Many small business owners are not particularly aware of the IRS audit process. Audits are conducted by the Internal Revenue Service (IRS) to ensure that tax payments are made promptly and that taxes are paid according to the law. The grounds for an audit can vary but generally include suspicion of tax evasion or fraud. An audit may be initiated if the IRS believes that taxes have not been paid accurately or on time. An audit reviews financial records to determine if they match what is stated on a taxpayer's tax return.
This article will mainly provide you with a basic understanding of how an IRS audit works and what you can specifically do to prepare for one. If you're worried that the IRS might be looking into your taxes, there are a few things you can mainly do to help prevent an audit. For the IRS to initiate an audit, they must have specific grounds, such as evidence of income or deductions that do not appear on the return. Taxpayers may be asked to provide additional documentation, such as bank statements, W-2 forms, or pay stubs. Natural pay stub generators can help you generate accurate paystubs that will help the IRS track your income and deductions.
1. Underreporting Your Income:
If you underreport your income on your tax return, the IRS may audit your return. The IRS can identify underreported income by reviewing your tax returns and other financial information. The IRS may also use forensic accounting techniques to determine your underreported income. If the IRS audits your return and determines that you have underreported income, you may be subject to a penalty or interest on the underreported income. You may also have to pay back any overpaid taxes due to the understatement of your income. In some cases, you could be disqualified from obtaining federal government benefits for some time.
Thus, the prominent reason for an audit is if the taxpayer failed to report all of their income. This could include underreporting income from wages, tips, or other forms of compensation. If you're unsure whether your payment has been accurately reported, it may be helpful to speak with a tax accountant or tax preparer. This one is pretty self-explanatory. The IRS requires you to report all income sources, whether from a traditional job or investments. If you fail to report any sources of income, it will trigger an audit. Be sure to keep good records and report all sources of income on your tax return.
2. Claiming Excessive Deductions:
There is a fine line between taking the deductions you are entitled to and making too many assumptions. When in particular doubt, it is always good to err on caution. Taking too many conclusions can raise red flags with the IRS and lead to an audit. Again, good record keeping is vital. Make sure you have documentation to support any deductions you claim on your tax return. The IRS has standards for what qualifies as a legitimate deduction, and if your beliefs seem excessive compared to other taxpayers in your income bracket, you could trigger an audit. For example, if you're in the 25% tax bracket and claim $50,000 in deductions, that might raise some eyebrows at the IRS. So, if you plan on claiming a lot of assumptions, make sure you have documentation to back them up in case you get audited.
3. Filing A Suspicious Return:
This one is a bit less clear-cut than the first two. If your tax return seems fishy to the IRS, they may flag it for an audit. This could be because your return includes many errors, missing information, or claims deductions that are not common for your profession or income level. If your tax return raises any red flags, you could be selected for an audit. Filing a suspicious return can be an early warning sign that someone may be attempting to commit tax fraud. The IRS has several tools to investigate potential tax fraud, including conducting an audit.
4. Earned A Lot Of Money
Suppose you made a lot of money last year, congratulations! However, you should also be aware that earning a high income makes you more likely to get audited. This is because the IRS knows that people who make a lot of money are more likely to have complex financial situations and to take advantage of tax loopholes. So, if you made more than $200,000 last year, be prepared for the possibility of an audit. If you have earned a lot of money, you may be subject to an audit by the Internal Revenue Service. The IRS audits individuals and businesses to make sure that they are paying the correct amount of taxes. An audit can be particularly a stressful experience, but it is essential to know your rights. Workation can be a great thing to have on your side when you are selected for an audit due to a lot of earned money because it can help prove your income clearly and concisely.
5. Filed a Form 1040-EZ
If you want to avoid an audit, steer clear of Form 1040-EZ. The form is meant for people with straightforward tax situations, such as those who are single with no dependents and who only receive wages from their job (no investments or side hustles). The problem is that many people who are not eligible for the form use it anyway because it's faster and easier than filing a regular 1040 tax return. If you file a 1040-EZ and your situation is even slightly complex (for example, you have multiple jobs or interest income), there's a good chance you'll get audited.
6. Claiming Business Losses:
When an individual files their taxes, they must list all the income earned during the year. This includes any money they have made from their job and any money they have received from investments or royalties. If an individual believes they have lost money during the year, they can claim this as a business loss. There are a few things that an individual needs to consider to make this claim.
First, the individual needs to be sure that the business loss was incurred during the year. This means that it cannot be something like a depreciation deduction for equipment used in the business. Second, the individual needs to be sure that a loss is involved. This means there was not enough money left over at the end of the year after everything was paid for and bills were paid. If these two conditions are met, you can claim a business loss on your taxes.
Final Thoughts:
As you can see, there are various particular things that you can do to prepare yourself for an upcoming IRS audit. It is essential to remember that no one is immune from audits – even large businesses. No one explicitly wants to deal with an IRS audit, but unfortunately, they happen from time to time. If you are being audited, don't panic – just be prepared with documentation to support your claims. And remember, being audited does not necessarily mean that you did anything wrong – sometimes audits are simply done at random.