As you know, a small percentage of tax returns are selected to be audited. Those who have experienced an audit know that it can be a nightmare and is worth avoiding if possible. Luckily, there are a few red flags the IRS looks for when deciding which tax returns to audit, especially those that take advantage of a large amount of deductions. This tax season, follow these tips to reduce your chances of getting picked:
1. Avoid Typos and Entry Errors: The easiest way to raise a red flag with the IRS is reporting numbers that do not match with what the IRS has on file. Be careful when preparing your taxes. Even if your taxes are professionally prepared it is still worth it to double check the numbers before you submit. Don’t assume the IRS won’t notice your small mistakes.
2. The More Money You Earn, The Bigger Your Risk: Keep in mind that those who earn over $250,000 a year automatically become a bigger target for the IRS, simply because there is more money at stake. If you fall under this category, be mindful of your increased audit potential and take extra time when preparing and reviewing your taxes. It also helps to stay financially organized and keep meticulous records, in case you are selected for an audit.
3. Be Careful With Large Charitable Donations: Obviously there is nothing wrong with being very generous and giving to charities. It is a kind thing to do plus you’re entitled to report it on your taxes. However, note that larger than average charitable sums stand out to IRS agents and raise some questions, even if your donation is completely legitimate. Protect yourself by making sure everything you report is properly documented.
4. Beware the “Earned Income Tax Credit”: Last year, the IRS said tax returns that claim the Earned Income Tax Credit are twice as likely to be audited. This is because improper claims of this credit cost the government an estimated $10 billion a year. The EITC involves complex rules that often lead to high error rates by both taxpayers and tax professionals. If you or your preparer has claimed the EITC, make sure to double-check that you qualify and understand its guidelines.
5. Know the Commonly Abused Deductions and Other Red Flags: One deduction that is often abused is the Home Office Deduction, so the IRS scrutinizes most returns that claim it. Additionally, reporting a major income drop is a quick way to raise a red flag because the IRS will think you have failed to report something. Lastly, be careful about what you report as your own business activity because the IRS may take a closer look to see if what you are reporting is closer to a hobby, especially if you claim losses over several years.
6. Assess Your Risk: There are various tools such as TurboTax’s IRS audit risk tool or Kiplinger’s questionnaire that can help you assess your risk and take further step to reduce this risk if necessary.
7. Keep (Proper and Organized) Records of Everything: If you are worried about an audit, make sure to keep all records in a safe place, including receipts, invoices, account statements, cancelled checks and documentation of travel and business assets. Anything you deduct on your taxes should be easily proved by your records. Also, keep your filed tax returns indefinitely. Supporting documents for tax returns should be kept for at least seven years in case the IRS finds an issue from a previous year.
Remember that honesty is the best policy. Definitely take all of your deductions. Just make sure you have the records to back them up. Don’t fudge the facts in hopes that you will fool the IRS because this could end up costing you hundreds of dollars (or more) in the long run if you are selected for an audit.
For more tips and information you can trust, visit bbb.org.