23 Jan Worried About A Tax Audit?
As our clients know, we spend a lot of time talking about income taxes. No, we’re not masochists but we do know that for most people (especially for our retired clients) income tax planning is one of the best ways to keep more of your money. Thoughtful and consistent income tax planning done each year can add thousands of dollars to your net worth over time.
For this reason, we spend a lot of time thinking about how to legally reduce our client’s income tax burden. We review tax returns, run tax projections and work closely with CPAs/ tax preparers to help achieve this objective for our clients.
One of the questions clients ask when talking about tax planning opportunities is: “Will this generate an audit?” While we want to take advantage of all the legal opportunities to save money on taxes, we don’t want our clients to face the fear, anxiety and hassle of going through a tax audit.
Chance Of An Audit
From a purely statistical standpoint the chance of actually getting audited is very low. The Wall Street Journal recently reported (1) that in 2019, the IRS audited only 0.45% of the returns it received, the lowest level in at least four decades. Audits were down 25% from the previous year, marking the eighth straight year of decline. In addition, the number of audits is getting lower and lower due to a continuing budget crisis at the IRS.
However, it’s important to note that some people are more likely to get audited than others. Yes, you guessed correctly, upper-income taxpayers generally have a higher chance of getting audited (2).
In 2011, before the IRS budget cuts had really taken their full force, tax payers with more than $1 million had a 1 in 8 chance of being audited. Now these numbers for the same income bracket is a 1-in-25 rate (2).
The further away from $1MM you are, the less likely you are to be audited. For example, those making $200,000 or more in 2011 had a 1 in 25 chance of being audited. This year, those same people’s chances are 1 in 80.
How To Potentially Lower Your Audit Risk
Living in the electronic age means that the IRS is collecting more data on people than they may realize. By law, financial institutions are typically required to report tax-related activity in your account to the IRS, and therefore, they are able to “double-check” your return against 1099s and other tax forms provided by the financial institution.
IRS computers routinely search for discrepancies between what taxpayers report on their tax returns and what is reported separately to the government by employers, financial institutions and other “third-party providers.” The IRS also looks for returns that didn’t report taxable income.
Therefore, before you hit “send” to submit your return, double-check to see if the numbers on your return match those on the relevant tax forms. Keep in mind that no physical person has to manually check these; computers can work behind the scenes to match up the numbers and flag returns that have obvious inconsistencies.
Schedule C’s And The Benefits Of Incorporation
If you are a W-2 employee, there are strict limits to the amount of legal tax planning available to you. Beyond company benefits programs and the normal set of deductions available to all taxpayers, there is a limit to the choices you can make to lower your tax bill. On the other hand, Small business owners have more options available.
However, because most small business owners do not have company payroll departments calculating and withholding taxes on a frequent basis, the IRS has a much more watchful gaze pointed in their direction. This is especially true for unincorporated businesses, who report their income on a Schedule C.
IRS research has shown the largest amounts of noncompliance typically come from returns of taxpayers who own their own businesses, deal in large amounts of cash, receive payments that aren’t subject to tax-withholding requirements and whose income isn’t reported separately to the IRS by third parties (WP article). Auditors often zero in on filers of Schedule C, or, “Profit or Loss from Business.” Compliance tends to be much higher when there is withholding, third-party reporting or both.
Strategic income tax planning plays an important role in helping to maximize your wealth and lower your taxes.
Curtis Hearn, CFP®
The above article is intended to provide generalized financial information; it does not give personalized tax, investment, legal or other professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other matters that affect you our your business.
About Gratus Capital, LLC
Gratus Capital is a consultative wealth manager focused on serving individuals, families, foundations, endowments, and other institutions nationwide. We offer comprehensive financial planning and active portfolio management. Clients benefit from having a dedicated team focused on providing counsel, recommending intelligent, custom solutions, and upholding fiduciary standards. Contact us today to learn how we can help you reach your financial goals.