How to Avoid an Audit

audit

Contributed By Brandon Ballenger, Money Talks News

With today’s historic deficits, it’s not surprising Uncle Sam is looking harder for missing cash. There’s no guaranteed way to avoid an audit, because the government admits to randomly picking thousands of people every year. But there are ways to avoid red flags – things that make your return suspect and more likely to be chosen for an audit. An audit doesn’t mean you’re guilty of anything – it just means the IRS might need 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. Here are some tips to avoid being audited:

1. Be careful with pros – Many people don’t need to hire a tax professional – there’s free professional preparation for those making $51,000 a year or less. But if you do decide to pay for help, choose wisely. Check references and credentials: If the IRS suspects a tax preparer is routinely fudging numbers, they can audit all their clients.

2. Put business before pleasure – You can add 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. According to the IRS, “An activity is presumed for profit if it makes a profit in at least three of the last five tax years.”

3. Incorporate – According to the Wall Street Journal, self-employeds are 10 times more likely to get audited if they file a Schedule C rather than a corporate return. The reason is partially explained by a line in this government study: “70 percent of the sole proprietor tax returns reporting losses had losses that were either fully or partially noncompliant.” In other words, people operating a hobby rather than a business are more likely to file a Schedule C.

4. Avoid outsized deductions – Another red flag is taking charitable deductions that look big compared to 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. We’ll soon cover the most common tax mistakes, but if you can’t wait to file, don’t miss simple stuff like signing your return and double-checking your Social Security number.

6. Make less – 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 percent, and for those making more than $1 million, more than 12 percent. Basically, the more you make, the better you prepared you should be.

7. Be careful with the earned income credit – More than 27 million people claimed the EITC last year, leading to $62 billion in refunds. 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.

8. Report all income – Many people don’t realize income from almost any source is taxable. You may not get caught on stuff like yard sale profits, but you might on gambling winnings. And for stuff that’s been reported to the IRS by someone else – like investment and self-employment income – you almost certainly will. Don’t assume because you didn’t get a copy of an income-reporting form, one wasn’t filed with the IRS.

9. E-file – 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.”

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.

And if you get picked anyway…Keep calm and carry on. An audit isn’t the end of the world. If you do get selected, don’t forget about Form 911: the form to request help from the Taxpayer Advocate Service. This service is an independent department of the IRS that helps people who can’t afford professional representation.

For more information, please visit www.irs.gov, or call (800) 829-1040.

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