On occasion, the IRS or a state tax agency may flag your tax return for a tax audit. If this happens, you may have the state or federal government looking at you very closely. What can you do?
Avoid Errors and File an Accurate Tax Return
The best line of defense against a tax audit is to file an accurate tax return each and every time. Incorrect calculations are one thing. Most of those errors are corrected and an updated tax return is sent back to you for review. Purposely not claiming a significant amount of income, claiming a tax deduction, or claiming a tax credit could trigger a tax audit.
What Is a Tax Audit?
A tax audit is when the IRS or state tax agency decides to examine your tax return a little more closely and verify that your income, credits, and deductions are accurate. They may ask to review your records.
How Many Years Can You Be Audited?
The IRS can audit tax returns filed within the last three years. If a substantial error is identified, they may go back and review up to the last six years.
Top IRS Tax Audit Triggers and Red Flags
The Internal Revenue Service (IRS) uses both automated and human processes when selecting which filed tax returns to perform an audit. The following are the most common red flags that could encourage closer scrutiny and / or a tax audit.
1. Not reporting all income
Businesses and organizations are required to report income over a certain amount. If you are a contractor, work with a number of different entities, or have a number of brokerage accounts, it is fairly easy to overlook some income. Make sure you keep good records and report all income at tax time.
2. Maintaining foreign accounts
There are strict guidelines regarding foreign bank accounts. Make sure you follow these guidelines with due diligence.
3. Excessive business expenses
The IRS will give a close look to excessive business tax deductions. Travel, business meals, and other business expenses should fall within your industry norms.
4. Being a high earner
According to IRS data, less than 1% of those earning less than $200,000 get audited. However, 4% of those earning over $200,000 and 12.5% of those earning over $1 million get audited.
IRS Tax Audit Penalties
The IRS has a number of layers of penalties depending on how late you take action and how much the IRS determines you owe.
A late filing penalty can be 5 to 25 percent of the unpaid tax. A minimum penalty of $135 may be charged for tax returns filed more than 60 days late.
If an audit results in accuracy related penalties, the IRS adds interest of 3 percent annually to the amount of your penalty.
If you are found to have committed civil fraud, the IRS can charge a 75% penalty on all underpaid tax that resulted from fraudulent activity.
If criminal charges are filed, you could be sentenced to up to a year in jail plus $25,000 in fines for each year that you failed to file. The statute of limitations for criminal charges is six years; there is no statute of limitation for civil charges.
If you are convicted of filing a fraudulent return as a result of an audit or as a result of IRS investigation, you could face up to 3 years in prison and up to $100,000 in fines.
1040TaxBiz is experienced within the tax preparation industry. We can walk you through a tax audit, but more importantly, we can help you file your taxes accurately, which is the best way to avoid a tax audit altogether.