Many individuals find filing taxes to be a stressful ordeal. As you manage your other finances, these challenges can become a problem. But if you're not careful, it could land you in hot water with the Internal Revenue Service (IRS). That's why it's essential to understand the rules and regulations of filing taxes and take all necessary precautions to avoid IRS audits and mistakes.
Here we will discuss helpful clumsy taxpayer tips and tricks to avoid IRS audits and mistakes.
During an audit, the Internal Revenue Service (IRS) thoroughly examines a business's or individual's financial records and transactions. They check to see if you are following the tax regulations and ensure the accuracy of the tax amount reported.
It's not unusual for the IRS to look into a taxpayer further if their tax credits or returns have any of a number of possible "triggers" that could make them look into the person further. The IRS uses a computer scoring system called Discriminant Information Function (DIF) to look at tax deductions, compare information about taxpayers, and often start an audit.
Here are a few triggers that may cause an audit:
The random selection of an audit does not necessarily indicate a problem. The Internal Revenue Service uses a variety of approaches, including:
It's not uncommon for returns to be chosen using nothing but a statistical algorithm. Your tax return will be compared to the average of returns like yours. These "norms" are derived from audits of a statistically significant random sample of returns and are used in the IRS's National Research Program. The IRS uses this system to maintain current data on which returns to select.
They may choose to audit your returns if they involve issues or transaction returns that were previously selected for an audit.
The next step is thoroughly examining the return by a seasoned revenue agent. Either they'll accept it or, if the auditor spots anything fishy, they'll highlight it and send the return on to an examination team.
The selection process for the original return is unaffected by the filing of an amended return. Amended returns, however, also go through a screening process and may be chosen for audit. As an added note, getting a refund is not always the cause for an investigation.
Even though audits are unusual, most people in the United States would rather not deal with one. According to the IRS, the number of actual audits is extremely low but has gradually increased since 2008. While there's no foolproof method to evade the IRS's scrutiny, there are certain red flags you can watch out for to reduce the probability of an audit.
For auditors, math errors or incorrect data entry is a major red flag, but it's also one of the easiest to avoid. Advice like "double-check your return" would seem obvious, but many people are still too careless regarding their tax returns.
“Double-checking your math and ensuring that all necessary paperwork, including receipts, 1099s, and W-2s, are in order will save you a lot of headaches later when filing.” said Tom Hamilton-Stubber, Managing Director, Tutor Cruncher
Mistakes on tax returns can occur when filers fail to account for all of their income or misplace important documents.
It's best practice to wait for all relevant financial documents (such as W-2s, bank statements, and investment account statements) to arrive before beginning your tax return. Having missing information can be harmful.
Verifying the correct number of dependents and exemptions is also crucial. The IRS's automated system is well-equipped to spot inconsistencies, and it will be impossible to tell whether or not a mistake was made.
If you have to decide between grouping an expense under "Other Expenses" or "Miscellaneous," always choose the latter option. If you lump together advertising and travel expenses instead of itemizing each individual advertising and travel expenditure, the IRS may suspect you of trying to invent a nonexistent expense.
Auditors may question itemized deductions that are too expensive or don't make sense, whether they come from a person or a small business owner. For instance, giving away 40 percent of your income to charity might raise suspicions with the Internal Revenue Service.
If you want to use Schedule A to itemize your tax deductions, it helps to know what counts as a real tax deduction. For instance, you cannot deduct the time spent traveling to and from your regular place of employment.
The IRS also gets copies of your W-2 and 1099 forms, which show how much money you've made. The IRS may contact you if they notice a discrepancy.
The IRS will almost certainly perform a cross-check to verify that all of the income listed on the tax return corresponds to the information provided on Form 1099. Audits are standard if you haven't correctly reported your 1099s, W-2s, or K-1s as income.
Ensure you have all your W-2s and 1099s before filing your taxes, especially if you did freelance work for multiple companies or switched jobs during the year.
If you omit any income at all from your tax return, the Internal Revenue Service is guaranteed to write to you. The Internal Revenue Service can easily check the income reported on tax returns against the records of businesses, banks, and other organizations. This is an honest mistake made by many people who have taken on short-term, part-time jobs or side hustles.
You should keep these documents for even longer. If you fail to report 25% or more of your income, the IRS may initiate an audit any time during the six years following the deadline.
Don't forget to include any Form K-1 income you may have. When filing taxes, S-corporations, partnerships, LLCs, trusts, and estates all use Form K-1 to report their income and other items. The IRS receives and distributes these forms to a growing number of taxpayers annually.
The possibility of being audited after claiming home office deductions deters many people from doing so. Not all home-based workers are eligible for this deduction, but it can help defray some of the expenses associated with having an office in your home. Only those who are self-employed or independent contractors are eligible for the home office deduction.
For this deduction to apply, you must "regularly and exclusively" conduct business from a designated area of your home. While a dedicated office space isn't required, it should be in a spot in your home that isn't used for anything else. This location must serve as your primary office or be where you regularly see your clients or patients.
