Strategies to Avoid an IRS Audit

With the recent passing of the Inflation Reduction Act, the IRS has been given an 80 billion significant budget increase, effectively doubling the size of the agency. This means that IRS enforcement is on the rise, making it more important than ever to understand how to minimize the risk of an audit. In this topic, we will explore the steps individuals and businesses can take to ensure compliance with tax laws and reduce the chances of facing an IRS audit.

Filing Tax Returns

Failing to file your tax returns is one of the quickest ways to attract the attention of the IRS and increase the risk of an audit. Many taxpayers who don’t think they have enough money or are unable to pay taxes may be tempted to avoid filing. The IRS may file an SFR (Substitute Tax Return)on your behalf, and begin calculating penalties, interest, and taxes owed. IRS will start the collection process based on SFR for the amount you own, this can cause significant problems and stress in the long run.

It is highly recommended to file your taxes even if you don’t owe any money or have no income. Penalties and interest for not filing can be severe, and in some cases, you may be able to get on a  full pay Installment Agreement, Partial Payment Installment Agreement or be placed in an ‘uncollectible status‘ also referred as CNC(Currently not collectible).

Avoid Schedule C

Small business ownership can be a great way to save on taxes, but reporting it as a sole proprietorship(SCH C) can significantly increase the risk of an audit. To minimize this risk, it’s recommended to file as a partnership or corporation when it’s financially affordable. Consistent losses can also raise red flags for the IRS and lead to questions about whether the business is actually a hobby rather than a legitimate business.

On the other hand, if the business is making large amounts of money, choosing to file as an S-Corporation can significantly reduce the risk of an audit and provide more opportunities for legal write-offs. Statistics show that choosing an S-Corp can reduce the risk of an audit.

Complying with 1099 Reporting Requirements

Properly issuing 1099s is a crucial aspect of avoiding an audit from the IRS. When claiming deductions for payments made to subcontractors, it’s essential to follow proper reporting procedures and issue the appropriate 1099 forms in January. Failure to do so can raise red flags for the IRS.

To ensure compliance, it’s recommended to request W-9 forms from all subcontractors before making any payments. If the deadline for issuing 1099s has already passed this year, take steps to prevent it from happening again in the future. By following proper 1099 reporting procedures, you can significantly reduce the risk of an IRS audit.

 Accurate Record Keeping and Avoid Round Numbers

One of the common mistakes that can trigger an audit is the use of round numbers on tax returns, such as $800 instead of $798.16. This is a major red flag for the IRS, as it raises questions about the accuracy of the deductions claimed.

It’s important to maintain accurate records and avoid estimating expenses. Good bookkeeping is the key to ensure that you have accurate numbers, and it also helps to avoid any confusion or discrepancies when filing your tax returns. By being accurate and keeping good records, you can avoid using round numbers and reduce the risk of an audit.

Know your Industry Average Expenses

When filing a tax return, it’s important to be aware of the industry averages and common expenses for your field. The IRS uses the information provided on tax returns to categorize expenses and compare them to income levels. This can raise red flags for abnormal expense levels, which can increase the risk of an audit.

You should have all the necessary receipts and support to back up your claim.

Balancing The Home Office Deduction

Claiming the home office deduction can be a legitimate way to save on taxes, but it’s important not to be too aggressive. The IRS is aware that some taxpayers may inflate this deduction to reduce their tax liability. However, it is a legitimate deduction, even if you have an S-Corporation. It’s important to have a clear procedure in place when claiming the home office deduction and  avoid being greedy.

you can take advantage of the home office deduction without increasing your risk of an audit.

Balancing Dining and Travel Expenses

Dining and travel expenses can be a legitimate way to reduce your tax liability, but it’s important to ensure that they look normal, well-balanced, and conform to your income level and industry. Taking excessive deductions for these expenses can raise red flags for the IRS and increase the risk of an audit.

DO NOT ignore IRS Notices

Ignoring notices or letters from the IRS is not a good strategy, as it will only make the situation worse. If you don’t file or don’t respond, the IRS will assume the worst and take aggressive action like garnishing you wages, take money from your bank account or other financial account, seize and sell your vehicle, real estate and other personal property. 

If you receive a notice from the IRS, it’s important to seek professional advice. An enrolled agent, who deals with the IRS regularly, will be able to advise you on the best course of action. Sometimes the notice or letter may be simple and easy to resolve, but it’s important to have a professional evaluate the situation before making any decisions. Ignoring the notice will only make the problem worse.

Conclusion: Navigating the IRS with Confidence

In conclusion, it’s important to take the deductions that you are entitled to, as long as you have good records to back them up. It’s also important to file your returns on time and ensure that they don’t look so aggressive, as this can increase the risk of an audit.

 By being organized, accurate and following the rules, you can navigate the IRS process with confidence.