What Causes An IRS Audit and How to Handle It

woman looking at tax bill

Round numbers, deduction overkill, and math mistakes can raise some red flags that may bring the IRS knocking on your door, wanting to double-check your numbers to ensure you don’t have any return-related discrepancies. Whether an IRS or state audit, there is no reason to worry, provided that you are telling nothing but the truth and that you aren’t trying to cheat the system.

However, an IRS audit may also be conducted if you feel that you are paying more than you owe. In any case, this guide will help you understand the fundamental reasons why you could get audited by the IRS, how to deal with an audit, and how to deal with it quickly and effectively. 

What Causes an IRS Audit?

The IRS audits taxpayers as a means to reduce the difference (aka tax gap) between what the IRS receives and the money it is owed. The IRS may conduct an audit if they suspect that the reported amount of tax is not correct, be it for an individual or business. Some other times, though, these audits are random. Below are seven primary concerns/red flags that could put you or your business under the IRS microscope. 

  1. Making math mistakes.  It is paramount that you or the person that files your taxes NEVER make a math error. An “oops, I wrote 8 instead of 3” or “I got distracted and forgot to include a zero” will not help you. Although to err is human, it will be best if you could avoid making one when it comes to filing your taxes. So, always double-check (triple-check if needed) to avoid the hefty fines later on. You can be assured that the IRS will not care the least bit if the mistake was accidental or innocent.
  1. Not reporting part of your income.  If for whatever reason, you decided to keep under wraps an activity of yours that made you money, such as a freelance job, then you are probably asking for trouble. You see, submitting your W-2 form and refraining from including your freelance income from your Form 1099 leads you absolutely nowhere. This is because the person to whom you did the freelance task has probably already sent a copy of your agreement to the IRS. So, the IRS knows about your income, whether you report it or not. It is just a matter of time to discover that you have withheld from reporting non-wage income. The same applies to interest and stock dividends as well.
  1. Reporting false donations.  Making a considerable contribution to charity can get you a significant tax deduction. Claiming too many charitable donations, though, without being able to produce the proper documentation, will put you at a tough spot for sure. The IRS WILL notice that you claim $15,000 in charitable deductions on your $35,000 salary.
  1. Reporting personal expenses as business expenses.  This applies to self-employed, who report too many losses on their Schedule C to hide income. And, if you don’t yet have a clear idea of what business expenses are deductible, you can check out the IRS Publication 535 page.
  1. Reporting too many business expenses.  Deducting too many expenses for purchases you made that are not necessary or ordinary to your business WILL raise some eyebrows at the IRS offices. Better stick to reporting purchases that are (1) appropriate for the business or trade and (2) accepted and common in the business or trade. If, for example, you are a lawyer and feel like painting your apartment, don’t claim paint and paintbrushes. Neither meets the requirements mentioned above.
  1. Claiming excessive home office deductions.  To be eligible for a home office deduction, it is crucial that you use part of your home regularly and exclusively for your business or trade. This means that you can give yourself deductions for home office expenses only if you have a designated section in your home that is strictly used for business purposes.
  1. Rounding up numbers.  Try to be as precise as possible when you make your calculations. Also, steer clear from making estimations and doing things like rounding to the nearest hundred.  A much better practice is to round to the nearest dollar instead. If all of the numbers you enter for expenses are even numbers, it will raise some eyebrows and may force the IRS to request some proof of those expenses.

Other surefire ways to attract an audit if you are a business owner is to try to claim more expenses than justified by filing a dubious expense claim while also reporting a loss. The IRS will probably notice this attempt to have a lower tax liability. 

What Are the Chances of Being Audited?

According to IRS statistics, people who report zero income (but occupy the higher tax brackets) get the most attention from the IRS. However, it should also be noted that in recent years IRS audits have decreased in number. This has to do with the smaller IRS workforce and declining budgets. This, of course, does not mean that receiving an audit letter is out of the question. 

That being said, most audits are conducted for people of income above $200,000, as well as those missing data on their return. The same applies to individuals or businesses whose returns are way above the average or normal, based on the IRS statistical data on the typical amounts for various income levels and professions. 

Another point to consider is that audits related to missing data and math errors are usually initiated by mail rather than in-person by an IRS agent. Our experience has shown that the average payment tied to correspondence audits is below $7,000. More complicated issues may require a field audit, which usually ends up with the taxpayer owing more money to the IRS (around $20,000). 

How to Handle an IRS Audit

The first thing to understand is that the IRS may conduct a field audit, an office audit, or a correspondence audit, based on the severity of the problem. The most thorough type of audit is the field audit, whereas the correspondence audits only require smaller things, such as clarification on a particular area of the tax return.   

