Nobody wants to get audited. You know, I hear this all the time, you know, about S-corporations and do they really get audited less and people read about this. So, we're going to talk about that today and kind of give you some statistics here. So, if you look at an overview of audits, the IRS audit rate for partnerships and S-corporations has historically been very low, 0.05% or one out of every 200 returns. And it is one half of the rate for individuals and one quarter of the rate for C-corporation. And typically, when a partnership or an S-corp return, and by the way, when we talk about S-corp return, you know, we're talking about a straight S-corporation or a PLLC or LLC being taxed as an S-corporation. But over 50% of the time, those audits resulted in no changes on the return. There's more statistics here, but you know, from 2011 to 2019, the IRS doesn't publish this, but every so often. But if you take a look at their S-corporation during that time period, it was 0.1%, whereas any corporation other than the S-corp was 2.9%. Yes, historically, S-corporations do get audited less following these statistics here. That doesn't mean that you can do whatever you want to do. The IRS has these algorithms and they determine whether a return should be audited. You know, it's not usually one person sitting there kind of reviewing a return. I mean, they don't have enough people for that. These algorithms give them a number. It's called the DIF number, discriminant function score. They set up criteria for this, but they don't let anybody know about what that criteria is. So what are they looking for, whatever they're looking at? And then, you know, sometimes that criteria is ratios of income to expenses. You know, it's been that way, I know, for mileage, for years. A certain amount of mileage could trigger an audit. You know, I had a guy who worked for the IRS years ago told me that. He said, you know, if you take your mileage as this percentage or higher, that is an automatic red flag for the IRS. So there are things that they're looking for. And you know, sometimes we just don't know what that is. So pushing the envelope with the IRS is probably not a good idea. You know, what are accepted practices? What are things that, you know, you can do legally? You know, but there are things that will grab their attention. And most of the time, it's not a person. This DIF score kicks it out, and then somebody starts looking at it. So if you know that there are things that are on their radar, and we do know there are certain things on their radar right now, they do post and say, hey, you know, we are looking at this and so forth. And one of those is reasonable compensation for S-corporations. You know, for years, you know, that number is kind of, they put it out there and they said, you know what, it's got to be reasonable. But they really don't tell us what reasonable is. But we know now that they are definitely looking at that, and that's on the radar. What they do is they'll say, these are the hot buttons. These are things that we're looking at. The Treasury Department, the IRS, they're not necessarily saying, you know, here it is, and here's the Pandora's box. But there are some things that we know can influence an audit and make these scores, you know, pop out. One is, you know, unusual or high deductions. You know, if you have higher deductions in your business than most businesses in your industry, then it could set up, you know, some attention from the IRS. You know, if we know that, you know, CRNAs typically spend X amount of dollars on travel, you know, and they track this by SSC code. And you've got a CRNA who's 10 times the amount of travel as with a normal CRNA. That could raise a flag, right? That's an industry standard. Or it could be, you know, other deductions that are on there that might not be industry standard. But if you looked at that comparison to the general population, it sticks out because it's so much higher than any other in the general population. So if you're working with a CPA and he goes, I don't know about that, you want to find out why he says that. You know, sometimes what I've found is that a lot of CPAs are really, really conservative and they'd rather do anything than go through an audit with the IRS. But if you know you're right, it's okay to take advantage of what's there. You don't want to be so scared that you don't take advantage of what's there. You also don't want to push the envelopes either. So that's just something, you know, to pay attention to. What are the industry standards? What do people in my industry typically do? Failure to file or pay taxes. Non-compliance with filing and payment deadlines can definitely increase your likelihood of an audit. If you're not paying your quarterly taxes or you're not paying them on time, if you didn't file a tax return, you know, that can be a big flag and you might get away with that for a little while just to be honest. But again, at some point they are going to figure it out and they're going to come after you. So you would be surprised Sharon. CRNAs that I know