As an attorney helping clients with audits, I see simple mistakes turn into huge problems. If you are a small business owner, you must comply with record keeping rules and if you have no reason to save on legal fees during an audit. I receive many questions about the audit, including the procedure and timing.
Everyone is at risk for an audit, especially high net worth individuals. Often, individuals with small businesses that do well run into problems as a result of inadequate bookkeeping. As a result of the end of COVID-19, the IRS has repeatedly announced an increase in tax audits.
IRS Audit Selection Process
The IRS selects a tax return for review using several different methods. The main method is for the IRS to use computer programs to compare tax returns to statistical industry “norms” to identify outliers. This is a very targeted approach towards small businesses and the self-employed. Computer programs show underreported income, excessive deductions, such as home office and mileage deductions, and large travel, meal or entertainment expenses. The IRS also receives notices from banks of any transaction over $10,000 for the IRS.
Furthermore, every year the IRS publishes a “dirty dozen list”. Transactions on this list are known for consistent fraudulent behavior and the IRS pays attention to tax returns with all items on the list. Currently, the Employee Retention Credit (“ERC”) tops the list. The IRS is planning to audit most of the businesses that have applied for ERC as there have been promoters across the country duping ineligible people into claiming the loan.
Another big goal is cryptocurrency reporting. The fuel tax credit is intended for off-highway operations and agriculture and as such is not available to most taxpayers; however, many taxpayers claim the credit incorrectly. Over the past five years, the Tax Administration has also consistently targeted easement preservation. Further, the IRS began cracking down on nonpayment of federal income tax owed related to cryptocurrency transactions in 2019. Similar to cannabis and cryptocurrency, the rise in popularity of online gambling has led to increased IRS scrutiny of gambling revenues.
Finally, another major avenue through which audits originate is through whistleblower reports or referrals. Oftentimes, disgruntled employees will report suspected tax fraud activity, especially since the IRS and most states offer rewards for reporting taxpayer fraud.
Although the odds are in your favor, if you are a small business, you should always try to be compliant as many small things can trigger an audit. .
General audit process
Most taxpayers do not understand the full power of the Tax Administration. First, the IRS will generally send notices and introduce a revenue agent. The Revenue Agent then sends an Information Document Request (IDR) to request a list of documentation. The IRS has a list of documents they usually ask for, which includes receipts, insurance reports, medical records, journals or diaries, maps and other documents related to the tax relief claimed.
Next, the audit involves a conversation with the taxpayer, usually the managing shareholder or partner of the company. This interview allows the IRS to understand the premise of the business and any additional questions related to the first IDR. Before this interview, it is important that you prepare, which includes reviewing previous IDR responses, including previously submitted documentation. Revenue agents generally want to see all books and records for the last three tax years.
After the interview, the revenue agent may send follow-up IDRs or conduct a field visit. A field visit is one in which a revenue agent visits the business and possibly interacts with employees. With this visit, they want to make sure that your company is really engaged in the activities you described in the interview.
Once the revenue agent has completed his investigative process, he will issue a report and hold a closing conference. In case you disagree with the report, you can ask to speak to their manager, go to IRS Appeals or even petition the USTCUSTC.
Items to remember
I always caution 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 during the initial interview. First, the attorney knows why the revenue agent is asking specific questions. Second, it can defuse tensions.
Audits are avoided – they ask detailed questions about the past three years of business operations. The interview may be in person or over the phone depending on the tax agent. Revenue agents are there to ensure that individuals do not take advantage of the system. As a result, they act as investigators, looking to track down every penny your business, and possibly you, has received in the past three years.
If for any reason the tax agent feels that you are telling the truth, he will expand the inquiry to include not only the previous three years of business, but also any other businesses in which you have an ownership interest, as well as your personal income tax returns. In addition, if they believe you are not answering truthfully and providing all documents, under Section 7602, the IRS has the authority to contact third parties. They must send a notice before engaging in this activity, but it is an option.
As a result, it is important that you always keep accurate and clear records of your books. If you are able to easily provide documentation of everything, the process will be quite simple and straightforward. Meanwhile, if things aren’t clear, you could end up spending more in legal fees than you owe in taxes.
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I have dedicated my career to simplifying the Tax Code. As a tax attorney, I understand that there are very few resources for the general population. Additionally, I know that tax laws and the IRS are daunting. I try to relieve the stress of clients through my work at Pontius Tak Lav. In my spare time, I cook and kayak with my wife and two wonderful children; as a result, I know that nothing is more important than family. To enable others to spend more carefree time with their families, I: (i) provide legal strategies to ease the tax burden; (ii) assist in the audit process; and (iii) helping individuals and corporations pay back taxes.
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