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The bank deposit analysis is essential to every single IRS audit.
An IRS Bank Deposit Analysis is a tool used by the Internal Revenue Service (IRS) to help determine whether an individual or business has accurately reported their income on their tax returns. Preparing an IRS Bank Deposit Analysis involves gathering and organizing financial records, including bank statements and other documentation of deposits made into your account(s).
This process can be time-consuming and may require some effort, but it is important to accurately report your income to the IRS to avoid potential penalties and fines.
In this article, we will provide an overview of the steps involved in preparing an IRS Bank Deposit Analysis and offer some tips for making the process as smooth as possible. Let’s begin with reviewing what an IRS bank deposit analysis includes.
What is an IRS Bank Deposit Analysis?
A bank deposit analysis is where the IRS will analyze all the deposits coming into a bank account that you own, either personal or business, and determine whether those deposits are taxable or non-taxable income.
It can be difficult to determine the source of cash deposits, as it is not always clear whether the money was received from the sale of a car or from wages earned through work. As a taxpayer or business owner, it is your responsibility to provide documentation to establish the origin of income and determine whether the deposit is considered non-taxable. It is important to accurately report all income to the Internal Revenue Service (IRS) to avoid potential penalties and fines.
How to Start Preparing for an IRS Bank Deposit Analysis
Here are some steps you can follow to prepare an IRS Bank Deposit Analysis:
Gather financial records: Start by gathering all relevant financial records, including bank statements and any other documentation of deposits made into your account(s). This may include pay stubs, invoices, receipts, and other documentation that supports the sources of the deposits.
Organize the records: Next, organize the records in a way that makes it easy to review and analyze the deposits. This may involve sorting the records by account, timeframe, or source.
Calculate the total deposits: Using the financial records, calculate the total amount of deposits made into the account(s) being analyzed.
Identify the sources of the deposits: Determine the sources of the deposits, such as wages, self-employment income, rents, and other sources.
Determine the taxability of the deposits: Review the documentation provided and consider the taxability of the deposits based on the source of the funds and any applicable tax laws.
Prepare the analysis: Using the information gathered, prepare the IRS Bank Deposit Analysis by completing all relevant sections, including a summary of deposits, a breakdown of deposits by source and account, and any supporting documentation.
The IRS Bank Deposit Analysis Process: How It Works
Let’s dive into the key considerations surrounding the IRS Bank Deposit Analysis process. This includes an overview of how the process operates, as well as the types of information that may be requested from taxpayers in the course of the analysis.
Sources of Income
It may be difficult to determine the source and taxability of certain types of income, such as funds transferred from a credit line or money received from escrow. In these cases, it may be necessary to provide additional documentation or seek clarification from the source of the funds to establish the origin of the income and determine its taxability.
If you receive a check and a copy of it from the IRS, you can use the information on the check to understand where the money is coming from and whether or not it is taxable. It might be helpful to contact the person who wrote the check to confirm the source of the income and why you received it.
Determining Income
The Bank Deposit Analysis is an essential part of every single IRS audit because determining income is essential to every single IRS audit.
Upon completion of the IRS Bank Deposit Analysis, the IRS will prepare a work paper that compares the total deposits identified in the analysis to the income reported on the individual or business’s tax return. If there is a discrepancy between the two, especially if there is an increase in the total deposits, the IRS may assess additional taxes based on the increase in income.
This process may be repeated for each year being audited. It is important to accurately report all income on tax returns to avoid potential assessments of additional taxes and penalties.
Additional Years
If IRS selects the first year for audit as a test year and discovers unreported income, it is likely that additional years will also be audited. However, if the amount of unreported income is relatively small or insignificant, IRS may not conclude that the same errors are occurring in other years. It is important to accurately report all income on tax returns to avoid potential assessments of additional taxes and penalties.
Be Careful with Cash
During an IRS audit, it is advisable to devote significant attention to the Bank Deposit Analysis and maintain thorough records, particularly when depositing cash. It can be difficult to trace the source of cash deposits, so it is important to document the origin of the funds through photocopies of checks, contracts, or other relevant documentation.
