Navigating FBAR and IRS Audits: Key Insights

By David W. Klasing, CPA, Esq., Law Offices of David Klasing – December 18, 2023
Navigating FBAR and IRS Audits: Key Insights

Staying off the IRS’s audit radar is a shred goal for all, especially concerning Foreign Bank and Financial Accounts (FBAR) reporting. Although evading audits entirely is impossible, adopting smart practices can certainly reduce the chances of triggering one. Following are some essential strategies for avoiding IRS audits and inquiries, particularly focusing on FBAR filers. 

Uncovering Audit Triggers

IRS audits typically stem from discrepancies on tax returns, though random audits also occur. The IRS’s computer system employs the Discriminant Information Function (DIF) program, flagging unusual tax returns. This algorithm identifies anomalies, comparing returns against a baseline established by taxpayers in similar income brackets. Anything from dubious deductions within the taxpayer’s tax bracket to wrongly claiming dependents can trigger an audit. Common triggers include:

  • Failing to report all income
  • Reporting significant business gains or losses
  • Operating a cash-intensive business or making substantial cash deposits
  • Engaging in freelance or contract work
  • Claiming home office deductions
  • Misrepresenting hobby expenses as business costs
  • Possessing financial assets abroad, with specific attention to FBAR implications

Furthermore, an audit might be prompted by an event in another person’s tax return. If one’s business partner is audited, his or her return could also be selected. The IRS terms these as “related examinations.” In cases of fraud within one business, the IRS might audit multiple firms in the same industry.

Occasionally, audits are completely random. The IRS employs statistical formulas to pick a percentage of returns for unplanned audits. Those required to file an FBAR face a higher likelihood of being audited.

Cracking the FBAR Audit Code

While FBARs aren’t automatically audited, existing audit selection processes for tax returns can apply to FBARs. Seeking assistance from a tax attorney specializing in international tax law can prove invaluable.

The FBAR mandates reporting financial interests abroad. This applies to citizens, residents, corporations, partnerships, trusts and estates. An FBAR might be necessary even if foreign accounts don’t generate taxable income.

The most significant FBAR audit trigger is failing to meet the deadline. Taxpayers must report financial accounts with a cumulative value exceeding $10,000 at any point in a year. Incorrect FBAR filing can lead to penalties of up to 50% of offshore funds, possibly escalating to criminal charges.

Mitigating the IRS Audit Risk

While complete immunity from IRS audits isn’t guaranteed, prudent steps can minimize the risk significantly. Accurate income reporting, meticulous record-keeping and truthful filings are paramount in sidestepping audits.

Reviewing tax returns for errors and inconsistencies drastically reduces audit risk. The stress of tax preparation can lead to overlooked details. Seeking a tax attorney’s neutral assessment is advisable. Waiting for all income data before filing prevents errors due to incomplete information. Complete all sections, even if with zeros, to avoid audit complications.

Honesty and precision with deductions and credits are crucial. The IRS is skeptical of “perfection.” Avoiding rounded figures for deductions and handling losses cautiously reduces suspicion. Evaluating whether a business loss qualifies as a hobby is wise.

Prioritizing FBAR Compliance

FBAR compliance is critical, aided by data-sharing agreements between the U.S. and more than 100 nations. Filing by April 15 and enrolling in the Offshore Voluntary Disclosure Program for delays are wise moves. Prolonged FBAR delays jeopardize penalty reductions.

Facing an IRS Audit

In an audit, collaboration is key. Attempting to conceal actions during an audit is counterproductive. A skilled tax attorney can help leverage your rights to address the situation effectively. An audit response starts with a thorough review of tax records. You might possess evidence of accurate filing or need to explore reconciling options.

David W. Klasing

David W. Klasing Esq., CPA, M.S.-Tax, has earned dual California licenses that enable him to simultaneously practice as an attorney and as a CPA in the practice areas of taxation, estate planning and business law.