In this Edition
February 8, 2022

Keeping Meticulous Records Is the Key to Tax Deductions and Painless IRS Audits

PODCAST: Filing Electronically and Direct Deposit of Refunds

Entrepreneurs and Taxes: How Expenses Are Claimed on Tax Returns

Get More Worms by Filing Your Taxes Early

3 Financial Lessons of the Pandemic
Keeping Meticulous Records Is the Key to Tax Deductions and Painless IRS Audits
If you operate a business, or you’re starting a new one, you know you need to keep records of your income and expenses. Specifically, you should carefully record your expenses in order to claim all of the tax deductions to which you’re entitled. And you want to make sure you can defend the amounts reported on your tax returns in case you’re ever audited by the IRS.

Be aware that there’s no one way to keep business records. But there are strict rules when it comes to keeping records and proving expenses are legitimate for tax purposes. Certain types of expenses, such as automobile, travel, meals and home office costs, require special attention because they’re subject to special record-keeping requirements or limitations.

Here are two recent court cases to illustrate some of the issues.

Case 1: To Claim Deductions, an Activity Must Be Engaged in for Profit

A business expense can be deducted if a taxpayer can establish that the primary objective of the activity is making a profit. The expense must also be substantiated and be an ordinary and necessary business expense. In one case, a taxpayer claimed deductions that created a loss, which she used to shelter other income from tax.

She engaged in various activities including acting in the entertainment industry and selling jewelry. The IRS found her activities weren’t engaged in for-profit and it disallowed her deductions.

The taxpayer took her case to the U.S. Tax Court, where she found some success. The court found that she was engaged in the business of acting during the years in issue. However, she didn’t prove that all claimed expenses were ordinary and necessary business expenses. The court did allow deductions for expenses including headshots, casting agency fees, lessons to enhance the taxpayer’s acting skills, and part of the compensation for a personal assistant. But the court disallowed other deductions because it found insufficient evidence “to firmly establish a connection” between the expenses and the business.

In addition, the court found that the taxpayer didn’t prove that she engaged in her jewelry sales activity for profit. She didn’t operate it in a businesslike manner, spend sufficient time on it, or seek out expertise in the jewelry industry. Therefore, all deductions related to that activity were disallowed. (TC Memo 2021-107)

Case 2: A Business Must Substantiate Claimed Deductions With Records

A taxpayer worked as a contract emergency room doctor at a medical center. He also started a business to provide emergency room physicians overseas. On Schedule C of his tax return, he deducted expenses related to his home office, travel, driving, continuing education, cost of goods sold, and interest. The IRS disallowed most of the deductions.

As evidence in Tax Court, the doctor showed charts listing his expenses but didn’t provide receipts or other substantiation showing the expenses were actually paid. He also failed to account for the portion of expenses attributable to personal activity.

The court disallowed the deductions stating that his charts weren’t enough and didn’t substantiate that the expenses were ordinary and necessary in his business. It noted that “even an otherwise deductible expense may be denied without sufficient substantiation.” The doctor also didn’t qualify to take home office deductions because he didn’t prove it was his principal place of business. (TC Memo 2022-1) We can help Contact us if you need assistance retaining adequate business records. Taking a meticulous, proactive approach can protect your deductions and help make an audit much less difficult.

Dianna Streed, CPA, CGMA
D 507.453.5967
PODCAST
Filing Electronically and Direct Deposit of Refunds

There has been a lot of discussion about the issues the IRS is having with their backlog of work and staffing. Although they have started processing returns, they are warning people that it is going to be a rocky season. So anything that taxpayers can do to help themselves will make their lives easier and get their refunds in the quickest way possible.
Entrepreneurs and Taxes: How Expenses Are Claimed on Tax Returns
While some businesses have closed since the start of the COVID-19 crisis, many new ventures have launched. Entrepreneurs have cited a number of reasons why they decided to start a business in the midst of a pandemic. For example, they had more time, wanted to take advantage of new opportunities or they needed money due to being laid off. Whatever the reason, if you’ve recently started a new business, or you’re contemplating starting one, be aware of the tax implications.

As you know, before you even open the doors in a start-up business, you generally have to spend a lot of money. You may have to train workers and pay for rent, utilities, marketing and more.

Entrepreneurs are often unaware that many expenses incurred by start-ups can’t be deducted right away. Keep in mind that the way you handle some of your initial expenses can make a large difference in your tax bill.

Essential Tax Points

When starting or planning a new enterprise, keep these factors in mind:

  • Start-up costs include those incurred or paid while creating an active trade or business — or investigating the creation or acquisition of one.
  • Under the federal tax code, taxpayers can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs in the year the venture begins. Of course, $5,000 doesn’t go far these days! And the $5,000 deduction is reduced dollar-for-dollar by the amount by which your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized over 180 months on a straight-line basis.
  • No deductions or amortization write-offs are allowed until the year when “active conduct” of your new business commences. That usually means the year when the enterprise has all the pieces in place to begin earning revenue. To determine if a taxpayer meets this test, the IRS and courts generally ask questions such as: Did the taxpayer undertake the activity intending to earn a profit? Was the taxpayer regularly and actively involved? Has the activity actually begun?

Types of Expenses

Start-up expenses generally include all expenses that are incurred to:

  • Investigate the creation or acquisition of a business,
  • Create a business, or
  • Engage in a for-profit activity in anticipation of that activity becoming an active business.

To be eligible for the election, an expense also must be one that would be deductible if it were incurred after a business began. One example would be the money you spend analyzing potential markets for a new product or service.

To qualify as an “organization expense,” the outlay must be related to the creation of a corporation or partnership. Some examples of organization expenses are legal and accounting fees for services related to organizing the new business and filing fees paid to the state of incorporation.

