50,270 in 2012.

IRS Annual Gift Limit 2012

The IRS permits tax-free gifts to any persons up to a certain limit each year. The annual gift limit is per person, so a couple who is married filing jointly can actually give double the amount of the IRS gift limit each year. Additionally, when giving to a married couple that files jointly, each spouse can receive the full gift amount. For parents looking to give a tax-free annual gift to their married children, that means that a full four times the amount of the limit can be given tax-free.

The 2012 gift limit is $13,000. The annual gift exclusion is unchanged from 2011.

Therefore, a married couple can give $26,000 to a single person, or a full $52,000 to another married couple without triggering gift taxes or any estate tax issues.

Speaking of estate taxes, the 2012 estate tax exclusion is $5,120,00. That is an increase from the estate tax deduction in 2011 of $5 million.

IRS Tax Updates

Although the IRS releases updated tax numbers, deduction amounts and tax credit eligibility throughout the year, the release of widespread numbers like new 2012 tax brackets and other widely claimed tax deductions happens in October of the previous year to allow for official publication of IRS manuals and rules to be completed in time for the start of the tax filing season on January 1st of the following year.

You can subscribe to emails from the IRS or just check the Internal Revenue Service website in late October or early February each year.

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2012 Standard Deduction Amount Set originally published at Finance Gourmet

2011 Mileage Rate Update

However, the IRS increased the optional standard mileage rates for the last six months of 2011 citing, “increased gas prices … having a major impact on individual Americans.” The 2011 IRS mileage rate increased to 55.5 cents per mile from the original IRS 2011 mileage deduction rate of 51 cents, which still applies to the first six months of 2011.

In other words, when you figure out your income tax deductions for your 2011 taxes in 2012, you’ll have to use two different mileage rates to get the correct deduction for miles driven for business purposes. As always, the IRS requires contemporaneous driving records in order to deduct the mileage on your taxes. Using those records, taxpayers will multiply each deductible mile by 51 cents for trips between January 1st and June 30th and 55.5 cents per mile for trips between July 1st and December 31st.

Other IRS Mileage Rates for 2011

The standard IRS mileage rate is the one for business purposes. However, there are two other cases where you can deduct mileage.

Certain miles driven for medical purposes or for moving purposes may be deducted. The rate for this deduction was 19 cents per mile at the beginning of 2011. The mileage rate increases to 23.5 cents per mile for the second half of 2011.

Miles driven for charitable purposes can also be deducted in some cases. Mileage for charity is deducted at the rate of 14 cents per mile. The charitable mileage rate was not increased by the IRS.

Options Business Standard Mileage Rate

Income tax deductions for mileage may be computed in two ways. The most commonly used method uses the standard mileage rate set by the IRS. The deduction is computed by multiplying the standard rate times the number of miles driven.

However, taxpayers may also deduct the actual costs of operating a vehicle. Doing so, requires drivers to keep all receipts for fuel and maintenance and then to computer the vehicle’s depreciation. Most people forgo this extra effort and just use the mileage rate.

Businesses Reimbursement Rate for Mileage

Most American companies use the IRS mileage rate for reimbursing employees for miles driven on behalf of the company. There are two main reasons for this. First, companies deduct the money they reimburse to employees as a business expense. The IRS can’t complain the company is using too high or too low of a rate if it is using the same one as the IRS. Second, companies are shielded from employee complaints about the rate being too high or too low by saying that they are not responsible for the rate and that the IRS sets it.

However, there is no automatic requirement that companies raise their 2011 mileage reimbursement rates just because the IRS made a mid-year increase in the rate.

Check with your company to verify what your reimbursement mileage rate should be for the rest of 2011.

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IRS Mileage Rate 2011 Increase originally published at Finance Gourmet

Wait! Actually, tax day 2011 is actually on April 18th thanks to a Washington D.C. holiday being observed on April 15th.

That means all you slacker, procrastinators, and just plain still working on them taxpayers out there get a whole other weekend to work on your income taxes.

Don’t forget, you can also file for an extension. Everyone is permitted an automatic tax filing extension of six months by filling out and submitting Form 4868 – Application for Automatic Extension of Time To File U.S. Individual Income Tax Return.

You still have to pay your taxes by April 15th. An extension to file is not the same as an extension to pay.

Wondering what happens if I don’t file my income taxes?

If you can’t pay your income taxes, you can ask the IRS for a payment plan. There is a fee for setting up a payment plan, however. If you can’t pay them now, but will be able to pay within a month or two, don’t set up a payment plan. Just send the IRS a check for some of your tax bill with your tax return. The IRS will send you a bill for the rest in 30 to 60 days. Pay the balance then and the interest and penalties may be lower than the cost of setting up a payment plan (you’ll pay interest on a payment plan as well).

