What comes to mind when you think about the IRS? For most people there’s a mild panic that only gets worse with every new phone call, letter, or email received from them. But there's more than meets the eye when it comes to the many red flags small and large businesses should avoid to not grab the attention of the IRS.
This is why we’ve asked Charley Devany, Fractional CFO & Tax Consultant, to join us once more. Since his last visit for our 16th episode, the U.S. tax environment has endured a few changes, which we’re discussing today.
Which aspects of tax are most frustrating?
Gathering data is the dealbreaker for most companies. Charley’s advice: store all your IRS correspondence, W2s, 1099s in folders to form a solid departure point with your tax consultant. In the case of Schedule Cs, LLCs, or S-Corporations, you’ll need to keep track of your expenses.
How did COVID-19 affect taxation?
The IRS, like millions of organizations, completely shut down for a portion of the pandemic. Taxation has evolved as a result:
Don’t send physical mail to the IRS unless you absolutely have to.
File and pay electronically.
Track your IRS compliance by setting up your own direct account with them.
A direct account increases your visibility into your state of tax compliance, reducing the risk of people stealing stimulus checks or even identity theft.
On the upside, audit numbers are lower and more activity is being triggered by ratios.
Tax in relation to healthcare and social security
People who were let go during the pandemic may have qualified for a discount on healthcare. For those who made use of this benefit but then got another job within the same fiscal year, there’s a chance of this being flagged by the IRS. Their focus is on your total annual income, not which months you may have had nothing come in at all.
Tax deferments are also largely misunderstood. Deferments are delays, not reductions or erasures.
How do people end up in trouble with the IRS (a.k.a. not paying attention to the red flags)?
Earning below the income tax threshold doesn’t erase your responsibility to pay for social security and medicare. With interest and penalties, the figures can be scary for a minimum wage earner who hasn’t paid their dues over years.
Penalties and interest
In an offer and compromise situation, you could request for your penalties and interest associated with a specific year to be waived. Whether you’re going back 2 or 10 years, you can only have one year’s worth of these withdrawn, so think carefully or ask your accountant for a recommendation.
It’s important to stay updated because not all extensions are automatically applied to your IRS account. For example, the extensions due to the pandemic and to the arctic freezes applied to millions of people but not everyone took action to confirm or ensure that they were in fact granted the extension. The best way to resolve this is to pick up the phone and call the IRS to request support.
Focus on these common IRS red-flags
Charley makes it easy for you to get a sense of what matters most (but remember it all matters so don’t ignore anything not mentioned on this list):
If you have a federal ID number and any kind of sales tax, it’s likely that you’re going to be audited.
The IRS will review roughly 50 transactions, looking for a ratio of missing sales tax, before documenting the assumption that the same ratio might exist across all other business transactions.
The ratio will inform a dollar amount of ‘missing sales tax’ that will be for your account.
The more bulk entries you have, the worse. Avoid dumping amounts in at the end of each month, with a blanket allocation like ‘Purchases.’
Property sales tax will apply if you’re incorporated.
How do you manage sales tax?
Charley strongly recommends that however you approach this, you link every purchase to an invoice. It’s easiest to literally start today (hint hint: make your life easier by sharing this podcast episode with the rest of your finance team). Avoid the need to go back years and years and play catch up.
Sales and use tax gets quite complicated. Charley recommends consulting with specialists about establishing tax nexus when trading between states. Selling physical products in a state versus selling it online and shipping it from another state have different tax implications.
How to clear yourself after being flagged by the IRS - Will Any of These Red Flags Trigger an Audit?
Ideally you’d like to avoid being noticed, but it’s not to say that if you are that you’re in trouble. Being flagged doesn’t necessarily mean you’re a tax criminal. Most times the IRS is seeking information, so providing it will suffice in preventing ‘the chase.’
With 1099s it can seem overwhelming. There may not be a corresponding 1099 for each project or company you earn from (as a self-employed person). The IRS will usually request information; you can confirm with them which items weren’t reported or didn’t have 1099 forms.
The solution: offer and compromise.
Start with an analysis of your balance sheet, to identify your liquid assets.
Here’s the harsh reality: the IRS can legally take money out of your IRA/401k and they can push you into mortgaging a property that you own, free and clear. Don’t bother crying to them if your living expenses outweigh your income, either, because that makes no difference.
The third crucial step: have you filed? The statute of limitations is 10 years so even if you don’t have enough money to pay what you owe for this time window, file everything and get a record of what you owe.
When submitting your offer and compromise proposal, you’ll:
Pay an application fee of $200
Pay 20% of your offer at that point in time
Fill in the offer paperwork
Include a set of financial statements to be reviewed alongside everything else.
It’s at this point that many people tend to feel frustrated and hire accountants. If you do have an accountant, and you’ve provided them the power to speak with the IRS on your behalf, don’t try to fabricate any information. The IRS has a habit of calling you and your representatives separately as a way to determine the truth about your ability to pay your taxes.
Once your offer is accepted, prioritize paying the IRS or your deal’s off the table and you can find yourself back at square one without any leniency.
How likely is it that the IRS will accept your offer after getting the wrong kind of attention from some common red flags?
If your math is correct, it’s likely.
They’re not averse to digging up more details, so be prepared for questions and requests for more information. Since the start of the COVID-19 pandemic, though, field visits aren’t as big a deal.
Bankruptcy as an option
Making the IRS an offer won’t affect your credit score, but bankruptcy will. The upside of bankruptcy is that you’ll get to keep your equity, like your 401k. Charley emphasizes that you almost always need an attorney’s support to file for bankruptcy. It’s an option, but it’s costlier in time and funds, when compared with making an offer.
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