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Ask Phil: Audits

Today, Optima Tax Relief’s Lead Tax Attorney, Phil Hwang, discusses his 5 top tips for how to avoid an IRS audit. 

File Your Taxes: Some taxpayers don’t file because they think they don’t have to. The minimum requirement to file a tax return depends on your filing status and income, but generally most U.S. citizens and permanent residents need to file. Remember, if you don’t file when you’re required to, you will be hit with IRS penalties and interest. The IRS could also file a tax return on your behalf. While this might sound like a burden lifted off your own shoulders, this could be much worse than filing yourself because it can result in owing more taxes. You can use the IRS’s online Interactive Tax Assistant to find out if you need to file a tax return. 

Report All Your Income: Failing to report all your income is the quickest way to being audited by the IRS. Keep in mind that the IRS receives copies of every W-2, 1099, and other tax forms that you receive. They know exactly how much you earned in the previous year and if your reported income does not match what they have on file, you’re much more likely to be audited.  

Use Common Sense with Business Expenses: This tip is for the self-employed filers. The IRS requires all business expenses to be ordinary and necessary to be deductible during tax time. This means it should be common for your industry and necessary for the production of income. Excessive meals and entertainment, trips taken for non-business purposes, and commuting costs are examples of nondeductible business expenses. 

Keep Good Records of Income and Expenses: Keeping good records of income and expenses can not only help you monitor the progress and financial well-being of your business, but also keep track of your deductible expenses, prepare your tax returns, and substantiate claims made on your tax returns. The IRS recommends keeping returns, records, and other tax documents for at least three years. 

Be Wary of Multi-Year Losses: If your business consistently reports losses during tax time, the IRS will likely audit you. In addition, the IRS only allows you to write off losses for three of the five previous tax years. If you can’t prove your business is beginning to turn a profit, even a small one, the IRS can categorize your business as a hobby, at which point you will be unable to deduct any of your expenses. 

Tune in next Friday for another episode of “Ask Phil” where Phil will review common IRS tax forms. 

If You Think You’re at Risk of Being Audited by the IRS, Contact Us Today for a Free Consultation 

Are You At Risk of IRS Audits and Collections?

The Inflation Reduction Act of 2022 has equipped the IRS with more than $80 billion in funding. That means more audits and more enforcement. CEO David King and Lead Tax Attorney Philip Hwang provide helpful tips on what you can expect from the IRS moving forward and how you can resolve your tax burden.

What You Need to Know About State Tax Audits

what you need to know about state tax audits

We often discuss tax audits conducted by the IRS, but you can just as easily be audited by your state’s Department of Revenue. Like an IRS audit, state tax audits can be stressful and intimidating for taxpayers. But what triggers a state tax audit? Is it less severe than an IRS audit? Would a state tax audit result in an automatic IRS audit? Here’s what you need to know about state tax audits. 

What is a state tax audit? 

A state tax audit is an audit performed by your state’s Department of Revenue because they believe there is a discrepancy on your state tax return. It is no less severe than an IRS audit and can result in financial and legal consequences. During the audit, your state will review your state tax return to verify that your reported income and deductions are correct. Typically, your state will send you a written notice in the mail to inform you of the audit. The notice should include the tax years they plan to review, any information you will need to provide, and their contact information. You can opt to have an accountant or tax attorney represent you during the audit or proceed without one. Once the audit is completed, your state will send you a written notice of the results. The results can result in the acceptance of your state tax return with no further action needed, but it can also result in taxes and penalties owed. The taxpayer may be entitled to appeal the judgment if they don’t agree with the audit results. Depending on the state, the appeals procedure may include a hearing before an administrative law judge or an appeals board. 

What triggers a state tax audit? 

You should be aware of frequent errors that can result in a state tax audit. These can include:  

  • Failing to record all income: You are required to report all income, including self-employment, rental, and investment income. Not doing so is one the fastest ways to trigger an audit. 
  • Being a nexus: If your business is a nexus, or a company that has a presence in one or more states, you might be at risk of a state audit. Each state will want to ensure you are complying with their individual tax laws. 
  • Failing to report use tax: If you purchase taxable items in one state and intend to use, store, or consume them in another state, you must pay use tax in your own state. For example, if you purchase a car in a state that does not charge sales tax, but plan to use the car in a state that does, you must pay use tax on the purchase price of the car in your state. 
  • Being a sole proprietor: If you are a sole proprietor and prepare your own tax returns, you may be viewed as more likely to make a mistake when filing. 

Misreporting data, math mistakes, incomplete state tax forms, excessive deductions, and failing to file your state tax return on time are some more common reasons for state audits. 

Will a state tax audit result in an automatic IRS audit? 

Your biggest worry when being audited by your state Department of Revenue is whether you will also trigger an IRS audit. While there is no certainty of this happening, it definitely is a possibility since both state and federal taxing agencies communicate with each other. Large mistakes on your state return will likely result in an IRS audit, but small mathematical errors may not. In some cases, your state might require you to amend your state return, which can impact your federal tax return, thus getting the IRS’s attention. It goes without saying that the best way to avoid a state or federal tax audit is to submit complete and accurate tax returns. Facing an audit can be stressful and intimidating but having audit representation can have a positive impact. Optima Tax Relief has over a decade of experience representing clients during both state and IRS tax audits.  

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