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What is an IRS audit, really?

Especially since the passing of the Inflation Reduction Act that provided $80 billion in funding to the IRS, many small business owners have been concerned about the possibility of having their finances audited. While most of the funds are dedicated to improving taxpayer services, it is true that some of the funding will be used for enforcement and audits.  

So, what does that mean for your business, and how can you avoid being audited in the future? 

What is an IRS audit? 

An IRS audit is an examination of your tax returns, financial records, and other documents to ensure that you have reported your income and deductions accurately and in compliance with the tax laws. Receiving an IRS notice doesn’t mean you’re being audited, and an IRS audit is not the same as other types of business reviews. An IRS audit is conducted by the government, and it can result in penalties, interest and even criminal charges if it uncovers fraud or other serious issues. 

But don’t panic—audits are not a common occurrence. Last year, only 0.38% of returns were audited by the IRS, according to USA Today. It’s also unlikely that taxpayers making less than $400,000 in annual income will be targeted for audits. 

What are the different types of audits? 

While the prospect of an IRS audit may seem daunting, it’s important to remember that not all audits are created equal. There are several types of IRS audits that you may encounter as a small business owner. Here are the most common ones: 

  1. Correspondence Audit: This is the most common type of audit, and it can be conducted entirely by mail. The IRS will request specific documents or information from you, and you will have a deadline to provide the requested materials. This type of audit is usually focused on a single issue, such as a missing tax form or a discrepancy in reported income, and most commonly occurs with charities and nonprofit organizations. 
  2. Office Audit: An office audit is conducted in person at an IRS office. During an office audit, an IRS agent will review your financial records and ask you questions about your tax returns. This type of audit is typically focused on one or two specific issues, such as a deduction that the IRS believes may not be valid. 
  3. Field Audit: A field audit is the most comprehensive type of audit, and it involves an in-person visit from an IRS agent to your place of business. During a field audit, the agent will review all of your financial records and ask you questions about your business operations. This type of audit is usually reserved for larger businesses or more complex tax issues. 
  4. Taxpayer Compliance Measurement Program (TCMP) Audit: This type of audit is relatively rare, and it is typically used to measure compliance rates across a larger population of taxpayers. The IRS will select a random sample of your returns and conduct a comprehensive audit of those returns to measure your compliance with the tax laws. 
  5. Specialized Audit: A specialized audit is conducted by an IRS agent with expertise in a particular area, such as international tax issues or employee benefit plans. These audits are typically reserved for businesses with complex tax issues that require specialized knowledge. 

Note: Beware of scam calls impersonating the IRS! If you are selected for an audit, the IRS will only notify you by mail, not by telephone.  

What should you do if you’re audited? 

No matter the type of audit, you have the right to be represented by a tax professional, so make sure you choose one who is qualified to represent you. If you are notified of an IRS audit, it’s important to respond promptly and professionally. Ignoring or delaying an audit can only make the situation worse. Instead, gather the requested documents and information and work with your tax professional to respond to the IRS’s requests. 

It’s also important to remember that an audit does not necessarily mean that you have done something wrong. The IRS uses algorithms to screen returns for potential red flags and sometimes selects random returns for closer review. However, the IRS has stated it will be auditing more employment tax returns in the future because of the possibility of false or incorrect Employee Retention Credit (ERC) claims. If your business has received this credit, make sure to have all the necessary documentation, like employee, wage, and eligibility information, to support the claim under audit.  

If you have been selected for an audit, it’s not necessarily a reflection of you or your business. That being said, there are steps you can take to reduce your chances of being audited. First and foremost, make sure that you are reporting your income and deductions accurately and in compliance with the tax laws. By maintaining accurate records, reporting your income and deductions correctly, and working with a tax professional throughout the year, you can reduce your chances of being audited in the future. 

If you need a tax professional, Padgett can help! Contact your local office today.

Are you eligible for the Clean Vehicle Credit?

What you need to know about car buying after the Inflation Reduction Act

Although most of the media attention surrounding the passage of the Inflation Reduction Act on August 16 focused on the additional $80 billion in funding provided to the IRS, the Act also contained other pieces of important legislation. For example, the IRA included provisions to reduce the deficit, institute price limits on prescription medications and decrease carbon emissions.  

Part of the effort to decrease emissions involved revising a previous credit for purchasing electric vehicles, renaming it the Clean Vehicle Credit. The revision included (but was not limited to) changes in the types and cost of the vehicles, location of the manufacturers, and the calculation of the credit.      