Additionally, making a note of the source of cash deposits, such as the sale of a car or the receipt of a contract payment, can help to explain and potentially resolve any issues with the IRS. Accurate record-keeping is crucial in the event of an IRS audit to ensure that all income is accurately reported and to avoid potential assessments of additional taxes and penalties.
Still Have Questions?
Business owners should contact Milikowsky Tax Law if they have any additional questions about how to navigate the IRS audit process.
At Milikowsky Tax Law, we have over a decade of experience working with IRS and tax audits. We’re experts in defending business owners in the face of IRS or other government agency audits.
Interested in learning more? Read on to learn how to respond to an IRS audit.
In August 2022, Senate Democrats passed the Inflation Reduction Act, which allocates nearly $80 billion to the International Revenue Service (IRS) and leaves business owners asking: What are the tax implications of this bill? Will there be more audits? How will audits change?
In this article, we’ll break down what the Inflation Reduction Act is, where the money is going, the resulting tax implications, what businesses will be targeted, and how IRS audits will change. Let’s dive in.
What is the Inflation Reduction Act?
The Inflation Reduction Act is a climate, health, and tax package passed by Senate Democrats. The bill passed with all 50 Democratic votes in the Senate. The final version of the act proposes policy changes such as:- Climate and energy provisions
- Prescription drug price reforms, and
- Taxes on corporations
Will the Inflation Reduction Act Increase IRS Audits?
The Inflation Reduction Act allocates $79.6 billion to the International Revenue Service over the next decade. These funds will increase IRS audits. Let’s take a look at where exactly the money is going.Enforcement: IRS is Hiring
According to the 2021 IRS Data Book, IRS in Fiscal Year 2021 had about 79,000 full-time equivalent (FTE) employees, and about 35,000 of them were dedicated to enforcement activity. In 2021, IRS closed about 739,000 tax examinations and processed more than 261 million tax returns and supplemental documents. This number of tax examinations in 2021 was less than half of the number of tax examinations in 2012. So, what does this mean for business owners? IRS is making an effort to conduct more audits than in the past few years and using the additional resources from the Inflation Reduction Act to do so. Let’s take a look at how. With the increased budget resulting from the Inflation Reduction Act, IRS will be expanding its staff. IRS will be hiring additional:- Revenue agents (to conduct audits)
- Criminal Investigators (to carry out criminal investigations), and
- Revenue officers (to collect taxes)
Operations and Developments
The remaining additional funding will be used for:- Technology
- Development of a direct free E-file system
- Operations, and
- Taxpayer services
What Sizes of Businesses will be Impacted by the Inflation Reduction Act?
What businesses will be impacted by the Inflation Reduction Act? Let’s discuss.Large Corporations and the 15% Minimum Corporate Tax
Large corporations with profits over $1 billion will be impacted by the Inflation Reduction Act. The bill imposes a 15% minimum tax on adjusted financial statement income for these corporations. Businesses owned by private equity would be exempt from this tax and the Joint Committee on Taxation projects that the tax would affect approximately 150 corporations. While the current statutory corporate tax rate is 21%, around 200 or more large corporations use tax loopholes to avoid paying that rate and pay below 15%. The bill will target these corporations. This provision would be effective for taxable years beginning after December 31, 2022.Self-Employed Business Owners Are More Likely to be Audited
Self-employed business owners will be more likely to be audited as a result of this bill. Why? IRS is focused on self-employed people, whose financial situations can become tricky. For example, in these businesses, there are no W-2 jobs with a paycheck; there is just money coming in and going out. This increase in audits means that self-employed people will have to be even more careful in filing the proper forms and providing the correct taxable income.Why is IRS Making These Changes?
According to Forbes, “the two primary revenue-raising provisions of the bill are a 15% corporate minimum tax and IRS tax enforcement funding, together estimated to raise over $400 billion.” “In total, the bill will raise over $700 billion in revenue over 10 years, including the aforementioned tax changes, as well as taxes and savings from a prescription drug-pricing proposal.”How Will Audits Change with a Better-funded IRS?
