Speaker 1: Today, I'm going to talk about how to handle an IRS tax audit. So the word audit comes from an old Latin translation meaning, run, the IRS is coming. Okay, not really. In fact, the Latin word for audit is audere, which means to hear. And listen, once you learn how tax audits actually work, then you won't be afraid of them at all. Actually, in some weird way, you may look forward to them. And with the IRS beefing up their staff and reportedly hiring 87,000 new agents, it's very important that you watch this video and learn this information. So today, what I want to do is cover how IRS tax audits actually work, how to prevent and maybe win an audit, and what happens if you unfortunately lose a tax audit. But really quick before I dive in, if you appreciate this type of content, then please make sure you like this video for the YouTube algorithm. It really goes a long way in helping this video reach more people like you. All right, let's go ahead and get started with number one, what is an audit? So it's probably exactly what you think it is. A tax audit is when the IRS does a review of your personal and business finances to make sure you're paying your fair share in taxes. Typically that means the IRS is going to want to review stuff like your personal information, learning about who you are, your occupation, where you live, and so on. And if you have a business, they'll also want to review your business information like when you started the company, what type of company you have, and where it's located, just to name a few. They'll also want to review your financial statements and bookkeeping records to make sure you properly reported your income. At the same time, they may take a look at your tax forms that they have on file to make sure you reported them. And of course, the big thing is reviewing your tax deductions and credits to make sure you actually qualify for them. Usually the primary goal of an IRS tax audit is to ensure two things. Number one, that you are not reporting less income than you actually earned. Or number two, you are not over-reporting the deductible expenses that you have because in either case, it would mean that you're reporting less tax liability and you're not paying your fair share in taxes. But if you have all your affairs in proper order, then guess what? An audit is more of an inconvenience than something that you need to be nervous about. Which leads me to number two, what triggers an IRS audit. So it's basically impossible to predict an IRS audit because they can be triggered for three common reasons. Like number one, an automated computer screening, which happens when a tax return falls outside of the norm and flagged for review. And I'll talk about some of these flags in just a second, but first let me give you the second reason that you may get audited. And that is number two, by association. So if your tax return is connected to someone else who is being audited, like a business partner or maybe a business vendor that you have, then you may be audited just by being associated with them. And then lastly, the catch all is number three, a random selection through the IRS tax system. I know people who file their taxes every year on time and they pay exactly what they owe, but they still end up getting audited. And sometimes it's just bad luck. But other times there are specific triggers such as, okay, failing to report your income that has already been reported to the IRS, like your W-2 income or your 1099 income. Because here's the thing, your income is usually someone else's tax deduction. Let me say that again. Your income is usually someone else's deduction. So let's break that down. Let's say for example, you have a side hustle and you're getting paid as a contractor, well, the person or the company that pays you will want to write off that expense on their taxes to legally reduce their taxable income. So that company would then report that contractor expense on their tax return and then issue you a 1099 form with the exact amount that you should have received. So you probably can start to see the dilemma here or the catch here, right? If the IRS sees a payroll or contractor deduction on someone else's tax return, then the IRS would expect to see income on the other return. So it's kind of like one of those check and balance systems. And look, even if you are paid in cash, someone would still likely report and should report that deduction on their tax return and that the IRS asks, okay, who did you pay? The finger will be pointed back to the contractor or employee. Now outside of income, other things can raise a red flag and trigger an audit such as taking a super big tax deduction when you have very little income, misclassifying employees as 1099s when they should be W-2s and then failing to actually issue out 1099s or W-2s to your employees. However, these things shouldn't be something you need to worry about if you have a great tax accountant that you're working with, which by the way, we are starting to set more clients into life taxes. So if you need help with creating a tax strategy or tax preparation, then go ahead and click the link down in the description below so that you can learn how to work directly with our team. All right, now let's move on to number three and talk about the different types of audits. So on TV, when you see IRS audits happening, you'll see a bunch of action packed stuff going on like agents raiding someone's home and then pinning the taxpayer on the floor and the accountant booking a trip out to the Cayman Islands. But that's not really how things go down. Okay. In real life audits fit into one of these formats. Number one, correspondence audits. Okay. This is when the IRS will notify you usually via a mail letter, not email and especially not a phone