In any case, it is paramount to handle the audit respectfully and carefully – always with the assistance of your tax professional, who will know what information should be withheld and what information should be released. If possible, allow your tax professionals to act as a buffer by having the field audit conducted at their offices. 

In the event you receive an audit letter, it is best to forward it to your tax professional, who will then take it from there and deal with the tax auditor(s). After all, they have experience in dealing with the IRS and audits. If though you decide to take matters into your own hands, it is highly probable that you will say something that might trigger the IRS to open up more areas of your return for inspection. 

Do take an audit seriously, without fretting or panicking, and remember that not all audits turn out adversely for the taxpayer. To help minimize any negative impact on your business, you should do the following: 

1. Organize your accounting records from the past 6-7 years with the assistance of your tax professional. This includes everything from leases, hard copies of tax-prep data, and accounting books to canceled checks, expenses, and bank statements. 

2. Only answer to the auditor’s question about your tax return in a clear and straightforward way (not making excuses). Do not volunteer any other information, though, or provide accounting records that have not been requested from you. 

3. Let your tax professional handle things for you. They know exactly what to do, what to say, what not to say, and why. 

4. Only provide copies, not the originals. There is a high likelihood that your original documents get misplaced or even lost if you hand them over to the agent. The IRS will take no responsibility for losing your documents during an audit because this is part of your obligations. For that reason, either give copies or ask the IRS agent to copy the originals and then give them back to you. 

5. Know your taxpayer rights, the law that is supporting the deductions you claim, and the audit process. Although it is advised to try to settle any differences you may have with the agent at the audit level, you could escalate things and ask for a conference with the IRS Appeals Division. Or you could simply hire an experienced tax professional to argue your case in a way that will bring the best results for you. Given how complex the tax code has become, having a qualified tax pro by your side is definitely worth their fee to help you. 

Are you facing an audit or want to act proactively and stay on the safe side? We have your back. Just give us a call or get in touch with us for a free tax consultation. Our team of qualified and experienced tax professionals will help you get out of an unpleasant situation and ensure that you never find yourself there again.

What Is The IRS Offer In Compromise?

IRS Offer In Compromise form

Offer in Compromise is an IRS program that enables taxpayers to get a fresh start with the Internal Revenue Service. In doing so, they have the chance to settle their tax debt for less than the overall amount of money they owe. Therefore, if you are struggling to pay your federal or state tax debt, this could be a useful program to consider. In 2018 alone, the IRS accepted around 24,000 offers (up 24% from 2010) while rejecting just as many.

So, how can you determine if Offer in Compromise (OIC) is an initiative that could solve your tax issues? How can you get an offer accepted? How much should you offer to the IRS? We give you all the necessary details and answer these concerns below.

How Much Should I Offer in Compromise to the IRS?

This is perhaps one of the most challenging parts of submitting an Offer in Compromise. On the one hand, you don’t want to come forward with an unrealistically low offer that could ruin your acceptance chances. On the other hand, you do aspire to pay as little as possible to the IRS so that you can finally settle your tax debt. Given that each case is different, there is really no magic formula. In fact, it requires a lot of experience to be able to recognize when an offer is too low.

That being said, there ARE some ways to get some idea of how much is probably enough when you make an Offer in Compromise. Let’s start with the basics – the bare minimum offer sum. Note that it will NOT guarantee that your offer gets accepted by the IRS. It will, however, give some confidence that your offer is in the right ballpark.

What the IRS is primarily focused on is to receive offers of at least the same amount of the taxpayer’s Reasonable Collection Potential (RCP). This is a number the IRS uses to determine your ability to pay the owed taxes, and takes into consideration several liabilities, such as your:

  • Assets
  • Monthly living expenses
  • Monthly income

So, generally speaking, you can begin with an estimate of 12 months’ worth of your disposable income. Then, calculate any additional cash you can get from selling valuable assets and submit an offer with an amount higher than your RCP. This is critical, especially if you are planning on submitting an Offer in Compromise on the basis that you are unable to pay the due tax (as opposed to Effective Tax Administration or Doubt as to Liability).

The problem lies in calculating your Reasonable Collection Potential. Here are some steps to follow:

  • Estimate the income you have from all sources within a month and then subtract the full sum that corresponds to your living expenses (the necessary ones only, such as car payment, groceries, utilities, rent, etc.). The number you will get is your monthly disposable income.
  • Multiply your monthly disposable income by 12 to get your annual disposable income.
  • Add to that amount any assets that you could sell, such as valuable collectibles, investments, and an extra car. At this point, note that determining how much these assets are worth is a point of negotiation with the IRS for many taxpayers.

