Q: I saw that the tax office is planning to review every tax return, not just a sample, looking for incorrect claims. What will it be targeting?
A: The tax office says that each year it contacts about two million people about their returns. It is usually alerted to possible incorrect claims if it detects third part data indicating unreported income or sees deductions that appear high compared with people with a similar job and income level. As you say, it is increasing the level of scrutiny.
The ATO says that if it follows up it will ask for an explanation and documentation to support a deduction
ATO assistant commissioner Karen Foal says: “For example, if you’ve claimed deductions for clothing but you work in a job where a compulsory uniform is unlikely, we may just want to know a little more about why you’ve claimed that deduction.”
Foal says the ATO is working on a system that will make it easier for taxpayers to keep records of expenses. “The myDeductions tool in the ATO app allows you to snap a picture of all your receipts and upload your deduction details directly to your tax return.”
The ATO may also contact employers when it is following up returns. It will ask employers whether the employee was already reimbursed for expenses that are being claimed or to verify that the expenses were related to earning income.
Turning to the specifics, earlier this year the ATO reported that claims for rental property tax deductions contain errors in 90 per cent of cases.
Errors include incorrect interest claims for the entire investment loan where it has been refinanced for private purposes, incorrect classification of capital works as repairs and maintenance, and taxpayers not apportioning deductions for holiday homes when they are not genuinely available for rent.
“When you consider that rentals include over 2.1 million taxpayers claiming $47.4 billion in deductions, against $44.4 billion in reported income, you get a sense of the potential revenue at risk,” the ATO says.
The ATO provides guidance to help rental property owners avoid common tax mistakes.
Make sure the property is available for rent. The property must be genuinely available for rent before the owner can claim a tax deduction. The owner must be able to show a clear intention to rent the property, such as advertising the property. The rent should be in line with similar properties in its area and there should not be unreasonable rental conditions.
Portioning expenses. If your rental property is rented out to family or friends below market rate, you can only claim a deduction for that period in proportion to the amount of rent. You can’t claim any deductions for periods when friends or family stay in the property free of charge, or for periods of personal use.
If you own a rental property with someone else, you must declare rental income and claim expenses according to your legal ownership of the property.
Mortgage interest. You can claim interest as a deduction if you borrow to purchase a rental property. If you use some of the borrowing for personal use, such as going on holiday, you cannot claim that interest cost incurred during that period. You can only claim the part of the interest that relates to the rental property.
Borrowing expenses. Borrowing expenses include loan establishment fees, title search fees and the cost of preparing and filing mortgage documents. If your expenses are more than $100, the deduction has to be spread over five years. If they are less than $100, you can claim the full amount in the same year you incurred the expense.
Purchase costs. You can’t claim any deductions for the costs of buying your property. These costs, which include conveyancing fees and stamp duty, are added to the cost base of the property, which is used to work out any capital gains tax liability.
Repairs, improvements and construction costs. Ongoing repairs that relate directly to wear and tear or damage that happened as a result of renting out the property, such as fixing a hot water system, can be claimed in full in the same income year you incurred the expense.
Initial repairs for damage that existed when the property was purchased are not immediately deductible. These costs are added to the cost base and used to work out the capital gain when the property is sold.
Work such as replacing a roof or renovating a bathroom is classified as an improvement and not immediately deductible. These can be claimed at 2.5 per cent each year for 40 years from the date of completion. Likewise, capital works, such as extensions and alterations, can be claimed at 2.5 per cent of the cost over 40 years from the date the construction is completed.
Capital gains. If you make a capital gain on the sale of the property, you will need to include the gain in your tax return for that financial year. If you make a capital loss, you can carry the loss forward and deduct it from capital gains in later years.
Working from home
Last year, the ATO reported that a record number of taxpayers were claiming deductions for expenses incurred while working from home. A high level of mistakes and questionable claims has prompted it to increase attention on home office expenses.
ATO assistant commissioner Kath Anderson says 6.7 million taxpayers claimed $7.9 billion in deductions for “other work-related expenses” last year, which includes expenses related to working from home.
“While extra costs related to working from home are usually deductible, we are seeing some taxpayers either over-claiming or claiming private costs,” Anderson says.
There is evidence that taxpayers don’t have a clear idea what they can and cannot claim. “We are seeing some taxpayers claiming for expenses they never paid for, expenses their employer reimbursed, private expenses and expenses with no supporting records.”
Claims for the work-related portion of expenses like phone, internet, depreciation of a computer, printing and stationery are all allowed.
But the ATO is finding that people are claiming the entire amount of these expenses, not the part related to work.
The work-related cost of utilities, such as electricity for heating, cooling and lighting, are deductible but taxpayers need to be able to demonstrate that part of these cost are work-related.
People working from home cannot generally claim occupancy-related expenses, such as rent, mortgage payments, property insurance, land tax and rates.
Anderson says the ATO will be contacting taxpayers and asking them to verify home office expenses. It will expect to see records of their work-related expenses.
“This tax time we expect to disallow a lot of claims where the taxpayer hasn’t kept records to prove that they legitimately incurred the expense and that the expense was related to their work,” she says.
The three golden rules for the home office are: you must have spent the money yourself and not been reimbursed; the claim must be directly related to earning income; you must have records to support a claim.
Last year, the ATO announced that it would be closely examining claims for work-related car expenses, as part of its monitoring of work related expense claims.
More than 3.7 million people made a work-related car expense claim last financial year, worth a total of $8.8 billion.
Anderson says: “We are particularly concerned about taxpayers claiming for things they are not entitled to, like private trips, trips they didn’t make and car expenses that their employers paid for.”
There are two ways to calculate a deduction for car expenses: the cents per kilometre method, which is limited to claims for work-related travel up to 5000 kms; and a log book to determine the work-related proportion of actual expenses incurred.
Anderson says each year around 870,000 people claim for 5000 kms under the cents per kilometre method, which does not require a log book.
“We are concerned that some taxpayers mistakenly believe that this is a standard deduction they are entitled to, without needing to provide any evidence of having travelled that distance, or even having undertaken any travel at all,” she says.
Even though there is no requirement for a log book with the cents per kilometre method, taxpayers need to be able to show how they have calculated their claim. For example, they could keep a diary of the places they have driven to for work and how often.
In one case, a taxpayer claimed $3800 for transporting tools to and from work, claiming he could not store them at his workplace. When the ATO contacted his employer, it found that the taxpayer had a company car and was not required to use their own car. In addition, the employer provided all tools at the job.
Anderson says ATO research shows that about half of all taxpayers believe it is OK to falsify tax deduction claims. “Our research tells us there are quite a few people who think it is OK to skim a little bit,” she says.
“Unless you have a work-related need to travel while performing your job, you won’t be able to claim a deduction. Travelling to work and back home is not deductible for most people.”
Taxpayers face a minimum fine of $4200 for providing misleading statements in their tax returns, rising to $12,600 if there is evidence of intentional misleading.
Anderson says taxpayers can avoid mistakes if they follow the three golden rules of claiming car expenses. Only make a claim if:
* You paid the for the expense yourself and were not reimbursed;
* it’s directly related to earning your income – that is, your employer required you to make the trips as part of your job; and
* you have a record to support your claim.