Terri Johnson, CPA
Are You Setting Yourself Up For An Audit?
The IRS is ramping up efforts to collect taxes on those they believe are underreporting income, and thus underpaying taxes, on their tax returns. And the Treasury Department has admitted that low-income taxpayers are audited more often because their tax returns tend to be less complex, and thus cheaper, for agents to audit. Taxpayers should always properly and completely report their income on their tax returns. After all, by signing that return (or e-file form) you are certifying, under penalties of perjury, that the information on that return is complete and accurate.
Some taxpayers are more aggressive than others in the tax deductions or write-offs they are willing to take. The tax code is complex, and not always black and white. If a deduction or credit applies to your situation, then by all means take it. But before finalizing and signing your tax return, compare your net income to your living situation. Can the income on your return sustain your quality of living? Put yourself in the auditor's shoes. Does your monthly budget greatly exceed the income on your return? Take into account your mortgage, car payments, utilities, tuition payments for dependents, and other general living expenses. An agent can do a very quick analysis to determine if a more in-depth review is warranted.
As Ben Franklin so famously said, "An ounce of prevention is worth a pound of cure".
There are easy ways to reduce your chances of an audit.
Report all income - The IRS is becoming more aggressive in assuring that all income is reported properly by requiring that 1099s be sent to more vendors and that unusual transactions, such as cryptocurrency, are traced. Agents can, and will, review your POS systems, credit card processing system transactions, and bank statements. The burden is on the taxpayer to substantiate the numbers on the tax return and rebut any findings in an audit.
Properly report deductions -Pick and choose your deductions carefully. Don't be overly aggressive in the deductions your report, especially in areas where agents know taxpayers take liberties. Auto expenses require substantiation as to business use percentage and mileage tracking. If you can't back up these figures, think twice about reporting them. On the other hand, many taxpayers are hesitant to take the home office deduction, as they fear that it will trigger an audit. The IRS encourages taxpayers to take all deductions they are entitled to. In fact, they made the home office deduction easier to calculate by creating a simplified method that doesn't require utility or repair receipts. Just make sure you have a bonafide home office.
Don't commingle personal and business records - Keep your business accounts separate from your personal accounts. Having good accounting procedures in place will make it easier to substantiate the figures on your tax return and will keep the audit running smoothly. If you use the same bank or credit card accounts for business and personal use, this also acts as an invitation for the IRS to audit your personal accounts in more detail.
Be aware of computer reviews - Most audits are triggered because something on a return caught the attention of IRS computers. Here are some common triggers:
Deductions higher than normal in your industry - Aare your travel expenses or cost of goods sold higher than most? IRS databases compare the income and expenses on a tax return with average income and deductions on other tax returns within the same industry code and geographic location.
Consistent losses - The IRS expects that a business will begin to show a profit at some point and will look to determine whether it's a business or hobby. If you are consistently showing losses on your Schedule C, this increases your chances of an audit.
Preparer errors - Each tax preparer must request and renew an ID number (PTIN) with the IRS annually. The IRS tracks errors found on returns by a preparer's PTIN. If a preparer is found to have more error-prone returns than normal, the IRS will focus more efforts on other returns prepared by that individual.
IRS scrutiny of your return, and possible costly penalties and interest, can be avoided. However, if you do find yourself on the receiving end of an audit, enlist the assistance of a CPA or tax attorney. They can work with the IRS on your behalf and help keep the process moving smoothly.