IRS tax audit. The very words can instill fear in the hearts of even the strongest, most honest men and women. Relax. We're here with some tips to help keep auditors from knocking on your door in the dead of night.
First off, remember that an audit is just the IRS asking for an explanation or proof of the information you've provided on your return. Assuming you are strong -- and honest -- you will have the necessary documentation to back up your claims. And if you've made an honest error, the IRS will generally just ask you to pay the difference -- or maybe they will owe you money -- along with interest and a penalty.
Still, your goal is to avoid an audit altogether, if possible. So, read through our list of tips designed to help you have as little IRS contact as possible.
10: Report All Income
You know those W-2 and 1099 forms you get in the mail at the beginning of the year that show the income you've earned the previous year? Well, the IRS gets copies of those too. So, be sure to include every single one on your tax return. The IRS's supercomputers match the amounts and may come after you if they show you received one that you didn't include with your return. If you receive a form with an incorrect amount, get in touch with the issuer and ask that a corrected form be sent to both you and the IRS.
And just because you work in a profession where a lot of cash changes hands -- you wait tables or cut hair, perhaps -- that doesn't mean you can sock those tips away unreported. Again, those supercomputers crunch the numbers and spit out guidelines for IRS agents, with pointers on how to dig out unreported cash income. They will find you and the cash you have stashed in your mattress.
9: Hire an Accountant or Use Software
Old wives' tales abound in the world of taxes, and one of the most common is that professionally prepared tax returns are less likely to be audited. While there's little data to back up that superstition, it doesn't hurt to have a pro do your taxes, especially if your personal financial situation is complicated or you own a business. Tax preparers can help you get all the deductions you're entitled to and make sure a complex return is filed correctly, which may help keep the IRS from tagging your return.
If your situation is more straightforward, a commercially available tax-prep package such as TurboTax or Free File, the free program offered by the IRS for people making under $58,000, may be a good alternative [source: IRS Free File]. These programs not only do the math for you -- making them a big plus for those of us who are more word savvy -- they ask questions to help ensure you're including all of the deductions that apply.
8: Make Less Money
In general, the less money you make, the less likely you are to be audited -- until you get below $25,000. In fact, people firmly in the middle class, those making up to $100,000 per year, are the least likely to be audited. In 2011, 1 percent of the individual returns of people reporting income between $100,000 and $200,000 were audited [source: Fishman].
The audit percentages increase from there as income rises. Nearly 30 percent of the highest earners -- those earning and reporting $10 million or more in income -- were audited that same year. What this all means is that the likelihood of an audit is pretty low until you start making six figures -- and even then, the chances aren't especially high.
More Tips for Avoiding an Audit
7: Take Reasonable Charitable Deductions
A charitable donation is one of the few things in this world that's good all the way around. It helps people, it makes donors feel good about themselves and it can be written off of your income taxes. But because no good deed goes unpunished, your chances of receiving a visit from the IRS if you claim an unusually high number of charitable deductions goes way up.
The IRS works with the law of averages in many ways, this being one. Their supercomputers tell them the average amount people donate for each income category. Step way outside that amount and you may get hit with an audit. That said, don't stop donating to the charities of your choice. Just keep good records, get appraisals for high-value items you donate and be sure to file Form 8283 for all noncash donations above $500 in value [source: IRS Form 8283].
6: Claim Valid Business Deductions
Both the self-employed and employees can deduct legitimate business expenses on their tax returns. For employees, they must be expenses that your employer has not reimbursed. For the self-employed, all manner of deductions are available -- but take too many of them, and the IRS may come knocking.
That said, don't let legitimate expenses fall through the cracks. Meals, entertainment and travel are often genuine business expenses; just don't claim too much relative to your income. Documentation is essential here. Keep receipts, but also log the purpose of meetings and travel.
Cars are another often-overlooked business expense. Keep good records of business mileage, including where you go and for what purpose. Remember, if you claim the mileage deduction, you can't also claim expenses such as gas, insurance and upkeep.
If you work out of your house, you're sitting on a gold mine of deductions, including a portion of your mortgage (or rent), insurance and utilities -- plus equipment and office supplies. In 2013, the IRS made it easier than ever with a simplified home office deduction that allows you to deduct $5 per square foot of space used for business, up to a max of 300 square feet (91 square meters), or $1,500. To claim this deduction, you must use the space regularly and exclusively for business -- no working in front of the TV in the den, surrounded by kids, toys and cheese doodles, and writing off the whole space as your office. The IRS will know.
5: Document Alimony Payments
Alimony payments can be a trigger for the IRS because the rules are strict about what is and is not deductible for the payer. In general, the payer can deduct alimony payments provided:
- They are made by cash or check;
- They are made under a divorce decree or separation agreement;
- They are called alimony in the agreement;
- They end on the death of the payee; and
- Alimony does not include child support payments or noncash property settlements [source: IRS Alimony].
Alimony payments received by a spouse are considered taxable income by the IRS. The IRS will match up the returns of payer and payee to ensure the alimony amounts reported are the same. Differences can be a trigger for a follow-up conversation.
