How to Help Your Clients Avoid Getting Audited This Tax Season
It’s every client’s worst tax nightmare: They receive a letter in the mail from the Internal Revenue Service saying something has triggered an audit. The instructions that come with each audit letter are different. Some people might only have to send a few documents – like bills, canceled checks, loan agreements, or medical bills – via snail mail to the IRS for review.
Others, however, are called in for a dreaded face-to-face interview, which the agency often sets up when the taxpayer has too many documents to mail in. Failing an audit can lead to extremely serious consequences depending on why the client didn’t pass. If the reason for the audit trigger is minor, like not paying taxes on time, the IRS might charge additional interest on top of late filing fees. If the agency suspects or uncovers criminal activity, such as tax evasion, the taxpayer can face huge fines in the range of six figures, a felony charge, and jail time.
While many things can cause the IRS to take a closer look at a client’s tax returns, here, we’ll discuss three common ones that can trigger an audit. (And, we’ll assume your client isn’t a criminal, just a normal taxpayer who made a mistake.)
3 Common Reasons Taxpayers Get Audited
1. Not reporting cryptocurrency
Over the last few years, the number of Americans who have bought or traded cryptocurrency has risen to 16%, says Pew Research. And even though the IRS was way behind when Bitcoin and its competitors were first introduced to the world, that’s not the case anymore.
Now, the IRS says some taxpayers are lagging when it comes to reporting their cryptocurrency assets on their transactions and that this is something they’re cracking down hard on each tax season from here on out.
There are two main factors behind this: First, crypto holders are well known for continuously under-reporting their digital currency assets (whether deliberately or because they’re not sure of the new rules). Second, cases like that of Sam Bankman-Fried – even though his alleged crimes are extreme – highlight the issues behind cryptocurrency firms, some of which actively use their platforms to launder money. And, the IRS is actively auditing crypto buyers and sellers, bringing hundreds of thousands in for additional questioning.
The new tax rules are quite complex, but here’s how your clients can avoid an audit:
- If they purchase cryptocurrency, they need to pay taxes on it, just like anything else you buy or sell. Remember: The IRS considers crypto to be “property,” so that’s exactly how you should view it too.
- Report all crypto activities and other digital assets correctly on the appropriate tax forms. After calculating gains and losses, fill out Form 8949, and report these numbers on Form 1040, Schedule D, Line 7.
- If they earn income from self-employment in addition to owning crypto, they can use Forms 1099-MISC or 1099-NEC to report your income to the IRS.
Unless you invested in crypto through a non-taxable or tax-deferred account like a retirement account, you’re required to report these assets to the IRS. The rules are complex, and this is a perfect chance for you, the accountant, to add value to your clients by guiding them through this special area of tax reporting.
2. Not separating personal expenses from business ones.
Clients who own businesses are entitled to certain deductions when they file taxes for their company. They are, for instance, allowed to deduct meals, mileage, and even entertainment-related expenses – as long as these were clearly incurred while they were doing business and are properly recorded in the right ledgers. It’s easy, however, to stop keeping clear ledgers of which expenses were personal and which the IRS deems “business expenses.”
Here are a few simple steps you can take during the year to help your business-owning clients stay out of trouble:
- Check their books carefully each month. Make sure personal expenses are clearly separate from business ones, question them about any seemingly vague spending, and ensure they have receipts for everything and are willing to save them.
- Before tax season starts (or as soon as you can), review the books with them one more time and make sure you’re both on the same page. If either you or they are confused about whether a deduction was business or personal, stop, ask additional questions, and, if they can’t produce a receipt, think twice before simply writing it off as a necessary expense incurred by their company.
Overwhelmed, busy clients who run businesses may run out of time to correctly reconcile their books each night or even be unsure what counts as which and just wing it when writing it down. Keep an eye on all your business clients, and make notes on any who have a history of mixing things up. This is an easy way to get audited, but with some careful oversight by you and encouraging them to come and honestly speak with you, you can help ensure they won’t find themselves getting an unwelcome letter in the mail from the Internal Revenue Service.
3. Being a minority.
This one might surprise you. No, the IRS can’t tell a person’s race simply through their tax return. Yet, according to a recent New York Times article published at the end of January of this year, Black Americans are finding themselves called for an audit three to five times more often than any other group.
Why? Well, the IRS created an algorithm years ago that helped them automatically flag certain tax returns for additional review. While this was done to help them keep their revenue up even when their budget was being slashed, there are inherent discriminatory issues in the triggers the algorithm responds to. Specifically, when people claim tax credits that are usually in place to help low-income families, like the Earned Income Tax Credit (EITC), the algorithm overwhelmingly and disproportionately flags these accounts as ones that might need auditing. And, unfortunately, since it requires more expertise for an auditor to go after a business, it’s much easier to audit an individual. Black Americans seem to be a group of people who make the exact kinds of mistakes that are easy for any taxpayer who isn’t an accountant to make, such as claiming credits they’re really not eligible for or not properly reporting all their sources of income.
While accountants have begun to recognize that the needs of diverse groups are different, it’s crucial for you to continue to educate yourself on the different ways tax laws impact people of different races and so on. This is not only an excellent way to help people the laws unfairly affect, but also, from a business perspective, gaining expertise in the varying needs of your clients and not seeing them as all the same is a specialized niche that is sorely needed for taxpayers.
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