While many taxpayers look forward to filing season as the time they can get “free money” in the form of their tax refund, those with more complex returns are focused as well on avoiding situations that might lead to an audit.
“Things are different today than they used to be on audits,” observed Bradford Hall, managing director of Hall & Company CPAs. “They used to select returns based on various items on returns. They would review for anomalies, such as high charitable deductions which they would pick out of the crowd. Now it’s more of a matching process—Here’s what we have on you from these 1099s or 1098s, or medical deductions.’ They have information in their computer bank and they can compare it with your return.”
Of course, those whose annual earnings top $1 million are likely to be selected for audit approximately once every 10 years, Hall noted.
“But for those making less than a couple of hundred thousand, we’ve found that most audits are targeted to particular deductions or areas on the tax return,” he said. “The IRS doesn’t always tell us what it was that kicked our clients into an audit situation. But basically, they target specific areas such as auto expenses, home mortgage interest, property tax deductions or Schedule C income. Lots of times they will compare your W-2 with your bank deposits. If there are large deposits without the income to back them up, it will raise a red flag. It can be a problem for some people to remember where their deposits came from.”
“When Form 1099s come in, taxpayers need to realize that they will not get every Form 1099 that is reported to the IRS,” Hall observed. “There is a misunderstanding among taxpayers that they are only required to report amounts from the 1099s that they receive. Of course, everyone is required to report the amount of income they received throughout the year, whether they get a Form 1099 or not.”
“For every client that has a business, they’re doing at least a 14-month cash receipts test,” Hall said. “They do this for sole proprietorships, LLCs, small corporations, S corporations and general partnerships—any kind of business.”
One thing to watch out for is where a business changes its form, and receives a new federal ID number, Hall noted.
“The IRS has started to compare credit card sales to business income,” he said. “We’ve had a number of businesses where the credit card process had originally been set for a sole proprietor. The sole proprietor subsequently incorporated with a different federal ID number, and didn’t contact the credit card company to let them know that the ID number had changed. That triggered an audit, because the credit card company reported income that wasn’t on the individual tax return in the right area. Very few businesses remember to contact the credit card company and their vendors to let them know they have changed to a different entity.”
“The key to having a properly done tax return is to spend time and effort on it,” Hall said. “Most people don’t want to put in the time and the effort, and that leaves them at high risk for an audit. They should know that to the degree they spend time with their CPA the more accurate the tax return will be, and they will be able to sleep better at night knowing it’s been done properly.”