1. Know your risk
You want to be able to document every deduction and keep that proof for at least three years from your filing date. Certain ZIP codes, like those in higher-income neighborhoods, have a higher audit rate, says tax attorney Frederick W. Daily, author of five tax-related books, including Stand Up to the IRS.
Self-employed workers also tend to get a red flag, especially when they claim a business operating loss "of any size," says Daily. Also on the IRS's radar: those whose overall deductions approach 50 percent of their reported gross income.
2. Avoid round numbers
A tax return with lots of round numbers — $1,200 in travel expenses or $1,500 in charitable contributions — suggests that you're just estimating those claims, "and the IRS loves to go after people who don't keep good records," says Daily. "You don't need to include cents, but use the closest accurate dollar amounts, such as $1,260 or $1,525.
3. Explain on paper what you can't with e-filing
Do-it-yourself tax preparation software makes for easier and more accurate tax return preparation. But you can get into trouble if you file electronically with software that has no capability to include disclosure statements. You should include such explanations "whenever there's something unusual in your return," says Eva Rosenberg, who is an accountant and an "enrolled agent," a person authorized to represent taxpayers before the IRS.
If you use a software program, Rosenberg suggests not using its e-filing feature if there's anything that might leave an IRS officer wondering. "Print out your return and attach an explanation statement and mail it in," she says. A new feature this year: "You will able to include PDF attachments with certain forms. Ask if your software supports this."
In many cases, a type-written note will suffice to explain such red-flag issues as losses for a small business, a high mortgage-interest deduction or a home office deduction for a regular W-2 employee. In other cases, you'll be able to attach signed documents related to charitable contributions or dependents.
4. Double-check your math
It's no surprise that sloppy arithmetic on a paper return can flag an audit. "People list correct numbers but on the wrong line," says Rosenberg. So make sure sums are not only correct but in the correct place.
5. Mind each line
Don't forget the easy stuff — your Social Security number, address and signature. "It's a myth that if you fail to sign your return, you will automatically be audited," she says. "The IRS will simply send it back for your signature. But if you repeatedly forget to sign and the IRS believes this is a deliberate pattern, you could face fraud penalties, and unwanted attention on your future returns."
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.
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