With year-end discounts just around the corner, here’s what you need to know to be eligible for the credit if you’re considering purchasing an electric vehicle this year: 

When will the purchase take place? 

When you purchase or place the vehicle in service will determine whether you are subject to the old or new rules for qualifying for the credit.   

The Clean Vehicle Credit will phase in the new rules over time. For example, the requirement that vehicles must be manufactured in North America is already in effect for electric vehicles sold after August 15, 2022. Meanwhile, other changes like the elimination of the manufacturer limitations and new battery capacity rules will be in effect for vehicles purchased after January 1, 2023.   

Who was the manufacturer and how much does the vehicle cost? 

Under the old rules, there was an exclusion that prevented you from claiming the credit for vehicles manufactured by Tesla or General Motors.  

The new Clean Vehicle Credit will remove that limitation as of January 1, so if you’re interested in a GM or Tesla, you may want to wait to purchase. The Act does impose an MSRP limit of up to $55,000 for vehicles and $80,000 for vans, SUV’s and pickup trucks purchased after December 31, 2022. Keep that in mind if you are considering a Tesla or another higher-priced model. 

What is your income? 

Beginning in 2023, there’s a limit on your ability to claim the credit based on your modified adjusted gross income (MAGI). If your MAGI exceeds $300,000 for joint filers, $225,000 for heads of household, or $150,000 for all others, you aren’t eligible to claim the credit. For those whose income exceeds the limits, you would need to purchase and begin using the vehicle before year-end to qualify under the old rules.  

Which is better for you, the old rules or the new? 

The maximum credit is still $7,500 under either the old rules or the new post-Inflation Reduction Act rules, but the way to calculate them is different.  

Be sure to discuss the specifics of the credit and your vehicle purchase with your tax advisor to determine your eligibility under either the old or new rules and what you can do to maximize your available credit! If you don’t have a tax advisor yet, Padgett’s nationwide network of EAs and CPAs are here to help, so find a location near you today. 

What does the Inflation Reduction Act mean for your business?

Even before the Senate voted to pass the Inflation Reduction Act (IRA) on August 7, rumors were flying online about what the bill included and what effect it would have on Americans, especially those with businesses or side jobs.

Though the bill includes provisions to reduce the deficit, institute price limits on prescription medications and decrease carbon emissions, much of the conversation has centered around the included plans to provide the IRS with approximately $80 billion, which could provide the funding to hire as many as 87,000 new employees.

Many Americans, for whom the IRS is a distant concern that conjures up ideas of audits and owed taxes, are understandably concerned about these numbers. But what do they really mean? Are these provisions for the IRS accurate? Why is the IRS being given so much money? Will there be more audits? How will this realistically affect the average American?

Padgett president Roger Harris, a vocal small business advocate and former member of the IRS Advisory Council, helps answer these questions and break down the common concerns about the Inflation Reduction Act.

Does the bill actually include provisions for 87,000 new employees?

According to Harris, maybe, but “there are not going to be 87,000 new auditors on the street tomorrow,” he says.

The 87,000 number is an estimate based on the overall budget. The provided $80 billion could potentially hire that many new employees, but there are several other factors at play in the allotment of the funding.

First, the funds are allotted into four categories: $45.6 billion for enforcement, $25.3 billion for operations, $3.2 billion for taxpayer services, and $4.8 billion for business system modernization. While this would include funding to hire new employees, some of whom may be auditors, it will also need to be spent on buildings and technology. Even if 87,000 new employees were hired, those employees would each need a place to work, with space in an office, a desk and a computer.

Additionally, these funds are intended to be spent across a 10-year span, through September 31, 2031. These new job openings will not be available right away. Even if they were, it’s unrealistic that the IRS would be able to hire so many employees so quickly.

Many businesses are already facing a tough hiring market. For the IRS, who struggles to remain competitive with the private sector, the hiring market is even tougher. It can already be difficult to fill current open positions to replace existing employees who have retired or resigned.

IRS employees also generally undergo extensive training after being hired—in some cases, up to three years before they’re considered fully trained. Without a strong training program in place, existing employees often train these new hires, which in turn, pulls more staff away from their actual job duties. “For example, if you hire ten new auditors, you’d have to take two more out of the field to train them,” Harris said, to illustrate the effect. “So really, you have a net new hire of eight until training is complete.”

Why is the IRS receiving all of this money?

Almost every accounting organization has endorsed more funding for the IRS. In recent years, the IRS has seen a dramatic increase in workload, yet a dramatic decrease in the workforce. You have likely experienced the downsides of an under-funded IRS.

