As we have written previously, IRS audits have significantly increased. Having an audit is not fun. It can consume a lot of ones time and money if you hire a professional to represent you. We seen a lot of audits which in our opinion shouldn’t have been triggered but because the tax return has a certain trigger the taxpayer has to deal with it. To often we see sloppy mistakes that taxpayers and tax preparers make which triggers the audit. So review these items and consider if your tax return should be done differently or by a different person if you have any of these items.
- Loss from a flow through (S Corporation, Partnerships, LLCs): We have seen an significant increase in audits in which the tax return is taking a deduction for a loss from a flow through. The loss may be justified, but the IRS is looking for these attributes more often and they are finding mistakes. Once selected, they will look for a calculation that should be part of the tax return that shows that the taxpayer has adequate tax basis to take the loss. There must be tax basis to take the loss. Too often we have seen that the tax preparer has not prepared the proper tax basis calculation and thus triggered the audit. Most of the taxpayers didn’t know that the tax preparer didn’t’ prepare all the necessary forms. So, if you have losses from flow through, double check with your tax preparer. This issue can also be expanded to the flow through and all the shareholders or partners and for multiple years.
- Large decreased in taxable income: Even though most of the country has just came out of the recession, and most of us had to work harder and earned less, the IRS is still pulling tax returns for audit when the taxable income as decreased significantly. If your taxable income decreased significantly, please make sure you take extra care that your tax return is correct, so if you are audited, it will go smoother.
- Real Estate Professional: Real Estate professional is a tax status that if met can allow a taxpayer to use that loss against other non rental income. Typically rental losses are considered a passive activity and outside of some minor rules, is only able to be offset against other passive income. So, if a taxpayer has rental losses, and has other non passive income, certain rules have to be met to net the amounts together and thus pay tax on the net. The real estate professional status continue to be a hot audit item.
- Not reporting income: The IRS computers receive information on taxpayer that typically deals with income and certain deductible items like mortgage interest. If the IRS computers show a larger amount of income than reported on your tax return, your chances of an audit have significantly increased. If the amount is small, the IRS may just send you a letter, but if the amount is large, you will probably have to deal with an audit. So, make sure you review all your W-2’s, 1099, even including your investment transactions. Even if the amount reported isn’t fully taxable your tax preparer should be aware of the income and properly report it to agree with the IRS computers.
- Being Self-Employed (Sole Proprietorship): The IRS audits self employed taxpayers more often than others. They have statistics that these taxpayers as a whole try to reduce taxable income illegally. They also have seen that these taxpayers typically don’t’ have the best records, so they audit them and find more tax dollars to send back to Washington D.C. If you are self employed that is fine, make sure you have good accounting records. Try using a simple program like Quick Books to keep track of your income, expense, and liabilities which include credit cards. We highly recommend that self employed set up a DBA bank account and have separate credit cards for just the business. This makes it easier to track business transactions. Our opinion is that if your net income is approaching $100,000 or larger, you should consider incorporating and electing S Corporation. Generally your income tax can be decreased, you can create some asset protection and your audit risk should be reduced.
- Foreign Bank Accounts: The IRS is still allocating a lot of resources to find taxpayers that have foreign bank accounts and haven’t properly reported them. If a taxpayer has a foreign bank account or even signature authority they need to properly complete the proper forms to disclose them.
- Research Credit: The tax code allows tax credits for money spent on research costs. The government wants to create an incentive for the US taxpayer to strive to create new or better technology. However, too often have we seen that the company didn’t properly follow the rules to support the research credit.
A lot of audits could have been alleviated if the tax return was prepared properly. Also, the taxpayer needs to be prepared for an audit. This means one must keep organized records. We recommend using an accounting software program that is appropriate for your business. Depending on the type of business you have, you will need to create some best practices to be more organized in accounting. For example, if you purchase goods or services with cash, make sure you keep the receipts. Taxpayers that have organized books and records can complete an examination much quicker. So be prepared if you are audited.
The IRS isn’t the only one taxpayers need to be prepared for. Depending on your business, make sure you are prepared for state audits, sales tax audits, and payroll audits. All the government agencies are out there looking for more tax revenue.
