If you show income from your job or business and claim rental-property losses, be wary. The IRS rules limit deducting those losses in the current year, unless you prove you’re actively involved in managing the property.

“It’s a real hot item right now: Audit people who make significant income from their jobs and also claim rental losses,” McKenzie said.

In one case, the wife of a real-estate attorney — a stay-at-home mom with three young kids — managed the family’s rental properties, but the IRS said the couple couldn’t deduct rental losses in the current year. On appeal they won their case, McKenzie said.

“We were able to prove yes, he couldn’t have devoted 50% of his time [to the rentals] and made $600,000 a year, but she could,” he said.

An unexpected letter from the Internal Revenue Service can make your stomach drop, but you can take steps to reduce your audit risk.

Taxpayers overall face a low audit risk: The IRS audited 1.1% of all individual tax returns filed in 2010, or 1.6 million returns of 141 million filed.

The vast majority of those audits — 1.2 million — were done by mail. Just 392,000 involved an in-person meeting with the IRS. That’s not necessarily good news. Taxpayers often are confused by IRS correspondence and with such audits don’t have the benefit of working with one single agent, the National Taxpayer Advocate says.

Schedule C

Sole proprietors filing a Schedule C can reduce their audit risk by sticking to the facts — or at least making sure their expenses and income are not dramatically different from similar businesses.

For example, one Chicago-based hot-dog-stand owner said his cost of goods sold was 50% of gross receipts, said Robert McKenzie, a partner in the law firm Arnstein & Lehr. “I know Chicago hot dogs are great, but he had a high cost.”

The IRS found the hot-dog salesman was reporting his expenses but only part of his revenue. He faced “a lot of tax and penalty,” McKenzie said.

ITS Financial LLC, the Dayton, Ohio-based Instant Tax Service franchiser and franchisees were accused of fraud by the U.S. Justice Department.

The department today said it filed federal lawsuits against ITS operators in Indianapolis, Chicago, Las Vegas and Kansas City, Kansas, claiming they intentionally prepare and file fraudulent tax returns with the aim of maximizing both customer refunds and their own preparation fees.

“The government claims these fees are outrageously high — for example up to $1,000 for preparing tax returns in as little as 15 minutes — and are often not disclosed to customers” in advance, the Justice Department said a press statement announcing the filings.

“ITS Financial knew of illegal activity within its franchises but took no meaningful steps to stop it,” the U.S. alleged in a fifth complaint, filed today at the federal court in Dayton. It seeks court orders barring the franchiser and each franchisee from continuing in the tax preparation business.

According to the ITS website, the company was founded in 2004 by Chief Executive Officer Fez Ogbazion and has grown to be the fourth-biggest U.S. tax preparer, with locations in 34 states.

Ogbazion is named as a defendant in the Dayton-filed complaint. Legal department officials at ITS’s headquarters weren’t immediately available to comment on the complaints.

That case is U.S. v. Ogbazion, 12-cv-95, U.S. District Court, Southern District of Ohio (Dayton). Other cases are U.S. v. Ghebremichael, 12-cv-2282, U.S. District Court, Northern District of Illinois (Chicago); U.S. v. Franklin, 12-cv-394, U.S. District Court, Southern District of Indiana (Indianapolis); U.S. v. Tewolde, 12-cv-516, U.S. District Court, District of Nevada (Las Vegas) and U.S. v. Tsehaye, 12-cv-2183, U.S. District Court, District of Kansas (Kansas City).

To contact the reporter on this story: Andrew Harris in Chicago at aharris16@bloomberg.net

If you are living and working abroad you may be entitled to the Foreign Earned Income Exclusion. Here are five important facts from the IRS about the exclusion:

The Foreign Earned Income Exclusion United States Citizens and resident aliens who live and work abroad may be able to exclude all or part of their foreign salary or wages from their income when filing their U.S. federal tax return. They may also qualify to exclude compensation for their personal services or certain foreign housing costs.

The General Rules To qualify for the foreign earned income exclusion, a U.S. citizen or resident alien must have a tax home in a foreign country and income received for working in a foreign country, otherwise known as foreign earned income. The taxpayer must also meet one of two tests: the bona fide residence test or the physical presence test.

The Exclusion Amount The foreign earned income exclusion is adjusted annually for inflation. For 2009, the maximum exclusion is up to $91,400 per qualifying person.

Claiming the Exclusion The foreign earned income exclusion and the foreign housing exclusion or deductions are claimed using Form 2555, Foreign Earned Income, which should be attached to the taxpayer’s Form 1040. A shorter Form 2555-EZ, Foreign Earned Income Exclusion, is available to certain taxpayers claiming only the foreign income exclusion.

Taking Other Credits or Deductions Once the foreign earned income exclusion is chosen, a foreign tax credit or deduction for taxes cannot be claimed on the excluded income. If a foreign tax credit or tax deduction is taken on any of the excluded income, the foreign earned income exclusion will be considered revoked.

WASHINGTON — The Internal Revenue Service today announced a major expansion of its “Fresh Start” initiative to help struggling taxpayers by taking steps to provide new penalty relief to the unemployed and making Installment Agreements available to more people.

Under the new Fresh Start provisions, part of a broader effort started at the IRS in 2008, certain taxpayers who have been unemployed for 30 days or longer will be able to avoid failure-to-pay penalties. In addition, the IRS is doubling the dollar threshold for taxpayers eligible for Installment Agreements to help more people qualify for the program.