Depending on how much of your home you use for your business, you can deduct a portion of your mortgage interest, renter's or homeowner's insurance, and utility costs. Remember to keep track of your money.
A more straightforward method is to deduct $5 per sq. foot, up to $300 per square foot, of home office space for a maximum deduction of $1,500. A home office deduction might be available for a portion of the year if you worked from home for a few months as a freelancer or self-employed worker.
Many company expenses are tax deductible, but before you take advantage of them, the Internal Revenue Service wants to ensure you didn't create a shady enterprise to dodge taxes.
Reporting losses for three years or more on Schedule C (which details profits and business expenses) as a sole proprietor may prompt an auditor to request proof that you are actually in business.
While it's normal for a company to incur losses in the beginning stages of its existence or during years when it's still finding its footing in the market, the Internal Revenue Service will start to get suspicious if it consistently loses money over the long term. Businesses that consistently report net losses or appear to be operating at a loss should raise red flags during audits.
The IRS will recognize your organization as legitimate if you've made money in three of the last five years.
Even if a company doesn't meet the "three-of-five-year profit" rule, a taxpayer can still deduct business losses if the taxpayer can show a profit motive.
Document every cent spent and every goal set for your company's future. You must be running a legitimate business in order to take deductions for a side gig.
A business plan is recommended, as is a profit motive. All financial transactions must be recorded accurately. If a taxpayer incurs a loss over a period of one or two years, they must have a strategy in place to prevent a repeat performance. In order to get a tax break, taxpayers need to demonstrate that they understand their organization and are up to date on developments within their field.
If your company has significantly higher costs than others in its industry, the IRS may contact you. The IRS checks for discrepancies in the deductions claimed by taxpayers by comparing the claims of those in a relatively similar income range or business sector.
Keep comprehensive records of your company expenses for at least three years after the deadline for filing taxes and for at least six years if you get your earnings from more than one source of income. This is especially important during years when your expenses are high.
Create a system to keep your company funds separate from your personal funds. Separating business and personal funds is a must if you're in business for yourself.
In this way, your financial history will be transparent. To prove that your expenses were necessary for the operation of your business, keep records such as logs and calendars detailing the work you've done. If you use a credit card to cover your business's costs, keeping that card separate from your personal one is wise.
Unless the shares are held in a tax-deferred retirement account, the earnings from the trade of stocks will be subject to taxation. When filing your taxes, you'll need to use Schedule D to account for any capital gains or losses reported to you by your brokerage firm on Form 1099-B.
Gains on investments held for less than a year are considered "short-term," and are subject to taxation at the individual's regular rate of income taxation. In most cases, the capital gains tax rate is 0 percent, 15 percent, or 20 percent, depending on your tax bracket, for investments held for more than a year. Any significant shift in capital gains income or failure to report details from Form 1099-B could result in an audit.
Since 2020, the IRS has included a question about cryptocurrency transactions on the first page of Form 1040. For 2022 returns, it plans to expand the question and provide more guidance about the taxable types of transactions.
The IRS's draft of the 2022 Form 1040 includes a new question regarding digital assets: "At any time during 2022 did you receive as a reward, award or payment for property or services, or sell, exchange, gift or otherwise dispose of a digital asset (or a financial interest in a digital asset)"
A taxpayer's return will be delayed if not audited if they do not respond to this question with a yes or no.
Generally, any income, gains, or losses from the sale of cryptocurrency or other digital assets must be reported correctly. Any profit or loss from selling cryptocurrency or other digital assets must be reported on your federal tax return as a capital gain or loss, just like any other property type.
Donations to charity may be deducted from your taxable income if you itemize, so be sure to keep accurate records of your donations.
The donor must have contemporaneous written documentation from the charitable organization to claim a deduction for a donation of $250 or more, whether in cash or in kind. It is up to the donor to secure the appropriate letter.
You must have the documentation at the time you file your income tax return claiming the deduction; otherwise, you will not be able to use a letter from the charity if you are audited. Significant gifts of items other than cash, such as furniture, appliances, or even cars, must be documented in additional ways. For example, if you want to deduct a non-cash donation over $5,000, you'll need a professional appraisal and a letter of thanks from the charity.
Also, failing to include supporting paperwork for in-kind donations can lead to an audit. For instance, you must include a copy of Form 8283 with your tax returns if you give away any property with a value of more than $500, whether it's a single item or a collection of related items.
If you are selected for an audit, there are a few strategies that you can use to pass it.
Putting off an audit is usually a good idea. If you need extra time to organize your files or for any other reason, feel free to ask for it. Assuming no tax fraud or substantial underreporting of income was committed, the IRS has three years from the date the return was filed to complete an audit.
Ensure the IRS doesn't visit your business or residence to conduct the audit. Instead, you should contact the Internal Revenue Service (IRS) or your tax expert to handle it. Contact a tax expert if you've been asked to host an audit at your place of business.
