It’s tax season again and even more alarming than the thought of actually getting all that paperwork together and filing your taxes is the prospect of being audited by the IRS. Over 200 million tax returns are processed every year and even though less than 2% of these are audited, if it happens to you it can be a time consuming and intrusive process. It isn’t just this year’s tax return that you should be concerned with – the IRS can actually audit you up to three years from the date you last filed your tax return; six years in some cases.
Although it is a closely guarded secret just how the IRS singles out certain tax returns to be audited, there are two basic methods they use. Every year, a number of random audits are undertaken for each taxpayer group, which includes corporations, individuals and small businesses. If you are randomly selected for an audit, there is little you can do to avoid the process. However, audits are also conducted on the basis of various ‘red flags’ on tax returns which help to alert the IRS to possible error or fraud. Being aware of these red flags and trying to avoid them can help you to minimize the possibility of an audit, although there is still no way to completely guarantee you won’t be audited.
So what are these IRS red flags? Income is one; in general, the higher your income, the greater your chances of being audited; in particular, individuals who earn over $200,000 a year are more likely to be audited. Owning your own business or being self-employed are other red flags; the IRS assumes – rightly or wrongly – that someone who is self-employed is more likely to make mistakes on their tax return, or is more likely to under report their taxable income.
Those who work at home also tend to be inaccurate or sometimes even dishonest when it comes to declaring tax deductions. If you are declaring something as a business expense, make sure you can justify it and provide paperwork if necessary. In addition, if you work from home and are claiming home office expenses as a tax deduction, you must actually have a separate office space in order to claim it as a tax deduction and not just a computer in the living room. Be especially careful if you own a sole proprietorship – these are audited more than any other type of company. Workers who rely heavily on tips, such as taxi drivers and restaurant wait staff are also more likely to be audited by the IRS. Certain professions that operate on the concept of billable hours, such as child caregiver, auto repair person or attorney, also tend to attract a higher number of audits. Not declaring all sources of income can also cause problems; if you receive income from different sources – child support, freelance work, stocks and shares - be sure to report all of it, even if it isn’t a significant amount.
One of the biggest targets for IRS audits is those who use a car in the course of their work and claim mileage as a taxable deduction. If this applies to you, it’s particularly important that you keep accurate and detailed mileage records, as well as any business related receipts for gas, food and lodging obtained while on the road. If you are married and filing separately, make sure that items are consistent on both your returns – a surprisingly simple mistake and yet another red flag to the IRS. And always be careful when itemizing your tax deductions – excessive itemizing may increase your chances of being audited, even though it helps to maximize the amount of your return.
Giving to charity is commendable and if you do that, of course you want to declare any gift or financial contribution as a tax deduction. Beware of extremely high charitable deductions; this is another red flag to the IRS and can increase your chances of being audited, especially if your charitable contributions exceed 10% of your income. Many charities allow you to donate a car, boat or truck as a tax deduction; if you are doing this, be sure to not overstate the value of your vehicle – another thing that the IRS makes a point of looking for.
In addition to being aware of the IRS red flags, there are other steps that you can take to minimize the risk. The simplest and most effective thing you can do is to pay to have your tax return prepared by an accountant or professional tax preparer – it will cost you, but it lessens the chance of errors as well as an audit. The cost of having your tax return prepared professionally also often includes additional help and support should you be audited. If you prepare your own taxes, check your figures and calculations and although it seems obvious, make sure that you have filled out the correct form. Even such things as an illegible signature, poor handwriting or an incorrect social security number can make your return stand out. When it comes to tax returns, being noticed is something you don’t want to do.