Small Business IRS Audit Triggers Chicago Illinois

Updated July 7, 2015

What are the Small Business IRS Audit Triggers Chicago Illinois? There are a variety of reasons that your personal or small business return can be chosen for an audit examination.

 IRS Discriminant Inventory Function System

The Internal Revenue Service employs a computer scoring system called the Discriminant Inventory Function System (DIF) which assigns a numeric code to each return after it has been processed. If your score under the DIF system is high, then there is a larger chance that the return will be examined.

 All business income tax returns have a Zip Code and a SIC Code (Standard Industry Classification) which is more commonly referred to on the income tax forms as your business code. What the Service does is compare similar businesses from a similar geographic region to each other. If you have a manufacturing business in small town Ohio, it should not be compared to a restaurant in downtown Chicago. The variable and fixed expense percentages would be completely different, rendering any information received from the system incomparable and useless.

 When your business is compared to similar businesses in a similar geographic area, and certain of you deductions stand out as being statistically significant, they will be electronically red-flagged as part of the electronic scoring process. (This is where the term “Red Flag” originated.) When the return is sent to an IRS Employee, it is then much easier for them to find the portions of the return that generated the higher score in making a determination to audit.

 The computerized matching program of The IRS or CMA is yet another way to get chosen. The IRS is provided with a copy of all of the tax forms used for the completion of your personal or business income tax return. An example would be that when W-2’s are sent to employees, a copy must also go to The IRS. If you showed a deduction of $250,000 for direct labor on a business return, and only have $100,000 in W-2’s provided to The IRS, you might have a problem. They might examine just to make sure that you are withholding and handling your payrolls properly. If your credit card processor sends in a form showing that you received $1.3 million from credit card processing, and the sales figure on your business income tax return is only $900,000, they might examine just to make sure that you weren’t guilty of evading income tax.

 Fraud Reporting

Fraud Reporting is yet another way that you or your business can be chosen. IRS Form 3949-A, commonly known as the Information Referral Form, is used to report suspected fraud. We’ve all had cases where a couple was going through a divorce, and one of the spouses sent this in to hurt their ex. If you have a former employee who has information regarding your business filing a knowingly false income tax return, the whistle blower can receive a monetary reward by reporting the fraud under IRS Form 211.

 IRS Random Auditing System

You can also be chosen at random, given the Random Auditing System which was recently re-instituted. The percentage of this occurrence is not provided by governmental sources, but it is supposedly very rare.

 How to protect your self from an IRS Audit

So what is the easiest way to protect yourself or your company from being audited? Don’t cheat, do it correctly, and choose an accountant that knows what they are doing. There really is no magic here. If the bookkeeping and return preparation it is done correctly, there just isn’t a major reason for anyone to examine it. The IRS has bigger fish to fry with all of the people who cheat on their own returns and all of the inexperienced and fraudulent tax preparers that are knowingly committing fraud.

 The last way to protect yourself or your company is to avoid electronically filing your returns. By not electronically filing a return, you make it difficult for the IRS to check it. In order for them to use the DIF System, the return has to be electronic. One of the main reasons that The IRS originally allowed electronic filing was so that they wouldn’t have to pay an IRS Employee to feed the information from a return into a computer so that it could be checked in the first place. When you electronically file, you’re just making it easy for them to check and score your return.

 Let’s review. How do we avoid the Small Business IRS Audit Triggers? Don’t cheat. Do it correctly. Choose an accountant who knows the tax laws and makes you follow them. And don’t electronically file. What’s the worst thing that could happen at that point? You would be able to sleep at night. Why? Because if by some ridiculous quirk of fate you get audited and have done it right in the first place, what are they going to get?

 
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Small Business IRS Audit Triggers Chicago Illinois