“The IRS collects the money that runs our government,” Harris said. “If you just consider COVID-19, there were stimulus checks, the Employee Retention Credit and the Advance Child Tax Credit, all now being run through the tax system. You’ve also got the Earned Income Tax Credit and the Affordable Care Act run through the IRS.”

With the IRS handling so many crucial tasks for taxpayers, it’s important for paperwork to be handled properly and issues resolved quickly. But with its lack of funding, the IRS has been struggling to keep up. As of August, millions of 2021 tax returns are still unprocessed, leaving many people still waiting for a refund. Inaccurate notices have been sent out to taxpayers. Calling the IRS to resolve an issue like these could take hours—or more.

With additional funding, some of the new employees the IRS could hire will help to answer the phones, process returns, and identify errors. The IRS can also improve their technological tools to speed up processing and make issue resolution easier for taxpayers.

“It’s frustrating for a taxpayer to get a notice that says to call the IRS, and then spend hours on hold or end up speaking to someone who can’t even help,” Harris said. “We should all support fixing that.”

Will there be more audits?

“Everybody, take a deep breath,” Harris says. There may be more audits, but this is not necessarily a bad thing: “The problem is not audits themselves, but when we audit the wrong people. This problem is made worse if the IRS agents are inexperienced or not properly trained.”

Part of the concern around increased audits comes from a confusion about what an audit really is. A notice in the mail asking questions about your tax return, while concerning and requiring action, is not necessarily an audit. An audit is a thorough examination of an organization’s finances and generally involves an on-site inspection or verification process with an IRS agent and sometimes lawyers or accountants. This process can be time-consuming and expensive, doesn’t occur as often as many think, and should only be done when absolutely necessary.

In a voluntary tax system such as the U.S., audits are a necessary element. They are needed to catch criminals and to encourage compliance among other taxpayers. However, he urges the IRS to improve its selection process and ensure the auditors are well-trained so that honest taxpayers are not being unfairly audited.

“We need to enforce tax laws, just like we need state patrol on the highway to keep people from speeding,” he said. “They only need to pull enough people over so that the people behind them remember to slow down. What we shouldn’t accept is auditing of honest taxpayers. If I’m a small business owner, don’t waste my time with a four- or five-day audit. It’s expensive, and it’s no good for anybody. It does no good for the IRS to spend their money on audits that produce no revenue.”

What immediate effect will this have on the average American?

Initially, according to Harris, the effect is “little to none.” Time must be spent hiring and training employees, adopting new technologies and improving infrastructure. None of this is a rapid process, so taxpayers likely won’t see the effects for a year or more.

But importantly, the Inflation Reduction Act shows that responsibility has now shifted. Congress is willing to supply the IRS with funding to improve their functioning, so now it is time for the IRS to step up and take action.

“On the surface, the bill is tilted toward enforcement,” Harris says. “And I’m not qualified to speak on why the money was divided this way, but I understand that different problems require different solutions. For example, a person answering the phone can potentially help many taxpayers in a day, yet a person performing an audit deals with one taxpayer at a time. The dollar amount in a budget is not necessarily equivalent to the importance of the activity.”

“What’s the right amount of enforcement to get the level of compliance our tax system needs? That’s what we should be striving for,” he continues. “The IRS clearly needs better taxpayer service, better technology, and just enough enforcement to ensure the integrity of the tax system.”

In his own letter to the IRS, Harris encourages them to spend the time ensuring the money is spent appropriately, and to focus first on rebuilding taxpayer support before increasing enforcement activity. Only then, he suggests, can we expect people to accept the necessity of enforcement.

“Every taxpayer that files their tax return in April and pays the tax they owe expects other taxpayers to do the same. If that basic belief goes away our entire tax system could suffer. We believe that enforcement to reinforce the concept of fairness for each taxpayer should not be controversial.”


Meet Roger Harris, Padgett President

Roger Harris is the president of Padgett and has been serving in this role since 1992. He has worked with the company for 50 years, since studying at the J.M. Tull School of Accounting at the University of Georgia. Prior to becoming president of the company, Roger served as President and Chairman of the Board for 10 years in one of the largest Padgett franchises in the system, giving him years of valuable expertise in the franchise industry. He has used his expertise as an industry expert in the Wall Street Journal, USA Today, The Morning Business Report, Bloomberg Business News and Accounting Today. Roger has also offered testimony before Congress, putting his decades of experience to work as an advocate for small business legislation.

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