The Senate recently approved nearly $80 billion in IRS funding, with $45.6 billion specifically for enforcement. This new funding is expected to result in more tax audits. There is no sure way to avoid an IRS audit. However, there are some things that the IRS has generally viewed as “red flags.” These could increase the chances of an audit for taxpayers. Here are our top five tips to avoid an IRS audit.
File Your Tax Return
Currently, you must file a tax return if your gross income meets certain thresholds based on your age and filing status. If you meet the minimum income requirement and you do not file a federal income tax return, or file late. In 2024, you can be penalized 5% of your unpaid tax liability for each month your return is late. However, the penalty will not exceed 25% for your total tax balance. Additionally, you will incur a 0.5% per month for failure to pay penalty, up to 25%.
While both penalties have a cap, interest will continue to accrue until the balance is paid off. It is compounded daily at the federal short-term rate, plus an additional 3% for individuals. In 2024, the underpayment penalty is 8% for individual taxpayers. In addition, the IRS may prepare a substitute for return (SFR) on your behalf. They do this by using your W2 and 1099 forms for that tax year and even your bank account records. The SFR will likely result in a larger tax bill, since tax credits and deductions will not be claimed. In short, choosing to not file a return each year will not excuse you from paying taxes.
Report All Income
Underreporting income is one of the most common reasons taxpayers get audited. Remember, the IRS receives copies of all your W-2 and 1099 forms for the year. If incomes do not match up, they will investigate your tax situation. The IRS could then give you the IRS negligence penalty. This can cost you an additional 20% of the underpaid amount in penalties. That said, it’s always best to report all earnings the first time around.
Use Common Sense with Business Expenses
The IRS reminds taxpayers that business expenses should be “ordinary and necessary” to produce income for your specific trade or business. In other words, items like office equipment and advertising costs are fine, but you should not try to deduct your daily lunch expenses. You should always avoid comingling personal and business expenses.
Keep Good Records
Keeping good records that support your reported income is critical. This can include invoices, canceled checks, mileage logs, and other documents. The IRS recommends keeping records for three years after filing. Bookkeeping can be a tedious process, so it may be best to hire a professional if you are not up to the task.
Know How to Report Losses
The IRS will likely audit individuals and businesses that report multiple or consecutive losses. If your business claims a loss for several years, the IRS may classify it as a hobby instead of a for-profit business. Once this happens, you will not be allowed to claim a loss related to the business and you will have to prove that your “business” has an acceptable motive to earn a profit.
Tax Relief for Taxpayers
Odds of an audit increase when the IRS notices any red flags. The audit process can be tedious and taxing. Failing an audit can result in a huge, unforeseen tax bill. It’s best to seek assistance from experts who can help you avoid an IRS audit. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
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** Optima Tax Relief is a tax resolution firm independent of the IRS**