1. Be Careful with Reporting Expenses
If you report a net annual loss, the IRS may take interest in you, especially if the loss is major. The IRS may examine your return more closely if they suspect that the loss is the result of underreported income. While you must always report 100% of your income, you can avoid reporting excessive losses by reducing the number of deductions you claim. For example, writing off rent, car expenses, mileage, and technology can save you money, but they can also trigger an IRS audit if the numbers amount to more than you earned.
2. File on Time
Some believe that because fewer returns are in the pool to choose from, filing early in tax season increases the likelihood of an audit. Due to this misconception, many people file late or even ask for an extension. However, Bonadio Group partner and CPA Steven Terrigino asserts that filing after the deadline isn’t a wise strategy for avoiding an audit. Choose the filing option that is most comfortable for you, as this will create a history of compliance, including all ancillary returns—i.e., payroll and sales tax.
3. Think Before You Report Losses
The IRS can go easy on you if your business had a rough patch. Unfortunately, some business owners exploit it by showing made-up losses intentionally. The IRS’s perspective is that if you fail to make a profit in three out of the last five years, it is a hobby, not a business. The best advice: If you want business-related tax deductions, you should do your best to make profits. And don’t report losses for some peanut amounts of tax deductions.
4. Use a Separate Bank Account for Your Business
It’s advisable to use a separate bank account for your business. Not only for IRS purposes but also so you can better view all your finances. Connect it to a bookkeeping platform like Fincent. This ensures that no transactions are overlooked, simplifying your tax filing process.
5. Know Your Taxpayer Rights
Taxpayer rights are essential as they protect individuals from unfair treatment by tax authorities, ensuring a fair and transparent tax system. These rights guarantee that taxpayers can challenge the IRS’s actions, appeal decisions, and receive clear explanations of tax laws and procedures. Upholding taxpayer rights fosters trust in the tax system and maintains the principles of justice and accountability.
The Taxpayer Bill of Rights lists ten fundamental rights for all taxpayers, including:
The right to quality service and fair treatment
The right to appeal IRS decisions
The right to challenge the IRS position and be heard
The right to privacy and confidentiality
Citing these rights can help restrain invasive IRS agents who overstep their authority. Make sure any complaints reference the specific rights being violated.
6. Select a Reputable Tax Return Preparer
Getting sound tax counsel is essential if you want to legally reduce your tax liability and keep your tax return from receiving unnecessary attention. The IRS advises citizens to stay away from dishonest tax return preparers. The IRS may audit the preparer’s clients after locating them and reviewing their client list.
7. Stay Cautious About Certain Forms
Any information you enter into software, whether used by you or a tax expert to complete your tax return, automatically populates the return. But carefully consider whether to accept stances that recommend or require specific forms and schedules that all but ensure an examination by the IRS. Speak with a tax advisor about this. These include:
Form 5213, Election to Postpone Determination as to Whether the Presumption Applies That an Activity Is Engaged in for Profit – This form is used if you have an activity and want to deduct losses but are concerned that you can’t prove this is a business rather than a hobby. The form postpones any inquiry until the end of 5 years (seven years for certain horse activities) but probably assures an IRS look at your activity at that time. If you have a realistic profit motive (there are nine factors that the IRS and courts look at), you can take losses and don’t need to file the form. But be prepared to back up your belief if your return is questioned.
Form 8275, Disclosure Statement – This form tells the IRS about items or positions not otherwise adequately disclosed on the return to avoid certain penalties. Do you want to take this position?
Form 8275-R, Regulation Disclosure Statement – This form tells the IRS that a position contrary to regulations is being taken on a tax return to avoid certain penalties.
8. Avoid Using Round Numbers
Use exact numbers wherever you can because round numbers can appear suspicious. If you round up to the closest dollar, the IRS usually doesn’t object. However, if you round up by tens or hundreds of dollars to get a nice, round number, that could lead to an audit.
Acceptable: Rounding up from $2.60 to $3
Not acceptable: Rounding up from $260 to $300
Ensure you aren’t using the same numbers year after year unless the numbers are correct and you have documentation. Expenses are expected to change; if yours haven’t, that could raise some red flags.
9. Record all IRS Interactions
Record all interactions with the IRS in writing. Make follow-up phone calls with confirmation emails summarizing the conversation. Don’t provide more information than legally required. Answer questions fully, but don’t volunteer extra details. Recording all interactions with the IRS is crucial for maintaining accurate and comprehensive documentation of your tax affairs. This practice provides a reliable reference in case of disputes and ensures transparency and accountability, aiding in the smooth resolution of any tax-related matters.
10. Avoid Being a Sole Proprietor
There are benefits to operating as a sole proprietorship, such as reduced paperwork, simpler taxes, and the ability to retain all profits. However, it’s important to note that the IRS tends to exhibit a bias against sole proprietorships in tax audits, with certain statistics indicating that businesses with this status face a 300% higher likelihood of being audited.
11. Don’t Leave Questions Blank
Fill out your tax return carefully and fill in all questions. Each question on the tax form should have an appropriate answer, even if that answer is $0. Avoiding the practice of leaving IRS forms blank is essential for preventing delays and ensuring accurate processing of your tax information. Filling out every section of the forms, even if the answer is zero or not applicable, helps to avoid potential misunderstandings, reduces the likelihood of audits, and facilitates a smoother interaction with tax authorities. An unintentional oversight could get your return some extra attention.
Great points brought to you in part by Jenna Gleespen at Budget and Invest.
