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How to Avoid an IRS Audit

How to Avoid an IRS Audit

While there is no guaranteed method of avoiding tax audits, there are things that could help trigger them. Since the Senate approved nearly $80 billion in IRS funding through the Inflation Reduction Act of 2022, with $45.6 billion specifically for enforcement, the IRS has promised an increase in tax audits.  Below are some things that the IRS has historically viewed as “red flags,” which could increase the chances of an audit for taxpayers. But first, let’s review the different types of audits. 

Types of IRS Audits 

The IRS conducts different types of audits to review and verify taxpayers’ financial information and ensure compliance with tax laws. There are three primary types of IRS audits: 

  • Correspondence Audits: These are the most common and least intrusive type of IRS audit. In a correspondence audit, the IRS requests specific documentation to support claims on their tax return. Typically, these audits are focused on one or a few specific issues, such as income, deductions, or credits. Taxpayers can respond to these audits by mail, providing the requested documentation and explanations. 
  • Office Audits: An office audit, as the name suggests, takes place at an IRS office or a local IRS branch office. The IRS will contact the taxpayer to schedule a face-to-face appointment for the audit. The taxpayer will be required to bring the necessary records and documentation to the IRS office. Office audits are often more comprehensive than correspondence audits as they can cover a wider range of issues on a tax return. 
  • Field Audits: Field audits are the most extensive and thorough type of IRS audit. In a field audit, an IRS agent comes to the taxpayer’s home or business to conduct the audit in person. These audits are usually reserved for more complex or high-risk cases. That said, they can involve a comprehensive review of a taxpayer’s financial records and activities. Field audits are often conducted when there are significant discrepancies or concerns about a taxpayer’s compliance with tax laws. However, note that the IRS has halted most unannounced visits to taxpayers. 

Reporting a Business Loss  

The IRS will be more inclined to audit a taxpayer who reports a net business loss, even if it’s small. Reporting losses year after year will only increase IRS interest in your tax returns. Remember, it is mandatory to report all earnings in a tax year. However, it might be helpful to reconsider which expenses should be deducted from your tax return. Reporting even a small profit could reduce the chance of being audited by the IRS.  

Being Vague About Expenses 

When it comes to expenses, the more detail the better. This is especially true when categorizing them on your return. Try to avoid listing expenses under “Other Expenses” as this will lead to more scrutiny from the IRS. It may even be helpful to provide supplemental documentation explaining why certain expenses drastically increased or decreased for that year. Doing so can give potential auditors a valid explanation for such occurrences and possibly avoid a tax audit. Additionally, rounding dollar amounts are red flags for the IRS. You should always use exact dollar amounts on your tax return. 

Filing Late 

Some taxpayers believe that filing late can actually decrease the risk of being audited. However, filing on time, as well as paying on time, can help establish a history of IRS compliance. This will be far more beneficial in the long run.  In addition, not filing by the due date will also result in receiving your tax refund later if you are expecting one. Even worse, if your late filing triggers an audit, it may prompt the IRS to look at older tax returns you’ve filed. If they find any other errors, this can add additional time to their normal processing schedule. 

Claiming Excessive Deductions 

It is best to avoid any excessive expenses. For example, deducting the cost of your breakfast and lunch each workday may not be acceptable to the IRS. Excessive deductions for your donations to charitable organizations can also increase the chances of being audited. Inflating business expenses can result in being audited, especially if you try to claim large amounts for business entertainment or claim a vehicle that is used for only business purposes 100 percent of the time.

Now that home offices are more common, it’s important to only claim the home office deduction for the portion of your home that is used exclusively for business purposes. When claiming this deduction, you will need to figure out how much square footage in your home is dedicated to your business. For tax year 2023, the rate for the simplified square footage calculation is $5 per square foot, with a maximum of 300 square feet or $1,500. Excessive deductions claimed on your return are fast tracks to being audited by the IRS. That said, it’s best to only claim the deductions you actually qualify for to avoid owing any additional taxes. 

Keeping Poor Records

Even the simplest tax situations require adequate records. If your finances are more complicated, then detailed records are necessary. Some taxpayers may feel inclined to estimate their expenses because they did not save receipts or documents, which the IRS views as a red flag. It’s important to make sure you have detailed records for the past three tax years at minimum. Having items like your previous tax returns, medical bills, business receipts, real estate documents, and investment statements can help substantiate your claims and avoid an IRS audit.

Choosing the Wrong Filing Status

Your filing status (single, married filing jointly, married filing separately or head of household) determines how you treat many tax decisions, such as what forms you’ll fill out, which deductions and credits you’ll take and how much you will pay (or save) in taxes. Select the wrong status, and it will trigger a cascade of mistakes–maybe even an audit. On top of that, if you decide to file jointly with your spouse, this means you’re responsible for any errors or deliberate falsehoods on your partner’s return, so make sure that you’re comfortable with what it says.

Tax Relief for Those Being Audited 

The chances of being audited are low, but those chances increase when the IRS notices any of the above red flags. The audit process can be very stressful. It is a tedious process that requires collecting information regarding your income, expenses, and itemized deductions. Failing an audit can result in a huge, unexpected tax bill. It’s best to seek assistance from experts who can help you avoid an IRS audit. Remember, filing your taxes correctly the first time can help avoid interest, tax penalties, and additional taxes owed. Optima Tax Relief is the nation’s leading tax resolution firm with over $1 billion in resolved tax liabilities. 

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What You Need to Know About State Tax Audits

what you need to know about state tax audits

We often discuss IRS tax audits, but you can just as easily be audited by your state. 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. It will also note 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 lead to the acceptance of your state tax return with no further action needed. However, 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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