Sometimes it feels like we all do our taxes on the honor system. You report your income, you write off your expenses, but who is checking all that? How do they know you’re telling the truth? Some things the IRS can easily check, like your salary from your job. Others they might only verify if they do an audit.
A tax audit is like a spot check. Instead of collecting billions of receipts from millions of people, the IRS lets us do the reporting ourselves and then audits a select few every year. Although one might never happen to you, it always pays to be prepared.
Who Can Be Audited?
Some audits are completely random. It wouldn’t be a spot check if you could predict who would receive one. However, an audit is much more likely if the IRS finds something suspicious in your tax return.
One common red flag is beyond your ability to fix: if you’ve had transactions with someone else who is being audited, you might also be audited. It’s always wise not to get into a financial relationship with someone who isn’t honest and above board. If anyone suggests you not report a transaction so that they don’t have to pay taxes on it, find someone else to do business with.
Beyond this, common audit triggers include math errors or suspiciously round numbers. You can avoid errors by using software or even just a calculator. And round only to the nearest dollar, not the nearest hundred, when recording expenses.
Naturally, if you fail to report any income, that is likely to trigger an audit. When you receive a W2 or 1099, the IRS gets one too. So you can’t fool them by conveniently forgetting to record one. While someone who has paid you under $600 in a year doesn’t have to report this to the IRS, you still do. Try to keep scrupulous records so you don’t miss any.
Too many write-offs, even if they’re completely honest, can also raise suspicions. If you give large amounts to charity, have large business expenses, or write off your home office, this will increase your chance of an audit.
How to Be Ready for a Tax Audit
Since an audit can happen to anyone, everyone should be prepared for one. Less than 1% of filers actually get audited, but it pays to be ready. The most important step everyone should take is to keep careful records. This includes pay stubs, receipts, letters of acknowledgement from charities, investment documents—anything that proves a source of income or a write-off.
If you don’t have written proof of something you want to write off, simply don’t deduct that amount. Don’t guess at what you might have spent on transport or childcare. Check your records, and write off only what you have records for. You might be able to regain some documents by contacting the people who sent the originals. For instance, if you donated $10,000 to your favorite charity, they will probably be happy to send you another thank-you letter that you can show the IRS.
After you’ve filed your taxes for the year, don’t trash everything you used! Instead, put it in a safe place for at least three years. Normally, the IRS does not audit returns further back than three years, although they can go back up to six years if they have identified a serious error.
Working with a tax professional can help you be ready for an audit. Your accountant can explain to you which documents you need and how long to save them.
How an Audit Works
If you are selected for an audit, the IRS will notify you by mail. There are three types of audit. In a mail audit, you will only need to send a copy of the documentation they request by mail. In an office audit, you will have to report to a local IRS office and bring all your documentation. You can bring your accountant or a lawyer with you if you wish. Finally, in a field audit, an IRS agent will come to your home or business and go through your books in person.
Whichever method the IRS uses, they will issue their decision afterward. If they see no discrepancies, they will accept your tax filing in its original form. If there are errors, they will propose corrections. In many of these cases, you can simply accept their edits and pay any additional taxes you now owe. In others, you may be assessed an accuracy penalty up to 20% of the additional tax due. So, if you understated your income or overstated your deductions to the point that you owe an extra $1000, you might also have to pay another $200 as an accuracy penalty. You may be able to pay that $1200 in installments.
If, however, the IRS judges that you actually committed fraud, rather than an error, you can owe a much larger penalty. In rare cases, this can result in prison time. This is reserved for large deliberate discrepancies.
You can contest your audit, if you believe they’ve made an error. If you intend to contest your audit, don’t agree to their corrected version of your return. Instead, you should probably hire a professional to help you make your case.
How a Professional Can Help
Hiring a tax professional is a great way to keep everything in order and above board. Since your tax return will be free from errors, it’s much less likely to trigger an audit. And, if you do get audited, your accountant can help you prepare the necessary documentation.Whatever you do in your financial life, the right professionals can make all the difference. To find the right expert for your finances, contact us today.