After the Inflation Reduction Act, audits will not only be more common, but also different. Why? The flux of new hires means the audits will be conducted by revenue agents with less experience. For example, according to IRS, a revenue agent “must be trained on the job for at least two to three years to have the experience and expertise to audit a complex return.”How Can Businesses Prepare for and Navigate These Changes?
You can prepare for an IRS audit by ensuring that you have all of your documentation in order and that you can answer any questions IRS may have. If you are audited, it is important to cooperate with IRS and to provide them with any requested information. If you are self-employed, we encourage you to keep track of income and expenses so you can file a tax return. Consider taking a look at bank and credit card statements for an idea of business expenses. For more, read our ultimate guide to IRS audits.Hire an Experienced Tax Attorney
In the event of an IRS audit, business owners should consider enlisting the help of an experienced tax attorney. A tax attorney can help to guide you through the process of an IRS audit as well as navigate any issues brought on by a less experienced revenue agent.Still Have Questions?
Business owners should contact Milikowsky Tax Law if they have any additional questions about how the Inflation Reduction Act will impact them. At Milikowsky Tax Law, we have over a decade of experience working with IRS and tax audits. We’re experts in defending business owners in the face of IRS or other government agency audits. Interested in learning more? Read on to learn how to respond to an IRS audit in 2022.
The Small Business Administration (SBA) has forgiven over 98% of the total Paycheck Protection Program (PPP) loan value that borrowers requested them to forgive; recently, however, SBA has begun to issue more forgiveness PPP loan forgiveness denials.
Many of these recent denials issued by the SBA are not consistent with their own guidelines. Borrowers have received denial letters based on:
- Insufficient communication between SBA and lenders
- Misapplication of SBA’s Interim Final Rules (IFRs) or affiliation rules
- Mistakes by SBA surrounding the loss or misuse of borrower information
Borrowers should be aware that such denials are appealable. Consider challenging forgiveness denials if you believe SBA’s decision is in error.
Read our full guide to SBA’s PPP loan forgiveness denial below to learn more about how to appeal a denial, the criteria required for an appeal, and who can represent your company in the process.
How Do I Know if My Business’ PPP Loan Forgiveness was Denied?
If SBA denied your application, you will receive an SBA Final Decision Letter in the mail.
Learn more about what to do if your PPP loan is not forgiven, here.
How Do I Know Why My Business’ Forgiveness Application was Denied?
The first page of the Final Decision letter contains a section indented and in bold that provides the reasons SBA denied your request for forgiveness. It’s important to understand why SBA is rejecting the forgiveness application before taking action- such as appealing the denial.
Who Makes the Decision on PPP Forgiveness?
The decision to deny your PPP loan forgiveness can be made by:
- Your lender (i.e. bank, credit union)
- The Small Business Administration (SBA)
How Much Time Do I Have to Appeal a PPP Loan Forgiveness Denial?
You must respond to SBA and submit your appeal within 30 days of the date listed on your SBA Final Decision Letter. The timeline for SBA forgiveness appeals is inflexible. Once your initial 30-day period expires, you will lose your right to appeal SBA’s denial to forgive your PPP loan.
How Do I Appeal a PPP Loan Forgiveness Denial?
You must appeal denials of forgiveness to the SBA’s Office of Hearings and Appeals (OHA) within the 30-day period.
File appeals through OHA’s case portal. Filings for PPP appeals received in any other manner may be rejected and not docketed for processing.
SBA states that OHA has jurisdiction over appeals where SBA has provided the borrower with a PPP final loan review decision finding the borrower:
- Is ineligible for a PPP loan
- Is ineligible for the PPP loan amount received
- Used the loan proceeds for unauthorized uses
- Is ineligible for the PPP loan forgiveness amount determined by the lender in its full or partial approval decision issued to SBA, or
- Is ineligible for PPP loan forgiveness when the lender has issued a full denial decision to SBA.
Learn more about how to appeal an SBA PPP forgiveness denial, here.
What Information Do I Need to Provide in the Appeal?