call. Okay. Those are scammers, but you'll receive a mail letter and the IRS will share with you exactly what they found. Maybe it is an omission of income or error on your tax return. From there, you have two options. You can either A, pay the amount detailed in the letter if you agree that you omitted some type of income or made some type of mistake. Or option B, you could dispute it and then provide necessary documentations such as receipts for the income or the breakdown of the deductions. So that's the correspondence audit. The next type of audit is number two, an office audit. Now contrary to the movies, this is where the IRS will actually schedule you to interview at their office asking you some questions about your tax return. And a third popular audit is number three, a line by line audit, which is where the IRS will go through your entire tax return line by line and you'll need to provide evidence for each line item. It's almost like you're completely redoing your tax return, but this time you actually need to provide documentation. But again, if you're organized and you have bookkeeping in place and you have your personal and business finances separated, then you'll be able to do this with flying colors. Let's move on to number four and talk about how to prevent and win an audit. So it's probably obvious by now that there's actually no way to completely avoid an audit because sometimes it just happens randomly. However, you can dramatically reduce the time spent inside of an audit or the likelihood of it occurring at all by simply reverse engineering exactly what triggers an audit in the first place. Of course, tip number one would be make sure you report all your income. Yes, the IRS uses forms like W2s, 1099s, 1098s to make sure taxpayers report their income, but don't just rely on receiving these in the mail. Actually think about all your activities and all your streams of income because sometimes mail can get lost or you change addresses and sometimes the company who are supposed to give you the document fails to do so in a timely manner. And I get it, right? It can be difficult to remember that one side hustle that you did for just two months, one year and a half ago, but it's still your responsibility and that is why you must stay organized. Number two, double, heck, triple check your tax return, even if you have a professional tax preparer to handle it for you because unless your tax accountant has access to all your bank accounts and all your brokerage accounts, only you would know what things may have been missed or potentially what errors have been made. And of course, number three, follow the rules. Make sure you're classifying your employees the correct way. Make sure you're paying your independent contractors correctly. Make sure you're withholding the proper amount of taxes if you have W2 employees. And if you're an S corp, make sure you're paying yourself a reasonable salary and so on. I also have a fantastic video called IRS Tax Court Cases where I review many different audits and I don't think that video got the views it deserved, but it's very important, especially for entrepreneurs. So you can check that video out down in the description below to watch after you finish this one. All right. Now here's a quick bonus tip. If you can respond to the IRS in a quick and timely manner, then that's going to show them that you're organized and you're keeping records. So they may give you the benefit of the doubt and end the audit early. On the other hand, if you're scrambling and you're given incomplete information, then you are literally giving the IRS agent a reason to investigate you deeper, which leads me to number five. How far can the IRS go back and audit you? So the IRS typically has three years after you file a tax return to audit you for that tax year. However, it can extend up to seven years in certain circumstances, such as failing to report more than 25% of your income or omitting more than $5,000 in foreign income. For example, if you have cash sitting in an offshore account and you fail to report it. In other cases, the timeframe for an IRS audit can be extended indefinitely if you are not filing your taxes at all and you're required to, or if you have interest in a foreign corporation and not filing IRS form 5471. So I like to tell people, instead of throwing away your tax forms and your physical receipts, digitize them and then store them on your computer or even better inside of the cloud so that you always have record in the event that you need to substantiate any tax deduction or any income that you made. Now number six, what happens if you lose an IRS audit? So if you messed up and you got caught, then guess what? You still don't need to stress about it too much unless you had criminal intentions, because more than likely you are not going to jail and you're not going to have your business deleted off the planet earth. Instead, the more likely scenario is that you're going to need to pay the proper amount in taxes that you should have and then be assessed IRS tax penalties. And look, there are many penalties to look out for, such as the failure to file penalty and the failing to pay penalty, just to name a few. And these can add up and be very costly for taxpayers and entrepreneurs. Now I have an old video that I made maybe a year and a half ago where I break down all the IRS tax penalties in great detail, including how much they are, when they're triggered and much more. So you can check that video out over here if you want to watch that next. But if you're not worried about the penalties and you mainly want to make sure you're able to substantiate your tax deductions and report your income, then I would highly recommend you check out this next video on IRS receipt requirements and I'll see you over there.