Should you prepare your clients for an audit?

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tax audit stamp on US tax form 1040

Firms around the country raced to beat the clock to get returns and extensions filed last week. But will that be the last time you see those returns as the preparer? Audit rates have been steadily declining for decades.

If the recent staffing crisis at the IRS is not indication enough of the lack of manpower, I do not know what is. But that does not mean your clients are immune from audits. In fact, despite audit rates declining overall, taxpayers earning less than $25,000 suddenly are seeing an increase in audit notices.

But what is tripping up returns that practitioners should be aware of? Here’s a look:

Mismatched information

Most returns are computer-processed now before they ever (if at all) see a human. Items as simple as a number being transposed or a line item on a W-2 being misreported can throw up a flag. Preparers need to review for transposition errors as much as they need to make sure the taxpayer did not inadvertently miss a statement. Missing a 1099, K-1 or otherwise could also throw up a red flag.

While these items may only result in an automatic adjustment, they could also result in the IRS taking a closer look at your client’s return. Don’t miss other items like name and address changes or taxpayer-identification numbers. The IRS has taken huge steps to help avoid tax return fraud through identity theft and even something innocuous could mean hours working with an agent for you and your clients. Not to mention stress.

If the recent staffing crisis at the IRS is not indication enough of the lack of manpower, I do not know what is. But that does not mean your clients are immune from audits.

Be careful with your deductions

Among the IRS favorites to audit? Mileage deductions, meals deductions, travel, and home office. Why? Taxpayers rarely document them appropriately and often fail to prove their actual business use. Nearly everyone had a “home office” during COVID but make sure to remind your clients that their dining room table does not count. The home office needs to be a separate and identifiable space used solely for business purposes for the convenience of your employer.

Pay attention to your credits

Earned income credits, child tax credits and claims of head of household have all been dinged for closer looks. Practitioners are required to perform extra due diligence before claiming the credits on returns. To add complexity to an area already closely monitored, the 2021 returns will likely have massive inconsistency on the advanced child tax credits. While not all of them will result in audits, many will result in automatic adjustments and delayed refunds, causing headaches for preparers who will no doubt be fielding questions from clients for months to come.

The moral of the story is that not just your high-income clients are at risk for audit. For years, the general rule of thumb was most individuals earning less than $400,000 annually had a lower risk of audit, but as computer review has increased inefficiency and accuracy in addition to the scrutiny over identity theft and tax fraud through erroneous deductions and credits, the balance has shifted towards the returns with lower numbers.

Just remember: Do not skip your due diligence because returns seem small, uncomplicated or do not warrant a close review.