- A tax audit is when the IRS examines your tax return information to ensure all the reported data is correct.
- There are four kinds of tax audits: field, correspondence, taxpayer compliance measurement program and office audit.
- Incorrect data or incomplete tax returns can trigger an audit.
- This article is for small business owners who want to learn the best ways to avoid a tax audit and what they should do if they receive an audit notice from the IRS.
One concern for many taxpayers is the possibility of being audited by the IRS. A tax audit is an examen of an arrangement ’ s or individual ’ second tax reelect to verify that fiscal information is being reported correctly. While the chances of being singled out for closer examination are statistically low, some factors could increase your odds of being audited. fortunately, there are measures you can take now to minimize the likelihood that you and your business will be audited by the IRS .
What triggers an audit?
A variety of potential “ triggers ” in tax returns tend to raise questions and attract unwanted attention from the IRS. The IRS uses a calculator scoring arrangement, called the Discriminant Information Function ( DIF ) system, which analyzes tax deductions, compares taxpayer data and is often the basis for initiating an audited account .
- Issues can crop up when income is not fully reported, or business operating losses are considered unusual.
- Other triggers include errors or inconsistencies in the return, omissions, lavish business expense deductions for meals and entertainment, and a sharp drop in reported income from one year to the next.
- Exceptionally large charitable deductions can sometimes trigger an IRS audit, but they’re usually allowed when a taxpayer has receipts and documentation to back them up.
- Making a lot of money can also be a red flag. “The majority of tax returns that are audited belong to taxpayers whose income is more than $500,000, or over $1 million a year,” said, Adriene Raynott, a senior business analyst at Cogneesol. “And the chances of audit increase when taxpayers try to wipe out their income through tax deductions.”
- Another item likely to prompt the IRS to dig deeper is having money in a foreign bank account.
- Examiners also pay closer attention to cash-intensive businesses such as restaurants and convenience stores, which generate a lot of cash receipts from smaller transactions. [See Related Story: Getting Audited? How to Handle It Like a Pro]
Although most clientele owners and other taxpayers cringe at the estimate of having to defend their tax return in an IRS audited account, there ’ s normally little reason to worry. In its 2015 Data Book, the IRS reported that 72.6 % of audits were resolved via parallelism, rather than face-to-face meetings. The remaining 27.4 % were conducted in the battlefield ( at the taxpayer ’ mho place of clientele or CPA ’ s office ) or at an IRS facility. While about 1.4 million tax returns were examined, that act represents less than 1 % of the more than 150 million individual returns received and processed every year.
Scott Berger, a CPA and chief at the Boca Raton, Florida, position of Kaufman Rossin, said the IRS is moving more toward parallelism audits, which can impact person taxpayers, small businesses and exclusive proprietorships. With this type of audit, the taxpayer receives a notice from the IRS saying that the representation is examining a tax return and has questions about specific credit line items. The aim of the telling is normally to request supporting documentation for the trace items being questioned. Key takeaway: Several factors can trigger an audit, like an incomplete tax return, incorrect information on your tax documents, large charitable deductions, or having money in a foreign bank account.
How to minimize your risk of a tax audit
According to Berger, one of the best ways to reduce your chances of being audited is to keep detail records. This ensures that if you are questioned by the IRS, you can substantiate deductions, income and other information. He recommended organizing bookkeeping systems to create a clear and accurate record of all transactions deoxyadenosine monophosphate good as wield and preserving the generator documents used for account and tax cooking. “ The other thing I would recommend that person do is hire a bookkeeper, ” said Berger. “ look at what it ’ mho going to save you, not what it ’ south going to cost you. ” With the aid of a intimate bookkeeper or tax preparer, “ issues will be vetted before they ’ re presented on a tax return, ” Berger said. Accounting and bookkeeping professionals can besides help incarnate and validate information reported to the IRS, he added. Key takeaway: To avoid being audited, keep organized records of your finances using a bookkeeping or accounting system . When filing taxes, work with a tax preparer to ensure your information is reported correctly.
