Respect Not Fear the IRA
A recent survey determined that 25% of Americans are afraid that they will be audited by the IRS – not including any other state and local tax agencies - https://www.lexingtonlaw.com/blog/news/irs-audit-preparedness.html. And rightly so; this is a belief that the IRS wants people to have. No matter what you think about his politics and him personally, Donald Trump stated in an interview that his personal and business returns were audited every year by the IRS.
Let’s face it. IRS audits do not always turn out well for the Taxpayer. Not everyone losing in an IRS audit goes to jail, but it can be a possibility. Wesley Snipes, famous actor known for portraying Blade, a vampire hunter, served 3 years in prison for criminal tax evasion – failing to file federal income tax returns. Most audits do not result in a criminal investigation, but anything could happen in an examination.
One should always respect the IRS and respect the tax law. Do not fear it. You can take any ordinary and necessary business expense deduction allowed by law. The irony is that when the survey was taken, the IRS performed the least number of audits in recent history. You may not know this but in the seventies the IRS audited 1 of every 44, according to the IRS Data Book, 2018. Now, the IRS audit rate has dropped to 1 out of every 200. Half of their audits are focused on a single issue, Earned Income Tax Credit (claimed by 1 out of 7 filers). The IRS focuses their efforts on 3 main targets:
- Small businesses such as sole proprietors and single member limited liability company (SMLLC) who operate cash businesses (subject to underreporting income)
- Small business owners such as S-Corporations, multiple member limited liability companies (MMLLC) and partnerships with pass-thru income
- Phony trusts, churches, home-based business and similar frauds and protests
While the IRS audited 0.5% of Individuals in 2018, they audited sole proprietors and SMLLC up to 2.4%. Their audit effort decreased for S Corporations, MMLLCs, and partnerships to 0.2%. The likelihood of an audit can be managed by tax planning and how you select to operate your business activity.
It is not all good news! The IRS has announced that they will be increasing their examinations on the Self-Employed/Small Business Sector by 50%. Yes. They plan to audit more small businesses such as sole-proprietors, S Corporations, MMLLCs, and partnerships. They also are focusing more examinations on the real estate industry – such as fix/flippers and landlords. The business transactions can be complicated and difficult to track and explain. The rules in this area are highly complex and open to interpretation. In 2010, the IRS announced that they found an 85% error rate in their study of 50,000 Schedule E reporting rental income.
Like Blade wading in to slay vampires, the IRS plans to wade into small businesses to get more money for our federal government. The best way to protect yourself from the IRS is tax planning. A detailed written tax plan will assist you in documenting your story and proving that you are following the rules. In addition, you can audit proof your tax return.
We offer a Weekly Community Q&A every Thursday beginning 10AM Mountain - to register email us at email@example.com. On March….,…., we will be discussing “How to Audit-Proof Your Tax Return”. You are welcome to join us.