The criteria for an appeal filed with the SBA are strict. According to SBA, appeals must contain:
- A complete, detailed statement as to why the SBA loan review decision is erroneous, with accurate information and legal arguments supporting the statement;
- No more than 20 pages (not including attachments)
- Clearly labeled exhibits and attachments
Due to the strict criteria of the appeal, we recommend hiring a qualified attorney to represent your business and help you to create a strong, successful appeal.
Who Can Represent My Business in the Appeal Process?
An identified legal representative of the business or a qualified attorney must represent the appeal since the SBA PPP loan is a business loan and not a personal loan. To represent your business, one must be:
- A shareholder owner
- An officer, or
- An attorney
Who Can’t Represent My Business in the SBA Appeal Process?
The following positions are not legally entitled or allowed to represent businesses in the SBA appeal process:
- Certified Public Accountants (CPAs)
- Lenders
- General Employees
What if I Lose My Appeal?
Any appeal denied in the Office of Hearings and Appeals will have to go to a higher court. Why? Because SBA is a federal agency. The process of going to federal court can be extremely tedious and expensive due to the strict regulations.
To avoid the costly and time-consuming process of going to the federal district court, we recommend hiring a qualified attorney to make sure you’re building a strong appeal for your business.
While each case is unique and this is not an indication of success in other cases nor a promise of results, our team at Milikowsky Tax Law has extensive experience in government audits and cases involving government entities from IRS to SBA and CSLB.
Contact Milikowsky Tax Law and learn how we can help.
As a small business owner, you may be wondering what the process is for an IRS audit. An IRS audit is when IRS reviews your tax return to ensure that you have reported your income and expenses correctly.
The founder of Milikowsky Tax Law, John Milikowsky, breaks down the process of an IRS audit for small business owners. Check out the video below for more information:
In this article, we will review the various stages of an audit as well as information you can obtain from IRS during an audit to ensure that your tax return is correct.
The IRS Audit Process
The process of an IRS audit can feel overwhelming for a small business owner. However, it doesn’t have to be. Let’s take a look at each step of the process.The Audit Letter
An IRS audit starts with an audit letter that is generally sent to the business owner or taxpayer. This letter will include:- The name of the assigned revenue agent
- The telephone number and fax number of the revenue agent
- The number of days you have to respond to the revenue agent
What If You Need More Time to Provide Information to IRS?
It is important to respond to the audit letter, even if just to request more time. If you do need more time, you can request an additional 30 or 60 days. Typically, they’ll give you 30 days to respond, have an interview, and meet. During this time, you will want to consider hiring a professional to help guide you through the audit process.Consider Hiring a Tax Attorney or CPA
As you collect information for IRS, you can choose to enlist the help of an experienced tax attorney or a CPA. We’d recommend a tax attorney because any communication you have between your attorney is protected under attorney-client privilege, whereas it’s not protected by any other tax professional or CPA.Initial Document Request
If you’re being audited by IRS, one of the first things they’ll do is send you an Initial Document Request (IDR). This request will list all of the documents and information that the revenue agent needs in order to complete the audit. If you don’t provide this information, IRS can summon the information. For instance, if you don’t provide your bank statements, IRS can go directly to your bank to obtain them. If this occurs, within 30 days, IRS can obtain your bank statements, canceled checks, and deposited items.Second Initial Document Request
After you respond to the IDR, IRS will have another discussion. If IRS does not feel that they have all the information they need or if you failed to provide all requested information, they can issue an additional Initial Document Request. This process can continue with as many document requests as they need based upon the number of alleged issues on your tax return. And if they don’t feel that you provided all the information, they’ll issue another IDR, typically IDR Number Two, and it could go up to as many IDRs as they need based upon the number of issues that they’re looking at on your tax return.Interviews With the Taxpayer
After you provide all necessary information to IRS, they will typically conduct an interview. At Milikowsky Tax Law, we attempt to schedule the interview at the end of the audit or not have one at all. That being said, sometimes it is an unavoidable step in the process.An Interview May Come With a Summons
If IRS wants to interview you and it is an important part of their audit, they can submit a summons. If you disregard this summons, IRS can file an action in the federal court to require you to appear and provide the documents or any other testimonial information. This step depends upon how important an interview is to resolve the audit.Revenue Agent Report
After the business owner and IRS have exchanged information through the audit letter, IDR(s), and an interview, taxpayers will typically receive a Revenue Agent Report (RAR). The Revenue Agent’s Report is a detailed document describing an IRS examiner’s audit findings. Additionally, the Revenue Agent’s Report states “the amount of deficiency or refund the agent finds the taxpayer to owe or be owed, respectively.” Learn more about how to read a Revenue Agent Report, here.Audit Conclusion: Respond to the Revenue Agent Report
Typically, a business owner will have 30 days to respond to the Revenue Agent Report. It might be less time, especially if there have been multiple Revenue Agent Reports. Taxpayers have the right to disagree with a revenue agent’s report. If taxpayers disagree, they can challenge the agent’s findings through:- A formal protest to the IRS Office of Appeals division by appealing to the U.S. Tax Court, or
- Paying the new assessment and then suing for a refund.