The current IRS interest rate for 2011 2Q is 4 percent.

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Taxes Not Due Today – April 18 not 15 originally published at Finance Gourmet

In addition, many businesses use the standard IRS mileage rates to reimburse employees for miles driven for work purposes. This both ensures that the company can deduct those reimbursements fully as a business expense, and that there is no disagreement about what the mileage reimbursement rate should be since an impartial government agency is the one that sets it.

The mileage deduction rate is adjusted every year. The standard 2011 tax deduction mileage rate has been published.

Standard IRS 2011 Mileage Rates

Beginning on January 1st, 2011, the standard mileage rates for calculating the deductible costs of operating a car or truck for business purposes is 51 cents per mile. Remember that although you cannot deduct the cost of commuting to a job, you can take a small business deduction for miles driven for the business.

The standard mileage deduction for deducting moving expenses is 19 cents per mile. The mileage rate for 2011 for medical expenses deductions is also 19 cents per mile.

The 2011 standard mileage rate for miles driven in service of eligible charitable organizations is 14 cents per mile.

Remember that to claim any deduction for miles driven you must have detailed contemporaneous records. That means that you need to keep a log of all miles driven and that the log must be updated as the car is used, not at a later date. To meet the IRS rules for deducting miles driven for business purposes, simply record the beginning and ending mileage as well as the date for all business trips or other deductible miles driven.

If you want to take it a step further, change the color of the pen ink every so often as a way to “demonstrate” that the log was indeed compiled over many different time periods. (It isn’t “proof”, but it does look good if you ever have to argue that your mileage records are legitimate.)

New 2011 Mileage Rate Rules

Beginning in 2011, people can use the standard business mileage rate for vehicles that are hired such as taxicabs and limousines. However, remember that you must record all such mileage with contemporaneous records just like regular mileage deductions.

IRS Mileage Rate 2011 Second Half

Due to higher gas prices in 2011, the IRS increased the standard mileage deduction rate in 2011 to 55.5 cents for the final six months of the year.

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2011 Mileage Rate IRS Standard Deduction Amount Set originally published at Finance Gourmet

What Is the Standard Deduction for 2011

There was a small adjustment higher in most IRS tax numbers due to inflation. That means that most taxpayers should benefit from higher income limits and wider tax brackets than they had on their 2010 income taxes.

Standard Deduction 2011

Taxpayers must choose whether to itemize their deduction or take the standard deduction on their income taxes. For most taxpayers whose income comes primarily from a job as a regular employee, the decision about whether it is better to itemize or claim the standard deduction on income taxes comes down to how much mortgage interest they pay. Basically, if the mortgage interest deduction available is higher than the standard deduction amount, then itemizing makes sense.

The new standard deduction amount for 2011 is $11,600 for married couples filing jointly. That is an increase in the standard deduction from 2010 of $200. The 2011 standard deduction for single filers is $5,800, up from $5,700 in 2010.

Those checkboxes on IRS Form 1040 that ask whether you are blind or over age 65 increase the standard tax deduction for each taxpayer. Blind people and senior citizens qualify for an extra $1,150 in their standard deduction for married filers and $1,450 for singles and heads of household.

2011 Tax Brackets Widen

The income tax brackets for 2011 have also widened due to inflation adjustments. For example, the 15 percent tax bracket now goes up to $69,000 for married filing jointly, while the 15 percent tax bracket for single filers goes up to $34,500.

Here is a 2011 Tax Bracket Table for Single Filers

• $0 to $8,500 = 10% bracket
• $8,500 to $34,500 = 15% bracket
• $34,500 to $83,600 = 25% bracket
• $83,600 to $174,400 = 28% bracket
• $174,400 to $379,150 = 33% bracket
• $379,150 and up = 35% bracket

The Tax Bracket 2011 for Married Filing Jointly table is

• $0 to $17,0000 = 10% bracket
• $17,000 to $69,000 = 15% bracket
• $69,000 to $139,350 = 25% bracket
• $139,350 to $212,300 = 28% bracket
• $212,300 to $379,150 = 33% bracket
• $379,150 and up = 35% bracket

The upper ends of each tax bracket are higher for 2011 because the brackets are adjusted for inflation each year.

2011 Tax Deductions Limits Raised

Like other tax numbers, the ceilings and maximum income limits for various tax deductions and tax credits in 2011 have been increased as well.

