Proactive measures can quell your fears of an IRS audit trigger, putting the necessary safeguards in place to protect your practice
One of the most nerve-wracking threats faced by thousands of chiropractors each year is the possibility of being audited. The Internal Revenue Service is apparently sending mixed signals about tax audits. On the one hand, the IRS’s own figures reveal that, in general, only 1-2% of taxpayers have their returns audited each year.
But programs such as non-audit letters demanding explanations for discrepancies between amounts reported as paid by patient credit cards and reported income may be cause for concern. This, along with the IRS’s recent announcement about homing in on cash-based businesses and professional practices, appears to increase the risk of small-business owners and self-employed professional IRS audit triggers.
Shrinking the target
There’s no sure way to avoid an income tax audit because details about the IRS audit trigger process are cloaked in secrecy. But most returns are first reviewed by a computer, which scans for triggers previously associated with noncompliance. In addition to auditing flagged returns, the IRS also selects some at random.
An easy and often-overlooked method to legally reduce the possibility of an audit is to simply double-check your numbers. Many audits stem from the IRS checking the figures on the return against those reported by other sources and coming up with a different total—or spotting income that wasn’t reported.
Consider other moves that may help reduce the risk of being audited:
Hire a professional to prepare your tax returns. This can reduce the chance of errors or overlooking important information that affects your finances and can cause an IRS audit trigger.
Be honest. While it may be tempting to lie about income or expenses, those who are honest fare better when it comes to avoiding an audit and surviving one.
Watch the deductibles. If not handled correctly or honestly, deductions can be a huge red flag that leads to an audit.
File electronically. When tax returns are filed electronically, the risk of IRS errors from information being keyed in is reduced substantially.
The worst thing you can do after an IRS audit trigger and upon receiving an audit notice is ignore it. Fortunately, among the more important rights given any chiropractor (or practice) whose returns are targeted is whether to be represented by a tax professional or to answer the IRS’s questions directly.
Another important consideration is where to hold the meeting. Should it take place in the accountant’s office where the working documents are easily accessible? Should it be at the chiropractor’s place of business to demonstrate that there is nothing to hide and the practice is legitimate?
Or, should the practice’s principal, manager, or the operation’s representative trudge down to the IRS office armed only with the specific documents and information requested? There is no one correct answer, so evaluate the risks and benefits within the context of your situation.
Red flags for possible IRS audit trigger
Avoiding costly penalties, fees, and audits is crucial to your success. The most common tax mistakes made by those operating a practice include:
Failing to file and pay taxes on time. Determining the correct tax form and its filing date depends on your practice’s structure. If, for instance, you operate as an S corporation, Form 1120S is used (due on March 15). With a sole proprietorship, Schedule C must accompany Form 1040 (due on April 15).
Forgetting estimated tax payments. Some businesses and practices are required to make quarterly estimated tax payments during the year. If filing as a sole proprietor, a partner, an S corporation, or a self-employed individual, estimated tax payments will have to be made if a tax bill of $1,000 or more is anticipated.
Not taking business deductions or taking excessive deductions. The most commonly overlooked deductions include depreciation, the decrease in asset values over time due to wear and tear, out-of-pocket expenses, purchases of new equipment, and automobile expenses. Taking excessive deductions or mixing personal and business deductions can lead to an IRS audit trigger and federal tax fraud charge.
Keeping poor records. With good records, all practice-related expenses can be deducted, inventory tracked and managed, employee payrolls maintained and reported, and the potential for costly errors eliminated.
Mis-classifying employees as independent contractors. A practice may try to treat workers as independent contractors to save money, as payroll taxes are not due for contractors. But this can end up costing your practice should the IRS disagree with your assessment of their status.
Checking the checker
Whether it is a field audit, office audit, or a correspondence IRS audit trigger, at the end of the examination, a 30-day letter will be issued. If the IRS is correct, the examination report can be signed with the new assessment due within 30 days. Anyone failing to agree with the examiner’s findings can appeal during the 30-day period. An appeal, handled by an IRS appeals officer, can often take a year or longer, during which the tax bill remains in limbo.
A disagreement over an auditor’s findings is usually referred to the appellate level of the IRS, where the representative is often more knowledgeable and likely to be more lenient. Of course, even here, the chiropractor does not have to agree. While the additional taxes demanded by the IRS auditor can go unpaid, the interest and any penalties continue to accrue. But further appeal is still possible.
Until an agreement is reached with the IRS, from the initial screening of the tax returns for accuracy until the final appeal has been exhausted, the appeals process remains open and payment of the contested tax bill need not be paid. Mistakes in favor of the taxpayer are discovered in about 25 percent of cases.
The IRS is usually quite sympathetic to honest mistakes and more than willing to discuss underpayments of taxes within the gray areas of our tax rules. They’ll frequently negotiate the amount of taxes due. But they don’t like deliberate fraud.
Go straight to the top
The main purpose of the U.S. Tax Court is to review deficiencies asserted by the IRS for additional income, estate, gift, or self-employment taxes. The tax court is the only judicial body from which relief may be obtained without having to first pay the disputed taxes.
The court offers the option of using a relatively informal procedure for cases in which both the disputed tax deficiency and the amount of claimed overpayment is less than $50,000. Usually, chiropractors represent themselves or their practice, though they may be represented by anyone authorized to practice before the IRS.
Unfortunately, decisions by the small tax case division of the U.S. Tax Court neither set a precedent nor can they be appealed.
Naturally, any chiropractor who loses in regular tax court may appeal the case to the U.S. Court of Appeals. But the free ride ends when the tax court rules. If it decides in the IRS’s favor, future appeal requires an appeal bond guaranteeing payment of any tax deficiency finally determined.
The latest threat for an IRS audit trigger
IRS officials say the letters questioning underreported business income recently sent to many small businesses, professional practices, and others are not the same as an audit, but rather requests for more information. Some lawmakers and business owners who received the letters say the initiative is alarming.
On another front, a number of lawmakers have questioned whether the failure to voluntarily disclose information required under the Affordable Care Act (ACA) within the first year of its implementation would result in a practice or business being flagged for an audit. According to the IRS, however, because reporting ACA-related information will be voluntary for the first year, those choosing not to report it will not be penalized.
The IRS recently rolled out a streamlined program designed to enable small taxpayers, businesses, and practices undergoing audits to more quickly settle their differences with the IRS. The Fast Track Settlement program is designed to speed up the audit and appeals process for small businesses, professional practices, and self-employed individuals who are being examined by the Small Business/Self Employed Division of the IRS.
Honesty and clarity can go a long way toward preventing and dealing with an IRS audit trigger. As illustrated, the audit of your practice’s income tax return need not be the end of the world. If that examination does result in an assessment of additional taxes, appeal after appeal is possible until, at some stage, either compromise is reached or you are satisfied with the outcome.
Mark E. Battersby is a tax and financial adviser, freelance writer, lecturer, and author located in suburban Philadelphia. He can be reached at 610-789-2480.
DISCLAIMER: The author is not engaged in rendering tax, legal, or accounting advice regarding an IRS audit trigger. Please consult your professional adviser about issues related to your practice.