Facing an IRS Audit?
If you or someone you know received an audit letter from IRS, reach out to our team of experts at Milikowsky Tax Law. We have over a decade of experience working with IRS audits and are experts in defending business owners in the face of IRS or other government agency audits. Have more questions about IRS audits? Check out our full guide, here.
Employment Development Department (EDD) performs many services, but their primary role that impacts small businesses is collecting and auditing payroll taxes. Employers pay payroll taxes for W-2 employees, but not for 1099 independent contractors.
The line between an independent contractor and an employee was more concretely defined with the implementation of Assembly Bill 5 (AB-5). A worker must meet all three of the following criteria to be classified as an independent contractor:
- The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work
- The worker performs work that is outside the usual course of the hiring entity’s business
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
Misclassification mistakes can oftentimes be exactly that – an innocent mistake. However, there are also instances where businesses have taken advantage of classifying employees as independent contractors to avoid paying payroll taxes and investing in employee benefits. This was the case with Dynamex– read the full story here.
Purposeful and accidental employee misclassifications strip employees of their benefits and the government of their tax funding. In order to protect both, EDD performs misclassification audits on businesses that are flagged for potential misclassifications. The top 4 EDD audit triggers include:
- Independent contractors filing for unemployment
- Employee complaints to EDD
- Late filing of taxes
- Randomized verification audits
If EDD sends you a notice in the mail notifying you they want to audit your business, there is a limit to how far back they can audit.
EDD Audit Statute of Limitations
The government agency can audit your business EDD can audit your business 12 quarters back from the quarter in which the audit is started, however, audits can go back up to eight years in some cases.
Watch our full video below to learn more.
Only cases involving fraud or intent to evade payroll taxes are not limited by that statute of limitations. In these instances, EDD can audit the business as retroactively as they deem.
Section 1132 of the Unemployment Insurance Code states:
“Except in the case of failure without good cause to file a return or report, fraud or intent to evade any provision of this division or authorized regulations, every notice of assessment shall be made within three years after the last day of the month following the close of the calendar quarter during which the contribution liability included in the assessment accrued or within three years after the deficient return or report is filed, or was due, whichever period expires the later. An employing unit may waive this limitation period or may consent to its extension.
In case of failure without good cause to file a return or report, every notice of assessment shall be made within eight years after the last day of the month following the close of the calendar quarter during which the contribution liability included in the assessment accrued. An employing unit may waive this limitation period or may consent to its extension.”
How Long Do EDD Audits Take?
EDD audits typically last about three to nine months depending on a myriad of factors:
- How prepared and organized are you for the audit
- If they find more information that may need to deepen the investigation
- How backlogged the department is
Your auditor will have to review your records, federal income tax return, W-2s, payroll tax returns, 1099 forms, financial statements, and more. They also interview your 1099 independent contractors to cross-verify information.
The more contractors you have, the longer the audit can potentially take.