Although most of the 2011 IRS Publication have not been finalized and posted online at irs.gov yet, many of these higher deduction limits have been published in other locations on the website. You can use the search box below to search IRS.gov for other tax forms or publications.

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Standard Deduction 2011 and 2011 Tax Brackets originally published at Finance Gourmet

The IRS publishes various numbers, tax brackets, and the like for the next tax year during the fall of the previous year, depending upon what the number is, and how it is to be calculated. Maximum salary limits for Roth IRA contributions in 2010, for example, were known well in advance because the number was set in statute to be the same as the high income limitations for 2009 Roth IRA contributions.

However, starting in 2011, the income limitations for Roth IRA contributions are indexed for inflation. In other words, the IRS must wait until it has the proper inflation index calculation according to its rules and regulations. Then, it must apply that inflation amount to the Roth IRA contribution limits for income and compute new Roth IRA income phase-out limits and the maximum salary allowed to make Roth contributions at all.

These numbers will not be available until later in the year. When we get the new 2011 Roth IRA limits, we will pass them on to you.

Don’t forget, the law removing the salary cap for converting a traditional IRA to a Roth IRA has been made permanent, so you can covert your IRA in 2011 regardless of how high your MAGI is.

New Roth IRA Income Maximum Salary Limits for 2011

With all of that being said, we can actually make some educated assumptions.

Inflation has been low to non-existent for 2011. That means that Roth IRA income limits will likely not be going up for the 2011 tax year, or that any increase will be very small.

For your advanced tax planning strategies, you can continue using the same Roth IRA numbers from 2010 taxes for your 2011 taxes. There may be some small adjustments necessary when the final IRS numbers come out, but you can safely assume that any calculations based on the 2010 tax-year will be fairly close.

Note: The same information applies to traditional IRA limits for 2011 as well.

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2011 Roth IRA Income Limits originally published at Finance Gourmet

Small business tax deductions

Self-employment taxes, or SE Tax, is so high because it includes taxes that would usually be paid by the employer. In a typical employer-employee scenario, the employee pays 6.2% in Social Security Taxes. The employer withholds this amount from the employee’s paycheck. What many people don’t realize is that the employer also pays 6.2% in social security tax for the employee. (A 2011 tax deal reduced the employee portion to 4.2 percent, but it has only been extended for two months as of this update.)

A small business owner that files as a sole-proprietor is on the hook for the whole amount! The self-employment tax rate – sometimes called the SE tax rate – is 15.3%, which is 12.4% for social security taxes plus another 2.9% for Medicare taxes.

That 15.3% is on top of regular Federal Income Taxes. A successful small business owner in the 30% tax bracket, pays a blood curdling 45% tax rate. And, that is before adding in Medicare tax and state and local taxes.

In other words, a small business owner can easily end up paying 50% taxes!

Deduct Self-Employment Tax

The only good news in this whole equation is that half of the self-employment tax can be deducted when figuring adjusted gross income. Of course, this is small consolation because it results in under 2% tax savings. In order to keep from paying too much income tax, the entrepreneur needs to find bigger tax deductions and other small business tax breaks.

Depreciation Rates

Some of the biggest small business tax deductions come from the purchase of equipment for the business. Unfortunately, big purchases are often considered capital expenditures that must be depreciated over the “useful life” of the product. The best small business tax advice is to get accelerated depreciation whenever possible to get higher tax deductions now.

The only defense against high taxes from running a small business is to get as many business tax deductions as possible. The business lowers its profit for tax purposes, and passes along less income to the business owner on Schedule C – Profit and Loss From Business Operations.

Section 179 Deduction 2011

IRS Section 179 allows for better small business tax deductions and bonus depreciation in some cases. A section 179 expense allows for business expenditures to be deducted immediately, instead of depreciated. This is very useful for dated tax depreciation limits like those that apply to high-tech equipment.

For example, a freelance writer needs a netbook for his freelance writing business, with a Section 179 deduction, the small business owner deducts $200 in the year the netbook was purchased, instead of deducting a measly $40 per year for five years.

The Section 179 tax deduction rate was set to drop back to $134,000 after the special bonus depreciation and higher 179 limits increased in economic stimulus legislation expired after 2009. However, the new jobs creation legislation recently passed by Congress extends the higher ceiling for Section 179 tax deductions. The 2011 Limit for Section 179 Deductions is $250,000 for qualified capital expenditures.

Maximizing Section 179 Tax Deductions is important personal finance advice for any entrepreneur. You may also be interested in the IRS Mileage Rates for 2011 and the amount for the standard deduction 2011.

How do you save on your small business taxes?

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2011 Section 179 Deduction Limits for Small Businesses Taxes originally published at Finance Gourmet