In school, you were taught a year is comprised of four seasons. That’s because no one wants to remember the fifth. Tax audit season, the real season of our discontent.
The words alone are enough to send the blood curdling in your veins and blow chills down your spine.
The last thing you want is having the tax man pay you a visit, even if the chances of him ever knocking at your door are pretty slim. Actually, the odds have been dropping like a rock in recent years with the IRS auditing only 0.84% of individual taxpayers.
However, if the Internal Revenue Service does decide to throw a tax audit in your direction, you can’t be caught off guard. Taxes abound in gray areas. Unless you have a bulletproof knowledge of all the tricky winding corridors of the financial domain, you might find yourself wondering helplessly around.
Also, an audit can be time-consuming, expensive and emotionally harassing.
The safest thing to do is to remain low on the IRS radar and not to draw unnecessary attention to yourself. After all, an ounce of prevention is worth a pound of cure.
So here is a list of a few things to do, not to mention not to do, in order to keep your tax audit defense strong. Even if the next tips do look straightforward enough, they still deserve your unwavering attention. The obvious is always the first to be overlooked.
How to Build Yourself a Strong Tax Audit Defense
1. Triple Check your Tax Returns
Erroneous data entry. A space on the return mistakenly left blank. Numbers that don’t match. Forgetting to sign the return. Bad math. These are all huge red flags for the tax men. Trivial mistakes that might bring about serious consequences.
Tax filing is the last thing you want to be careless about. Wait for all of your income, bank and investment reports before starting to fill in on your tax return.
When you report your dependents and exemptions, double-check your arithmetic. Also, avoid using round numbers, even if it comes easier to you.
The IRS’s automated system is designed to sound the alarm at the tiniest discrepancy detected, and rounding figures scream estimates. This is a textbook tax audit red flag.
2. Don’t Throw Away the Receipt
Do as your mother taught you – keep all the receipts neatly organized and your accounting records handy, even if it lends a certain bureaucratic Kafkaesque light to your surroundings.
Receipts will not keep a tax audit at bay, but they can reduce its severity when the dark times come. Plus, the IRS will appreciate the trouble you went through.
Moreover, if you’ve contributed to charity, be sure to back that up with a receipt and other necessary documentation. The recipient organization should provide you with one. Unfortunately, more often than not, charities are seen as fertile grounds for tax evasion.
The old practice of simply estimating the value of a donation is long gone, right at about the time when donors caught up with the fact that generosity is a good cover for dodging a tax.
3. No Delays on Your Tax Returns
Did we mention No Delays? Excuses like ‘my dog ate my tax return and I couldn’t finish another one in time’ won’t stick. They didn’t cut in school, and the IRS is no more sympathetic than your math teacher.
One of the surest ways to get into tax audit is to not file your tax returns. Even if you don’t have an income or a debt to the state, you still have to be an exemplary citizen and let Uncle Sam know how you’re doing.
4. Separate Work from Personal Life
The most common mistake is to believe you can trick the system by attributing unrealistic personal expenses to a business. Sure, take the home-office deduction you’re entitled to, but don’t get greedy.
A lot of assumptions are circulating around about what falls in the deductible category and what does not. As we mentioned before, it’s a gray area.
A safe rule would be – anything you spend money on to make money should get you a refund.
A car used for business is deductible, and you can throw in the occasional family vacation. And there’s nothing stopping you from updating your Facebook status using your office laptop.
Dining, travel, and entertainment are all expenses that should pass unnoticed at a tax audit if they conform to your income level and business type.
However, claiming your guest bedroom is a home office might raise some suspicion. Especially if there’s a king sized bed governing in the middle of the room.
If you do mix pleasure with business, be sure it goes on the record. Maintain a detailed log outlining the use of office equipment for business-related purposes.
5. E-file Your Tax Return
Remember the first point we’ve made about tax returns? The IRS claims that E-filling can dramatically reduce errors, thus reducing the chances of a tax audit.
First introduced as a prototype system in 1986, online tax preparation programs spread like fire around the country by the end of the decade. Now nearly every individual tax return is e-filed.
Not only is it free for the majority of taxpayers, but filing your federal taxes electronically decreases by 20% the likelihood of arithmetic errors and misplaced data entries on your tax return.
6. Mix in with the Crowds
The more you make, the bigger the odds of a tax audit. The less you earn, the bigger the odds of a tax audit. A little bit confusing, right?
Because high net worth individuals have been shown historically to be attracted to the many cheating opportunities presented to them – a lot of room for caramel fudging here, the IRS has learned to shine a spotlight on taxpayers who report an income of more than $1 million a year.
Similarly, anyone who files a Schedule C as a tax-saving strategy might see it backfire. When you gain access to the Earned Income Tax Credit, you also wave your red flag to the IRS.
Your best chance is to go vanilla and mix in with the majority, individuals of modest income who don’t have children, propriety or extreme life-changing circumstances and always file their Form 1040-EZ on time. No hustle, no loss.
Since we’re talking stiff penalties and possible jail time if your fail at your tax audit exam, let’s reiterate some of the points made above. Keep in mind, the following will always trigger the IRS alarm:
- Failing to honestly report all of your income.
- Doing the math wrong.
- Exaggerating business expenses and ‘handling’ deductions.
- Not saving receipts.
- Failing to report tax on income earned abroad.
- Turning your business into a hobby.
Even as an honest taxpayer you can do something wrong, resulting in the dreaded tax audit you fought your whole life to avoid.
To be on the sure side, you might want to outsource your federal income tax returns. In that case, take care to choose the right preparer. Do not ignore the audit. The tax man will always ring twice.