Audit – 5 IRS Triggers and What to Do if Audited?
The word audit sounds frightening to most people. Although the possibility of being audited is under 1% and half of those are for the people making over a million a year – anything you can do to lower the odds even further is a win.
It goes without saying that the most efficient way to avoid raising any red flags is to follow IRS guidelines. Also, provide correct and true documentation. Beyond that, in this article are the 5 IRS triggers for audit and what do to if audited.
1. Underreporting Your Income
This IRS trigger is not something you should try or can avoid when it comes to filing your income – no matter how small or huge it is. The reason this is probably the top trigger for audit is taxes. Because every cent you don’t report is the cent that goes untaxed.
Important To Know
One key thing to remember, no matter if you underreported your income by mistake or you chose to do so, IRS will most likely know about it. And if you wonder how? Here’s the deal: the payer or your bank also submitted the same documentation.
With this in mind, accidental mistakes are always possible and if you know which they are, you can avoid making them:
- A common error that happens often in case you had more than one employer in a year is not reporting one or more W-2 incomes.
- Not reporting money you made from your side gigs or freelance jobs
- Excluding capital gains from cryptocurrency, stock trades, and properties.
- Leaving off earnings and interests from investments and savings.
2. Constantly Reporting Business Losses
It’s perfectly normal, even for the IRS, that many new businesses and startups claim a loss in the first few years. Generating revenue takes time and everyone knows it. However, if your business is “failing” on paper for several years, IRS red flags will be raised just enough to audit you.
Having a business means – reporting your revenue and losses on Schedule C. The IRS uses data in your occupational field to calculate average expenses for the businesses in the same industry. So, for example, if your expenses are twice above the average in your field, you will raise suspicion.
What To Do When Submitting?
When submitting your losses or expenses on your tax return, double-check the following:
- Business deductions
- Don’t mix personal and business – e.g. home office or vehicle deductions which include personal use.
- Unreported cash flows – through apps or other third-party payment platforms
3. Math and Data Entry Errors
These types of errors are easily overlooked, but IRS has automated processes that catch millions of math or data entry mistakes each year, and using the wrong formula or form is no excuse for the IRS.
Keep in mind that mistakenly filling a form, or using a wrong formula, does not automatically mean an audit is coming. However, IRS will definitely contact you and propose a solution, if your mistake was a minor one. In case automated software flags your math error for manual review, it can reveal other issues with your fillings and business and trigger an audit.
Working with a tax professional will definitely reduce your chances to submit your forms without math and data entry errors.
4. Using Round Numbers
Does this sound strange to you? Let’s explain! Being a business owner means having your thoughts on many different things. And in most cases, bookkeeping isn’t very high on a to-do list. But, here’s the tricky part. People, who leave their books unattended for some time, tend to “guesstimate” their expenses or incomes at tax time. Most of them use round numbers while guessing and, IRS knows it! If possible, it’s best to use exact numbers when filing your taxes.
5. Owning a Cash-Based Business
In the event that you own a business with heavy cash flow or with a number of different cash transactions, your chances of getting audited get a little bit higher.
IRS discovered a tendency among cash – business owners to underreport income – especially in places where workers make tips. Therefore, IRS targets businesses like laundromats, beauty salons, restaurants, and convenience stores more aggressively and these businesses are likely to get audited.
What to Do if Audited?
While the list of factors mentioned in this article increases your chances of being audited, it’s important to remember that mainly, audits are completely random. In other words, the IRS picks a number of tax returns each year as a compliance check. Look at it this way! Audits are something like quality control measures you might need to use in your own business.
If you’re wondering what to do if audited, you’ve come to the right place. Here are the most common types of audits and how it all works.
1. A correspondence audit – The IRS sends you a notification, in writing, of a possible issue with your filling. After that, you respond in writing as well, with documentation and/or information to support your case.
2. Field audits – are much less common. These types of audits represent in-person audits that happen at your business premises, your tax professional’s office, or a local IRS office.
What Do You Need?
The notice of an audit will have your auditor’s contact information, a list of documentation or information the auditor wishes to examine, and instructions for the next steps. The best way to pass an audit is to follow those instructions and collect all the documentation. Furthermore, you will need to share your financial statements, such as your income, expenses and loss statement, balance sheets, and any other documents that you used while doing your books.
We Can Help You!
If you receive a notice of an IRS audit, you have the right to know the reason you are being audited, to hire a representation, and to appeal.
YPTA provides a dedicated team of accounting professionals to suit your business needs. This team consists of a full-charge bookkeeper, an accounting software specialist, and an accounting manager or controller. Talk to an expert today if you have questions about audits, small and mid-size business taxes, or other tax-related questions!