right now who haven't filed their taxes in two years or you know, they filed them and they haven't paid. You know, I got one right now is over $200,000 behind on paying her taxes. These things happen, you know, remember, you know, we've got to remember who we're dealing with here. I mean CRNAs are smart people. You guys are the smartest people I know, but this stuff typically is not what you like to do and a lot of times it's not in your wheelhouse either. So, you know, I find with CRNAs, you know, making sure that you're surrounding yourself with people who are smarter than you and other things is probably the key to that. Inconsistency or errors, you know, mistakes under tax return, especially income reporting. Those are big ones. So Sharon, when you work for the hospital, that's 1099 work, right? Yes. So at the end of the year, they issue you a 1099 MISC. Yes. Whatever that number is, remember that 1099 doesn't only go to you. It goes to the IRS and Big Brother and it goes to the state. And so let's say on your 1099, they issued you and it said $235,123. And when you put it on your tax return, you did a faux pas, whoops, and you left off the two and it said $35,123. You think that's going to be glaring? So what happens is your 1099 that was issued to your tax ID number doesn't match up to your return. Now we got a problem. The computer kicks it out. Now somebody can look at it or you could get, you know, just a form in the mail that nobody's really looked at yet. But those things, those inconsistencies, those errors, especially dealing with income, those are big things to report. You know, expenses, the IRS, they have no idea what your expenses are, right? Unless they audit you and then you don't have records to back it up. But the income side, remember that is all reported to the IRS. That's where you really, really don't want to have a faux pas, especially removing a tube sham. And then industry, you know, certain industries face higher audit risk due to the nature or the historical non-compliance. And I'm not saying CRNAs are in that, but there are certain industries that are right for things that, how should I say, might not smell good? You know, the construction industry, right? I mean, there are things there that you can run a lot of expenses through the construction industry. And again, I'm not pointing out or picking on anybody, but that might be one that, you know, compliance, they got paid in cash. You know, Pierce used to work in construction and I'm sure people tried to pay him in cash at some point. And I've talked to a guy and we were talking about, you know, financial planning. He was married to a CRNA. He said, I've got, you know, I've got X amount of dollars in my freezer. I said, X amount of dollars in your freezer? Yeah, and I didn't ask, but I assume that he had gotten paid in cash and didn't want to deposit in the bank. Large transactions, those can be a trigger, such as selling assets or other, you know, major financial events. You know, if you, let's say you had a company and you sold that company. Now you went from making $500,000 a year, and this year you made $50 million. That's a very large event. You sold your company. Those things can get some scrutiny in the IRS because you had such a big swing. You know, you went from here to way up here, from way up here to way down here. They don't look at that as much, do they? Yeah, well, I mean, you know, it's the inconsistency, you know, what happened. So making sure you kind of maintain the status quo or some growth is probably better. And then unfortunately, you know, there is random selection. The IRS just chooses some returns. It's funny, you know, I had a CPA buddy of mine years ago, and he actually worked for the IRS, and he said to me, he said, you know, I always file an extension for my tax return. I said, you do? Why don't you always file an extension? He said, well, it's kind of like, you know, when you're in Alaska, and the bear's upstream, and the salmon are swimming upstream, and he said the bear's standing there, and he's swiping them. He's swiping the salmon. Eventually that bear gets full, and he goes away, and then the rest of the salmon swim on by. And I've never forgotten that analogy of what he said, but you know, they do select a certain number of folks and returns to audit each year, and sometimes it's just random. But again, these are things to think about, you know, with an S-Corporation. And like I said, we established that S-Corporations have a lower audit risk, but it is not a zero audit risk. And one of the reasons that is, is these are flow-through returns. Remember, the S-Corporation, as we've talked about previously, it does its own tax return, but all the taxes are paid by you at your level. That entity doesn't pay taxes. It passes everything through. It's a pass-through entity to your personal return. So it's a whole lot easier to track that, because they can just track it through the personal return instead of money in the water with the business return.

S-corporations

audit risk

IRS algorithms

tax compliance

income reporting