For more information on what to expect during an EDD Audit, read our article here.
The Internal Revenue Service (IRS) has the power to investigate the finances of a taxpayer if they believe the taxpayer is withholding assets. One tool IRS uses to do this is a bank summons, which is a legal document that requires your bank to provide your bank statements, account balance, and other information to IRS.
John Milikowsky, the founder of Milikowsky Tax Law, explains how IRS can summon your bank account records. Check out the video below for more information.
- When IRS can summon bank records, and
- Notices that a taxpayer is given regarding access to their bank records
Can IRS Summon Your Bank Records?
The short answer is yes. IRS can look over bank records if it believes you are withholding assets.What is an IRS Summons?
An IRS summons is a legal document that orders a person or entity to appear before IRS to provide testimony or to turn over specified documents or records. The summons will typically include:- The name of the person or entity being summoned
- The reason for the summons, and
- The date by which the person or entity must respond
Does IRS Summon Bank Records Often?
IRS does typically summon bank records. Therefore, taxpayers should be prepared to provide this information.Who Does IRS Issue a Summons to?
IRS can send the summons to third parties, and they don’t need a court order to do so. If IRS issues a summons, it can be to:- A bank
- A business associate
- A company you did business with
- And more
Is IRS Required to Give Notice When Requesting a Summons?
IRS is not required to give notice before summoning your bank records. However, most of the time they will provide notice. This notice includes information on how to object to the summons and/or provide information on IRS’s investigation.Do Taxpayers Have to Provide Their Bank Information?
Some taxpayers may not intend to give over their bank statements or produce all of their bank records, canceled checks, and deposit items. However, taxpayers should be prepared to do so; IRS does not have to go to court to get a summons. An IRS revenue agent can issue a summons and send it to your bank, and within 30 days, they will be sent your records from the bank (if the accounts are available).How Far Back Can IRS Summon Bank Records For?
IRS has a statute of limitations for an audit of three years from the date the return was filed or two years from the date the tax was due, whichever is later. IRS typically conducts audits less than three years from the date of filing, because there’s a statute of limitations; IRS has three years to audit you, and that’s three years from the date you file your return typically. It can be extended if IRS finds a gross understatement of tax. In this circumstance, the limitation could be increased to five years. If fraud is present, there’s no statute of limitations.Can IRS Access Your Bank Records Without Your Permission?
In some cases, IRS may be able to get your bank records without your permission. This usually happens when IRS is investigating conceivable criminal activity. However, even in these cases, IRS is required to give you notice before they obtain your bank records.How Does the Process of an IRS Summons For Bank Records Work?
The Initial Document Request
If you’re being audited by IRS, they’ll send you an initial document request. This request will list all of the documents and information that the Revenue Agent assigned to your case needs to complete the audit. There will likely also be a request to include business bank records. If you don’t respond to that request, IRS can send summonses out.A Copy of the Summons
Usually, when IRS sends out a summons, they provide you with a copy.Communication with a Revenue Agent
Typically, when we work audits, we request a revenue agent contact us before they send the summons out. Now, it’s not IRS’s obligation to wait to send the summons out if we request that we work with them and first provide those documents.Have Questions About Whether or Not IRS Can Summons Your Bank Account?
If you have any questions about whether or not IRS can summon your bank records, you should speak with a professional tax attorney. They will be able to advise you on your specific situation and help determine the best course of action.The Bottom Line
In summary, IRS can summons your bank information and send the summons to third parties without a court order. They can summons any type of information because the powers of IRS are fairly broad to collect and investigate anything connected with income and expenses that are reported on your tax return.Consider Milikowsky Tax Law
At Milikowsky Tax Law, we have over a decade of experience working with IRS and tax audits and are experts in defending business owners in the face of IRS or other government agency audits. Read on to learn how to respond to an IRS audit in 2022.
Internal Revenue Service (IRS) will flag businesses for an audit when the agency finds suspicious activity in your business’ tax returns. The suspicious activity may be innocent in nature, but IRS performs an audit to ensure your business paid the required taxes.
