It’s the one thing every taxpayer can agree on: Avoiding an IRS audit is good.
While there are certainly those who try to cheat the system, most people just want to make sure they haven’t made an error that will land them in hot water with Uncle Sam.
Nobody wants the IRS scrutinizing their taxes.
IRS audits come in three forms: correspondence, office, or field audit.
The IRS is feared because people either don’t understand the tax law and/or they cheat on their taxes. If you work with a good tax adviser, preferably a CPA, and keep proper documentation of expenses for deductions, there’s no need to be afraid.
To stay out of the IRS’ crosshairs:
Prepare an accurate return.
“This may seem like common sense, but filing an inaccurate return is the biggest reason you’ll encounter follow-up from the IRS,” says Eric Smith, a spokesperson for the IRS. “An ounce of prevention is worth a pound of cure — good recordkeeping really matters.”
He recommends reviewing income statements throughout the year and making sure your year-end statements are accurate, as banks and employers can make mistakes. If your W2s and 1099s don’t add up to what you believe they should be, contact the payor immediately.Double check your work.
Another aspect of preparing an accurate return is getting a second set of eyes on the work you’ve done. Find someone you trust to review your return. It’s easy to transpose numbers or have heavy thumbs.Avoid round numbers.
Is your tax return filled with a bunch of zeros? Yes, you’re supposed to round up on your tax returns, but to the nearest dollar — not thousand. It’s rare to see multiple round numbers on one tax return. Too many could signal to the IRS that you’re not using accurate numbers.Report even the most minute income.
Chances are, you accrue small amounts of income through a variety of sources that could easily be forgotten — yet underreporting these types of income is another red flag to the IRS. That $10 of bank interest or $15 of dividends may be on the second page of your statement and are easy to miss.
Plus, banks are not required to send a 1099 if you’ve accrued less than $10 of interest.
Be sure to look at your December bank statement, or the January one for any mid-month statements, to review and report those numbers.Do business as an S corp or LLC.
Reporting business income on a Schedule C is one red flag that could catch the attention of the IRS.
Instead, form your business as an S corporation or an LLC. Because a Schedule C is only an income statement, there is no balance sheet to help verify your numbers.
An S corporation or a partnership return, which LLC would file, requires a balance sheet, so the IRS has much more confidence in your numbers.
It is important to note, however, that the administrative burden of maintaining the compliance necessary for an S Corp or LLC is significantly more challenging. Therefore, this option typically only makes sense for business owners who show over $100,000 in profit or have an existing employee they run payroll for.Choose electronic filing.
According to Smith, 89% of returns were filed electronically in 2019. That number increases to 95% if you include people who used software, but still printed their returns and submitted them through the mail.
Sure, it’s more convenient — but it also helps you avoid easy mistakes that could result in unwanted follow-up correspondence from the IRS.
How? The tax software handles the calculations and can catch errors you could otherwise miss.
Many tax software companies even go so far as to guarantee their calculations are 100% accurate. And some let you buy additional audit protection services when you file.Be mindful of your charitable donations.
Many taxpayers make charitable donations at the end of the year, which can generate a tax benefit.
However, it’s important to work with your tax adviser, as large charitable contribution deductions can trigger an audit. The key is the size of the contribution relative to your income and the type of contribution. A cash contribution is less likely to be challenged than a property or stock donation. If it is challenged, you simply have to provide documented proof of the donation.Double check your terminology.
Attending seminars and conferences to learn new skills or make new connections for your business? You can usually deduct these job-related expenses if you use the right label. Be careful when taking deductions for seminars. If it’s really for business, it should be called “continuing education”, not a seminar.PPP loan forgiveness.
If you received a Paycheck Protection Program (PPP) loan as part of the CARES Act this year, you may still be waiting to find out if your loan was forgiven. And that unknown outcome is causing a new layer of complexity for 2020 taxes.
According to the U.S. Department of Treasury, “If a business reasonably believes that a PPP loan will be forgiven in the future, expenses related to the loan are not deductible, whether the business has filed for forgiveness or not. In the case where a PPP loan was expected to be forgiven, and it is not, businesses will be able to deduct those expenses.”
As such, it’s wise to delay filing your taxes until you have this information — whether that means holding off on filing until the last possible moment while you await that verdict or filing for an extension.
That way, you’ll avoid having to possibly re-submit an amended tax return. Which is not necessary a red-flag event, but it is time consuming and why double your own work?Tread lightly on premature IRA distributions.
If you took a premature distribution from a qualifying plan this year because you were negatively impacted by COVID-19, the jury is still out as to whether you’ll be subject to the additional 10% tax. There’s no guidance yet explaining which circumstances will exempt someone from paying the penalty for early withdrawal.
We still don’t know how someone will prove they had COVID hardship if they did not test positive, were required to quarantine, or lost their job.