As a lawyer assisting clients with audits, I see that simple mistakes become big problems. If you own a small business, you need to follow bookkeeping rules, and if there’s no reason at all, it’s only to save legal fees on an audit. I receive numerous questions in connection with an exam, including the procedure and timing.
Everyone is at risk of being audited, but especially high net worth individuals. Oftentimes, those with thriving small businesses encounter problems that stem from poor bookkeeping. Due to the end of COVID-19, the IRS has repeatedly announced an increase in tax audits.
The IRS Audit Selection Process
The IRS selects a tax return for review in a number of ways. The main method is for the IRS to use computer programs to compare tax returns against statistical “norms” in the industry to identify outliers. This is a very targeted approach for small businesses and the self-employed. The computer programs look for underreported income, excessive deductions such as B. home office and mileage deductions, as well as high travel, meal or entertainment costs. The IRS also receives notifications from the banks of any transaction exceeding $10,000 to the IRS.
In addition, the IRS publishes a “Dirty Dozen List” each year. Transactions on this list are known to consistently exhibit fraudulent behavior, and the IRS monitors tax returns for all items on the list. Currently, Employee Retention Credit (“ERC”) tops the list. The IRS plans to audit the majority of companies that have applied to receive the ERC because there are funders across the country who have enticed ineligible individuals to apply for the loan.
Another big goal is the reporting of cryptocurrencies. The fuel tax credit is intended for off-road business and agricultural use and is therefore unavailable to most taxpayers; However, many taxpayers incorrectly claim the credit. In the past five years, the IRS has also consistently targeted conservation efforts. Additionally, in 2019, the IRS began cracking down on non-payment of federal income tax related to cryptocurrency transactions. Similar to cannabis and cryptocurrency, the increasing popularity of online gambling has led to increased scrutiny of gambling proceeds by the IRS.
Finally, another important starting point for audits are whistleblower reports or tips. Often a disgruntled employee will report suspected tax fraud activity, especially since the IRS and most states offer rewards for reporting tax fraud.
Although odds are good for you as a small business, you should always try to be compliant as many small things can trigger an audit. .
The general process of an exam
Most taxpayers don’t understand the full power of the IRS. First, the IRS generally sends notices and introduces the financial agent. The revenue agent then sends an information document request (IDR) to request a list of documents. The IRS maintains a list of the documents it frequently requests, including receipts, insurance reports, medical records, logs or journals, tickets, and other documents related to the tax deductions being claimed.
Next, an audit involves an interview with the taxpayer, usually with the managing partner or shareholder of the company. This interview allows the IRS to understand the company’s premise and any follow-up questions related to the first IDR. Before this interview, it is important to prepare. This includes reviewing the previous responses to the IDRs, including the documentation previously provided. Tax officers generally want to see all books and records for the last three tax years.
After the interview, the revenue agent can send more IDRs or conduct an on-site visit. During an on-site visit, the revenue agent will tour the business and may communicate with employees. During this visit, they want to make sure that your company is actually carrying out the activities you described in your interview.
Once a revenue agent completes their investigative process, they produce a report and hold a final conference. If you disagree with the report, you can request to speak to your manager, contact the IRS Complaints Office, or even petition the USTCUSTC.
things to remember
I always advise people to contact an attorney immediately after receiving a notice from the IRS. It is extremely important that the lawyer handles all communication and is present at the first interview. First, a lawyer knows why a tax officer asks certain questions. Second, it can relieve tension.
Audits are evasive – they ask detailed questions about the company over the past three years. Depending on the financial agent, the interview can take place either in person or by telephone. It is the job of the tax authorities to ensure that individuals do not take advantage of the system. Therefore, they act as investigators, trying to track down every penny your company, and possibly yourself, has received over the past three years.
If for any reason the tax officer finds that you are untruthful, they will extend the scrutiny not only to the last three years of the company, but also to any other company in which you have an ownership interest, as well as your personal income tax information. Additionally, Section 7602 gives the IRS authority to contact a third party if it believes you are not responding honestly and not providing all documents. You must send notification prior to commencing this activity, but you can do so.
Therefore, it is important to always keep accurate and clear records of your books. If you are able to easily document everything, the process is quite simple and straightforward. In the meantime, if things aren’t clear, you could be spending more on legal fees than you owe in taxes.
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I dedicate my career to simplifying the Internal Revenue Code. As a tax attorney, I know that there are very few resources available to the general public. Also, I know that tax laws and the IRS are daunting. Through my work at Pontius Tax Law, I try to relieve my clients’ stress. In my spare time I cook and kayak with my husband and two wonderful children. That’s why I know that nothing is more important than family. To help others spend more time with their families with peace of mind, I provide (i) legal strategies to relieve tax burdens; (ii) assistance with the examination process; and (iii) assist individuals and businesses with tax returns.
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