What Your CPA Wants You to Know
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What Your CPA Wants You to Know
61. The Secrets to Avoiding an IRS Audit on Your Tax Return
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Ever wonder why some tax returns get the dreaded IRS audit while others glide by?
Join us as we share the red flags that you do NOT want to file on your tax return! We've seen several audits happen because of these things and we want to share them with you.
We explain the chances of your tax return getting audited and what happens if you DO get audited. If you have a business on your tax return, we share many things we've seen lead to an audit!
Make sure to check out this very crucial episode!
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Red Flag Audits and Tax Tips
Speaker 1Yeah , it's going to make it look like you made up the numbers , or more specifically , round numbers on mileage , I had an iris agent tell me specifically that you would not believe how many people had exactly $5,650 in auto expense . Well , that year the mileage rate was 56 and a half cents per mile , which means that there were millions of people that just put 10,000 miles flat . Well , that's not very likely . So that makes them want to come look and say hey , you know , I think maybe you didn't actually keep a mileage log , which we require you to do if you're going to deduct the mileage .
Speaker 2Welcome to what your CPA wants you to know tax and accounting help can be Expensive , so we've created this podcast to help guide you through it all and make you feel like you have a CPA in your back pocket . I'm Carson sands and I'm Taryn sands .
Speaker 1I'm a CPA with over 10 years of experience helping people start and grow their businesses .
Speaker 2And I'm an MBA with a specialization and marketing and entrepreneurship . Taxes suck and we want to make sure you don't pay more than your fair share .
Speaker 1We're here to share everything your CPA wants you to know in a fun and easy to understand way . Let's get started .
Speaker 2Let's do it .
Speaker 1Are you scared of being audited ? Are you worried that you're not doing something right that might raise some red flags ? Well , this episode is all about red flag audits .
Speaker 2We have so many people coming to us stating I'm just so scared of the IRS , I just don't want to go to jail . So we thought that this episode would be a good one so that we can explain what some red flags are . You definitely don't want to file a tax return with one of these things on them , and make sure that you avoid them and avoid an audit .
Speaker 1The first thing you should know is that , in general , if you're not making over $10 million a year in income , there is about a point two percent chance that you're going to get audited . Now , that's the average . So if you're not doing any of these red flag items we're going to mention , your odds are very low .
Speaker 2Yeah , so you shouldn't be just scared all the time of getting audited .
Speaker 1That just doesn't happen a lot right now , especially if you're not a very high earner , so that is actually a very low probability , so you can rest easy knowing that and if you do get randomly selected and I say randomly selected because I'm assuming that you're all Brilliant people that listen to every episode of our podcast and you're not going to Commit any of these red flags and you're following all the rules , but you might get randomly selected even if you don't do anything wrong .
Speaker 1Well have no fear . If you're keeping good records and doing all the things that we teach you , you'll get through that audit with a few more gray hairs , but not owing a single penny more .
Speaker 2Yes , and most of those audits now are just male audits . So as long as you're keeping good records , this isn't very likely that would happen , but you could definitely get through it wait , male audits , you mean , girls don't get audited .
Speaker 1That seems super unfair .
Speaker 2Male in audits .
Speaker 1in the mail oh you mean like that thing , that it's like email , but they send it on paper .
Speaker 2Yes , like the thing that the . Irs likes , either write them a letter or fax them .
Speaker 1That what's a fax I ? Know , oh , you mean like something that's true , a fact .
Speaker 2No , as an ancient IRS technology that they still use all the time .
Speaker 1That's right . They don't use emails because it could be intercepted . However , when you fax them , I'm faxing them from my email program that mimics a fax and it's going directly to their email , which mimics a fax and they get an email . We're still emailing each other .
Speaker 2I don't know how that's more secure , but it apparently it is someone was saying the other day that they Didn't know if they had a good CPA because their CPA said , oh , I need to send a fax to the IRS about this letter you got , and she was like no , we don't fax anymore . Like I must have the worst CPA ever .
Speaker 1Well , no , no , we still fax things . I don't like it . I don't even have a fax machine , but I do have a way to send faxes from my computer and unfortunately I have to do it all the time .
Speaker 2Yeah , we fax things to them because the only other option is to mail it and that usually takes so much more time , so you might as well just fax them .
Speaker 1Yeah , it's better if you have that option . Okay , so , moving on , here's some things that could increase you above that 0.2% average .
Speaker 2Some red flag audits and if you file a tax return with a red flag , like , what does that mean ? And what we mean by that is that their computer system is going to see this and it's going to mark your return .
Speaker 1That's some of them , or there could be things that just jump out for other reasons . But yes , and the worst part is , a lot of these red flag items are what brings you to their attention , and it only costs you a little bit . But while they're digging into you , they find something else . You did wrong . It wasn't even a red flag , but it costs you way more than the red flag costs in the first place . So it's better not to bring yourself to their attention .
Speaker 2Yeah , that always happens , like the thing that actually gets them audited is not what the pain point of the whole audit is . They actually stumble across something else that wasn't even part of the initial audit .
Speaker 1Yeah , we noticed you did this wrong too . Okay , well , now you owe us thousands of dollars . Yeah , that happens .
Speaker 2And I do have to mention that we have never had a tax return prepared at our firm be audited , knock on wood , because we make sure that we are not filing a tax return with our name on it that has a red flag on it .
Speaker 1Right , that's not to say somebody might not get randomly selected , which does happen , unrelated to anything that you did on or did not do on the tax return , but we've worked on many audits for clients that were audited on a return that somebody else prepared and then they came to us for help .
Speaker 2And all of those . We were like why did you file it that way ? None of those were randomly selected .
Speaker 1Every single time we've worked on one . I've looked at it and gone yeah , if I was the IRS , I would have audited you too , so I'll help you straighten this out . But yeah , this looks not good at all .
Speaker 2So this is a very important episode , because audits are expensive and you just want to make sure that you're not filing one that's like hey , audit me .
Speaker 1Right , right . So here's one . Here's a red flag audit . We've talked about this on many episodes Whenever you have a business , the IRS doesn't want to see a loss three years in a row . In fact , they want you to show a profit on an average three out of five years . So if you have a loss three years in a row , you've already failed to meet the three out of five years of profit plan and you might get a little bit more scrutiny there .
Speaker 2This happens a lot , when people send us their stuff over because it's great when you have a loss , right , because that brings down your taxes , and who doesn't want their taxes to be lower ? That's when we have to say , hey , you know , we filed a loss on this last year . This is not going to look good . You can't keep doing it Like is this an actual hobby , or are you going to keep going with your business ?
Speaker 1Right , that's exactly right .
Speaker 2So definitely , if you have that schedule see business make sure you're not always filing a loss because at some point that's going to bite you in the butt .
Speaker 1Right , okay , so here's another big one Round numbers . For example , my office supplies expense was exactly $1,000 .
Speaker 2Yeah , that's very unlikely so and everything else on this list , and then is zero .
Speaker 1Yeah , it's going to make it look like you made up the numbers , or , more specifically , round numbers on mileage . I had an IRS agent tell me specifically that you would not believe how many people had exactly $5,650 in auto expense . Well , that year the mileage rate was 56 and a half cents per mile , which means that there were millions of people that just put 10,000 miles flat . Well , that's not very likely . So that makes them want to come look and say hey , you know , I think maybe you didn't actually keep a mileage log , which we require you to do if you're going to deduct the mileage . So show me that mileage log , or we're taking this away . And while we're here , we're going to go ahead and look at 20 other things and hope that you didn't do anything wrong on those .
Speaker 2Exactly so . They don't like you having a lot of round numbers , so it just kind of makes them realize that those aren't really the exact numbers .
Speaker 1Yeah , I know tracking all this stuff is not fun , but just track it and have the real number , you know , and it's going to end in a two or an eight or something , not in a zero . That's just weird .
Speaker 2Exactly so make sure your numbers are weird .
Speaker 1Oh , here's another big one unreported income . Specifically when there are tax forms filed reporting that income , for example a 1099 or a W2 or a 1099 for gambling income or something like that these are filed with the IRS and they are electronically filed , which means their computer system knows about this income and they call this a matching error . That means that there was income reported to your social security number and you didn't put it on your tax return . That's a 100% maybe not audit , but at least a letter , because they don't even have to have a person look at that . Their computer already caught it and auto-generated and printed a letter and they just had to have someone stick it in an envelope and send it to you saying oh , you didn't report this , you owe us some money .
Speaker 2A scenario would be maybe you forgot that you did some contract work and maybe it wasn't that much to you , maybe it was like $1,000 . And so you went ahead and did your tax return , but you forgot to give your CPA that your CPA doesn't know about it . They don't know it exists . So then the IRS knows it exists and your numbers don't match up . So when you're getting ready to file your tax return , make sure that you're thinking about all of the things you did in the year and it can be a lot of things , like Carson said , that could be gambling income . You want to make sure that you have all of your forms before you file .
Speaker 1Right and not to beat a dead horse , but in Teran's example that $1,000 , 1099 , I mean worst case scenario , it's going to cost you an extra $370 in taxes . But what the big problem is is they might decide oh , since we're already taking a look at you , let's go ahead and look at everything , and maybe you made another big mistake that wouldn't have even been noticed . I hope you don't make any mistakes , but if you did , then it's going to get caught now .
Speaker 2Yeah , and they can go looking at things that you don't want them to look into everything and it's just a pain in the butt , especially if you have to pay your CPA to do it . That costs you more money . So just make sure that you're reporting all of your income and not leaving anything out . Do you want to start your own business but have no idea where to start ? Does the tax and accounting part of business ownership scare you ? Or maybe you just don't have the budget for CPA services right now ? If this sounds like you , listen up .
Speaker 2We've created a new business guide to help you through every step of the process so you feel confident and supported when starting your business . Our guide will help make sure you don't miss any important steps and educate you on the tax and accounting side of things . The best part is that it's priced for less than one meeting with the CPA , so don't ignore this part of the process . Use our guide to educate and empower yourself without the hefty cost of multiple meetings with the CPA . We will guide you through the initial steps , provide yearly checklists and give you things to put on your radar for the future as your business grows . And just for being a podcast listener , you get a discount . Find the link in the show notes to purchase the guide and use code podcast at checkout to use that discount . Now back to the show .
Red Flags for IRS Audits
Speaker 1Okay , another one that is almost an automatic audit . Negative gross profit Okay , that's an accounting term .
Speaker 2I know Taryn's about to bust me on that , so let me just explain that , and so we can all understand .
Speaker 1Okay . So having a net loss on your business is okay , but negative gross profit means that your total income minus your cost of goods sold was negative . In other words , the items that you bought to resell cost more than what you sold them for . That doesn't make any sense . It doesn't make any sense at all . For example , you're a cabinet maker and just the cost of your wood alone was higher than what you made off of cabinets for the whole year . That's before you take into account any other expenses like your office supplies and your accounting fees and things like that .
Speaker 1So whenever the IRS sees that they're like , well , this is a hobby , I mean , if you're spending more on wood than you're making for selling cabinets , then you're making cabinets for fun , so that's , we're not letting you deduct that . And whenever we say that you're going to get audited for something like that and they'll find something else , this is a specific example where we've seen that happen Negative gross profit on somebody's side business , and it opened up the floodgates for all these other issues that came up . And it was . It was a . It was a disaster .
Speaker 2Yeah , we will not file a tax return . That has that on there .
Speaker 1Right , we didn't file the tax return that had it on there , we were just helping clean up the mess after the fact .
Speaker 2We've only worked on audits that other people cause issues for .
Speaker 1Another one . Earlier we were saying that you don't need to worry too much as long as you don't do any red flag issues . If you're below 10 million in revenue or below 10 million in taxable income , that you have a 0.2% chance . Well , if you happen to make over $10 million , you have an 8.7% chance of getting audited . So you have a very high likelihood of getting audited if you're one of those high earners . And it kind of makes sense if you think about it . Irs agents are highly trained . Usually they have degrees and they're expensive to keep on staff . So who are they going to send them after ? People that might owe 5,000 extra might not even be worth their time or somebody that might owe an extra 5 million that they left off their tax return . They're going to get a lot more bang for their buck with that .
Speaker 2Exactly , they were going to go after the high tax payer . So if you are in some of the lower brackets , your likelihood of getting audited is definitely lower .
Speaker 1Don't feel bad for the people that make over 10 million . They have enough money to pay people to handle that for them , so hopefully they don't have to deal with the IRS on their own .
Speaker 2Definitely not One small . The star on that is that if you're using the EIC credit , so this would be the offset of high income earners . Which is the very , very bottom . If you're using that credit which I guess you can go into a little bit more about what that is then you do have a slightly higher chance of being audited .
Speaker 1Right , the earned income credit is a special credit that is given to people that did work but made very little money , and where that threshold is depends on how many kids you have , where they're married and some other factors . But if you had a job and just didn't make very much , then this is a refundable credit , and that just means that even if you didn't pay any taxes in , they will send you a check for this refund , and for that reason the earned income tax credit is abused a lot , and so it's subject to a lot higher degree of scrutiny than a lot of other credits .
