Hello and welcome to today’s episode of Streetsmarts, with Howe & Rusling. I’m Vince Carson, Certified Public Accountant and Financial Planner at Howe and Rusling.
If you haven’t heard yet, the IRS is planning on hiring thousands of new enforcement agents over the next few years. This is causing many of us to get nervous; as we all know that there’s nothing worse than getting a letter from the IRS. And then the next worst thing is finding out that the IRS has selected you or your business for an audit.
What is a tax audit?
An IRS audit is an examination of an individual or organizations’ financial information to ensure that said person or organization is reporting tax returns in accordance with U.S. tax laws.
Let’s first touch base on the statute of limitations. The general rule of thumb is that the IRS has a three-year window to complete an audit on your tax returns (unless you commit fraud or you underreport your income by 25% or more). Therefore, at a bare minimum, it’s highly advised to save your tax records for at least three years. It’s also important to note that there is no statute of limitation in cases where a return was never filed. In other words, if you never filed a return, the clock for the audit window never starts.
Primary types of IRS audits
The first type of audit is known as the correspondence audit. This is the most common type of IRS audit and is usually viewed as being the least cumbersome to manage. This is because the IRS is looking for limited information or clarification on a specific area. In a correspondence audit, a tax payer will receive a letter from the IRS requesting information be mailed to them. The other primary type of IRS audit is known as the field audit. This is when an IRS agent will actually come to your place of business, in person, and scrape through your financial records to determine whether your return is substantiated with evidence. Field audits are the most comprehensive type of IRS audit and can be extremely intrusive.
So how does the IRS select businesses for audit?
There are a variety of situations when the IRS will select a return for audit, but let’s cover the usual suspects. One primary reason why a return might be selected for audit is if your business, when compared to other businesses in your industry, is outside the “norm” with regards to income and deductions. The IRS develops these “norms” by using statistical techniques. A second reason why a return might be selected for audit is if your business was involved in a transaction with other taxpayers whose returns were selected for audit. Meaning, you are at higher risk of audit if related parties to your business come under IRS scrutiny. As a last point on this topic, there very well might not be a trigger that caused your return to get audited. If history is to be our guide, the IRS randomly selects returns to audit every year. We all hope that we don’t pick the short straw.
I hope today’s episode clarified some of the nuances regarding IRS audits. When thinking of your potential exposure to the IRS, it’s important to remember that the best thing you can do is keep good, clean, and organized records. The second best thing is to have a trained professional, that knows how to handle IRS audits, on your side of the table. As always, if you have any questions on your finances, our team at Howe & Rusling is always available to help.
Thank you so much for tuning into today’s episode of StreetSmarts with Howe & Rusling.