Don't think that you won't owe anything after the audit. The odds are against you here. The average cost of an adjustment for an audit conducted in-house at the IRS is $4,000, while a field audit costs $17,000.
Do not divulge any more information to the auditor than is required, and limit your interactions with them to the bare minimum. Do not give the auditor any proof of your wrongdoing, but also do not lie to them. Possible changes they make could cause less harm than if you had just given in to her original request.
Don't give the auditor copies of your tax returns from other years. If you do, and they find something they don't like, they will also change those years. Do not bring any records to the audit that do not relate to the year being audited or were not requested in advance.
Ask the auditor what kinds of disallowances they are considering, and explain why your position is right. Don't bother trying to haggle over the tax rate. Instead, try to negotiate tax issues, such as whether or not a particular deduction should be permitted. Neither should you try negotiating with the auditor by claiming financial hardship based on an unpaid bill.
Before going through an audit, familiarize yourself with your taxpayer rights, "the Taxpayers' Bill of Rights," by reading IRS Publication1, If you want to learn more about tax law, check out the commercial tax guides and free IRS publications that are available online. Before an audit, ask a tax expert if you have any questions about the tax code or your documentation.
During an audit, if the topic of tax fraud comes up, don't attempt to deal with it by yourself. If things are not going smoothly during an audit, you have the right to request a break so that you can speak with a tax professional. If you feel the auditor is being unfair, you can also request to talk to the manager.
Meg Wheeler, CPA, Meg K. Wheeler LLC, suggests, “Have your tax preparer walk through the return with you. They should be able to explain where every number came from and what each form means. Make sure you understand what is reported on your return. Ultimately, it will be up to you to defend it in an audit - so make sure what gets reported is correct.”
If you get the audit report and find that some of the conclusions are wrong, you should talk to the auditor immediately to see if an additional review is needed. If you want to find a middle ground, it's best to talk to the auditor or their supervisor about it. You can appeal the audit decision within the IRS or in the Tax Court if you find that you cannot accept the decision.
Getting audited is a stressful experience, but you do not have to do it alone. Getting professional help from a tax attorney or expert can help you go through the process smoothly. Here are a few benefits of getting professional tax advice during an audit:
Because of how much is at stake, audits by the Internal Revenue Service are tough. It's because of this that dealing with them can be so nerve-wracking.
In other situations, if you make a simple mistake, it's not a big deal, and you can fix it without any big problems. But with the IRS, one slip-up can have serious repercussions.
You need to take extra precautions to avoid making mistakes during the auditing process. Unfortunately, most people make more mistakes in stressful situations like audits.
One false move can spell disaster for a business when times are tough. In order to guarantee that no mistakes will be made, it's best to leave the job to experts.
Auditor visits to a business's location are common practice, and without representation, you may find yourself fielding questions and providing answers under oath. Having a professional represent you means that auditors will likely have to visit your representative's office instead of your own.
That may be the greatest safeguard against prying eyes during an IRS audit, especially for small business owners. As a result, there may be fewer disruptions in the workplace, and work can continue as usual.
There are plenty of opportunities to make blunders during an IRS audit. For example, incorrectly prepared or submitted forms can result in additional fees.
If you make a mistake, the Internal Revenue Service may suspect you of trying to cover up something. They will pay closer attention to your case if you keep making mistakes.
In addition, dealing with the IRS can bring up negative feelings in some people. As a result, they may act unprofessionally when dealing with an IRS agent. Even though it's not against the law, auditors can use their authority to make the process harder for everyone.
Although feeling anxious during an audit is natural, keeping a level head and being professional will get you much further than any other approach. If there is any concern that an auditor might make such a mistake, it may be prudent to bring in an expert to help.
They will have much experience working with the IRS and nothing to gain or lose from your audit. They will solely focus on helping you pass your IRS audit with the most favorable outcome.
Many people have never handled an audit by the Internal Revenue Service before. Even if they can manage one, learning how to do it correctly the first time will take much longer.
However, many professionals exist who have extensive experience handling IRS audits for companies of all sizes and types. They'll have everything they need to handle the audit quickly and effectively.
Sometimes this means racing against the clock to complete tasks before critical dates. It could also help you avoid fines and penalties for not responding quickly enough to the audit process.
Everyone knows how complex the tax system can be. First of all, mistakes are frequently made unintentionally. However, if you are deeply familiar with the system, you can take advantage of unusual quirks to ensure the smoothest possible audit agreement.
It stands to reason that if you hire a tax attorney with plenty of experience, they will have figured out many tricks of the trade that help them get the best results for their clients. If your audit is particularly complex, a tax expert may be able to secure more favorable terms for you.
Getting audited by the IRS is stressful and can cause many problems if handled incorrectly. Therefore, it is better to be steady than clumsy with your taxes. The tips and tricks explained above can help you avoid being audited, but only if you follow them diligently. In the event that you do get audited, getting help from a professional can become a safety net for you to hold onto during the strenuous process.