6. Don't claim to be "too generous"
The IRS knows that many taxpayers are extraordinarily generous, at least in the charitable contributions they declare. Claims of giving, say, 10 percent of income may trigger attention, as the norm is about 2 percent. So if you're a self-described philanthropist, be prepared to back up claims with written proof. As you give, collect letters or receipts from charities, both for monetary and in-kind donations — especially those over $250.
"When you donate to Goodwill, it's no longer enough to leave a bag of clothing outside the door," says H&R Block master tax adviser Elaine Smith. "You need a receipt."
For a big item such as a donated car, you used to be able to deduct fair market value, no matter what the charity did with the car. Now you can claim that amount only if the charity uses the car. If it's sold at auction, you can only deduct the usually much lower price that the car actually commanded. Your receipt should specify what happened to the car, and, if it was sold, for how much. And you should have detailed paperwork on any car donation worth $500 or more.
7. Keep records beyond receipts
If audited, you might need to demonstrate that a restaurant receipt actually represents dinner with a potential client, not a night on the town with your spouse. "Receipts don't talk," says Daily, so jot down notes as you go along and keep records. "It can be nothing more than 'dinner with John Smith, prospective sales client,' " he says. But such a log will add credibility to your claim. It's unlikely the IRS will contact your dinner partner, unless there's suspected fraud.
8. Self-employed? Consider incorporating
The self-employed who file a Schedule C rather than a corporate return are reportedly 10 times more likely to be audited. "One way to lower that risk is to have an entity, such as an LLC [limited liability company], or any other kind where you can file with a different tax ID number," Daily says.
9. Track your bank transfers
If your return is flagged, the auditor will run a total of all the deposits in your bank accounts. "If you move a lot of money between different accounts, it could appear as though you have three or four times more money than you really do," Rosenberg says. Be prepared to document these transfers carefully to show that a deposit doesn't necessarily equal new income. Not having such proof causes "more trouble in audits than any other issue," she says.
What triggers an audit?
A return can be flagged randomly in an IRS study of the behavior of similar taxpayers, such as those in the same profession. But more often, audits result from:
- Document mismatches: This includes the income you report not jibing with figures in W-2s, 1099s and other statements.
- A high DIF score: A top-secret IRS computer program, the Discriminant Inventory Function System, assigns a score to each individual return. "For instance, DIF compares your auto deductions with others in the same profession, your income in relation to others in your ZIP code," says Daily. The further your amounts are outside the averages, the higher your DIF and chance of audit.
- High income: If you make under $200,000 a year, your chances of an audit are about 1 percent. But based on 2012 audits, the risk approaches 4 percent among people making $200,000 to $1 million and is over 12 percent for those earning more than $1 million.
Sid Kirchheimer writes Scam Alert and covers consumer issues for AARP.