Audit. This word worries even the most meticulous business owner. When it comes to the IRS, the issue is usually never a simple one and almost always requires digging into the records of past years to substantiate a certain income or expense stated on a return. While receiving a notice of an audit from the IRS is never fun, there are many ways that you can prepare ahead of time for a tax audit, making the process significantly less stressful.
Hire a Tax Professional
If you have complex returns or are unsure of how to respond to that notice from the IRS, you may want to consider hiring a tax professional. There are many benefits to having a tax professional working for you, aside from the obvious benefit of you having to spend less time on dealing with tax-related stress. Tax preparation fees are tax-deductible and tax preparers are often able to claim credits or deductions that you would have otherwise missed. One major benefit that comes from having a tax preparer or CPA is the invaluable assistance and representation you receive during tax audits. MBS Accountancy offers tax consultation and preparation services, and our team of tax law experts is here to help you be prepared for anything that comes your way!
Keep Detailed Records
The second thing to be aware of when proactively preparing for an audit is to keep detailed records of your tax information. If you have not kept careful records in the past, try to recreate past years as best as possible in terms of tax documents. If having a large filing cabinet (or cabinets) does not appeal to you, you may want to consider going paperless. The IRS does accept electronic versions of your supporting tax documents, albeit they do require that the documents be legible and organized.
Know How Audits Are Triggered
Knowing how the audit process works will help you avoid raising red flags on your tax return. There are a couple of methods by which tax returns are selected for audits. The primary ways in which audits are triggered is through computerized scoring, audits of other companies linked to you, the exaggeration of business expenses or deductions, and owning a cash-only business.
a) Computerized Scoring
One of the ways that audits are triggered is through a computerized system that the IRS uses to scan tax returns and score them based on two methods: the Discriminant Information Function (DIF) and the Unreported Income Discriminant Information Function (UIDIF). The DIF compares tax returns within a specific income bracket and looks for things like duplicate dependents (claimed by more than one person) and incompatible expenses or deductions. If you report 25%-30% of your income as travel expenses, and the average percentage for your occupation and income range is 15%-20%, you will receive a higher score using this method.
Along with the DIF score, the UIDIF scores returns based on their potential for unreported income. While the DIF scans returns for mistakes and inaccurate information, the UIDIF scans tax returns for missing income. Tax returns with the highest total scores computed by these methods are considered for audits. As your score increases, so do your chances of being audited. You can usually lower your scores in the DIF and UIDIF by ensuring that all of the information on your tax return is accurate and that no income has been omitted.
b) Errors Found in Companies Linked To You
The IRS also flags tax returns for audits if any related businesses or organizations are audited and discrepancies are found between that company’s tax information and their own records. When there is a discrepancy found in a company’s information and your tax return is linked to that company, your tax return will likely be audited to verify the information on your taxes.
c) Exaggeration of Expenses or Deductions
Overstating your business expenses or deductions is a great way to increase your chances of being audited by the IRS. This is one of the most common reasons for audits and usually occurs when taxpayers file a Schedule C improperly or incorrectly, or when business expenses are greater than the average amount reported by others in the same industry.
d) Owning A Cash-Only Business
Businesses like restaurants, salons, and gas stations that have a large intake of cash are more likely to be audited than other businesses because the IRS assumes that it is easier to hide cash-based activity. If you own a restaurant or other cash-only business, you can generally expect to receive more scrutiny than other industries.
Know What To Expect When You Are Audited – The 3 Types of Audits
When you do receive a notification that your taxes are being audited, it is good to know the various ways your audit can take place, as well as your rights and responsibilities as a taxpayer. There are different types of audits that can occur, based on your exact situation and the discrepancies involved.
The correspondence audit is the most common and occurs, as you might expect, solely through the mail. The IRS will usually mail you a letter stating that they have found a discrepancy in your taxes and request supporting documents from you. Once you have sent the required documents, the error is usually resolved and no further action is needed from you.
An office audit, or field audit, is another type of audit and is more detailed than the correspondence audit. This is used for situations where there are many complex errors and the issues cannot be resolved through the mail. An IRS agent will come to your office and examine your records. They will usually complete their audit within that day. If you are required to provide further documents, you will be given a reasonable amount of time to submit those documents.
The next type of audit is a Taxpayer Compliance Measurement Program (TCMP) and involves a detailed analysis of every single line of your tax return. The purpose of this audit is to update the DIF system that the IRS utilizes to scan tax returns. The DIF scores are an important metric that is used to determine errors in tax returns and is routinely updated through these TCMP audits about every couple of years. In a normal audit, you have a specific area of focus that you must provide documentation to support, however, in a TCMP audit, you are required to provide documentation for every item on your tax return. If you are selected for this type of audit, hiring a tax professional or tax attorney would definitely be in your benefit.
After the audit is complete, you have the option of approval or disapproval regarding the findings of the audit. If you approve of the findings, then you will sign and submit a copy of your Consent To Proposed Tax Adjustment (IRS Form 870). By signing this form, you are stating that you understand and agree to the tax penalties and tax deficiencies that are listed in the examination report given to you. You can request a payment plan that will be determined by the amount you owe as well as your affordable monthly payment.If you disapprove of the findings, you have 30 days to take action, including requesting an appeal, mailing of additional documents for the IRS to consider, or discussing your case with the senior manager. If you do not respond within 30 days, you will receive a letter stating that your case has not been agreed to and you will be given an additional 30 days to respond. Failure to respond during this second period of time will result in the case being closed and you will be considered to have agreed to the findings of the audit.
MBS Accountancy – Your Ally in An IRS Audit
Our dedicated team of accountants and tax law experts embodies our company values, namely professionalism, responsiveness, and quality. We have helped thousands of people feel better about their taxes and have resolved many seemingly dismal tax situations. We offer great services like tax preparation services, QuickBooks consultation, and outsourced bookkeeping services, and much more! No matter how complex your tax filing issues are, MBS Accountancy will assist you and make life – and your taxes – simple for you! If you would like to speak with us today about your taxes or receive general advice regarding the requirements and best practices for filing taxes, contact us today and our team of experts will be more than happy to assist you!