10 tips to avoid an IRS audit
There's no guaranteed way to avoid an audit of your tax return, but there are steps you can take to reduce the risk.
This post comes from Brandon Ballenger at partner site Money Talks News.
What are the odds of being audited by the Internal Revenue Service? If you make less than $200,000 a year, just over one in 100, according to an IRS report (.pdf file).
The odds have gone up slightly over the past six years. That's because the IRS stepped up its game to work on closing the tax gap, or "the amount of tax liability faced by taxpayers that is not paid on time." That amount was $345 billion in 2001, rising to $450 billion in 2006, the last year it was calculated.
There's no guaranteed way to avoid an audit because the IRS randomly picks thousands of returns every year. But there are ways to avoid red flags that make your return suspect and more likely to be chosen for closer examination.
1. Pick the right pro
Many people don't need to hire a tax professional. Free professional preparation is available for those making $51,000 a year or less. But if you do decide to pay for help, choose wisely: If the IRS suspects a tax preparer is routinely fudging numbers, it can audit all the preparer's clients.
2. Put business before pleasure
You can and should deduct expenses related to a business, including for home office use if it applies. But expenses related to hobbies aren't deductible. The difference: A business makes money. From the IRS page called "Is Your Hobby a For-Profit Endeavor?": "An activity is presumed for profit if it makes a profit in at least three of the last five tax years."
3. Consider incorporating
According to The Wall Street Journal, the self-employed are 10 times more likely to be audited if they file a Schedule C rather than a corporate return. The reason may be partly explained by a GAO study (.pdf file): "Seventy percent of the sole proprietor tax returns reporting losses had losses that were either fully or partially noncompliant."
4. Avoid outsized deductions
Another red flag is taking charitable deductions that look big compared with your income. In general, the IRS says you can deduct up to half your adjusted gross income. But the rules get complicated, and the bigger the deduction, the higher the audit odds. That doesn't mean you shouldn't take all the deductions you're entitled to; it just means you should be prepared to back them up.
5. Take your time
Don't rush through your taxes. The more mistakes you make, the more your return sticks out.
6. Make less
Bank robber Willie Sutton was credited with saying he robbed banks "because that's where the money is." The IRS has a similar philosophy. Last year the odds of an audit went up sharply for higher earners. Audit odds for those making more than $200,000 were about 4%, and for those making more than $1 million, more than 12%.
We're not seriously suggesting you take a pay cut to lower your audit risk. But the more you make, the better prepared you should be.
7. Be careful with the earned income credit
The IRS doesn't focus only on the rich. Folks claiming the earned income tax credit -- available to low- to moderate-income working individuals and families" -- can also invite scrutiny. More than 27 million people claimed the credit last year.
Because the credit is refundable -- meaning the government will send you a check even if you paid no taxes -- it's ripe for abuse. Definitely take it if you're eligible, but make sure you are. Check out this IRS Web page for more.
8. Report all income
Many people don't realize that income from almost any source is taxable. You may not get caught on yard sale profits, but you might on gambling winnings. And for income that's been reported to the IRS by someone else -- like investment and self-employment income -- you almost certainly will.
Don't assume that because you didn't get a copy of an income-reporting form, one wasn't filed with the IRS. If your W-2, 1099, or other tax form hasn't shown up by now, call the company that's supposed to be sending it. Still no luck? Call the IRS at 800-829-1040.
It's true that the IRS uses computers to analyze returns for potential audits. But it's not true that e-filing increases your risk. In fact, the IRS says the opposite: When you e-file, "your chance of getting an error notice from the IRS is significantly reduced."
It's easier, cheaper, safer and gets faster refunds. There's no good reason not to file electronically.
10. Be careful with state returns
Federal and state governments communicate, so if you get audited by one, expect to hear from the other. That's a good reason to take just as much care in preparing a state return as the federal one.
What if I get picked anyway?
An audit doesn't mean you're guilty of anything; it just means the IRS wants a closer look. Good documentation is your best defense, so stay organized and don't throw anything out until you know you won't need it. The IRS typically has up to three years to audit a return, although they go back further in some cases.
Keep calm and carry on. An audit isn't the end of the world. The IRS has a video series explaining the whole audit process. Usually it's a notice or phone call asking for details about a few numbers on your return. It rarely requires an in-person interview or an agent showing up at your door.
If you do get selected for an audit, don't forget about Form 911 (.pdf file). It's used to request help from the Taxpayer Advocate Service. The number might seem like a joke, but the service is an independent department of the IRS that helps people who can't afford professional representation.
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