One of the worst things anyone can do when receiving an IRS audit letter is to ignore it. IRS will inevitably follow through with their proposed assessments if not contested. Tax Doctor Dean Michael recommends professional representation for all examination inquiries.
It is a common belief that if no wrong doing occurred, being completely honest with the IRS should eradicate the problem at hand. This is definitely the wrong thing to do. It’s not that taxpayers should be dishonest with the IRS but information given to them may be used in a manner for which it was not intended. Taxpayers representing themselves in an audit have a tendency to provide the IRS with more information than was requested. This can prove to work against the taxpayer when the IRS uses this information to propose additional tax assessments.
There is an old cliché “never talk to the cops without an attorney”. It’s the same thing here. Seasoned tax professionals will know which supporting documentation should be used in case defense and will not provide anything else to IRS other than what is needed/requested.
As for preventing an audit, there are some red flag IRS audit triggers the government looks for when considering an IRS audit:
Red Flag #1: Manipulating allowable expenses/deductions
If a taxpayer is claiming a percentage of their house as a home office, there is a specific equation used to determine the amount of that deduction. Many taxpayers go overboard with expenses and deductions that simply don’t make sense. In this type of examination, the IRS will personally visit the house to inspect the size and manner of the area claimed as office space. If it is not set up with office equipment only, they can disallow the deduction stating it was not primarily used for office space only.
Red Flag #2: Under-Reporting Income
Not claiming the true amount of income earned for any given year is a perfect example of this. Let’s say in 2010 a taxpayer claimed he only made $11,000 in total income for the year. In that same year this person paid $16,000 in mortgage interest. Obviously these numbers don’t add up since it would be impossible to pay $16,000 in mortgage interest if that person only made $11,000 in total income. This is a very obvious example for purposes of explanation and why the IRS would raise a red flag on this one. There are many other calculations used to create possible red flags that are not so obvious but is still caught by the IRS. In the eyes of the IRS, the math does not lie.
Red Flag #3: Major Refund Differences
In this example prior to this year, a taxpayer has received relatively the same tax refunds for 4 years in a row in the amount of $2000. Last year this taxpayer filed a tax return claiming the same annual income as every other year but the refund significantly increased up to $6000. While processing this year’s tax return IRS notices another $6000 refund yet again with no change in annual income. This will immediately flag that taxpayer for an audit. In this scenario there are a number of years where close to the same refund amount was received consecutively year after year. No significant change in the amount of income yet a major difference in refund. In the eyes of the IRS a noticeably increased refund without a difference in income could be due to “creative/exaggerated tax preparation”.
A dishonest tax accountant may use any number of creative calculations to generate a larger refund thereby causing an IRS audit. It’s important to understand IRS will typically pull a return for examination three years after it’s been processed. This being said, the money saved or gained trying to fudge on taxes will be paid back to the IRS tenfold when they catch on. The simple fact that IRS does not flag a return for audit unless it’s already been in their system for three years should be an eye opener. This means when additional taxes are assessed during audit, that amount comes with three years of penalties and interest added to it.
There is more trouble to come if an audit defense is not performed correctly and the discrepancies are not proven to be legitimate write-offs by the taxpayer during the initial IRS audit. IRS will then automatically pull two more years of tax returns to examine for the same discrepancies. . The old cliché rings through on this one “If it’s too good to be true, it probably is”. Don’t be fooled by promises of big refunds or tax debt settlements for “pennies on the dollar”. There are ways to take advantage of certain allowable tax benefits and obtain real solutions for specific tax problems. It’s taken 17 years of tax resolution experience and working with literally hundreds of tax professionals to realize which avenues can legally be taken to protect taxpayers.
These are a few ways how to avoid being audited. There are many more “red flags” that can generate an IRS audit here.
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