This year we compiled a list of perhaps the most important things you need to know about getting audited by the IRS. The “good news” is that IRS office examinations are perhaps at an all time low. The “bad news” is that there are perhaps more examinations than ever but most of the examinations are done by getting a letter from the IRS or correspondence audits. Make no mistake that getting that IRS letter is still an audit and you’re probably going to need professional representation even if first appears like something you can do yourself. If the IRS finds a problem in one year there’s a really good chance they’re going to look at the year before and the year after as well. Here’s a list of 12 IRS Red Flags you’ll need to look for.
1. Leaving Off Income From Your Return
Perhaps this is the most common mistake we see! Just because you didn’t put it on your return, doesn’t mean the IRS doesn’t know about it. Do you really want to risk it? It doesn’t matter if its $100 or $100,000. Leave it off and there’s a really good chance you’ll get caught. Simply saying you forgot about it, or you really didn’t make any money after considering your expenses is not good enough. The IRS won’t usually call you in on this for a year or two later. The IRS generally has three years to audit you. If you leave it off and its large enough, no matter what your expenses were, the IRS now has six years to audit you. Most common here are self-employment income and stock sales. It doesn’t matter that you didn’t make any money. What matters is that you didn’t report it and you should have.
2. Meals and Entertainment
You will need to support business meals and entertainment deductions. Simply paying these expenses through your business account is not enough. The IRS will take the position that all amounts claimed for business meals and entertainment is not deductible. You will need to support who, when, why and the amounts paid for each expense. Don’t make the mistake of trying to write-off every little meal expense. Chances are good that you’re not entertaining business clients at McDonalds or PizzaHut. Chances are you’re trying to deduct all your meals just because you have a business. Well … you can’t. Meals and entertainment is perhaps the most frequently attacked deduction by the IRS because the IRS knows that you most probably didn’t keep the documentation you need to support your deduction. On the other hand, just because you didn’t do everything “right” doesn’t mean you’re not entitled to the deductions. It just means that you’ve got a lot of work ahead to sort this out before you get to the audit.
3. Automobile expenses
Claiming amounts paid for business automobile use will be disallowed where you cannot support the business use of your vehicle. Hopefully, you already know that the IRS requires you to maintain mileage logs showing who, when and why you used your vehicle for business. Simply paying these expenses through your business account is not enough. The IRS will often take the position that amounts claimed for business automobile are not deductible. The “burden of proof” lies with you (not the IRS) to show that amounts you claimed are both reasonable and ordinary. Just because you don’t have the mileage logs doesn’t necessarily mean you don’t qualify. For example, you may be able to show bills for auto repairs that have your mileage on different dates showing how much you actually used your car. You may also be able to assert reasonableness of the deduction given you occupation if, for example, you are a realtor or Uber driver. There’s often a lot that can be done here given that you’re working with the right professional.
4. Home office deduction
Claiming the home office deduction is allowed only when you exclusively use a portion of your home for business. Perhaps the most difficult hurdle to overcome is the exclusive use requirement. Having a spare bedroom which has your desk and computer is not enough. A multi-purpose room in which you keep your home gym equipment or also serves as the kid’s playroom will almost certainly disallow the deduction. Having an office or place of business outside of your home where you work will similarly cast doubt on whether or not the home office is actually needed, or one of convenience for you. Recent changes in tax law also allow for a “safe harbor” method of taking the deduction for a smaller amount. Many taxpayers simply don’t want to take the deduction feeling its an audit red flag. That’s not necessarily correct. If you’re entitled to it, you probably should take the deduction. If its questionable, you may opt to simply not go there. A well-seasoned tax preparer will probably be your best source to see what works for you.
5. Claiming Labor Expenses
Now I’m not talking salaries here. I’m talking about expenses you pay to others who do work for you. This ranges from your lawyer, your accountant, your assistant, your workers to even the people who clean your office. Don’t give them a Form 1099 and you’re probably not going to get the deduction. It doesn’t matter that you paid it. You didn’t report it. Argue the point and you could get hit with penalties for the failure to report it and withhold taxes. You can even get hit with penalties for the failure to claim them as your employees.
6. “I’ve Got No Receipts”
This is a big one! Just because you paid for it, doesn’t mean you can take the deduction. The law is clear. You need to maintain evidence of what you paid, to whom and for what. Going to Best Buy and spending $1,000 does not necessarily mean you spent it on new office equipment. You could have simply bought school supplies for your daughter. You need to have receipts of what you purchased and why.
