Small Law Firms

Will Reporting Lower Taxable Income Increase My Chances Of A Tax Audit?

Reporting lower income in your 2020 tax returns probably won’t increase the chances of an audit, but you should still take some steps to avoid raising red flags.

By Steven Chung on October 13, 2021 2:44 pm

For tax professionals, it is almost the end of the 2020 tax filing season. They are swamped, preparing returns for last-minute filers hoping to meet the October 15th filing deadline. Sadly, many of their business clients experienced a loss of income due to COVID-19 and the government shutdown orders enacted to prevent the spread.

A common question from their business clients was whether reporting lower income would increase their chances of a tax audit. Their concerns are heightened with all of this talk from the government about reducing the tax gap, having the rich pay their fair share, and possibly looking at everyone’s bank inflows and outflows.

While a dramatic loss of income can be a factor in selecting a tax return for an examination, keep in mind that many other businesses have also suffered. So your chances of an audit are not likely to be higher than usual since your tax return will be one of many sad stories reporting less business income (or a net operating loss) and possibly reporting unemployment income.

With that being said, there are some red flags that can make a tax return subject to additional screening, even during a pandemic. The easiest way to get on the IRS radar is to report less income than what was reported by third parties. If your business gets 1099s from clients or customers, make sure that you have all of the forms. While this is not usually a problem since most businesses report more income than what was reported to the IRS, if your business took a huge loss, you may want to check your 1099 forms more closely than usual.

To cut costs, some people have to do more themselves. So they let their bookkeeper go or use tax return preparation software instead of retaining a tax professional. While this move is understandable, it could sometimes result in either preparing tax returns incorrectly or in ways that could raise suspicion by an auditor. A common example I see lawyers do is try to write off the cost of their courtroom suits as a business expense. I get why they do this and most tax auditors are actually pretty sympathetic. But the tax law states that the purchase of clothing that could be worn as everyday wear is not tax deductible. Some people get really aggressive with writing off gift and meal expenses.

Sometimes, people get bad advice. Usually from the internet. I see web pages that have outdated advice but are still on the first page of search rankings. As for internet forums, some are good while others devolve into a mosh pit where everyone says F TRUMP or BIDEN IS SENILE. And even in the good forums, the people don’t know you and can only inform based on what little they know. I must admit, I do check the internet as well. But I can tell when an answer requires additional verification.

So while reporting lower income in your 2020 tax returns probably won’t increase the chances of an audit, you should still take some steps to avoid raising red flags. In the final analysis, if you are concerned about an audit, the best advice is to make sure you will win the audit. This means reporting proper income and proper deductions and have supporting documentation to back up your claims. Have a tax professional take a look at the tax returns if you prepared them yourself to make sure you did everything correctly.

Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at [email protected]. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.