It’s a rare event to have your taxes audited by the Internal Revenue Service (IRS). After all, only about 0.19% of income tax returns filed were audited in 2022. But it still happens, and it can be a lot of work if the IRS comes knocking on your door.
Here are some ways to respond in case it happens to you and some possible red flags to avoid if you want to reduce your chances of being contacted by the IRS (especially if you're earning multiple streams of income).
1. Get your information together
It’s important to hold on to all the documents that you used to report your income and any deductions for three years from the time you file your return. Keep them in a safe place so if you do get an audit notice, you’ll have them available to help you.
If you get contacted by an IRS agent, you’ll need to pull together these and any additional documents that may help you answer questions they may ask you. Being prepared for their questions — with files on-hand to back up your answers — will go a long way
2. Make copies of your documents
The IRS will want to see any kind of documents that you may have used to prepare your returns, such as employment documents, personal financial statements, or receipts for charitable contributions. Make copies of these documents for the IRS office and hold on to the original documents. You likely won’t want to hand over any originals to the tax revenue service.
3. Only answer what you’re asked
You may want to talk about your charitable contributions, or your change in jobs, or any other tax issues that could be reflected on your tax return. But remember this is not a friendly conversation with an auditor. Instead, limit any answers to questions asked by the auditor, and try to be as precise and succinct as possible.
4. Enlist a tax professional
You may be able to go through the audit process on your own, but you should consider hiring an experienced tax professional such as a certified public accountant (CPA), enrolled agent, or tax attorney to work as your advocate during the audit process. They’ll likely have more knowledge of the intricacies of tax matters or might have a better understanding of the process to get you through it without any further issues.
5. Be prepared to pay
More than 75% of taxpayers who are audited will likely have to pay additional taxes. That can be a tough hit to your bank account, so be prepared for that possibility. You might want to consider dipping into your emergency fund or creating a new budget to compensate for the additional costs.
And know your payment options before you commit to the additional costs. You may be able to file an extension or negotiate a payment plan or reduced payment with the IRS. Sometimes it might even make sense to pay your taxes with a credit card.
IRS audit red flags to avoid
An audit can be scary. There are some things you’ll want to do to try to avoid being the victim of one as you prepare your taxes. So, what are some IRS audit red flags that may stand out to the tax revenue service as a potential target for an audit? Here are five items to watch for to help you avoid an audit.
1. Child Tax Credit
The Child Tax Credit has changed a bit due to the American Rescue Plan of 2021. It may cause confusion for those who received checks last year that they now have to reconcile with the child credit on their 2021 tax return.
The IRS sent out documents called Letter 6419 to clarify some of these issues. Make sure you have a copy of that and double-check that the stated amount you received in Child Tax Credit is correct.
2. Small-business costs
If you run a small business, this could cause discrepancies between your business taxes and personal taxes. Make sure to report your full income from a business and any business expenses. Be aware that a dramatic change on the expenses you report or potential losses could make the IRS notice.
And, if you’ve been working from home lately, double-check the qualifications before you write off your home office as a tax deduction. There are specific criteria that you may not meet, and that could raise IRS eyebrows. There are some critical tax implications to working remotely.
3. Large charitable contributions
If you found extra money in your budget to increase your charitable contributions, that’s a good thing. But a huge increase in your charitable contributions may be a sign to the IRS that something is wrong.
Tax filers can use this write-off to their advantage, but some might abuse it by overstating their charitable contributions. Collect receipts for charitable contributions throughout the year and pull them together before you start your tax return so you know exactly how much you have given in contributions.
More and more Americans are turning to cryptocurrency as an investment. In fact, a study last year found that 16% of Americans said they were invested in or traded cryptocurrency, a far cry from 1% of Americans who said they were invested in 2015.
But with more people holding cryptocurrency, it may be confusing to figure out regulations and tax law when it comes to crypto investments. Consider taking some time to account for any income or interest you may have received, and don’t forget any non-fungible tokens, or NFTs, that you may have invested in.
It may have been something as simple as a few typos in your address, or your Social Security number was a few digits off. But small errors could signal to the IRS that you may have been careless while preparing your return.
Remember to check your return before sending it in, and verify not only the numbers but other personal or professional information that might stand out if the IRS is reviewing your return.
As you prepare your tax returns for 2023, some of the best tax software may be able to point out potential red flags, or you may prefer to have a professional tax preparer take care of your taxes. Remember to account for any major changes and additional income streams to your tax return this year, and hold on to any additional paperwork you may need should you get audited.
The IRS recommendations for how long you should hold on to your taxes and documents vary, so research what’s best for your return in case you’re audited.
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