When Alisa* got audited, an honest mistake on her part underscored a cold, hard truth: the IRS is not anyone’s friend.
If you’ve ever been audited, you probably feel a lot like Alisa. Maybe a little scared or confused. Maybe a little angry and agitated. Being audited is not fun.
If the IRS were a friend to Alisa, it would have kindly let her fix her error when she accidentally submitted the paperwork for her business tax returns instead of her personal tax returns. She was the one under audit, not her business, after all.
As it happened, her business return had its share of problems, and the IRS was more than happy to jump on an opportunity to collect. For the auditor to be presented with an opportunity to recover even more unpaid tax, it must have seemed like a gift.
But for Alisa, it caused unimaginable stress, a ton of anxiety, and of course, a lot of money.
Had she known her rights as a taxpayer under audit, things could have turned out differently. But how could she have known the ins and outs of the tax code and how to use that information to protect her rights?
*Alisa is not a real person. But her story is true, and there are many quite like it.
Why Do People Get Audited?
Alisa got audited due to a math error on her personal return. But things snowballed for her after she submitted the wrong return during the audit process and the IRS found more reasons to start digging into her business tax returns.
The IRS doesn’t publish when and why they audit taxpayers. But there are some general criteria that seem to be common factors in the audits seen by the team at Tax Relief USA. Some of the common red flags we see from clients who are getting audited include:
Claiming very high vehicle mileage: Many individual and business taxpayers can rightfully claim vehicle mileage on their tax return. But when the mileage being claimed creeps into the range of tens of thousands of dollars, it can start to look suspicious.
Inconsistent filings: Tax payments for most people are fairly straightforward and predictable. When you deviate from the norm, it could be noticed by the IRS. For example: you have filed a joint return with your spouse for years, and then switch your status to married filing separately – this could flag your account for a closer look. Inconsistent tax filings for businesses can earn even more scrutiny.
Schedule E: If you file a Schedule E, you’re reporting supplemental income or losses from rental property, royalties, partnerships and S corporations, or the like. Your. Schedule E can start to look suspect if rental income and expenses are not being properly reported, calculation errors on rental depreciation may throw a flag
1099 mismatch: If you are an independent contractor, you should be receiving 1099 forms from reporting any taxable income you earn. The organization issuing those 1099 forms also reports this information to the IRS. If what you’re reporting as 1099 income does not match up with the 1099 income reported to the IRS and attributed to you, then your return automatically gets flagged and you’ll receive a notice from the IRS.
Losses every year: If you are using your business expenses to claim income tax deductions every year, but you consistently report losses, your account may be flagged for review. If you report a loss for three years in a five-year period, the IRS considers your expenses to be the result of a hobby and not a profit-seeking business. The so-called “Hobby Loss Rule” is in place to keep people from writing off business expenses on endeavors that do not make a profit.
Complex stock options: Many workers in the tech sector get stock options as a perk of the job. But stock options have their own tax complexity. While these can be a valuable employee benefit, it is wise to consult with a tax advisor before exercising any stock options to ensure you understand your tax liability.
Random audit: Even if your tax return is buttoned up and perfect as can be, you can still be audited. Between 15,000 and 20,000 people are randomly selected for an audit every year.
There are, of course, many more reasons that could trigger a tax audit. Whether you’re an individual or a business, the best defense against an audit is to know your position, know the tax code, and know your rights, so if the IRS does audit you, you’re prepared. Working with a reputable tax advisor is wise if you don’t have the time, energy, or patience to deal with an audit.
Types of Tax Audits
Being audited can connote a monolithic picture of the IRS showing up at your door and demanding to see years of receipts. But there are actually three different types of audit, and they come with different levels of intensity that range from simple bookkeeping to legal challenges.
- Adjustment - With this type of audit, the IRS mails you an adjustment letter detailing changes it made to your returns, any increase or decrease in taxes, and if applicable, penalties and interest. Taxpayers typically have an option to appeal if they disagree with the changes.
