Preparing For An IRS Audit: Part Three

by: Dr. Peter Ikre

This piece marks the culmination of a 3-part series on the audit or examination procedure of the Internal Revenue Service (IRS) designed to sensitize taxpayers (individuals and businesses) to the need for scrupulous preparation toward the yearly tax filing exercise. It is pointless attracting the attention of the IRS due to inconsistencies in the presentation of incomes or expenses (deductions) on tax returns. Any discrepancy in your returns will trigger an automatic audit from the IRS.  Remember that in most cases, the IRS keeps copies of your W-2s, 1099s, social security benefits and other tax-related documents in offices scattered across the country. Recently, an elderly couple came to my office with letters from the agency notifying them of non-disclosure of over $25,000 they received in 2010 in social security benefits for the 2011 tax season. Apparently, the 2012 tax returns indicated that they received same amount ($25000) in calendar year 2011. The problem was that they forgot to report income from social security in 2010. Unfortunately, the IRS does not forget these things! In fact, they are waiting for you to develop amnesia (memory loss) concerning these matters. The omission cost them $1550 in back taxes including penalties and interests. The lesson here is that you must gather all your documents in one place prior to the tax season. If you do not have all the documents, please request for an extension pending the arrival of all the documents. It is much better to file an extension than to be audited! The IRS has several motives for examining one’s tax returns including substantiation of incomes and expenses. However, the fundamental reason for scrutiny may be related to unreported income as exemplified in the case I narrated in the preceding page. After all, government coffers depend on revenues derived from levies on taxable income!
Businesses, like individuals, are subject to audit by the IRS if they fail to resolve irregularities in their tax returns. One area of vulnerability for business entities has to do with the classification of workers in a firm. In a business, there are several individuals, such as employees, vendors, and independent contractors working toward same organizational objectives. Gardner, Daff, and Welch (2013) stated that businesses are facing increased scrutiny in the area of owner-worker relationship in an effort to expand the revenue base of government through payroll, income, and unemployment taxes (p. 31). The misclassification of an independent contractor as an employee or vice-versa may provoke an audit response from the IRS. According to Gardner et al. (2013), the choice of independent contractors over employees offers significant tax benefits to a business in the form of payroll taxes and fringe benefits (such as health insurance). The company’s taxes and benefits do not apply to independent contractors. A business incurs substantial expenses in the process of hiring employees through payroll taxes and provision of other benefits. The IRS distinguishes employees from independent contractors on the following bases: a) behavioral control, b) financial control, and c) relationship of the parties. Unlike an employee, an independent contractor is seldom a full-time worker, able to set his/her hours, decides how job is done, and does not work within the precincts of a company. Furthermore, the contractor is not reimbursed for business or travel expenses and may earn a profit or suffer a loss in the course of providing service to a firm (pp. 31-32). To forestall unnecessary intrusion of the IRS into one’s business activities, business owners should define the nature of the relationship between independent contractors and the company. The following steps may serve the purpose: a) documentation of relationship, b) structure relationship with contractors in unequivocal terms, c) compliance with IRS reporting requirements, such as issuance of Form 1099s (Gardner et al., 2013, pp. 33).
It is time to debunk some myths often peddled during the tax season. One of such falsehoods has to do with the ramifications of filing for an extension beyond the customary deadline of April 15 of every year. Strangely, some individuals believe that filing for an extension may result in an IRS audit. There is no truth in the assertion since no relationship exists between a tax extension filing and the risk of being audited. However, the situation may be different if you make underpayments to the government. According to Government (1977), a study conducted by the General Accounting Office (GAO) showed that taxpayers who pay more than they should are less likely to be audited compared with those who underpay to the IRS (p. 19). The result is not surprising at all. The government is happy to have more money in the treasury and may turn a blind eye to overpayments if it can get away with it. This concludes the series on IRS auditing process. Next time I come your way, I will commence a new series on a fascinating topic that literally impacts every life in the United States: health care and more specifically, tax implications of the Affordable Care Act aka Obamacare. Merry Christmas and a prosperous New Year in all aspects of life.

References
Gardner, R., Daff, L., & Welch, J. (2013, February). Independent contractor or employee? Journal of Financial Planning, 26(2), 31-33.
Government (1977). Taxpayers who overpay less likely to be audited: GAO.
Journal of Accountancy, 143(1), 19-22.
Dr. Peter Ikre has more than 25 years experience in Healthcare, Accounting, Taxation, Business Management and Financial Consulting both internationally and locally. Dr. Ikre is currently a tax expert and loan modification specialist at Investigroup.  He can be reached directly at 9083421160 (cell); 9083441806 (alt.); 9086884778 (ext. 106) – office; email: pikre@investigroup.org

Posted by admin on Dec 23 2013. Filed under Community News. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry