From the Tax Law Offices of David W. Klasing - IRS Audits Explained for Business Owners

IRVINE, Calif., April 6, 2023 /PRNewswire/ -- An Internal Revenue Service (IRS) audit is an examination of an individual's or organization's accounts and financial information. The audit can easily spread to other entities and related individuals where an examined flow through entity dumps taxable income found to be understated on to multiple owner's individual tax returns and where these individuals own multiple entities that can easily be suspected of understating taxable income. The IRS endeavors to ensure that financial information is reported correctly and that tax obligations are fulfilled.

Business owners can be audited for several reasons. The process can be very intimidating and stressful. However, if your business & personal returns are audited you can contact our dual licensed Tax Audit Lawyers & CPAs for help. Our experienced & winning legal team will assess your case and prepare the best defense possible. Furthermore, we will vigorously appeal the IRS's audit assessment when the IRS gets either the facts or the law wrong, as we find they frequently do, and thus your audit does not initially go your way.

Seek guidance from our Dual Licensed Tax Attorneys and CPAs by calling the Tax Law Offices of David W. Klasing at (800) 681-1295 or schedule a reduced rate initial consultation here.

Types of IRS Audits that Small Businesses Can Face in California

Millions of business and individual tax returns are filed each year. Accordingly, the IRS has developed sophisticated, computerized systems designed to catch taxpayers who submit incorrect or fraudulent returns. Information from tax returns is compared with the information supplied by third parties like banks, businesses, and other individuals. If a businesses or individual's tax return is flagged, the IRS will review the returns at issue and determine whether the matter should be civilly or criminally investigated further.

For business owners and related entities, three general types of audits can be performed. Fortunately, our Dual Licensed Tax Attorneys and CPAs can explain the appropriate next steps if you are facing any of the following:

Correspondence Audits

Correspondence audits are performed, at least initially, through written correspondence. These audits typically question specific items from your business or individual tax returns instead of questioning your return in its entirety. For example, if you claim to have donated a large amount of money to charity, the IRS may ask for proof of these donations. In that case, your audit may be resolved by simply mailing the IRS agent copies of receipts that will verify the information in question.

Still, you should be notified of any type of audit through the mail, not just correspondence audits.

Field Audit

Field audits are among the IRS's most in-depth, stressful, frightening, invasive and high-risk types of in person examinations. If your business or individual return is subject to a field audit, an IRS agent will request an in-person meeting to discuss discrepancies found on your tax return to take place either in your home or business location. Support from experienced tax audit professionals is highly valuable and downright comforting when undergoing a field audit.

Office Audit

You will also have to sit down with an IRS agent in person if you are subject to an IRS office audit. However, these interviews will be performed at local IRS offices which can be downright intimidating. During your office audit, you will be asked to answer questions pertaining to any item reported on your businesses or individual income tax returns. In order for the issue to be resolved, you will have to prove that the information you filed was correct or that you made a mistake in good faith.

Are Businesses Targeted at Random for IRS Audits in California?

Business tax returns are initially selected for audits using a statistical formula that is a closely guarded secret. Your business's returns are statistically compared with similar returns to determine if you should be audited. The IRS asserts that auditing practices for businesses are initiated at random. However, many business owners often suspect they are being deliberately targeted for audits.

Potential Triggers for Business or Individual Eggshell Reverse Eggshell Audits or Criminal Tax Investigations

When the IRS examines a small businesses or individuals tax returns, it will look for specific signifiers or "badges" of fraud. If any of the following issues are noticed on your returns, then your business may be subject to a civil audit, eggshell audit, or criminal tax investigation:

Misrepresentation of Taxable Domestic or Offshore Income & Omitting Required Foreign Information Reporting

If you did not accurately report your businesses or individual taxable income, then you may be audited or criminally investigated. There are several ways that income may be misrepresented. For example, perpetrators may accidentally or intentionally understate income, overstate deductions, claim credits they are not entitled too or omit certain transactions and leave the related domestic or offshore taxable funds, entities or investments unreported.

Improperly Claiming Deductions

Small business owners in California regularly claim tax deductions for expenses like travel costs, vehicle use, and internet bills. These deductions are useful for lessening your tax liability. However, if you invent or fraudulently inflate deductions, a red flag may be raised that can trigger an IRS audit.

Excessive Expenses

Spending an extraordinary amount of money, or merely fraudulently representing your business expenses, and thus drastically increasing your business expenses from one year to the next may also trigger an audit or criminal tax investigation.

High Number of Cash Transactions

Several types of businesses ordinarily engage in a large number of cash transactions. For instance, restaurants, laundromats, and barbershops may accept a large amount of their income in cash.

Businesses that engage in mostly cash transactions may find themselves subject to IRS audits or criminal tax investigations because the government suspects that income has been fraudulently underreported. If your business engages in a great deal of cash transactions, you should be prepared to substantiate those transactions and help verify your income. Maintaining accurate point of sale registers, making daily cash deposits and keeping an accurate cash receipt journal can help. Avoid paying expenses in cash whenever possible. Whatever you do, do not pay employees and independent contractors in cash and then fail to issue W2's and 1099's as this can be criminally prosecuted as aiding and abetting the income tax evasion of another.

Claiming Losses Every Year

Losses are not uncommon for business owners. Still, if you claim losses for your business year after year, the IRS may question if your returns are legitimate or throw the hobby loss rules at you. You must be able to document any losses that your business sustained.

It is also worth mentioning that any carryforward Net Operating Loss (NOL) claimed on a tax return under audit can and will be routinely challenged which is an effective way of opening an audit on an otherwise closed tax years and you will thus be legally compelled to prove your NOL's or lose them. Moreover, a great way to find yourself criminally investigated is to live a lifestyle that is beyond what your reported historical taxable income shows you can afford.

Misclassified Employees & Employment Tax Fraud

Finally, the misclassification of employees as independent contractors will commonly trigger a business audit. It is well known to the IRS and state taxing authorities that businesses often attempt to lower their insurance costs & reduce payroll expenses by misclassifying what are in essence employees as independent contractors. If you wish to nip this exposure in the bud, we can enter you into the IRS's Voluntary Classification Settlement Program.

Engaging in employment tax fraud by routinely failing to remit the employment taxes and withholding of your employees to the federal and state governments, paying employees in cash and failing to issue W2's or 1099s, or fraudulently underreporting taxable wages can easily get you audited or criminally investigated. 

Small Business Owners in California Can Call Our Law Firm for Help with Their Tax Issues

Contact our experienced Dual Licensed Tax Attorneys and CPAs at the Tax Law Offices of David W. Klasing by calling (800) 681-1295 today.

How to avoid and Audit or Criminal Tax Investigation Altogether.

If you have failed to file a tax return for one or more years or have taken a position on a tax return that could not be supported upon an IRS or state tax authority audit, eggshell audit, reverse eggshell audit, or criminal tax investigation, it is in your best interest to contact an experienced tax defense attorney to determine your best route back into federal or state tax compliance without facing criminal prosecution.

Note: As long as a taxpayer that has willfully committed tax crimes (potentially including non-filed foreign information returns coupled with affirmative evasion of U.S. income tax on offshore income) self-reports the tax fraud (including a pattern of non-filed returns) through a domestic or offshore voluntary disclosure before the IRS has started an audit or criminal tax investigation / prosecution, the taxpayer can ordinarily be successfully brought back into tax compliance and receive a nearly guaranteed pass on criminal tax prosecution and simultaneously often receive a break on the civil penalties that would otherwise apply. 

It is imperative that you hire an experienced and reputable criminal tax defense attorney to take you through the voluntary disclosure process. Only an Attorney has the Attorney Client Privilege and Work Product Privileges that will prevent the very professional that you hire from being potentially being forced to become a witness against you, especially where they prepared the returns that need to be amended, in a subsequent criminal tax audit, investigation or prosecution.

Moreover, only an Attorney can enter you into a voluntary disclosure without engaging in the unauthorized practice of law (a crime in itself). Only an Attorney trained in Criminal Tax Defense fully understands the risks and rewards involved in voluntary disclosures and how to protect you if you do not qualify for a voluntary disclosure.

As uniquely qualified and extensively experienced Criminal Tax Defense Tax Attorneys, Kovel CPAs and EAs, our firm provides a one stop shop to efficiently achieve the optimal and predictable results that simultaneously protect your liberty and your net worth. See our Testimonials to see what our clients have to say about us!

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Public Contact: Dave Klasing Esq. M.S.-Tax CPA, [email protected]

SOURCE Tax Law Offices of David W. Klasing, PC