What to do if you receive an audit notice
Berger and early tax professionals said they by and large advise against communicating directly with the IRS if you receive an audited account letter. Berger said his clients much tell him that because they have nothing to hide, they want to call the IRS and let them know that. Based on his about 30 years as a CPA, Berger thinks that ’ s a bad idea. “ Generally speak, nothing good always comes out of that, ” he said. “ Yes, they have nothing to hide ; the return is all on the up and up, but this person on the early side of the phone has a job to do, and their job is to make certain the government collects all the taxes that it legitimately can. ” Berger besides cautioned that IRS audit letters are always sent by postal mail, so call calls or notifications sent via e-mail are constantly scams. Martin Press, a tax lawyer with Gunster jurisprudence firm, agrees that clients should not represent themselves in tax audits. equally soon as a humble business owner receives an audit notice in the mail, they should immediately contact their CPA and provide him or her with a sign office of lawyer form ( Form 2848 ), he said. This authorizes either a CPA, tax lawyer or enrolled agent to contact the IRS and handle the audit, without the taxpayer necessitate to be present. He besides said the audit interrogation should be held at the CPA ’ mho function and not the taxpayer ’ second locate of commercial enterprise. Press said clients are always relieved when he informs them that they do not have to appear before the IRS – either initially or at any fourth dimension down the road. “ The IRS, many times, claims that they have to start out with an interview of the taxpayer, ” Press said. “ There is no obligation for a taxpayer to do an interview at the begin of a tax examination. Under what we call the Taxpayer Bill of Rights, they may never have to give an interview with the Internal Revenue Service. ”
Although taxpayers are not required to meet directly with the IRS, an examen of a small clientele taxpayer is normally not over cursorily ; it much takes a minimal of six months to a year to resolve, Press said. If no resolving power is reached, however, or if taxpayers wish to dispute the consequence of the initial audit, they do have a correct to appeal it. Statistics released in the IRS ’ 2015 Data Book show that a relatively humble percentage of audit taxpayers decide to pursue foster carry through. “ Of the about 1.4 million examinations of tax returns, closely 28,000 taxpayers did not agree with the IRS examiner ’ mho determination, ” the report said. Key takeaway: If you are audited, do not handle it by yourself. Contact a certified public accountant or tax attorney to represent you. Resolving this issue can take from six months to a year, depending on your case.
Types of tax audits
All tax audits are not the same. The one you encounter depends on your situation, what the IRS gathered from your tax come back and the items that are needed to resolve the return. “ The IRS selects returns for commensurateness, office and battlefield audits using return selection software, ” said Dewey Martin, a certify public accountant and professor emeritus at the Husson University ’ mho School of Accounting. “ Details about this software are not available to the public. The software compares deductions and losses to income sources on filed tax returns to find outliers. ”
1. Correspondence audit
In this case, you will receive a address rate or letter from the IRS requesting a proof of affirmation or documentation that will help them verify the information reported on your tax return. Martin said this is the most common type of audited account, and you ’ re probably to receive this letter if you have a high degree of charitable contributions compared to income. “ I had a customer who was audited on this issue using the correspondence audited account because the contributions were higher than her income, ” Martin said. “ Once documentation was mailed to them, there were no changes to the tax recurrence. “
2. Office audit
This is when you have an in-person meet with a tax auditor at an IRS office. This occurs when there are several issues on your tax rejoinder that a symmetry audit won ’ t fix. “ sometimes this happens because a clientele operate as a proprietorship has some strange transactions, ” Martin said .
3. Field audit
This is a face-to-face meet with an IRS auditor. In this character, they come to your CPA ’ s or tax lawyer ’ mho office ( or, if you insist on handling things yourself, your position of business or home ) to hash out the details of your tax return key. “ If there is inventory involved in the business, the hearer will normally want to observe the actual inventory and review inventory records at the business placement, ” Martin explained.
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4. Taxpayer Compliance Measurement Program audits
This is when IRS auditors examine every detail and consequence in your life that they feel can affect your taxable income. This is a rare audit and may require you to show your birth security, marriage license and other personal documents. Their goal is to check that all the paperwork you provided is actually from you. Key takeaway: There are four types of tax audits; correspondence, field, office and tax compliance measurement program audit. Each one varies in degrees of verification required to resolve the issues in question on your tax return. Additional reporting by Joel N. Sussman. Some source interviews were conducted for a previous version of this article.