Federal Tax Audits

If you have been chosen for a federal tax audit, rarely is it a random selection these days. There may have be something odd in your tax return that triggered it, or something untoward in the way your tax preparer has prepared your return or the returns of others.

The Accounting Hot Seat

One of the most feared enforcement actions of the Internal Revenue Service is the tax audit. A tax audit is when a taxpayer’s entire financial life is opened up for IRS examination and accounting scrutiny—down to the penny. In a way, the tax audit is a dual tool. It is used to ensure accuracy in tax returns; it is used as a looming threat to inspire taxpayer compliance and integrity.

Underreporting Income Undermines You

Naturally, taxpayers want to avoid the burdens of paying taxes. Considering all of the hard work, sacrifice, and strategic positioning they may have employed to earn it, they want to save as much of their personal fortune as possible. However, underreporting income is a serious offense to the IRS. It can lead to serious, punitive consequences. Underreporting can also undermine your ability to get loans or effectively transact in the marketplace.

Institutions will ask for your tax returns as a provable verification of income. If you have underreported each year, a lender may see you as unqualified to receive a loan amount. A realtor may see you as ineligible to purchase your dream home. Yet, in reality, you may be able to afford it with ease. But your tax returns suggest otherwise and becomes plausible reason to deny you. At that juncture, you will be reevaluating — wondering if your creative accounting was truly worth it.

Red Flags that Trigger Audits

The IRS computer system scans for all things “unlikely” or “abnormal” in your returns or tax reporting documents. For example, if all of your expense entries are figures that are less than exact to the penny, it is clear that something is awry. For instance, if you are a self-employed independent contractor, it is highly unlikely that your calculated receipts show expenses for office supplies at exactly $500.00. It is more likely that the accurate figure would be $479.22. Yes, the system will check for this and other unlikelihoods.

Schedule C forms are always given extra scrutiny. This is the form that a mom-and-pop business, sole proprietor, or single person LLC may send out on their 1040. It details all operational expenditures related to your business — the write-offs. The IRS knows that, historically, this is where a lot of people try to get “creative” with the truth.

Other areas that may trigger audits are areas like “charitable contributions.” When those numbers seem a bit high, the IRS may want you to prove the genuineness of your “generosity” that year via certifiable documentation. Since you were feeling so generous that year, why wouldn’t they want to make sure that your generosity extends to them? Always refuse the temptation to embellish those charitable contribution numbers.

The 3 Main Types of Audits

Mainly, there are three kinds of audits.

  1. The Paper Audit
  2. The Field Audit
  3. The Lifestyle Audit

The Paper Audit is rather innocuous. It is an informational audit. The IRS will request that you send in certain informational documents for their review, after which, the audit can be satisfied.

The Field Audit is a bit more invasive. This is when revenue authorities will request to visit your business or your home. Once they arrive, they may request to interview persons related to your financial operations; they may also request to review financial records and other relevant documentation.

The Lifestyle Audit is more observational. Often, this audit may take place without your knowledge. Investigators may visit your city, your business, your home, your vacation homes, your helipad and country club. They will drive by. They may park. They may hang out a while. They may observe the number of expensive, exotic cars parked in your garages. They may observe the personal jet and helicopter that takes you back and forth from business meetings or vacation destinations. Once this observational information is gathered, they may ask you why you are only claiming to make 30K per year in income. After all, your Beverly Hills residential address suggests otherwise.

Their Negligence is Yours

One of the most common ways everyday taxpayers end up audited at the state or federal level is by selecting tax preparers who are unscrupulous or incompetent. Tax preparers get in trouble with the IRS all of the time. A significant number of them are amoral, predatory, and exploitative of the uninformed tax payer. (Translated: “shady.”) Others are wholly incompetent.

Every tax preparer wants your business during tax time. And though they can “cook your books” to get you a larger return in the immediate, they can cost you thousands (or millions) when their reckless accounting triggers a group audit three years from now. This means that once impropriety is eventually detected, that preparer will be audited and so will everyone they’ve ever prepared a tax return for. And because you signed the return, you will be held accountable to their shenanigans under the penalties of perjury.

Further, investigative authorities will seek out previous clients of an unscrupulous preparer to grill them with questions about the preparer’s methods. In exchange for a personal exoneration, the taxpayer may be asked to testify against the unethical tax preparer.

Opposing Accountants

Principled or not, a tax preparer that you have hired and an IRS auditor (accountant) are diametrically opposed when it comes to the intent of their accounting. One aims to get you the largest tax refund and smallest tax liability, the other does the opposite. During an audit, it can feel like dueling accounting because it is. “Accountant A” works for you. “Accountant B” works for the IRS. Each accountant looks for every loophole and opportunity to put more coin into their client’s pocket. However, one client and one accountant have a lot more power.

Post Audit Enforcements

In some cases you will see the federal government go beyond liens, levies, and garnishments to enforce your compliance. If you have a hefty tax liability, they can involve the State Department and revoke your passport — canceling your ability to freely roam the world until the debt is satisfied. If you are holding tax debt with your state, some states also have incredible additional powers to disrupt your life until you pay up. (See: “State Tax Audits”)

Tax Debt Relief Now

If you feel that you are the subject of an unfair audit, or have been the victim of a tax preparer with questionable principles, options may be available. Having a law firm that is dually licensed in tax law as well as tax accounting is extraordinarily helpful during investigative audits.

Contact us today.

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