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By cpa | April 1, 2008
The IRS uses a system called DIF (Discriminate Income Function) to identity tax returns to examine. The scoring system is set up to identify specific returns that, if audited, will generate additional income tax. Sometimes, the IRS computer selects returns for audit on a random basis. Your income, deductions or where you live could be irrelevant. However, there are things we can do to minimize the chances of being audited.
1. Check Your Math
The IRS computers automatically correct mathematical errors. I recommend typing up your returns or use a computerized tax preparation program.If the IRS’s computer system catches mathematical mistakes on your forms or if your return is hard to read, a person will look at your return.
You do not want to give the IRS any additional reasons for them to look at your return.
2. Self-Employed If you are self-employed and file a Schedule C, it automatically increases your audit chances. It is because you have more opportunities to either “hide” your income or “create” deductions by converting personal expenses into business expenses. If so, be prepared to substantiate your expenditures as deductible expenses. The IRS has specific audit programs aimed at specific professions and occupations that get their income in cash. The more cash you receive and the higher your income potential, the more likely the IRS is to find additional tax dollars by reviewing your return.How to Reduce the Chance of being Audited: If you are self-employed, the best way to avoid scrutiny from the IRS is to Incorporate or form a Limited Liability Company (LLC). Corporations and LLCs are audited far less frequently than individuals. It’s also a good idea to be incorporated to help protect your personal assets in the event of a lawsuit. Another benefit is the fact that corporations are allowed more deductions with fewer limitations.
3: Don’t stand out
Economic Reality: There is an economic reality that must be kept in mind when preparing a return. A certain amount of money is needed to support yourself and your family. Did you report enough adjusted gross income to cover normal and everyday living expenses such as rent, food, and clothing? If the answer is no, then the IRS will question the validity of the return simply because the income figures are not realistically possible. For example: If you live in a rich area, but you only claimed you earned $15,000 that year, this is a red flag for an audit. Inconsistencies: If there are inconsistencies, the IRS will want an explanation. For example: make sure to file the same information on your federal taxes that you filed on your state returns. Report All Income: This refers to the information reported to the IRS compared to what you report on your return. People, who pay you money, whether as an employee Form W-2 or Independent Contractor Form 1099, will report your income to the IRS. If your return shows less income than what has been reported to the IRS, it may trigger an audit.IRS has been targeting these areas for audit:
- Offshore credit card users
- High risk, high income taxpayers
- Non-filers
4: Always Prepare for an Audit
Always keep your receipts, you will do fine if you are unlucky enough to get audited. The rule is simple: no receipt, no deduction.Specially keep all of the receipts for auto, travel, meals and entertainment. I also recommend attaching detailed explanations of everything you claim on your return if you have unusually large deductions or unusual circumstances. For example, you have a huge medical deduction for a year that you feel would increase your chances of being audited; attach copies of your medical bills to your return. Although the IRS computer system still kicks out your return, it is ultimately an agent who decides if your particular return will be sent to an examiner for a complete audit. The agent might decide an audit would not be necessary because he might already have his questions answered.
5. Avoid red flag:Don’t use round numbers: Example: use $2,967 instead of $3,000. $3,000 indicates an estimate.Answer All Questions: Leave no blanks.Avoid “Misc.” and “Other” Deductions.Bad Debt Expense: Often questioned. Casualty Losses: Often Questioned.Medical Expenses: Remember the expenses need to exceed 7.5% of Adjusted Gross Income.Charitable Contributions: Understand the limitations and what constitutes a legitimate donation.Home Office: make sure that you understand it and you can support the usage of home office before taking it.
6. Amendments: If possible, try to avoid amendments. The filing of an amended tax return may attract IRS attention and subsequent scrutiny. An amendment can possibly open you up to an examination of both the amended return and the original return. However, if you do a good job on using detailed explanations, the agent may decide the audit is not worth the trouble.
7. When to filecertainly recommend that you have your return prepared early. If you have a big refund and are unconcerned with audit issues, file early and get your money back.It has been claimed that the later you file, the less likely it is the IRS will pick your return to be examined. We do not know for sure if this is still true. But….Due to budget constraints there is a limit to the number of returns selected for examination. Most returns are selected by the end of the summer, so file on the last extension possible (October 15th). By then it’s likely that the IRS has already reached its yearly quota of audited returns so your chances of an audit is reduced.If you are concerned about a potential audit, never file until the last minute. It probably won’t hurt and can possibly decrease your chances of being selected.
Conclusion:If your return is not simple, I suggest that you seek for an experienced CPA to prepare your return. It will not only reduce the errors, save your taxes and probably reduce your chance of being audited. A good experienced CPA usually accesses the reasonableness of your return and has you on board of preparing an audit.
I always said, if your return has more than a 10% chance of being audited, you would be audited 5 times (10% x 50 years) in your life. Is that the kind of risk you want to take?
Topics: Individuals |
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