As an attorney helping clients with audits, I see simple mistakes turn into big problems. If you are a small business owner, you must follow the record keeping rules and if you have no reason, it is to save on legal fees during an audit. I receive numerous questions regarding an audit, including the procedure and timing of the audit.
Everyone is at risk from an audit, but especially high net worth individuals. Often, people with small businesses that are doing well run into problems as a result of improper bookkeeping. As a result of the end of COVID-19, the IRS has repeatedly announced its increase in tax tests.
The IRS Audit Selection Process
The IRS selects a tax return for examination through several different methods. The primary method is for the IRS to use computer programs to compare tax returns against industry statistical “norms” to identify outliers. This is a very specific approach for small businesses and freelancers. Computer programs analyze unreported income, excessive deductions such as mileage and home office deductions, and major travel, dining, or entertainment expenses. The IRS also receives notices from banks of any transaction over $10,000 to the IRS.
In addition, each year the IRS publishes a “Dirty Dozen List”. Transactions on this list are known to have consistent fraudulent behavior and the IRS pays close attention to tax returns with any item on the list. Currently, the Employee Retention Credit (“ERC”) is at the top of the list. The IRS plans to audit most businesses that filed claims to receive the ERC because promoters across the country have been defrauding ineligible people to claim the credit.
Another big target is the cryptocurrency report. He fuel tax credit It is designed for off-road commercial and agricultural use and as such is not available to most taxpayers; however, many taxpayers mistakenly claim the credit. Over the past five years, the IRS has also consistently focused on conservation easements. Also, the IRS began to crack down regarding non-payment of federal income tax due in connection with cryptocurrency transactions in 2019. As with cannabis and cryptocurrency, the rise in popularity of online gambling has led to an increase in IRS scrutiny of gambling revenue.
Lastly, another main avenue in which audits originate is whistleblower reports or referrals. Often a disgruntled employee report suspected tax fraud activityespecially since the IRS and most states offer rewards for reporting tax fraud.
Although, the odds are in your favor if you are a small business, you should always try to comply because many little things could trigger an audit. .
The general process of an audit
Most taxpayers do not understand the full power of the IRS. First, the IRS will usually send out notices and file with the revenue agent. The revenue agent then submits an Information Document Request (IDR) to request a list of documentation. The IRS has a list of documents that commonly requestwhich includes receipts, insurance reports, medical records, logs or journals, tickets, and other documents related to claimed tax deductions.
Next, an audit involves an interview with the taxpayer, usually this will take place with the managing shareholder or partner of the company. This interview allows the IRS to understand the business premise and any follow-up questions regarding the first IDR. Before this interview, it is important to prepare, which includes reviewing previous responses to the IDRs, including any documentation provided above. Tax Agents generally want to see all books and records for the last three fiscal years.
After the interview, the Tax Agent can send follow-up IDRs or conduct a field visit. A field visit is one in which the revenue agent walks through the business and possibly communicates with employees. On this visit, they want to make sure that your business is actually involved in the activities you described in your interview.
Once a revenue agent completes their vetting process, they will issue a report and hold a closing conference. In the event that you do not agree with the report, you can ask to speak to your manager, go to IRS Appealsor even file a petition with the USTC
items to remember
I always advise people to contact an attorney immediately after receiving a notice from the IRS. It is extremely important that the attorney handle all communications and be present during the initial interview. First, a lawyer knows why a revenue agent is asking specific questions. Second, he can defuse tensions.
Audits are evasive: They ask detailed questions about the business over the last three years. The interview can be in person or by phone, depending on the revenue agent. Tax Agents are there to ensure that people do not take advantage of the system. As a result, they act and are investigators, seeking to track every penny your business, and possibly yourself, has received over the past three years.
If the tax agent detects for any reason that you are not telling the truth, he or she will expand the examination to include not only the previous three years of business, but also all other businesses in which you have an ownership interest, as well as your personal information. . income taxes Also, if they believe you are not answering honestly and providing all the documents, under Section 7602, the IRS has the authority to contact third parties. They must send a notice before participating in this activity, but it is a possibility.
As a result, it is important to always keep accurate and clear records of your books. If you can easily provide documentation of everything, the process will be pretty simple and straightforward. In the meantime, if things aren’t clear, you could spend more on attorneys’ fees than you owe on taxes.