As painful and as difficult as many people find filing their annual tax return with the Internal Revenue Service (IRS), a common fear that is shared by many people is the thought of being audited. This fear of being audited has been amplified by various movies, television shows and by some of the past heavy handed tactics of the IRS itself.
So how does a person or small business avoid the audit and thereby save time, money and anxiety? The first step is to keep good records so that if you are audited you can present data right away. When the audit process starts the IRS does notify the taxpayer about the issue in question, generally through the mail. When this notice comes in, contact the agent conducting the audit and offer to send, fax or e-mail the information that will support your claim.
Another aspect of IRS audits is to know what will increase the chances of being audited. These come down to a handful of things:
Business use of the home – Many people maintain a home office for a variety of reasons but unless your use of the home office is to conduct “the usual and regular money making effort” of your business then it is a red flag for the IRS agent and this single line item is one of the most common problems found in any audit. Another thing associated with business use of the home is depreciation of the home and subsequent sale of the house. If the house has been depreciated and then sold without the payment of capital gains on the business use of the house then be prepared for a tax bill via an audit along with the fines, penalties and interest on the unpaid taxes.
Medical Expenses – While few filers ever have enough medical expenses to make a difference at tax time, there are always those who try to deduct a swimming pool or some other huge capital improvement to the home as a medical expense and when these huge expenses show up that will be one of the first things that a tax examiner will ask about.
Math – It may seem like a very simple thing, but if the tax return has math errors then it has to be looked at again and this may prompt an audit. One very easy way to avoid a math error is to use one of the tax software programs so that the computer program does the math. An essential part of doing math correctly is also to only count the human children who are dependent upon the taxpayer and not dogs, cats, horses or any other animal. Of special note about children, if you plan on claiming them on your tax return, make sure that the child is not claiming themselves on their tax return.
Report all income – The IRS has very extensive databases and since every bank and any other type of business has to report income paid to others so they can deduct it on their return it is essential that every form of income be declared to the IRS. Income reports come in many different ways but the most common is the W-2 and the 1099. For those who have stock that pays dividends, this is also income as the interest on bank accounts.
Lastly, excessive business deductions or losses are another very common way for a taxpayer to cause an audit. Excessive deductions that can’t be proven is tantamount to telling a lie as far as the IRS is concerned and a tax return based on falsehood is a ripe plum for an audit and easy pickings for the IRS.