During An IRS Audit, What Do The Auditors Look For?

There’s nothing more stressful than getting that audit letter in your mailbox. IRS audit is time-consuming and could be nerve-wrecking as well. Over my career, I’ve taken multiple business and individual clients through IRS audits with no adjustments made to books or tax returns. I’d like to share a few pointers from my own experience:

I got audited, but why me?

Almost all IRS agents told me the same thing: IRS has a complex algorithm that compares your tax return data with the “curve” or “pattern” they have in their system (information gathered from “big data”) and checks for reasonableness. However, I have noticed that you are more likely to get audited if you check one or more boxes from below:

• Choppy trend: Hitting a great year, followed by a terrible one, and then hitting it out of the ballpark again - This won’t put you on the board 100% but certainly raises a red flag. Presenting a healthy and stable trend is generally recommended, unless there is genuinely an extraordinary event, for example, natural disasters, pandemics like COVID-19, etc.

• Big top line but running a loss: Sounds suspicious already, right? Be prepared to have reasonable explanations and documentations in line to pass this one.

• Making too much: Net income over $1mm is typically a good indicator that you’re “making too much money”. Simply put, IRS hopes there’s something in it for them to spend the time and resources on an audit. It’s just more likely for them to get something out of it if they know you have the $$$.

What do auditors look for?

• Process walkthrough - IRS agents ask a lot of questions, which can be intimidating. What they’re trying to do here is to understand your business process - how do you get new customers? How does a lead become cash in your bank? Based on what you said, is it possible for you to miss or under-report your income? These are all important assessments being made in this part of the audit.

• Bank activities - Does your income match all the deposits? Did all the activities foot? Was there commingling of funds between business and personal? I always advise my clients - if you don’t want IRS to open additional audits based on results from one initial audit, keep your business and personal expenses separate, and always keep a clean paper trail.

• Major spendings - Be prepared to present documentation for major spendings and provide comments. My clients always ask me: if I don’t have the receipts, does it mean IRS won’t let me take the deduction whatsoever? The answer is, it depends. For example, if you didn’t have the receipts for $30 charged by Uber, but you have documented on your credit card statement, that this is the trip when you went to LA for a conference, accompanied with conference related plane tickets and lodging details, there’s a good chance the IRS will allow it. However, you don’t want to push the rules - we all know that Nintendo you bought serves no purpose in your jewelry crafting business.

• Contractor payments - Definitely a big area. IRS agents typically ask for agreements with specific service terms, work reports and related documentation to help determine the legitimacy and compliance of the contractor payments. Were W9 and/or W8-BEN collected? Were Forms 1099 filed?

• Sample tests - If your business is on the larger scale, instead of going through all transactions, it is not uncommon for the IRS agent to sample a few transactions deemed significant or representative to form an opinion on overall financial integrity. For example, they may ask you to provide PO records from key customers, POD (proof of delivery) if you sell goods, etc.

When in need, get in touch with us to consult on your situation. At Zhong & Sanchez, we provide One-Stop-Shop Tax, Finance, Accounting and HR services for Startups and Entrepreneurs. We do it all, so you can stay focused on your business. Our experience in tax and accounting will free you from back office work; our extensive knowledge with start-ups will help you grow in the most efficient way. Located in the Silicon Valley, you can reach us at 510-606-6971 or schedule your first consultation today at https://calendly.com/zhongsanchez

IRS provides last-minute tips for last-minute filers

WASHINGTON — With the July 15 tax-filing deadline − postponed from April 15 – only a few days away, the IRS is reminding taxpayers who have yet to file their tax returns that IRS.gov has tools and services to help them meet their tax obligations.

IRS tax help is available 24 hours a day on IRS.gov. Whether filing a tax return, requesting an extension or making a payment, the IRS website can help last-minute filers on just about everything related to taxes. Taxpayers can also use the Interactive Tax Assistant tool to answer many tax questions they may encounter.

The IRS reminds taxpayers they have a range of expert help available through a qualified tax professional, including certified public accountants, enrolled agents and attorneys. The IRS encourages people who need the help of a tax professional to visit a special page on IRS.gov.

Prepare and file taxes for free

Taxpayers also have several options for preparing and filing their tax returns:

• Taxpayers with income of $69,000 or less can use IRS Free File to find free tax preparation software.

• Taxpayers with incomes above $66,000 and comfortable doing their own taxes can use Free File Fillable Forms for free.

• Use commercial tax prep software to prepare and file taxes through IRS approved electronic channels.

• Use an authorized e-File provider accepted by our electronic filing program. Authorized IRS e-file providers are qualified to prepare, transmit and electronically file returns.

• Members of the military and qualified veterans can use MilTax, a free online tax service provided by the Department of Defense and Military OneSource.

Receive refunds faster

The fastest way to receive a refund is to file electronically and use direct deposit. Taxpayers who file electronically and request direct deposit for their refund need to know that:

• Nine out of 10 tax refunds are issued in 21 days or less.

• The best way to check on a refund is the “Where’s My Refund?” tool.

• The “Where’s My Refund?” tool available on IRS.gov and the IRS2Go mobile app.

• “Where’s My Refund?” is updated once a day, usually overnight.

•  Refunds can be divided into up to three accounts.

Delays for paper tax returns

The IRS is experiencing delays in processing paper tax returns due to limited staffing. This is another reason that taxpayers should choose to electronically file their taxes.

