One question I am regularly asked is: “What are my chances of being audited?”
Most people find the audit process unpleasant and scary. There may be additional taxes, interest and penalties, not to mention professional fees if you have your tax advisor handle the audit.
While some tax returns are selected for audit randomly, others are chosen because of how the tax return is prepared.
For example, let’s say there is a larger than usual deduction to claim on a tax return. A large deduction like this could draw scrutiny – increasing the chance of audit.
There are ways to minimize this scrutiny during the tax preparation process.
First, where the deduction is claimed on the tax return can impact audit risk. In this situation, I would ask the taxpayer questions about the deduction to get a better understanding so I could then determine which rules apply. In many cases, more than one set of rules applies and that can provide an opportunity to reduce audit risk.
Second, voluntarily attaching documentation to explain the larger than usual deduction can impact audit risk. If the return is flagged because of the large deduction, an agent will review it and the additional documentation may resolve the issue with no further action taken.
Tax preparation can have a significant impact on audit risk!
How do you know your tax preparer is taking the right steps to minimize your chances of being audited?
And if you are audited, how do you know your tax preparer has taken the right steps to minimize your audit adjustments?
Here are a few questions you want your tax preparer to ask you to let you know they have your audit risk in mind.
#1 Would you like an audit defense plan?
The professional fees incurred during an audit usually well exceed the tax preparation fees. Even if your audit is successful and there are no adjustments, there are still professional fees to pay.
An audit defense plan is like an insurance policy for audits. While the defense plan doesn’t insure you won’t get audited, it does insure that if you do get audited, the professional fees are covered. The fee for the audit defense plan is usually a percentage of the tax preparation fees.
If your tax preparer offers an audit defense plan, it is a good indicator that they are confident in their work and that they likely have procedures and controls in place as part of their tax preparation process to minimize audit risk and audit adjustments.
#2 Do you need help with entering our adjusting entries?
When a business tax return is prepared, it is common for the tax preparer to make adjusting entries to the bookkeeping so the numbers reported on the tax return are accurate. The accuracy of the books can help reduce the chance of audit.
The accuracy of the books can also help minimize the chance of audit adjustments. Inaccurate books can draw scrutiny during an audit which can often lead to audit adjustments.
When a tax return is audited, one of the first things an auditor will ask for is the books so it is very important that the numbers reported on the books match the numbers reported on the tax return.
It is impossible for the books to match the tax return unless the tax preparer provides the adjusting entries that are made.
If your tax preparer is asking you about adjusting entries, it indicates they are thinking through the long-term process rather than just trying to get the tax return done before the filing deadline.
This also applies to personal tax returns because personal tax returns may report investing or business activity which should have their own books.
#3 Do you keep annual minutes for your company?
Whether your company is an LLC, partnership, corporation or other form and whether it files its own tax return or not, annual minutes are one of the best audit defense tools when it comes to minimizing audit adjustments.
Unfortunately, annual minutes are rarely used this way.
An auditor is usually looking at money you took out of the company, or money you put in the company, or expenses the company paid that were for your benefit. All of these items can be supported and documented in the annual minutes.
If your tax preparer is thinking about your audit risk, they will ask you about your company minutes and provide you with specific items to include in your minutes to support your tax return.