There are two words no accountant nor their clients wants to hear--IRS AUDIT. However, sometimes it happens that the IRS will chose your client for an income tax audit, and the list of some of the reasons a client may have been flagged for an audit are listed below:
Unfortunately, an IRS computer is to blame for most audits. Every tax return filed is analyzed by a computer program called the Discriminant Function (DIF), and it scores your return compared to other returns similar to yours. Based on that score, the DIF will determine if you are a candidate for an audit. For example, if you have a business that made $100,000 in sales and you took a deduction of $ 75,000 in advertising (not many businesses spend most of their sales income on advertising), chances are you’ll raise flags. Though only a small percentage of tax returns are actually audited, deductions like these will surely increase the chances. Trust me, you don’t want to win this lottery.
Factors that send up a red flag to the IRS that you may need to be audited:
Comparative size of the item to the rest of the return. This is like the advertising analogy. It does not make sense to the IRS that you spent 75 percent of your income on one expense.
An item on the return is out of character for the taxpayer. Example: A restaurant owner claiming 25 percent of their expenses on travel.
An item is reported in an inappropriate place on the return. For example, $2,000 of credit card interest is reported as a business expense. The IRS might suspect that you improperly deducted personal interest as a business deduction.
Evidence of intent to mislead on the return. Filing a tax return with missing schedules or not providing all the information asked for on the forms raises questions.
Your gross income. The IRS targets higher earners. If you make over $100,000 per year, your odds of an audit are 1 in 20 versus 1 in 100 for the general population.
Self-employment income. The IRS is most suspicious of people in business for themselves. Sole proprietors are four times more likely to be audited than a wage earner.
Losses from businesses and investments claimed on the tax return. If your business and investments show losses on your tax return, the IRS may want to know how you paid your bills. Taxpayers reporting a small business loss are most likely to be audited.
Sloppiness and round numbers. A messy return, especially if handwritten, attracts attention. The use of rounding is a dead giveaway that you are estimating and not reporting from records.
So how do you help your clients avoid an audit? One way is to make sure they are not doing any of the things listed above that will sending up red flags to the IRS. However, if you client has been tagged for an IRS audit, the first thing to do is make sure they have the back-up to support deductions. And not just copies of credit card purchases, they need actual receipts. Make sure to stress to new clients when you begin handling their finances and bookkeeping that they keep receipts for every single thing they spend that involves their business. If they have done this, an audit should not be the scary thing it could turn out to be without these important documents that justify certain deductions.
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