Investor Column | Here’s how to reduce your chances of getting audited by the IRS

President Joe Biden plans to boost IRS funding by about $80 billion soon. In addition, Biden has a 10-year plan to crack down on affluent individuals and small businesses’ tax under-reporting – OK, cheating on taxes.

IRS funding has declined by about 20%, as adjusted for inflation, by the government since 2010. As a result, the IRS has 20,000 fewer revenue agents, collection officials and support staff. Nevertheless, by beefing up the IRS, the government seeks to generate more than $700 billion in revenue to the Treasury over the coming decade.

Your audit chances are minor for years before 2021, but that’s changing big-time. So what can you do to reduce getting audited? Here are some tips.

Avoid round numbers

IRS expects decent accounting records to support amounts shown on your tax return. Using a software program like Quickbooks to link source documents to profit and loss statements, trial balances, and transaction journal is just a good start.

The problem is that many small business people fail to keep their bookkeeping up to date. Some get behind or misuse manual accounting systems. (Think pre-formatted columns on green accounting paper.) There is no substitute for 100% accuracy, but incomplete or sloppy accounting leads people to guess or estimate their business expenses.

Some self-employed people, for example, might think creatively and drop numbers like $2,100 for advertising, $600 for office supplies, and $200 for postage. However, using lots of perfect round numbers practically tells IRS you’re cheating because it statistically unlikely for all numbers to end in clean, pristine, rounded zero. So, for example, well-done accounting records would total $2,118.25 for advertising, $572.13 for office supplies, and $193.27 for postage.

Guessing and rounding numbers lead to peril for lazy business people who don’t crunch numbers as they go along. Using perfect round numbers for a self-employed individual is a dead giveaway that there is something wrong with a tax return.

File on time

Failing to file tax returns triggers many audits. Suppose you don’t have money to pay your income taxes? Arrange for a payment program if you have to, but still file your tax return.

Denial and avoidance lead fools to audits. The IRS will likely think you are cheating on your taxes by not filing. So you become low-hanging fruit for the IRS by not filing and make yourself a huge target. IRS computers and auditors will hound you for eternity. Understand penalties and interest grow until you pay the IRS.

Once the IRS starts sniffing around, they may audit you for other past years. So if you are in the hole for $6,200 for 2021, the IRS may investigate if you owe taxes for 2018, 2019, and 2020.

Moral: Stay current and file accurate computer-generated tax returns. If IRS sufficiency software believes you have a mathematical and logical tax return filed on time, you likely reduce your audit chances.

Act normal

IRS computers flag tax returns for suspicious deduction to income ratios. For example, for families earning $120,000, charitable contributions might be $1,200. Still, if someone claims $12,000, that might be enough to trigger an IRS audit.

While tithing is possible, cheating may be more likely. People are cheap, in my opinion, and typical American families earning $120,000 rarely give big money to charity. They’re too busy eating at fancy restaurants, paying orthodontists and taking vacations.

Report 1099s

Independent contractors may receive IRS form 1099 NEC from clients paying them more than $600. Whether you got a 1099 form or not, keep good records and report all your income. Keeping separate accounts for business income and expenses is prudent. IRS computers match 1099s registered under your social security number to the revenues reported on your tax return.

Tax notices from the IRS usually occur many months or years after filing your tax return. Discrepancies get kicked out of the IRS computer for further examination. Penalties and interest begin from the date you file until you satisfy the IRS.

Amounts shown deposited into bank accounts may be presumed as income in an IRS audit. Working for cash usually gets discovered by IRS in an audit through the matching program. Also, ex-wives, ex-lovers, and angry clients often tip off the IRS to audit someone.

Don’t be an amateur. Report your actual income to the IRS — and make sure revenues equal or exceed the total of your 1099s for business revenue. In addition, make sure all payments exceed credit card sales reporting and 1099s. IRS is also monitoring amounts paid to businesses and individuals by PayPal and cryptocurrencies.

Some people think they only have to report 1099 income. Wrong. All revenue received, even less than the $600 limit, needs reporting. As a result, IRS expects numbers higher than 1099s, or at a minimum equaling 1099s.

Review and update bookkeeping

Banks, Paypal, and other payment services report gross annual receipts from merchants accepting credit and debit cards to IRS. For example, reconcile form 1099K for payment cards and third-party networks submitted by the banks to your accounting records. Address discrepancies so you can file accurate tax returns with the IRS and reduce your chances of an audit.

Jim Germer is a Bradenton CPA and financial adviser at 3655 Cortez Road W, Suite 110, Bradenton, Florida 34210. Call (941) 746-5600 or email jim.germer@ceterafs.com. Securities are offered through Cetera Financial Specialists LLC (doing insurance business in CA as CFGFS Insurance Agency) member FINRA/SIPC. Advisory services are offered through Cetera Investment Advisers LLC. Cetera entities are under separate ownership from any other named entity. This article is designed to provide accurate and authoritative information on the subjects covered. It is not, however, intended to provide specific legal, tax, or other professional advice. For specific professional assistance, the services of an appropriate professional should be sought.