An Important Decision

Time may be of the essence if you have start-up expenses that you’d like to deduct for this year. You need to decide whether to take the election described above. Record keeping is important. Contact us about your business start-up plans. We can help with the tax and other aspects of your new venture.

Lance Campbell, CPA
D 507.252.6674
Tax Tip Tuesday - Video Short
3 Reasons Why Your Tax Return is Less this Year

In 30 seconds, we cover 3 reasons why your 2021 tax return's refund might be less than your 2020 tax return's refund.
Get More Worms by Filing Your Taxes Early
They say the early bird gets the worm. Early federal income tax filers may get a couple worms, which is a good thing in this metaphor.

Although it may seem like a quaint tradition to wait until the deadline — usually April 15, but actually April 18 in 2022 — there’s more than one valid reason for getting your return completed and submitted well before this date.

Prevent Identity Theft

In one tax identity theft scheme, a thief uses another individual’s personal information to file a fraudulent tax return early in the filing season and claim a bogus refund. The real taxpayer discovers the fraud when he or she files a return and is told by the IRS that the return is being rejected because one with the same Social Security number has already been filed for the tax year.

While the taxpayer should ultimately be able to prove that his or her return is the legitimate one, tax identity theft can be a hassle to straighten out and significantly delay a refund. Filing early may be your best defense: If you file first, it will be the tax return filed by a potential thief that will be rejected — not yours.

Get a Potentially Earlier Refund

Another reason to file early is you may put yourself closer to the front of the line to receive your tax refund (assuming you qualify for one). The IRS website still indicates that it expects to issue most refunds for the 2021 tax year within the usual 21 days, despite the massive pandemic-related delays that affected millions of 2020 tax returns.

The time is typically shorter if you file electronically and receive a refund by direct deposit into a bank account. Direct deposit also avoids the possibility that a refund check could be lost, stolen, returned to the IRS as undeliverable or caught in mail delays.

Look for Your Documents

To file your tax return, you need your Form W-2s (if you’re an employee) and Form 1099s (if you’ve worked as an independent contractor or “gig worker”). January 31 is the deadline for employers to issue 2021 Form W-2s to employees and, generally, for businesses to issue Form 1099s to recipients of any 2021 interest, dividend or reportable miscellaneous income payments (including those made to independent contractors).

If you haven’t received a W-2 or 1099 by February 1, first contact the entity that should have issued it. If that doesn’t work, you can contact the IRS for assistance.

Need Help?

If you have questions or would like an appointment to prepare your return, please contact us. We can help you ensure you file an accurate return that takes advantage of all the breaks available to you.

Paula Haferman, CPA
D 920.722.2141
3 Financial Lessons of the Pandemic
The onset of the COVID-19 pandemic in March 2020 disrupted the personal finances of many families who were negatively affected by job losses, reduced income, sickness and other challenges. This included families across the economic spectrum and workers in a wide range of both blue- and white-collar industries.

The virus’s rapid and continued spread — and the economic changes that followed — are vivid reminders of how vulnerable and unpredictable your family’s personal finances may be. Now, almost two years later, the pandemic’s impact persists. Here are three basic lessons to keep in mind:

1. Don’t live above your means. In some ways, this is even more important for high earners than it is for those with more modest incomes. Those with higher incomes sometimes overcommit themselves financially by living a lavish lifestyle.

For example, they may buy large homes in high-end neighborhoods or buy expensive luxury automobiles that stretch their finances. Then, if they experience a financial emergency like a job loss or reduced work hours, they’re suddenly unable to afford the lifestyle they’ve grown accustomed to.

2. Build up an adequate emergency savings fund. By living below your means, you may have extra money each month to build up an emergency savings fund. While every situation is different, many financial experts recommend saving between three- to six-months’ worth of living expenses in an emergency fund.

Emergency savings should generally be kept in a liquid savings or money market account. Such an account probably won’t generate a high return, but the money will be relatively safe and easily accessible if you need it for an emergency. Search online to find an account that offers the highest yield along with maximum liquidity.

3. Continuously map out a flexible career path. The time to make career contingency plans is before something like a worldwide pandemic disrupts the global economy and eliminates millions of jobs. As the COVID-19 pandemic has shown, what may appear to be a secure job and career can vanish in the blink of an eye.

Some entrepreneurial individuals have turned career setbacks into opportunities by going back to school or starting new businesses. Others have left their jobs to start freelancing and consulting businesses, using their marketable skills and industry contacts to carve out profitable niches for themselves as self-employed professionals. This has driven a phenomenon known as “the Great Resignation.”

Maybe you’ve seriously reconsidered your employment situation in recent months. Even if you’ve stayed put, it’s to everyone’s benefit to look carefully at his or her career path and head in a direction that both inspires and offers financial security.

The pandemic has been called a once-in-a-century event. Unfortunately, it feels to many of us as if it’s already lasted a century. Keep these three financial lessons in mind as you continue to adopt to forthcoming challenges and opportunities.

Dan Moriarty, CPA
D 262.404.2111
More Resources from CPA-HQ
Tracking Down Donation Substantiation

To support a charitable deduction, taxpayers need to comply with IRS substantiation requirements. But what if you never receive a letter from the charity substantiating a donation? This article explains the rules and notes a valuable tax deduction.
Imposter Fraud Targets Military Members and Vets

According to the Federal Trade Commission, veterans lost approximately $60 million to fraud in 2020. Among the greatest fraud threats to this group is “imposter” fraud. This brief article defines this type of fraud and offers suggestions on how to avoid falling victim to it.
PODCAST: Paying Taxes Electronically


In the past, the only way to pay your tax was by a paper check. Now the IRS and many states have ways that you can pay your tax or estimates without any fees. We are recommending to our clients that they pay their tax electronically due to processing delays at the IRS.