Taxpayers who filed a paper tax return and expect a refund may experience a delay beyond the normal time frame of four to six weeks from the time they mailed the return. The IRS will process paper returns in the order they are received.

Taxpayers should not file the same return again or call the IRS if they filed a paper tax return and are experiencing a refund delay.

Get more time to file

Individual taxpayers who need additional time to file beyond the July 15 deadline can request a filing extension to Oct. 15 in one of two ways:

• Filing Form 4868 through their tax professional, tax software or using the Free File link on IRS.gov.

• Submitting an electronic payment with Direct Pay, Electronic Federal Tax Payment System or by debit, credit card or digital wallet options and selecting Form 4868 or extension as the payment type. The automatic extension of time to file will process when taxpayers pay all or part of their taxes, electronically, by the July 15 due date. An extension to file is not an extension to pay. Taxes are still due by July 15.

Special rules may apply for some military personnel if they are:

• Serving in a combat zone or a qualified hazardous duty area

• Living outside the United States

Pay with ease

Taxpayers can file now and schedule their federal tax payments up to the July 15 due date. They can pay online, by phone or with their mobile device using the IRS2Go app. When paying federal taxes electronically taxpayers should remember:

• Electronic payment options are the optimal way to make a tax payment.

• They can pay when they file electronically using tax software online. If using a tax preparer, taxpayers should ask the preparer to make the tax payment through an electronic funds withdrawal from a bank account.

• IRS Direct Pay allows taxpayers to pay online directly from a checking or savings account for free, and to schedule payments up to 365 days in advance.

• Taxpayers can choose to pay with a credit card, debit card or digital wallet option through a payment processor. The payment processor adds a fee; no fees go to the IRS.

• The IRS2Go app provides the mobile-friendly payment options, including Direct Pay and through payment providers.

• Taxpayers may also enroll in the Electronic Federal Tax Payment System and have a choice of paying online or by phone by using the EFTPS Voice Response System.

Get more time to pay

Qualified taxpayers can choose to pay any taxes owed over time through an installment agreement. An online payment plan can be set up in a matter of minutes. Interest and late-payment penalties continue to accrue on any unpaid taxes after July 15.

Payment options include:

• Short-term payment plan (paying within 120 days).

• Long-term payment plan (paying in more than 120 days).

However, a taxpayer’s specific tax situation will determine which payment options are available.

The IRS has more information for taxpayers who owe taxes, but cannot afford to pay the full amount.

Get the full picture

Taxpayers can go to IRS.gov/account to securely access information about their federal tax account. They can view the amount they owe, access their tax records online, review their payment history and view key tax return information for the most recent tax return as originally filed.

Source: IRS Newswire

Treasury, IRS issue proposed regulations on new Opportunity Zone tax incentive

WASHINGTON —The Treasury Department and the Internal Revenue Service today issued proposed regulations and other published guidance for the new Opportunity Zone tax incentive.

Opportunity Zones, created by the 2017 Tax Cuts and Jobs Act, were designed to spur investment in distressed communities throughout the country through tax benefits. Under a nomination process completed in June, 8,761 communities in all 50 states, the District of Columbia and five U.S. territories were designated as qualified Opportunity Zones. Opportunity Zones retain their designation for 10 years. Investors may defer tax on almost any capital gain up to Dec. 31, 2026 by making an appropriate investment in a zone, making an election after December 21, 2017, and meeting other requirements.

The proposed regulations clarify that almost all capital gains qualify for deferral. In the case of a capital gain experienced by a partnership, the rules allow either a partnership or its partners to elect deferral. Similar rules apply to other pass-through entities, such as S corporations and their shareholders, and estates and trusts and their beneficiaries.

Generally, to qualify for deferral, the amount of a capital gain to be deferred must be invested in a Qualified Opportunity Fund (QOF), which must be an entity treated as a partnership or corporation for Federal tax purposes and organized in any of the 50 states, D.C. or five U.S. territories for the purpose of investing in qualified opportunity zone property.

The QOF must hold at least 90 percent of its assets in qualified Opportunity Zone property (investment standard). Investors who hold their QOF investment for at least 10 years may qualify to increase their basis to the fair market value of the investment on the date it is sold.

The proposed regulations also provide that if at least 70 percent of the tangible business property owned or leased by a trade or business is qualified opportunity zone business property, the requirement that “substantially all” of such tangible business property is qualified opportunity zone business property can be satisfied if other requirements are met. If the tangible property is a building, the proposed regulations provide that “substantial improvement” is measured based only on the basis of the building (not of the underlying land).

In addition to the proposed regulations, Treasury and the IRS issued an additional piece of guidance to aid taxpayers in participating in the qualified Opportunity Zone incentive. Rev. Rul. 2018-29 provides guidance for taxpayers on the “original use” requirement for land purchased after 2017 in qualified opportunity zones. They also released Form 8996, which investment vehicles will use to self-certify as QOFs.       

More information on Opportunity Zones, including answers to frequently-asked questions, is on the Tax Reform page of IRS.gov. The Tax Reform page will also feature updates on the implementation of this and other TCJA provisions.

At Zhong & Sanchez, we provide high-quality tax and financial reporting services to privately-held entities and small business owners. Our expertise ranges from income tax filing and accounting services to international compliance and financial analysis. Located in the Silicon Valley, you can reach us at 510-458-4451 or schedule your first consultation today at https://calendly.com/zhongsanchez

Source: IRS