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Articles Posted in Audit

It seems at times as though the IRS is an all-knowing, all-powerful entity that no one can escape. You can’t run, and you can’t hide. They know how much money you make, how much you have in your bank and investment accounts, and even how much you won while playing roulette at the casino last week. But the real question is: do they truly know all of this? Or do we just assume they do? How can they obtain all this personal information? The answer is pretty simple. In reality, the IRS does have plenty of financially insightful access to everything from your bank accounts to every tax form submitted with your name and social security number on it. But is there a limit to “Big Brother’s” financial access?

How Does the IRS Know That I Have Undisclosed Income?

The IRS uses a sophisticated computer system in order to match up your income as reported on your tax return with everything that your employers have reported under your name and social security number. For example, if you submit a return that only has the money that you’ve made from one client or job, neglecting to enter any of your other income, the IRS’ computers will catch the mistake. Then, you’ll receive a letter from them informing you of their findings and their impact on your current tax situation.

Audits are not a welcomed entity in anyone’s eyes. So, if you’ve just received a notice informing you of an impending IRS audit and state audit, do not panic. In some cases, people or businesses are selected for an audit at random. In others, an IRS audit is triggered by issues with your tax return, either because something appears irregular or incorrect or people associated with you, such as your business partners, are being audited as well. This dreaded process if often filled with stress and fraught with mixed emotions, because it may result in you having to pay fines or back taxes if the IRS or state agents find discrepancies on your filed tax forms. The good news is that riding out an audit doesn’t have to be scary or intimidating, as long as you have professional tax accounting guidance and representation.

How Will You Be Informed of a Pending Audit?

Depending on the type of audit and the inconsistencies found in your taxes, you’ll either receive a certified letter or an official IRS agent will come knocking on your door. In most cases, a letter comes first. It will describe the type of audit that you’re facing (more on that below), as well as how the IRS will further contact you in order to obtain your records.

Let us begin with a simple question: who prepares your taxes? Many individuals and small businesses attempt to go it alone to cut costs, which can be problematic in a few different ways. Many times, you do not have sufficient time to prepare the documentation properly, so you opt for shortcuts that result in audited by the IRS. You might also make simple, unintentional mistakes because you are trying to balance your company’s financials and your daily business operations, leading to mistakes in your accounting. Though it will require an upfront expenditure, it will save you time, money, and future headaches.

Here are some of the many benefits that a tax professional can bring to the table for your business.

Making Estimated Payments to the IRS

Winning money at a casino, sportsbook, or via the lottery is a rollercoaster ride with its inevitable up and downs. Yes, it is undeniably exciting to win and stash a little extra cash in your pocket. But the downside that many forget in the heat of the moment, is that you owe taxes on those winnings, and if those taxes are not disclosed on your annual tax return or paid in full, you could end up with plenty of problems with the IRS. They will not hesitate to collect what is owed to them and more, should you profit from gambling winnings.

What Constitutes Gambling Winnings?

The IRS only requires people to pay taxes on a certain amount of the money that they win through gambling. These amounts vary, based on how the money is won. Here is a general breakdown to keep in mind when at the casino or racetrack:

The IRS has estimated that U.S. taxpayers underpay their taxes by around $300 billion each year. Each taxpayer is responsible for calculating their own tax bill, but the IRS also uses other sources of information. It compares the information provided on taxpayer returns to that other information. If it finds a discrepancy, it sends a notice to the taxpayer. For years, the IRS used a form known as the CP2000 Notice, or the “Notice of Underreported Income.” The IRS recently began to use another form, the CP2057. Taxpayers should be aware of both notices, and our California tax advisors urge you to be aware of what you should do if you receive either one.

Warning Letters

Federal law gives the IRS extensive authority to collect unpaid taxes, but the process involves a lengthy series of notices. CP2000 and CP2057 are preliminary notices. They are not “bills,” in the sense that receiving one of these notices does not immediately trigger an obligation for the taxpayer to send money to the IRS. Instead, they are ways for the IRS to notify a taxpayer about discrepancies in their file, and to give them an opportunity to correct the information.

In order for the IRS to pursue a collection action against a taxpayer, they must send a formal notice and demand for payment, known as a CP501 Notice. This notice identifies a specific amount owed and gives a deadline for payment. If the taxpayer fails to pay by the deadline, or otherwise fails to respond to the notice, the IRS can file a tax lien. If the IRS intends to levy the taxpayer’s property, it must send a CP504 Notice.

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Preparing a tax return can be a time-consuming process. It can also generate a considerable amount of paperwork. Even if you have gone “paperless,” tax records take up space on a computer or external drive that you might rather use for something fun, like family photos or video games. How long should a taxpayer keep tax records? The simple answer is that you should keep records until all applicable statutes of limitations have expired. As is so often the case, though, the simple answer only barely scratches the surface.

What Records Do You Need to Keep?

Almost any document that you used to prepare a tax return could prove to be important down the road. This could include:
– W-2’s, 1099’s, and other forms that show income;
– Receipts, mileage logs, and other documents that show deductions;
– Documents that support any tax credits that you claimed;
– Financial statements for any businesses that you own or operate; and
– Any other documents that support information included in your tax return.

Statute of Limitations for Audits

As a general rule, the IRS has three years from the due date of a particular tax return to audit it. Many exceptions apply, of course. Some are based on the taxpayer’s own alleged conduct, while others are based on the type of information involved.
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The overall percentage of federal income tax returns audited by the IRS has been decreasing over the past several years. This is at least partly due to budget cuts, which leave the IRS with fewer resources to conduct audits. People with particularly high incomes have reportedly seen a steeper decline in audit rates than other people, but they still get audited at a higher rate than the general U.S. population.

The apparent decline in IRS audits is definitely not cause to be less careful with one’s taxes, especially for high-income individuals. The Tax Cuts and Jobs Act (TCJA) of 2017 led to significant tax cuts for many people with high incomes, but it also created opportunities for tax write-offs that are likely to catch the IRS’s attention. It may take the IRS a few years to catch up to some of these new opportunities, but they almost certainly will.

Decline in Audit Rates

In 2017, the IRS audited one out of every 160 tax returns that were filed. This was the sixth year of decline in the total number of audits, and the lowest number in fifteen years. The audit rate for individuals with annual earnings of $1 million or more was higher than the rate for the general population, at more than four percent in 2017. That same group, however, was audited at a rate of almost ten percent in 2015. This is also the lowest rate since the early ‘00s.
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