The result of these calculations will give you the bare minimum you can offer.

Should You Pay Installments or All At Once?

Many taxpayers wonder if they should pay the offer amount in installments rather than with one lump sum payment. Although the IRS enables monthly payments for this purpose, it is best to pay the offer in fewer than five monthly installments if it is possible. This is because the IRS will use 24 months of your disposable income for anything beyond five installments to calculate your Reasonable Collection Potential (with five or fewer installments, they will use 12 months of your RCP). If that happens, the amount the IRS will want from you will essentially double.

How To Get An Offer in Compromise Approved

As already mentioned, the IRS is highly likely to turn down offers that do not meet (even better, exceed) the taxpayer’s RCP. That being said, some factors play a leading role in making an Offer in Compromise quicker. These include:

  • Low Income W2 Earnings – You make less than $30,000 annually, and your only income source is a wage-earning job.
  • Fixed Retirement Income – You are a 55+ years of age retiree and receive a fixed income.
  • Social Security/ Disability Income – You only get a Disability or Social Security income.

Some factors, on the other hand, can contribute to longer-than-average decisions about your Offer in Compromise, such as:

  • High Balance – Offers with balances $25,000+ usually take much longer to process than those with lower balances.
  • Self-Employment – The IRS conducts in-depth research on your expenses, making sure you don’t mix your personal and business expenses.
  • Initial Rejection – If you have already submitted an offer that got rejected and want to have it reevaluated, you could be adding up to six more months to the overall procedure.
  • Other Circumstances – If you own multiple vehicles, have lots of loans, or many different deposits all over the place, you will need to do some explaining to the IRS. This pushes the process further back in time.

So, is everything lost? Not at all. You can still boost the Offer in Compromise process by doing the following:

  • Ensure you have all the necessary details – The IRS will request things like bank statements. Check that the ones you submit have all the pages, even those that you may find useless (i.e., a blank page). Then, send your Offer.
  • Provide good explanations – If your financials, for some reason, does not look right, make sure that you give a sound reason for it in the cover letter.
  • Reply fast and accurately – It is paramount that you respond to IRS requests for further clarification as timely as you can. The information you provide should also be accurate.
  • Propose the presumed maximum amount of money – The IRS expects to collect some money from you within a reasonable time period. Offering them the max sum of the presumed amount will most likely get your offer approved

To get there, ensure that you have filed all tax returns, made the required estimated tax payment for the current year, and include a bill of one or more tax debt in your offer. Business owners with employees must have made the needed federal tax deposits for the current quarter.

Besides what is reported to Form 433-A, the IRS will investigate several other factors, such as your level of education, age, asset equity, expenses, income, Collection Statute Expiration Date, and, of course, your lifestyle. If something about the way you live is contradictory to the fact that you are unable to pay your taxes, the IRS may reject your offer.

How Can I Submit An Offer In Compromise Application?

To apply for an Offer in Compromise, you will need the following Offer in Compromise Forms:

    • Form 656 – You need this to make your offer.
    • Form 433-A – This Collection Information Statement for Wage Earners and Self-Employed Individuals helps the IRS determine whether you are facing financial strain and to what extent.
    • Form 433-B – This is the same as with Form 433-A with the difference that it is a Collection Information Statement for Businesses. It serves the exact same purpose as Form 433-A.

Common Mistakes to Avoid when Filling out your OIC Application

The IRS will get all the information they need about your financial situation from Form 433-A (see above). It is, therefore, crucial that you ensure you don’t make any math errors on that form, although the form indeed requires a considerable amount of complex calculations. You certainly don’t want to put your OIC process to a halt to have incorrect calculations sorted out.

Other mistakes on OIC forms we usually see and either cause confusion or have a dramatic impact on a case are as follows:

  • Leaving empty/blank spaces – Never leave a field on a 433 or 656 empty. It is best to write “N/A” in these spaces.
  • Writing negative equity – It is essential that any negative equity is reported as zero. Many tax accountants subtract the negative equity from the taxpayer’s NRE (Net Realizable Equity) when the taxpayer’s asset (property, in this case) is worth less than they owe on it, which is wrong.

 

How Long Does It Take To Get a Response From the IRS?

Although there are no set timelines for exactly how long it will take the IRS to decide whether to reject or approve an Offer in Compromise, our experience has shown that it usually requires between 4-9 months. However, some more complex Offers in Compromise may need much more time to get resolved, which could reach 48 months from the day the OIC process was completed, which usually takes roughly 6 months. The most common factors that could drag a response from the IRS are related to self-employment. Regardless, the IRS does respond within two years.

