Essential Records for Tax Preparers
Upon accepting a new client, tax preparers are required to collect all pertinent financial documents for the years they will be handling tax filings. Once the tax return is finalized, the client receives a copy of their primary tax return. However, the responsibility of the tax preparer extends to retaining not only a copy of the tax return but also any ancillary documentation that supported the return’s preparation. Key documents necessary for tax preparers to maintain comprise:
- The primary tax form
- All related tax schedules
- Tax preparation worksheets
- Checklists provided or used by the client for tax preparation
- Receipts substantiating tax deductions or credits
- Bank and financial institution statements
- Company financial records such as general ledgers
- Documents detailing investment income
- Any other financial documentation provided by the client that influences the tax return
The IRS permits the storage of these documents in both physical and digital formats, offering flexibility in how tax preparers manage and safeguard client data.
Duration and Reasons for IRS Audits
Typically, the Internal Revenue Service (IRS) conducts audits on tax returns filed within the past three years. However, if significant discrepancies are discovered, the IRS has the authority to extend the audit to encompass returns from up to six years prior.
The aim of the IRS is to conduct audits in as timely a manner as possible following the filing of returns. Audits are primarily performed to reduce the gap between the amount the IRS is owed and the amount it has received. While some audits may be conducted randomly, the IRS frequently selects returns for audit based on indications of suspicious activity or anomalies in the data reported.
Common Triggers for IRS Audits
An IRS audit is a review process where the Internal Revenue Service or state tax authority examines a taxpayer’s financial and tax filings more closely to verify accuracy. Suspicions of financial discrepancies or unusual activity can prompt an audit. Understanding the triggers can help taxpayers avoid unwanted scrutiny. Here are several red flags for the IRS:
- Excessive Charitable Donations: Large charitable deductions can raise eyebrows, especially if they are disproportionate to income. For instance, claiming $10,000 in donations on a $40,000 salary may signal the need for further review. Always have proper documentation for charitable contributions.
- Underreported Income: All income must be reported, including non-wage earnings such as freelance jobs, stock dividends, and interest documented on Form 1099. Failing to report all sources of income, thinking they might go unnoticed, is a mistake, as the IRS often has access to the same forms submitted by employers.
- Overstated Work-Related Deductions: Deductions must be ordinary and necessary to your profession. While an artist can deduct the cost of paint and brushes, a hobbyist lawyer cannot claim such expenses. Claims must be directly linked to the necessity of performing your job.
- Mathematical Inaccuracies: Errors in calculation on your tax return can flag your file for an audit. Taxpayers should meticulously check their math or consult a professional to prevent mistakes that could lead to penalties.
- Claiming Excessive Losses on Schedule C: Self-employed individuals reporting numerous losses or blending personal expenses with business expenses might attract unwanted attention. This leads the IRS to question the viability of the business.
- Rounding Numbers: Tax filings should reflect precise amounts. Estimates or overly rounded numbers can create suspicion. For expenses or income, round to the nearest dollar, not to the nearest hundred.
- Questionable Home Office Deductions: The IRS has strict criteria for home office deductions. The space must be used exclusively for business. Casual or improper claims, like a workspace in a living area, can trigger an audit.
Understanding these common triggers and taking measures to ensure accuracy and compliance can significantly reduce the chances of an IRS audit.
Conclusion
Navigating the complexities of tax preparation and compliance can be daunting for both tax preparers and taxpayers alike. Staying informed about the essential records to keep, understanding the duration and reasons for IRS audits, and being aware of the common triggers can equip individuals with the knowledge needed to minimize the risk of an audit.
By maintaining accurate and thorough records, ensuring compliance with tax laws, and seeking professional advice when necessary, taxpayers can foster a smoother tax filing process. It’s crucial to remember that while audits can be intimidating, they are also manageable with the right preparation and response strategies.