4: Check Your Math
Check, double-check and even triple-check your math before filing your tax return. One mistake on your part can trigger extra scrutiny by the IRS, which is what you're trying to avoid. Using a software program can help, as most programs do most of the math for you. You still need to ensure you don't input your $45,000 income as $450,000, but you'll get some help on figuring your end result.
Along those same lines, if you find yourself without Internet access on April 14 and must fill out your return the old-fashioned way (that is, by hand with an ink pen), just be sure to be neat. Don't strike through and rewrite your answers. First, a handwritten return will get an extra set of eyes on it, rather than a computer scanner, and second, if the numbers can't be deciphered, you'll get a call or letter.
More Tips for Avoiding an Audit -- Continued
3: File on Time
As with many things IRS-related, there are differing opinions about whether you're more likely to be audited if you file on time or if you file an extension. Many believe that it is better to file an extension and ensure you get your tax return right the first time than to file on time and file an amended return at a later date. Amended returns go through a screening process and are audited more often than original returns.
If you file an extension, keep in mind that it is just a filing extension, not a payment extension. If you believe you owe money, you must pay it on April 15 -- or incur interest and late fees. If you can't pay everything you believe you owe, pay something. Doing so will save you on late fees and indicate a good-faith effort.
Bottom line, file on time if you can, but if filing on time means you may have to file an amended return later, file an extension and send in your payment with the extension, using IRS Form 4868.
2: Keep Good Records
Obviously, keeping good records won't keep you from being audited -- unless you believe in the law of inverse proportions, which says that the more prepared you are for something, the less likely it is to happen. However, an audit is really just a request for more information or explanation, so if you are prepared with the documentation to back up every deduction, claim, credit, dotted i and crossed t, you should sail through the audit process with little harm.
Remember, keep your records for a minimum of three years, keeping in mind that there is no statute of limitations for fraud, which means the IRS can ask for records going back to the stone age if they suspect you're up to no good.
1: Prepare for the Unexpected
This list has covered many of the most common things the IRS looks for when auditing returns. However, there are a few other reasons you may be audited:
- Outside the norm: If your return is outside "normal" when compared to similar returns, you may be audited. For example, if you own a home in an expensive area of the country, have a houseful of kids and claim an income of $10,000 when most of your neighbors make $100,000 or more, you may be audited.
- Random selection: Some returns are audited based only on random selection, not because there is anything wrong or outside the norm on the returns.
- Matching: When payer and payee returns don't match, such as the information from a W-2 or a claim of alimony, you may be audited.
- Associated audits: If business partners or other associates you have tax issues in common with are selected for audit, you may be audited as well.
While there may be nothing you can do to prepare for these audit situations, your best defense is to hold on to backup documentation for everything.
Many Americans don't think about their tax bills until the new year. But there are things you need to do before Dec. 31 if you want to pay less later.
Author's Note: 10 Tips to Avoid an IRS Audit
I was surprised to learn that despite encouraging electronic filing of tax returns, the IRS will never contact you electronically about conducting an audit. You will get a phone call -- and doesn't that sound like a fun conversation -- or snail mail, due to disclosure requirements. The lesson here: Open those IRS envelopes as soon as they arrive -- but do so at your own risk.
- FindLaw. "Avoiding an Income Tax Audit." 2014. (Oct. 29, 2014) http://tax.findlaw.com/tax-problems-audits/avoiding-an-income-tax-audit.html
- Fishman, Stephen. "What are the Odds of Being Audited?" Nolo. 2014. (Oct. 30, 2014) http://www.nolo.com/legal-encyclopedia/what-are-the-odds-being-audited.html
- Internal Revenue Service (IRS). "Alimony." (Oct. 30, 2014) http://www.irs.gov/publications/p17/ch18.html
- Internal Revenue Service (IRS). "Audit FAQs." Oct. 14, 2014. (Oct. 30, 2014) http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/IRS-Audit-FAQs
- Internal Revenue Service (IRS). "Free File: Do Your Federal Taxes for Free." Nov. 2, 2014 (Nov. 16, 2014). http://www.irs.gov/uac/Free-File:-Do-Your-Federal-Taxes-for-Free
- Internal Revenue Service (IRS). "IRS Form 8283, Noncash Charitable Contributions." Jan. 28, 2014. (Oct. 29, 2014) http://www.irs.gov/uac/Form-8283,-Noncash-Charitable-Contributions
- Internal Revenue Service (IRS). "IRS Audit." Oct. 10, 2014. (Oct. 30, 2014) http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/IRS-Audits
- Kiplinger. "14 IRS Audit Red Flags." February 2014. (Oct. 29, 2014) http://www.kiplinger.com/slideshow/taxes/T056-S001-irs-audit-red-flags-the-dirty-dozen-slide-show/index.html
- Wood, Robert W. "Does Going on Return Filing Extension Increase IRS Audit Risk?" Forbes. April 15, 2012. (Oct. 29, 2014) http://www.forbes.com/sites/robertwood/2012/04/15/does-going-on-return-filing-extension-increase-irs-audit-risk/
- Wood, Robert W. "Ten Ways to Audit Proof Your Tax Return." Forbes. Nov. 3, 2009. (Oct. 29, 2014) http://www.forbes.com/2009/11/03/audit-proof-tax-return-irs-personal-finance-wood.html