The Internal Revenue Service (IRS) was boosted by $80 billion in new funding stemming from the Inflation Reduction Act of 2022. Tax planning and compliance are now more important than ever.
In a May 2024 conference call with reporters, IRS commissioner Danny Werfel announced that the IRS’ strategic plan over the next three tax years includes a sharp increase in audits. Therefore, it’s important to ensure your IRS tax preparation efforts and IRS tax returns are solid and error-free, which should be a priority for tax year 2025 and beyond.
While the IRS will focus on wealthy individuals and large corporations, the importance of tax planning and compliance affects every income bracket and business. So, to avoid any tax planning problems (while embracing tax planning benefits that can minimize your tax liability), keep the following guidelines and tips in mind as next year’s tax season gradually approaches.
What is an IRS Tax Audit?
According to the IRS’ definition, an IRS audit is a review/examination of an organization’s or individual’s accounts and financial information to ensure that all information is reported correctly according to the tax laws and to verify the reported amount of tax.
Taxpayers are selected to be audited by random selection and computer screening based solely on a statistical formula. These screenings compare a tax return against the “norms” for similar returns and/or look for obvious errors that may signal a problem.
In addition, taxpayers may be selected for an audit based on related returns. In other words, a tax return may be singled out if it is connected to transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit.
How Will I Know if I am Audited, and What Happens Next?
If you are selected for an audit, you’ll receive a letter from the IRS in the mail. (Note: The IRS never initiates an audit via phone or email, so be on the lookout for potential scammers.)
After that, the IRS manages audits either by mail or through an in-person interview to review your records. The interview may occur at a regional IRS office, your home, business, or an accountant’s office .
How Long Does the Audit Process Take?
The IRS audit should take no more than five or six months. However, the length of time depends greatly on the complexity of the issues, the availability of information, the availability of both parties for meetings and interviews, and your agreement or disagreement with the eventual findings.
What Are Some Red Flags that Might Single Out My IRS Return for an Audit?
There are many potential red flags that can catch the IRS’ attention, ranging from miscalculations to incorrect personal info. However, when conducting your tax planning and preparation, there are a few common red flags that can often lead to an IRS audit.
Missing income on your return
Both employers and financial institutions send income information to the IRS along with the taxpayer, so if your total income does not match up with the information the IRS has on file, this could easily trigger an audit.
In addition, it’s important to use the correct form for each specific type of income. For example, freelance income is typically reported via Form 1099-NEC, while investment earnings are reported through Form 1099-B.
Unusable or unreasonable tax breaks
If you have an unusual tax deduction or credit for your tax bracket, make sure that you have the documentation to back it up, as the IRS will consider it a red flag.
For example, if your adjusted gross income is around $100,000, but your charitable donations are more in line with donations given by individuals with income of $500,000 or more, this will seem unusual and likely garner further attention.
Using round numbers
Accuracy is a cornerstone of tax planning and compliance, and too many perfectly round numbers look unusual on an IRS return.
For example, suppose you are claiming four or five digit credits or deductions. In that case, it will be highly unlikely that these expenses will be round numbers, like $5,000 or $10,000, unless they constitute an understandable and logical tax break, like a $5,000 donation to charity. Spending $5,000 in total on business or home office expenses, however, looks a little out of place.
Earned income tax credit
The earned income tax credit (EITC), a tax break for workers with low or moderate income, has been routinely scrutinized simply because the refund aspects of the credit tend to attract bad actors. While individuals with higher income are generally more likely to be audited, EITC claimants have a 5.5 times higher audit rate than the rest of U.S. filers, partly because of improper payments, according to research conducted by the Bipartisan Policy Center.
What is Tax Planning and How Can it Help me Avoid an Audit?
Tax planning is a multi-pronged venture aimed at minimizing errors and maximizing benefits.
It’s a year-long endeavor that can include detailed and complex strategies, and easier day-to-day initiatives like keeping perfect records, tracking income and expenses, and analyzing the timing of financial moves to align with the best tax breaks possible within a given year.
Optimize Tax Planning and Compliance with Expert Assistance
Tax planning problems are commonplace, and it’s easy to make a mistake that leads to an audit or to skim over deductions and credits that would minimize your tax liability.
After all, the best tax planning strategies are year-round and require constant and in-depth attention to detail, and most taxpayers simply don’t have the time or resources for consistent IRS tax preparation all year long.
Tax Planning and Compliance with Waters Hardy
At Waters Hardy, we can take the tax planning and compliance burden off your shoulders and ensure that your risk for an audit is minimized as much as possible. In addition, we’ll identify strategies and opportunities to boost your bottom line and put more money back into your pocket.
Reach out to us now to start the conversation. By partnering with Waters Hardy, you can eliminate any tax planning problems this year and for many years to come.