We’ve all heard the rumors… the IRS is hiring 80,000 armed agents! This is, of course, not true! However, it is true that increased IRS funding will likely result in increased audits.
As an honest taxpayer, you should prepare and file your taxes with the understanding that you may be audited. I tell everyone, “Prepare for the worst and hope for the best.” But an audit is not fun. It can be time consuming and difficult to properly manage, even if you did nothing wrong.
So, to play it smart, you should also prepare your tax return in a way that minimizes your risk of audit. To do this, you need to understand the types of IRS audits, what triggers an IRS audit, and what you can do to avoid an IRS audit.
Types of audits
As the name implies, a correspondence/mail audit is conducted via mail. The IRS sends you a letter and requests that you either respond with additional information or accept their proposed adjustment. Correspondence audits are typically resolved with one or two letters. If you missed a document, simply pay the tax calculated. If the IRS needs more documentation, send in the documentation. In rare cases, you may need to escalate through the due process procedures.
Office audits, like correspondence audits, begin with a letter — however, they’re typically only conducted on larger accounts. In these audits, the IRS requests that you bring documentation to their office for review. Office audits typically involve businesses and the associated business bank statements. Field audits are similar, except in these audits the IRS will make an in-person visit to your place of business. Again, these audits are typically only performed on very large taxpayers.
If you find yourself subject to an IRS criminal investigation, you need to call an attorney immediately. The IRS criminal investigation unit is considered one of the most knowledgeable enforcement arms of the US government. They are only involved with the most abusive tax fraud cases, such as bankruptcy fraud, corporate fraud, employment tax fraud, illegal gaming, identity theft, illegal narcotics operations, and money laundering.
What triggers an audit and how to avoid an audit
The most common cause of an IRS audit is a data mismatch. In other words, the information the IRS has does not match the information in your return.
The IRS uses computer systems to match the information in their systems with the information in your return and if the system identifies a mismatch, the return is audited. This can be the result of a lost or misplaced tax document, or a tax document that was reported incorrectly.
The best way to avoid this type of audit is to access your tax transcript from IRS.gov and ensure that all of your tax forms are reported. Additionally, if you receive complicated tax forms and you’re unsure of how they need to be reported, engage a qualified tax professional to assist you in preparing your filing.
The IRS is increasingly a systems-driven organization and as such, they rely on system-performed analytical procedures to identify returns that have data irregularities. While an irregularity does not necessarily mean there’s a mistake, there is a much higher probability that a return with an irregularity has a mistake than a return with no irregularities.
Some of the most common irregularities are large business deductions for individuals that have not historically owned a business. Additionally, business owners with a disproportionately large amount of travel expenses compared to business revenue are commonly selected for audit.
To avoid an audit triggered by a data irregularity, ensure all business transactions are properly categorized and reported. Using software like Quicken Home & Business to help properly categorize transactions is critical to help avoid this type of audit.
If your income is high, the good news is that you made a lot of money! The bad news is that all that money increases your chance of being selected for an audit.
To some extent, the IRS is just like a regular business. They focus on the accounts that offer the greatest opportunity for success, and when the numbers are large, there’s a good chance they can find a mistake that results in additional taxes.
As a high-income taxpayer, avoiding a data mismatch or a data irregularity becomes increasingly important. Additionally, when in doubt, taxpayers should err on the side of additional disclosure and report additional information on IRS Form 8275. As long as a taxpayer is transparent with their disclosures, the IRS is limited in their ability to assess penalties in the event of an adverse audit.
There’s a difference between a miscategorized deduction and criminal activity. However, even small taxpayers can make big mistakes when it comes to black or white questions on your tax return.
If you are engaged in buying or selling cryptocurrencies, for example, the IRS requires you to answer a yes or no question as it relates to this activity. There’s no ambiguity here. The answer is either yes or no.
While most IRS criminal enforcement focuses on drug smuggling and other dangerous criminal activity, do not intentionally lie on your tax return. It’s just not worth it.
Income taxes in the United States are based on a self-reporting system. As such, it is up to the individual to complete their tax return and calculate the amount of taxes owed.
The IRS takes a “trust but verify” approach to tax enforcement, and audits — especially adverse audits — are not fun. The good news is that if you understand reporting requirements, reconcile your records with the IRS, and ensure all of your transactions are properly categorized and disclosed, you can significantly limit your risk of audit.
– Planning for Taxes – Quicken + Simplifi Blog