Don’t Fear That the Tax Man is Here
Death and taxes. These are two certainties in life we’ve been conditioned to accept. Or maybe they’ve simply withstood the test of time and we’d be a fool to dismiss them. Outrunning the grim reaper is an interest of mine and a topic that I’ll save for another day. Taxes, on the the hand, are something this is at the top of everyone’s mind this time of the year. ‘Tis the season.
Over the past several years, the IRS has made several admissions that it is extremely understaffed. The biggest takeaway for most people of this fact is that tax refunds can often be delayed longer than people are accustomed to. However, it is also worth nothing that, for most people, the odds of getting auited by the IRS are extremely low. In 2021, .38% of all tax returns were audited. However, if you look further into the audit process, you’ll realize that most of those audits invovled individuals with incomes well in excess of 6 figures or red flag issues. What are “red flag issues”? These are some of the items that are most likely to trigger a tax audit:
Not reporting all of your income. This is a big red flag and almost certainly will lead to a letter from the IRS. Put simply, ireport all your income that has been documented by an employer, business, retirement account, etc. Key word here: documented. ALWAYS save tax forms you accumulate and report them accurately when filing your taxes.
Large deductions such as charitable contributions or business write-offs. Anything that seems abnormally high could be a trigger for an audit. Especially if your gross revenue is high and your large deduction wipes out a majority of your tax liability.
Incorrectly reporting health insurance premium credits. If you took government health insurance at a steep (income-based) discount, you can bet your taxable income better match up when you file your taxes. Basically, the lower you report your taxabale income to be, the more the government will pay for your health insurance premiums throughout the year. If it comes back the next year that you made a lot more money when you file your taxes, you will owe the government for the money they fronted you for health insurance premiums. It’s a simple reconciliation that you need to be aware of. Some people may try to cover themselves on their tax return by lying about their health insurance premiums. This is a very bad idea.
Erroneous and aggressively marketed deductions. Kiplinger has a good list here, but I don’t feel the need to cover them all. These bogus deductions all have one thing in common: evasion and/or fraud. This is not something you want to be on the tax radar for.
Round number expenses commonly ending in zero. Too many small business expenses all ending in zero might tempt an audit for any agent that spends more than a few seconds reviewing your return. $14,857 sounds a lot more believable for a travel expense than (about) $15,000.
If your tax preparer has been audited before - or a few times. Each tax preparer has a unique ID with the IRS for when they file for others. If they’ve been caught magically finding refunds for their clients before, there’s a good chance the IRS will take notice of future returns.
Home office deduction. This one seems to have been a bigger risk in the past, and I haven’t seen this one written about as much in the post-covid years, but it is still worth discussing. So long as you follow the formulas set forth by the IRS, you shouldn’t have anything to worry about. You may not want to claim half of your house as an office space because, well, it would be hard to defend in an audit.
Final thoughts here: There’s a big difference in getting audited and getting into trouble with the IRS. Don’t fret an audit - if you can document whatever it is you’ve done on your taxes, the IRS is merely asking for clarification. Never claim something you can’t substantiate. Don’t claim your pets as another child and make up a social security number for them. That is fraud.
The grey area that everyone wants to test often comes in terms of business expenses. Was that big meal a business expense? Was that long trip in the car for business reasons? Was your trip to the coast for business or pleasure? Good luck proving it wasn’t, Mr. Tax Man. ;)
Disclosure: I am not an accountant and the information I’ve covered in this blog shouldn’t be construed as tax advice. It is simply my conjecture from working with business owners and accountants for the past ten years.