The “good news” is that even if you have no receipts, you may be allowed many deductions that can be reasonably expected based on the work that you do based on supporting case law. Its not the best position to be in but in some cases we have no choice but to assert this privilege where your receipts have been destroyed or otherwise lost. Its never in your best interests to simply withhold information you may have or otherwise be able to get if you put in the time and efforts. However, in those cases where absolutely nothing can be found, you may have no choice.
7. Living EXTRAVAGANTLY
You may not feel your living extravagantly, but the IRS agent may disagree! Showing up with a new Gucci purse, putting the keys to your new Mercedes on the table, or inviting the revenue agent into your house may all seem innocent enough … after all, you paid for all these items with income you claimed. Or so you thought. But that examiner may find your lifestyle a bit too lavish based on the income you’re reporting. Even if someone gifted it to you the question remains “why”. Did you know that someone giving you money or property over $14,000 is usually required to file a gift tax return? Inviting the IRS to your office or home sometimes can’t be avoided. Having professional representation will help you prepare your answers and avoid embarrassing situations.
8. Internet Posting
Sure, you’re proud of your business. And you may even embellish your qualifications on the Internet. After all, who doesn’t. Your internet site makes you look like a “big shot” with lots of customers, experience, references and pictures. But what if that’s really not you. What if you claim your sales are much larger than you’re reporting. Or what if your friends on FaceBook are not the most honest people around. What if your big mouth gets your friend to report you to the IRS as a tax dodger. Ask me about the time I mistakenly posted something negative about the IRS on the Internet and received 3 calls from the IRS the same day! The IRS is watching and you can be assured the IRS agent will be looking you up as well. After all, it only takes a few clicks.
9. Claiming Education Deductions
Yes, you can receive a tax credit for expenses paid for education. However, not everyone qualifies. Just saying you did doesn’t work. Qualifying educational institutions are generally required to report your qualifying expenses. If you take the deduction you can almost guarantee the IRS will look for the matching deduction reported. If no deduction was reported you’re going to have to explain yourself. Claiming the deduction and wait until you get caught doesn’t work either. You’ll get nailed for taxes, penalties and interest and will likely be on the IRS watch list for sometime thereafter.
10. Using Unqualified Tax Preparers
Just because a tax preparer has a license doesn’t mean he’s any good. Disreputable tax preparers are looking to get your business by promising you a bigger refund or charging you less than you paid last year. And he’s looking to get all your friends business as well. When your friend at work tells you to use his guy and you’ll get a bigger refund, simply run the other way. That type of preparer is not worried because by the time you get audited, he’s long gone. You can’t get them on the phone, they moved, they don’t have copies of your records are all indicators that’s he not the guy for you. Even worse, when one other person’s tax return is examined, and the preparer did it wrong, the IRS is on the lookout for other tax returns that preparer put his name to. Even worse when you get audited and now they’re auditing your friend’s return as well. Get on the IRS watchlist this time and there’s a good chance the IRS will be looking at you again.
Representing taxpayers in an IRS audit is sometimes not my favorite type of work. It can be costly and often result in you getting hit with taxes, penalties and interest on any changes tax may result from the audit. I would much rather tell you you’re getting money back!
Our office handles most correspondence tax audits throughout the US and office examinations in Miami-Dade, Florida, Broward and Palm Beach counties for both individual and business taxpayers. Make no mistake about it – not having professional representation can hurt you. It can result in multiple year audits, multiple year tax adjustments and the assessment of tax penalties you may be able to otherwise avoid. Trying to do it yourself to save a couple of bucks will almost always result in you digging yourself deeper and perhaps paying more than you have to. Professional representation requires significant planning, document gathering and most often the reworking of your tax returns. Most of our work is done prior to contacting the IRS.
There is no such thing as a “simple” IRS problem
The IRS settlement process often requires months of correspondence that cannot be done in a single visit for even the most simple examinations.
We identify exposure areas to help you from having your tax problems from coming up again. If you owe money to the IRS, you should be prepared to pay it. If you cannot, we can often help arrange a payment plan or other tax settlement on your account. As each situation is a little different you should be prepared to discuss how we can best help you.