- Mail audit - When you get notice of an audit in the mail, it means someone at the IRS has looked at your returns and needs information from you. For the most part, the mail audit requests documentation to prove an item the IRS is questioning on your return.
- Field audit - This is the classic scenario of someone from the IRS coming to your door. If you are involved in a field audit, there will be an IRS auditor assigned to your case and you or your representative will have to meet with them and answer questions. Field audits typically last the longest and can take multiple years for the most complex cases..
What Happens After an Audit?
The ideal scenario after an audit is no change, no balance due. This happens when you or your tax professionals are successful in arguing your case.
The other outcome of an audit is having a balance due. If you get audited and the end result is more money owed, it can feel overwhelming and frustrating. What if you had other plans for the money instead of paying it as tax? What if you can’t afford to pay what is owed? Fortunately, you have some options.
Offer in compromise - If your audit says you owe and you’re in the stressful position of being unable to pay, you might be able to negotiate an offer in compromise (OIC). If you enter an OIC, you’ll have either six months or 24 months to pay off your tax bill. You then have to remain compliant for at least the next three years. If you fail to pay what you owe after agreeing to an OIC, the entire tax liability gets assessed back.
Installment agreement - What if you just need more time to get things in order before you have to pay an unexpected tax bill? An installment agreement is essentially a payment plan for your tax balance due. Most agreements spread payment over 72 months or 84 months. Taxpayers can enter installment agreements based on their financial status or based on the amount owed and the repayment time frame. It is possible to use an installment agreement to pay less than what you owe without going through the process of an OIC.
Fresh Start - While it’s true the IRS is not your friend, the IRS is not your enemy, either. Fresh Start is a good example of an IRS program designed to help taxpayers who can’t afford to pay the taxes they owe. Fresh Start includes OICs and some installment agreements. Learn more about the Fresh Start program here.
Appealing - If you disagree with the IRS’s decision your first emotion might be anger. If you really have something to fight over, you can appeal the decision. But if you’re going to appeal, you need to know exactly what part of the return is causing your discrepancy and have documentation for what the numbers should be. When you file for an appeal, you’ll get an appeals officer and your case will go to a new IRS auditor for an independent review. If you’re going to appeal you really need to have representation by a tax professional who can do research and fight for your tax position. If you have strong representation, you can often win the appeal or at least soften the blow of the assessment. If appealing is unsuccessful, you will need to be ready to go to tax court if you still want to pursue your position.
What is the Best Defense against an Audit? Go on the Offensive.
Know your rights. Alisa in the story at the top of this post made an honest mistake that gave the IRS an unexpected look at her business. She didn’t have enough knowledge about her rights as a taxpayer to stop the IRS from coming at her with a head full of steam. Being honest and prepared is the best defense you can have when you are being audited. If you have messy books or if your claims look bogus it’s not going to do you any favors.
But if you’d rather be playing offense than defense, the page to turn to in the playbook is working with a tax professional. While you can never fully preempt an audit, having your taxes done by a professional can help you avoid the pitfalls that commonly get tax returns flagged for an audit. You don’t want to end up like Alisa and get needlessly pushed around by an overzealous and aggressive auditor trying to claw revenue back into the IRS. Working with an expert tax representative is a sure-fire way to know your rights are being protected and that you are paying your fair share – and no more.
The Benefits of Working with a Tax Professional
When you work with a trusted partner like Tax Relief USA, you’ll have the benefit of expert knowledge and decades of experience working directly with the IRS on every imaginable tax situation. We have more relevant expertise and flexibility than most CPAs or attorneys. As enrolled agents, the team at Tax Relief USA is federally licensed to practice before the IRS in all 50 states and federally, and we can speak on your behalf, and submit returns and other documentation for you as well.
Additionally, our status as enrolled agents means we have to play by the rules and follow the law. This puts us in a position of mutual understanding and respect with the IRS, which in our experience, helps get our clients’ issues resolved quickly.
Want to learn more about how Tax Relief USA can help you resolve your issues with the IRS? Give us a call at (408) 533-1814 or answer a few questions here to get tax help now.