If the IRS accepts your offer, you need to stick to your part of the deal and pay the agreed sums. Now, if your offer gets rejected, know that you can file an appeal via Form 13711 (hence, renegotiate your OIC under more favorable terms) within 30 days of the rejection notice date.

Is an Offer In Compromise the Best Option for You?

Although an Offer in Compromise is an excellent collection solution, it is not the only option you could consider. To determine that, you will need to have a trusted tax professional evaluate your tax situation, the IRS collection alternatives, and your personal finances as a means to develop the optimal approach to repay your debt. Don’t hesitate to call or contact us for a free tax consultation to see how we can help you get out of debt as painlessly and swiftly as possible while negotiating the best terms for you.

What Is the IRS Fresh Start Program?

tax debt paperwork

The IRS Fresh Start Program is nothing new. It dates back to 2011, and has been designed to give taxpayers and small businesses burdened with first-time tax debt an opportunity to straighten things out and get out of debt while also avoiding tax liens.

Over the years, it has undergone significant changes. The majority of the provisions outlined in the initiative are designed to make applying for tax relief programs and paying back taxes a far easier process.

So, if you are dealing with back taxes and tax debt, chances are you have seen or heard about the IRS Fresh Start Program on TV or the radio at some point. Do you qualify for it? How can the Fresh Start Program help you get a second chance to get back on track with your taxes? What does it include? All these, and more, will be answered here.

How Does the IRS Fresh Start Program Work?  

The Fresh Start Program, sometimes referred to as the “IRS second chance program”, was created by the IRS to help taxpayers that owe back taxes. In 2011, it was a prerequisite for them (taxpayers) to have no federal tax liens filed against them. The program was focused on the following:

  • Making it easier to obtain a Federal Tax Liens (FTLs) release right after paying the debt.
  • Enabling small businesses to obtain Installment Agreements (IAs) easier.
  • Allowing an individual taxpayer that entered into DDIA (Direct Debit Installment Agreement) withdraw Federal Tax Liens more frequently.
  • Making it easier for more taxpayers to qualify and use the Offer-in-Compromise* program by expanding and streaming the qualifications of the particular initiative.
  • Lessening the number of Federal Tax Liens being filed by increasing the dollar amount that caused FTLs being filed from $5,000 to $10,000 (a few months later, it was raised to $25,000).

In 2012, the IRS Fresh Start Initiative was further expanded, allowing even more financially distressed taxpayers to qualify for it. Part of the reforms targeted addressing real-life situations that typically cause individuals to fall behind on their taxes.

The IRS Fresh Start Program revisions included an expansion of the amounts and types of expenses the IRS would consider relevant and reasonable when determining the money a taxpayer could afford to pay every month. Among these were local and state tax debts, student loans, and allowable living expenses. The reason behind this expansion was to enable those struggling financially the most to clear up their debt faster than in the past.

Also, when a taxpayer considers benefiting from an Offer-in-Compromise program, the IRS is now more flexible in calculating the individual’s future income. This makes it easier for a taxpayer to qualify for an Offer-in-Compromise.

About the Offer in Compromise Program & Reasonable Collection Potential

An Offer-in-Compromise is a program that enables taxpayers with due tax debt to come into some sort of an agreement with the IRS so that their tax liabilities are settled for less than the total amount they owe. For a taxpayer to have the chance to clear their debt via the Offer-in-Compromise program, the IRS should first calculate the taxpayer’s income and assets to determine the reasonable collection potential. This refers to the amount of money the IRS determines a taxpayer can pay for his/her tax debts and is basically his/her monthly disposable income and the liquidation value of his/her assets.

Unlike in the past, the IRS now calculates a taxpayer’s collection potential by looking into 12 months of future income (down from four years) for offers paid in less than five months and two years of future income (down from five years) for offers paid in 6-24 months. This gives some taxpayers the opportunity to have their tax issues resolved in 48 months, when, in the past, they would need 4-5 years.

The three prevalent types of Offer in Compromise are:

  • Doubt as to Collectibility – Enacted when you owe back taxes that it is impossible for you to pay even if you sold all of your assets.
  • Doubt as to Liability – You can dispute your tax liability provided that there is a relevant legitimate disagreement in argument, law, or facts.
  • Effective Tax Administration – Applies when the collection of tax debt will generate considerable economic hardship for you in the future. So, you may be able to pay your tax debt, but doing so will put you in financial strain in the long run. In this case, the IRS may settle your tax bill.

