IRS to Step Up Small Business Audits, VEBA Expert Warns
Attending last month’s Remodeling Show in Baltimore to present information on a plan that enables employers to sock away tax-deductible funds that can be taken out later for tax-free insurance benefits, enhance retirement savings and reduce estate taxes, Lance Wallach, of VEBA, Estate and Financial Planning, was also the bearer of some bad news: the IRS is starting to take a closer look at the returns of small businesses such as remodelers and home builders.
“Anybody could pretty much get away with anything up until this year, because just about nobody was being audited,” Wallach said. But with some extra money from Congress, the agency hired many more auditors last year and has trained them to start cracking down on questionable tax shelters and other dubious tax reduction strategies.
“You’ve got to be careful, you can’t be fooling around any more,” he advised, as audits start picking up substantially for this year and next. “You’ve got to start documenting what you do,” he added.
Wallach said that the agency has special task forces for different industries, such as remodeling, and they know what’s going on. “They’re going after profitable small businesses because that’s where the money is,” he said.
“Your expenditures and income had better be equal,” he warned, and if you’re taking cash for a small job and not reporting it, auditors can look at your cost of supplies and track your expenses. They will even drive around your neighborhood, he said, and then compare where you are living with the income on your tax reform. “It’s just common sense.”
Taking a deduction for bad debt is one of the possible triggers for an audit and the computer system kicks out certain things that look out of line, Wallach said, but many of the “red flags” change from year to year.
Tax attorneys and accountants won’t be as helpful as in the past in providing advice on how to reduce your taxes because they have been reminded by the IRS that they can be prosecuted for providing information on how to cover up tax avoidance. “The IRS gets people to pay their taxes by scaring them,” according to Wallach.
Tax-Exempt Trusts Provide Legitimate Tax Deductions
Turning to the good news, Wallach said that remodelers can sign up to participate in an already-existing Voluntary Employees Beneficiary Association (VEBA) and start making contributions for which they can take a legitimate tax deduction and take money out for certain benefits tax-free.
The VEBA — a tax-exempt trust that has been in the tax code since 1928 — can be used tax-free to pay for anything related to health or welfare, he said, including life, health, long-term care and disability insurance and un-reimbursed medical expenses. If the money is used for purposes not related to health or welfare, such as paying college tuition, it’s taxable when it’s taken out of the trust, but there’s no penalty. Growth in the funds is tax-deferred.
Wallach also recommended using VEBAs for estate and succession planning and for employee retirement plans. Employees need to be vested into the benefit by the time they have been working for an employer for 10 years and the benefit can be determined by criteria chosen by the employer — such as age, longevity and salary, he said.
Unlike retirement plans, VEBAs are safe from the clutches of divorcing spouses, said Wallach, who has been divorced a few times himself. And it is legal to stash money into a VEBA when being sued by a creditor, he added.
Incorporated businesses will have an easier time signing up for a VEBA, and about $20,000 in annual contributions is the threshold where participation makes financial sense, although money does not have to be put into one every year, he said. Administrative costs for a VEBA run roughly $2,000-$2,500 a year; the plan administrator does all of the paperwork.
Local insurance agents may not be the best resource for VEBAs, Wallach cautioned, because many of them have been using the concept to set up plans that are now considered abusive tax shelters. He also advised caution in dealing with financial planners. “If this stuff is done wrong, you’re going to be in trouble,” he said.