Speaker 2Basically , you're getting a refund , but you didn't pay anything in . So , in case you didn't know , if you get a refund , it's usually a refund of your money and this is not so . That's why they wanna make sure people are not abusing it .
Speaker 1Right , and in fact this credit is very unpopular with a lot of people , and so people are already mad that people that are do this credit are getting it . So they wanna make sure that nobody that isn't do the credit is getting it , although that's still only a 1.1% audit rate , so I doubt they're catching all of the thieves on that one .
Speaker 2Definitely not . Another thing that could be a red flag is just a crazy number on your return . That just doesn't make sense .
Speaker 1Right , statistical anomalies . You know your mortgage interest is $100,000 , but you only made $100,000 . Yeah , that looks weird .
Speaker 2If you have a very high charitable deductions yet very low income .
Speaker 1Where did you get that money ?
Speaker 2Yeah , they're gonna be checking to make sure you actually donated all of that to charity .
Speaker 1So that is and they're gonna make sure that you didn't have more income than you told them , because where did you get that $180,000 that you donated when you only made $120,000 ?
Speaker 2So things that don't make sense . Now , that could mean a lot of things .
Speaker 1It does mean a lot of different things , and there's even one specifically for advertising as well . If your business made $20,000 and you spent 15,000 on advertising , you know they're gonna wonder where you spent that money and why . So that's gonna be subject scrutiny Doesn't mean it's not legitimate , but it means that they are gonna at least look into that a little bit more .
Speaker 2It also includes businesses , so things that don't make sense , let's say for accounting firms . If , statistically you fall way outside for certain expenses or you had something that most of them don't , that could definitely be a red flag .
Speaker 1That's true . You know , if you're in the crane business and you have equipment purchases of $3 million , that kind of makes sense . But if you're an accountant and you have $3 million of equipment purchases , they might wanna know what you bought . They're gonna be like well , where's your yacht ? I don't understand why you needed a yacht for your CPA firm .
Speaker 2Yeah , you don't need heavy equipment for accounting firms .
Speaker 1Well , I don't know , we might .
Speaker 2So far we haven't needed it any .
Speaker 1No not yet .
Speaker 2So definitely be watching those numbers that sometimes if one number on your business schedule C is like really high , that would be a red flag .
Speaker 1Yes , absolutely . The last red flag we wanna discuss is real estate income deductions , and what we mean by that is not that you just have a rental property and you're deducting the taxes and the more interest , like you're supposed to . But typically if you have a loss on that property , you can't deduct it against your other income . You have to leave it sitting there to be used against rental income in a future year . But there's a couple of exceptions where you're allowed to deduct part or all of that , and one of those is if you're claiming that you're a real estate professional , that just means that you spend a certain number of hours every year working on real estate and that you spend more time working on real estate than any other business .
Speaker 2It's like your job , if real estate's your job .
Speaker 1Right , and so if you're making that claim , then you better have a really good reason . Now if you're a realtor and you also rent houses on the side and you're saying you're a real estate professional , then that's fine , you're gonna get by with that just fine . But if you have a W-2 from an accounting firm and you're claiming to be a real estate professional , they're gonna wonder how you're working . You know 2,500 hours a year as an accountant and you're still somehow working 2,600 hours a year as a real estate professional . It's just not enough hours .
Speaker 1So the red flag here would be Claiming you're a real estate professional to deduct that loss against your other income whenever you don't have a legitimate reason to do that .
Speaker 2So they would think people are abusing this and should not be a real estate pro . So definitely make sure , if you're using that , that you actually are following the rules .
Speaker 1They're really simple . Just talk to your tax professional about that and they'll help you out .
Speaker 2And don't use it if you do not fall under that category .
Speaker 1Please .
Speaker 2Well , that wraps it up for today . If you follow our advice on this , you should be all set and don't be too scared of getting an audit . But also make sure that if your tax preparer , your CPA , whoever , says , hey , you know this is not good , listen to him .
Speaker 1Right , and if you're filing your own tax return , keep an eye on those specific red flags and try to avoid them .
Speaker 2Until next time . Thank you so much for listening to .
Speaker 1What your CPA Wants .
Speaker 2You to Know . Podcast what your CPA Wants you to Know . Podcast what .
Speaker 1Your CPA Wants you To Know Podcast . This podcast is intended to provide accounting and tax information for educational purposes only . All tax situations are unique and should be handled with the assistance of a tax professional .