Articles Tagged with audit

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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