Primary Provisions in the IRS Fresh Start Program

Besides Offers in Compromise, the IRS Fresh Start initiative can contribute to delivering further benefits:

  • Tax lien avoidance – Under the IRS Fresh Start program tax liens are NOT filed for debts less than $10,000, except for cases when the penalties and back taxes surpass $10,000. This helps avoid the negative effects of tax liens (i.e., attach the lien to all the assets of the in-debt taxpayer until they repay their debt). The IRS may also help withdraw a tax lien notice if one is filed under specific circumstances: (1) you pay for your debt via a low-user-fees Direct Debit installment agreement, where you agree the IRS automatically makes monthly payment withdrawals from your checking account or (2) pay your debt and remain current with all the estimates tax filings and payments.
  • Installment agreements & penalty relief – The Fresh Start program helps avoid some tax penalties by increasing access to streamlined installment agreement with the IRS. Taxpayers can choose between five types of installment agreements, depending on the tax debt owed (for less than $10,000 to over $25,000) and the repayment period (between 3 years or less and longer than 24 months).

Other important changes in the Fresh Start Program:

  • For on-going businesses, the IRS no longer includes equity in income-producing assets in their calculation of reasonable collection potential.
  • When it comes to the factors that determine when a dissipated asset is included in the calculation of reasonable collection potential, the Fresh Start program comes further refreshed as it narrows the classification and parameters involved.

In the end, it is best to consider the Fresh Start Program more of a tax relief toolbox rather than a singular form and enrollment. The initiative now includes a set of measures designed to help small businesses and individuals rectify their tax problems and get second chance.

Do I Qualify for the IRS Fresh Start Program?  

Some of the general requirements the majority of tax relief applicants must meet are as follows:

  • Small business owners and self-employed workers must make all necessary estimated tax payments for the current year.
  • Business owners with employees need to make all required federal tax deposits.
  • You need to prove that you are unable to pay your tax debt because you lack assets or money.
  • You should not be involved in an ongoing proceeding for bankruptcy.
  • You must file all tax returns as obliged by law, even if you are unable to pay them.

Depending on which tax relief program you wish to apply for, you also need to take into consideration additional requirements. For instance, applying for an Offer in Compromise, you need to complete specified IRS forms (see below) as you will be called to provide detailed financial information.

On the other hand, a streamlined installment agreement requires that you owe less than $50,000 or that you:

  • Can pay a larger liability down to $50,000.
  • Have ensured your tax filings are up-to-date through the current tax year.
  • Have not fallen behind on tax payments with the IRS in the past.
  • Can pay off the remaining debt in up to 5 years (60 months or less).
  • Don’t incur new tax debt during the installment agreement period.
  • Stay current with tax filings and maintain the installment agreement during the time it is in effect.
  • File for an Offer in Compromise and can pay off the settlement amount you have agreed on within 12 months.

IRS Fresh Start Program Qualifications

Taxpayer Businesses
Owes less than $25,000* Owe less than $25,000. **
Can pay their initial debt down below $25,000 * Can pay the due amount (up to $25,000) within 34 months. **
First-time tax debtor Are current with federal tax filings. **
Are up-to-date with federal tax payments. **
First time falling behind on IRS tax payments. **

*You might also qualify for a federal tax lien withdrawal.

** You might also qualify for the abatement of specific penalties.

How Do I Apply for the IRS Fresh Start Program?

There is a different application route per the IRS Fresh Start program you wish to benefit from. Here are the details required:

  • Payment plans – You can download and fill out the Form 9465 (Installment Agreement Request). More details here.
  • Installment plans – The application depends on whether you are a business owner or employee and the total debt owed.
  • Offers in Compromise – You can file Form 433-F, 433-A, and Form 656 to initiate the process.

Note that it may take from a few minutes and up to 48 months to receive approval. Given the many parameters tied to the IRS Fresh Start program, trying to address the issue on your own may compromise your ability to take full advantage of the initiative. So, before you do anything, it is paramount to understand the ins and outs of the program first.

It is also critical that you assess your situation properly so that you can make the most informed and educated decision when choosing a solution.

For that reason, if you have a delinquent tax debt with the IRS or you’re in the midst of an IRS audit, it’s best to consult trusted tax professionals like us who will actively analyze your situation and strategize a plan that will best suit your unique requirements. Additionally, we can become your voice and aggressively negotiate with the IRS (and possibly even settle your debts for much less than what you owe at that given time) on your behalf.

Contact us today for a free tax consultation and let’s see how we can make the most of the IRS Fresh Start program for you.