Though, occasionally, the agency will randomly audit businesses. This instance is less likely, but can still occur. It’s important to make sure your business is ready no matter the circumstances.
Oftentimes, businesses are more susceptible to an audit if they:
- Have foreign assets
- Have a cash business
- Are self-employed
- Have a home-based business
- Claim a disproportionate number of deductions
- File incorrect or incomplete returns
- Have a large number of cash transactions
- Earn less than $25,000 or more than $500,00
- File a Schedule C
- Claim a vehicle as 100% business expense
- File taxes late
The rate of audits rose by 50% in 2021, and are projected to stay on this upward trend as the government searches for ways to fund the proposed Build Back Better Bill. How can you prepare for a potential audit before it occurs?.
Signs Your Business is Prepared for an Audit
1. You Keep Organized Records
Recordkeeping is a fundamental part of being prepared for an audit. Keeping receipts, expenses, pay stubs, income, and other financial documents well-organized helps show the auditor proof of monetary movement that supports your tax file.
This documentation can be physical or electronic – as long as it’s there. Best practice is to keep the original and provide copies to the auditor in case of accidental damage or misplacement.
Audits typically go back three years, but at Milikowsky Tax Law we recommend you keep financial records up to seven years back.
2. Your W-2 employees and 1099 workers are correctly classified
W-2 employees and 1099 workers perform different roles for your business. Therefore, they must be classified accordingly. Misclassification can lead to fines, penalties, and even jail time.
Why? Because misclassifying an employee as a 1099 independent contractor strips the worker of employee benefits, and the government of payroll taxes associated with having a W-2 employee.
W-2 employees are hired for specific jobs, work set hours, receive benefits, and have taxes withheld from payroll.
1099 independent contractors work on a contractual basis, are paid a set fee, do not receive benefits, do not have taxes withheld, and have more work flexibility.
The “right of control” helps business owners determine worker’s status by answering three criteria:
- Behavioral Control: Are you in charge of the manner in which workers perform their duty?
- Financial Control: Do you pay regular wages and have the ability to fire the employee?
- Relationship to business: Is the employee an essential part of helping your business run?
Assembly Bill 5 (AB-5) implemented at the beginning of 2020, set regulations for 1099 independent contractor classification. Under the new law, all workers are considered W-2 employees unless the independent contractor meets all three of the following conditions:
- The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
- The worker performs work that is outside the usual course of the hiring entity’s business; and
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
Correctly classified W-2 employees and 1099 workers help you avoid further investigation and penalties in an audit.
3. You Use Deductions Claims Appropriately
Tax deductions are implemented to help businesses reduce their taxable income, but what qualifies as a proper deduction? Under IRS, the deduction must be ordinary and necessary.
According to IRS, “an ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.”
A few deductions small businesses can claim include:
- PPP loans
- EIDL and EIDL advance funds
- Travel
- Office supplies
- Home office
- Rent
- Repairs and maintenance
- Utilities
- Employee benefits
- Employee bonuses
- Employee wages
- Employee education
- Insurance premiums
- Charitable donations
- Commissions
- And more
When looking at claims, IRS matches claim amounts to total income received. If your total claims filed are too high, IRS will suspect some deductions were falsified.
Accurate claims combined with receipts that prove purchases set you up for IRS audit success.
4. You Filed Accurate Taxes
Accurate business tax files strengthen your case during an IRS audit. The auditor is looking for errors, omissions, and potential fabrication during the audit process.
Oftentimes, audits arise because simple mathematical mistakes throw off numbers. By double-checking your return and using exact numbers when you file your taxes, your business will be better prepared for a potential audit.
During the process, they will crossmatch your business returns and look to see if your business reports match the total income reported by you and by your W-2 and 1099 workers.
5. You Know When to Use a Trusted Attorney
A trusted tax attorney can help build your case in the face of an IRS audit. Their expertise will help you:
- Prepare legal defense
- Review your documents to identify potential errors or issues
- Handle discussions with your auditor
- Represent your business before IRS
- Develop legal theories that may include “reasonable cause” defense
- Help you improve the chances of a successful audit
Have more questions about IRS audits? Read our article here answering the top 7 questions we receive about IRS audits.
