Society of Certified Senior Advisors: What Does the IRS Know and Do I Have to Tell Them?

What Does the IRS Know and Do I Have to Tell Them?

Lots of seniors are hiding a little something from the IRS: cash income from a side job is one of the most common. But can the tax man find out, and is a small amount perfectly legal?

Many older Americans are taking part in the gig economy. Whether it’s hiring yourself out as a handyman or renting out a spare room, you put the cash in your purse or wallet and then forget about it. But should you be reporting it at tax time? And can the IRS find out about past years when you didn’t mention it on your return?

The IRS estimates that it loses hundreds of billions of dollars per year in unreported income. That’s not surprising, considering all the income that, under the law, you are supposed to report. If you babysit your grandchildren, then you are legally a childcare provider. Did you barter or exchange something with a neighbor? The IRS can legally tax you on it. How about those bingo winnings? They’re subject to taxation, too.

Games of Chance

Many seniors are surprised to learn that gambling winnings are taxable income, whether from a bingo game, raffle, casino, racetrack, lottery or scratch-off card. They’re all supposed to be reported on line 21 of your Form 1040.

Taxes may be withheld from your winnings at professional gambling venues such as casinos, racetracks and the state lottery. Bingo winnings of $1,200 and up are subject to a rather stiff 28 percent withholding rate. If you’re playing one dollar cards at the local senior center and you get lucky, well, you’re supposed to report that as income.

If your winnings are in the form of property or prizes instead of cash, you will owe tax for fair market value. Say that vacation for two to Greece is worth $8,000; you’ll have to pay taxes on that amount just as if you won it in cash.

However, you get to take a deduction on your losses. Did you spend $30 on cards before winning the $50 jackpot? You only owe tax on $20. Wait a minute, that deduction only counts for gambling winnings. If you lost $300 on the ponies without winning a thing, the IRS will not let you apply it against the $400 you made driving for Uber.

Self-Employment Income

But wait, you don’t have to report income if it’s under $600, right? Wrong. A Form 1099 is issued for income other than wages, salary and tips. The minimum amount that must be reported varies depending on the type of income, but it’s $600 for an independent contractor. This leads many taxpayers to assume they don’t owe taxes on lesser amounts earned while self-employed, but legally ANY amount you receive must be reported, regardless of whether or not a form is required.

Will You Be Audited?

Where does the IRS draw the line for audits? All tax returns are put through a software program that shows how closely they adhere to statistical norms. If the machine flags a return, three layers of review by human beings determine if further action is taken. Four things are most likely to land you in the dreaded spotlight.

Failing to report all of the income that the IRS knows about. It can be hard to keep track of all the sources of income you might have, making this a common mistake. Don’t forget to include brokerage accounts (distributions, interest, dividends) and Form 1099s such as from a job back in the spring that you held for a month.

Stepping outside the rules for foreign accounts. The IRS takes a dim view of any American trying to hide money outside the country. The Foreign Account Tax Compliance Act requires you to name the institution holding funds and the highest dollar amount of your account in the prior year. Assets of $50,000 or more merit reporting on a Form 8938. Additionally, foreign banks must tell the IRS about American asset holders. Just holding assets in a foreign bank will get you additional scrutiny from the IRS, which is always on the lookout for someone trying to hide income offshore.

Fudging business expenses. If your return shows business travel more than 20 percent above the norm for your profession, the IRS will take a good look. Same for take-home cars (used in your business but driven home at the end of the day) without specific reasons for deductions related to their use.

Making more than $200,000. The IRS currently audits about 1 percent of taxpayers who make less than $200,000, and nearly 4 percent of those earning above that level. If you pass the $1 million mark in earnings, your chance of an audit increases to 12.5 percent. It stands to reason that their return on investment is greater for higher earners. It’s the same for business returns, where only 1 percent of corporations with assets under $1 million are audited, but kick that up to $10 million or more in assets and the likelihood of an audit increases to 17.6 percent.

Selling Online

What about sites like eBay? If you’re essentially hosting an online garage sale, it’s one of the few times when the IRS isn’t interested in your earnings. The litmus test is if you bought the item for more than you’re selling it for, you’re in the clear.

If your eBay dealings are more like a hobby, you have to report the income, but you can’t use losses to offset other income. Whether it’s a hobby or a business is a gray area, but the IRS will look at how often you sell, how much you earn and how much time you spend on it.

A Form 1099-K will be generated from the eBay site for anyone with more than $20,000 in gross sales and 200 or more transactions. Conversely, on a site like Etsy that features specialty items sold for a profit, a Form 1099-K will be produced for each vendor regardless of the amount of sales.

How the IRS Knows You Cheated

We can be fairly certain the IRS isn’t aware that we traded babysitting our friends’ kids for their parents staining our deck. But what about those cash payments? One of the oldest tricks in the book is to cash a check received as payment for a small job at the financial institution where it was issued to avoid having it show up in your account. But what if you deposit some of the cash? And how about that little business you run on the internet?

Large bank deposits. If you deposit more than $10,000 in cash into a bank or credit union account within 24 hours, the institution must report the deposit to the IRS. This report could trigger an examination of all your deposit activity to search for money laundering or illegal sales (such as drugs). The same is true if you make several large deposits that are less than $10,000. Known as “structuring” or “smurfing,” it’s criminal to purposely avoid reporting limits, even if the money is from a legal source. If the IRS suspects you’re guilty of such activity, it can seize your cash.

T-account analysis. Another trigger for a closer look by the IRS is when your sources of income appear to be insufficient for your living expenses. We’re not talking about the $20 splurge on a night out, or how you saved up enough money for a new fridge. Rather, the IRS is looking for an imbalance of $10,000 or more. It’s called a T-account analysis, and it’s the test that tripped up Al Capone.

Website and e-commerce transactions. Online business activity leaves a trail of clues for the IRS to follow. Agents can easily check what forms of payment the business accepts, what services or products are sold, and quarterly or annual income.

Small business profits. Does the IRS know you really had 29 (seven of whom paid in cash) clients instead of 22 at the dog grooming business you run from home? Not likely. But if you’re operating a major business, agents can compare your gross income and profit ratios to those of similar businesses reported on such sites as com. http://www.bizstats.com/ If you’re taking major deductions for travel and expenses while generating little profit on sizable gross income, expect a knock at your door followed by plenty of questions.

Matching tax documents. Don’t ever try to avoid reporting income that is independently reported to the IRS. Statements such as forms 1099 and W-2 are duplicated and sent to the feds, whose automated software will catch any discrepancies.