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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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 with your IRS audit, get out of an unpleasant situation and ensure that you never find yourself there again.