If you’ve been through an IRS audit, you know that one of the most important documents you receive at the end is the Revenue Agent Report (RAR).
Many taxpayers may not know where to start when it comes to reading their Revenue Agent Report.
John Milikowsky, the founder of Milikowsky Tax Law, explains how to read your Revenue Agent Report in detail.
Check out the video below for more information:
In this article, we walk you through the elements that make up an IRS Revenue Agent Report.
First, What is an IRS Revenue Agent Report?
The Revenue Agent’s Report is a detailed document describing an IRS examiner’s audit findings. Additionally, the Revenue Agent Report states “the amount of deficiency or refund the agent finds the taxpayer to owe or be owed, respectively.” Taxpayers have the right to disagree with a revenue agent’s report. If taxpayers disagree, they can challenge the agent’s findings through:
- A formal protest to the IRS Office of Appeals division by appealing to the U.S. Tax Court, or
- Paying the new assessment but then suing for a refund.
How to Read a Revenue Agent Report
Audit Information
The first section of the Revenue Agent Report is called the “Audit Information.” This includes basic information about the audit, such as the type of audit (field or correspondence), the date the audit began, and the taxpayer’s name and address. Learn more about the four types of IRS audits and how to navigate them.Audit Results
In this section, the revenue agent lists their findings. Each finding will include:- A description of the issue
- The amount of money in question
- The proposed changes to the tax return
Adjustments to Income
At the top of page one, you’ll find the adjustments to income. Adjustments typically start with income, whether income has increased or decreased, which could go either way. Typically, IRS will increase your income if they identify additional income that was not reported on your tax return.Expenses
After the adjustments to income, you’ll find expenses. The expenses on your return are negative, they offset income. If IRS disagrees as to an item of an expense, it will be listed as a positive number to offset the negative number.Corrected Tax Liability
Beneath these figures, the Revenue Agent Report will list the corrected tax liability and any credits, such as prepayments you have made or withholdings of income tax.Balance
Below the corrected tax liability and credits, the Revenue Agent Report will list the balance at the bottom of the first page.Penalties
The top of page two of the Revenue Agent Report will list the penalties. For example, if you filed a late return or made payments late, typically IRS will also include a negligence penalty. Negligence occurs if you kept poor records and you didn’t have any substantiation, or you didn’t have enough substantiation where IRS could tell you made some typical errors. In this event, they may file a negligence penalty. IRS can also assess a fraud penalty if they can establish willfulness and there is fraud for failure to file a return on time. Additionally, IRS may determine fraud in overestimating or overstating expenses or understating income where they believed it was more willful rather than negligent.Interest Due
In addition, on page two, IRS will assess interest from the date the return payment was due. If the Revenue Agent Report is reviewing an individual, this date is typically April 15th. If the agent is reviewing a corporation, the return payment due date is usually in March.Recommendations
The final section of the Revenue Agent Report is called “Recommendations.” In this section, the revenue agent will list their recommendations for how to resolve the findings. These recommendations are non-binding, but they can be helpful in negotiating with IRS.What to Do After Reading Your IRS Revenue Agent Report
At the end of this process, IRS can give you a set period of time in which to dispute these findings. This is typically 30 days but can occasionally be only 10 days. You have 30 days to provide a protest letter. If you do not, IRS will conclude the audit with a notice of deficiency. At this point, you’re required to file a tax court petition going to the United States tax court in order to dispute the findings.What We Recommend
If you believe that the revenue agent overlooked some facts and you have some substantiation that’s not being considered by the revenue agent, you should consider communicating with the supervisor and try to get the supervisor involved. File a protest letter within the deadline. Consider enlisting the help of an experienced tax attorney to navigate the complex situation and efficiently resolve any issues with IRS. At Milikowsky Tax Law, we have over a decade of experience working with IRS audits and are experts in defending business owners in the face of IRS or other government agency audits. Read on to learn how to respond to an IRS audit in 2022.