Preparation and Proactivity: the Keys to Getting Through an IRS Audit

Receiving a notification for an Internal Revenue Service audit is incredibly stressful, but if you’re proactive and organized, it’s nothing you can’t get through. Unfortunately, many people learn this the hard way—waiting until they’ve been audited to change their behavior.

If you’re in need of Washington, D.C. tax preparation, look no further than Cohen & Burnett. Today we’ll tell you how an audit begins, what to expect, and how to increase your chances of having a smooth and problem-free interaction with the IRS.

Understanding the Triggers

The IRS uses an algorithm called the Discriminant Inventory Function System to separate the data and identify audit-worthy accounts for a closer look. The DIFS software uses a sophisticated set of formulas to automatically score accounts based on their respective credits, losses, expenses, and deductions relative to their total income.

Common “high scorers” on DIFS analyses are wealthy taxpayers with high levels of Schedule C deductive expenses. Schedule C is used to report income via self-employment, which makes it relatively easy for “unorganized” taxpayers to classify personal expenses as business ones.

Another common red flag is claiming losses via a business partnership, and/or deducting passive losses (incurred from a business interest or partnership the filer is not actively involved in) against active income. These losses may be deducted without taking the filer’s hours committed into consideration, unless those losses exceed the income for three out of five years (in which case the business interest is considered a hobby).

Being Prepared

As with so many things in the tax world, the best tactic is to be organized and keep detailed records. A business owner who takes a client, the client’s spouse, and his own spouse to a charity gala, for example, may deduct the tickets and other costs as a business expense — but only if: 1. there was a reasonable expectation of deriving income from that client, and 2. they used the opportunity to discuss business information. In this case, saving not just the receipt for the event but also writing and filing a memo on what was discussed will help assure the IRS that the expense was indeed business-related.

Inheritance and Estate Assets

Heirs are another group commonly targeted for audits, as estate taxes for large inherited properties can entail a significant return. Given the highly technical and geographically-varying regulations for determining estate values, valuation inaccuracies are quite common. A death can cause confusion and stress to the inheriting parties and lead to assets being overlooked or neglected in the final report.

The solution? Estate holders must pay special care to planning their inheritance. Heirs should be informed and involved in the planning process and be aware of where to find important documents like the title and appraisal. If and when the IRS decides to audit, having these documents in hand will save heirs significant time and effort.

Tax Preparation with Cohen & Burnett

Cohen & Burnett is proud to have over 25 years of experience providing Washington, D.C. tax preparation, estate planning and execution, and asset protection planning. Our team creates individualized strategies for every client that walks through our doors. Visit our homepage for more information or contact us directly.

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