Audit rates are at historically low levels. For example, according to the latest available statistics from 2019, the overall rate was only .45%. And with the IRS understaffed and overwhelmed, don’t expect a big increase anytime soon.
Nevertheless, you should not tempt fate. Here are five tips for staying below the radar.
- Avoid mistakes. IRS computers are quick to pick up inconsistencies when they match forms they receive with your tax return entries. Ditto for math eros or other inaccuracies like incorrect Social Security numbers (SSNs). Even if you’re using a professional tax return preparer, you could set off alarms if you’ve provided the wrong information. Don’t forget to include all the taxable income reflected on the forms you’ve received.
- Be honest. This is one of those times when it pays to tell the truth. Your risk of being audited goes up immeasurably if you flat out lie about income items and deductions. That’s not to say you can’t be aggressive when you’re standing on firm ground, but don’t fudge the facts. Answer this question: Can you face an auditor and stick to your story with proof to back up your claims.
- Be realistic. You’re asking for trouble if you show deductions or credits that are outlandish or far greater than someone in similar circumstances would claim. For example, recent legislation authorized a charitable deduction for monetary gifts of up to 100% of your adjusted gross income (AGI) for 2020. But if you even come close to this mark – say, deductions equaling 80% of your AGI – if will likely raise suspicions.
- E-file. The pendulum has clearly swung from submitting paper returns to e-filing. Of the more than 165 million returns filed in 2019, an impressive 91.66% were e-filed by tax pros and individual taxpayers. When you e-file your return, the odds of being audited go down dramatically, partially because there’s less chance of making math and other entry mistakes. Of course, if you use a professional preparer, he or she is generally required by law to submit your return electronically, so you don’t have to worry.
- Use a tax pro. As alluded to above, you have a lower audit risk – but not zero – when you use a tax pro to prepare your return. Notably, you usually avoid the sort of careless errors that can lead to IRS inquiries. Plus, an experienced and knowledgeable professional can usually spot the “red flags ” that signal trouble and avoid many of them in the first place.
Be aware that there are three main types of audits. The most common type is a correspondence audit where you never meet face-to-face with an examiner. In 2019, almost three quarters of all individual audits were correspondence audits.
The second type is an office audit. Generally, the examiner will spend about 2-4 hours going over certain items on your return. With the third type of audit, the examiner usually comes to your place of business. This is the most serious type of audit and cause for the greatest concern.
What to do if you’re audited?
Despite your best efforts, the IRS might tap you for an audit in the near future. What should you do first?
Strategy: Don’t panic. This normally isn’t life-changing. There’s no reason to get in a tizzy.
Next, the smartest thing you can do is to enlist the services of a tax pro for audits other than correspondence audits. The pro will handle most mattes directly and you won’t have to do much other than answer some questions. Resist the temptation to provide more information than needed – only answer what you’re asked. Don’t volunteer anything else. In other words, if the examiner asks you a “yes or no” question, your answer should be either “yes” or “no” – period.
In most cases, you can emerge relatively unscathed with a tax pro on your side. However, if you’re bound and determined to go it alone, make sure you have supporting documentation that is readily available. Again, don’t volunteer any extra information.
Tip: Stay cool, calm and collected, and you’ll get through it.
Small Business Tax Strategies
May 2021