“We have an obligation to work with taxpayers who are struggling to make ends meet,” said IRS Commissioner Doug Shulman. ”This new approach makes sense for taxpayers and for the nation’s tax system, and it’s part of a wider effort we have underway to help struggling taxpayers.”

WASHINGTON –– The Internal Revenue Service today warned senior citizens and other taxpayers to beware of an emerging scheme tempting them to file tax returns claiming fraudulent refunds.

The scheme carries a common theme of promising refunds to people who have little or no income and normally don’t have a tax filing requirement. Under the scheme, promoters claim they can obtain for their victims, often senior citizens, a tax refund or nonexistent stimulus payment based on the American Opportunity Tax Credit, even if the victim was not enrolled in or paying for college.

In recent weeks, the IRS has identified and stopped an upsurge of these bogus refund claims coming in from across the United States. The IRS is actively investigating the sources of the scheme, and its promoters may be subject to criminal prosecution.

“This is a disgraceful effort by scam artists to take advantage of people by giving them false hopes of a nonexistent refund,” said IRS Commissioner Doug Shulman. “We want to warn innocent taxpayers about this new scheme before more people get trapped.”

Typically, con artists falsely claim that refunds are available even if the victim went to school decades ago. In many cases, scammers are targeting seniors, people with very low incomes and members of church congregations with bogus promises of free money.

The IRS has also seen a variation of this scheme that incorrectly claims the college credit is available to compensate people for paying taxes on groceries.

The IRS has already detected and stopped thousands of these fraudulent claims. Nevertheless, the scheme can still be quite costly for victims. Promoters may charge exorbitant upfront fees to file these claims and are often long gone when victims discover they’ve been scammed.

The IRS is reminding people to be careful because all taxpayers, including those who use paid tax preparers, are legally responsible for the accuracy of their returns, and must repay any refunds received in error.

To get the facts on tax benefits related to education, go to the Tax Benefits for Education Information Center on IRS.gov.

To avoid becoming ensnared in this scheme, the IRS says taxpayers should beware of any of the following:

• Fictitious claims for refunds or rebates based on false statements of entitlement to tax credits.
• Unfamiliar for-profit tax services selling refund and credit schemes to the membership of local churches.
• Internet solicitations that direct individuals to toll-free numbers and then solicit social security numbers.
• Homemade flyers and brochures implying credits or refunds are available without proof of eligibility.
• Offers of free money with no documentation required.
• Promises of refunds for “Low Income – No Documents Tax Returns.”
• Claims for the expired Economic Recovery Credit Program or for economic stimulus payments.
• Unsolicited offers to prepare a return and split the refund.
• Unfamiliar return preparation firms soliciting business from cities outside of the normal business or commuting area.

If your marriage status changes during the year, it can confuse the issue of which filing status to use on your return. Here are eight facts about the five filing status options to help you choose the best option for your situation.

Your marital status on the last day of the year determines your marital status for the entire year.
If more than one filing status applies to you, choose the one that gives you the lowest tax obligation.

1. Single filing status generally applies to anyone who is unmarried, divorced or legally separated according to state law.
2. A married couple may file a joint return together. The couple’s filing status would be Married Filing Jointly.
3. If your spouse died during the year and you did not remarry during 2011, usually you may still file a joint return with that spouse for the year of death.
4. A married couple may elect to file their returns separately. Each person’s filing status would generally be Married Filing Separately.
5. Head of Household generally applies to taxpayers who are unmarried. You must also have paid more than half the cost of maintaining a home for you and a qualifying person to qualify for this filing status.
6. You may be able to choose Qualifying Widow(er) with Dependent Child as your filing status if your spouse died during 2009 or 2010, you have a dependent child and you meet certain other conditions.

If you haven’t received a Form W-2 from your employer by January 31, you should take these steps:

1. Ask your employer if and when the W-2 was mailed. If it was mailed, it may have been returned because of an incorrect or incomplete address. After contacting the employer, allow a reasonable amount of time for the W-2 to be resent.
2. If you do not receive your W-2 by February 14, call the IRS at 800-829-1040 for help. When you call, you’ll need to provide personal information to identify yourself, as well an estimate of the wages you earned, the federal income tax withheld, and when you worked for that employer during 2010. This should be based on year-to-date information from your final pay stub or leave-and-earnings statement, if possible.
3. You still must file your tax return or request an extension to file by April 18, 2011, even if you do not receive your Form W-2. If you have not received your Form W-2 by the due date, and have completed steps 1 and 2, you may use Form 4852, Substitute for Form W-2, Wage and Tax Statement. Attach Form 4852 to the return, estimating income and withholding taxes as accurately as possible. Any refund may be delayed while the information is verified.
4. You may receive your missing W-2 after you filed your return using Form 4852, and the information may be different from what you reported on your return. If this happens, you must amend your return by filing a Form 1040X, Amended U.S. Individual Income Tax Return

The IRS reminds taxpayers that refund time frames provided by “Where’s My Refund” and tax providers are projected time frames and are subject to change. Many different factors can affect the timing of the refund after the IRS receives the return for processing.
The IRS issues the vast majority of refunds in 21 days or less so even though the issue date provided to you may have changed, it’s very likely that your refund is on its way.
There is no need to call unless you get a specific message indicating that you should. If the IRS needs more information to process your return, they will contact you by mail. The telephone assistors do not process refunds and will not be able to provide additional information.