How To Avoid An IRS Tax Audit
An IRS tax audit is triggered by the IRS’s computer center after running through the IRS “Discriminant Function” program called “DIF” or Unreported Income Discriminate Index Formula (UIDIF) program. These programs spit out tax returns for review separating those taxpayers that are worth pursuing for more taxes and those that are not based on DIF and other scoring metrics. About 2% are reviewed by humans, and about 1% are audited. No one understands exactly how these programs work but below we will describe some things to watch out for. Realize the IRS typically cannot audit a return more than 3 years old from the filing date.
Ways To Avoid An IRS Audit
There is no guaranteed way to avoid and IRS audit but there are things a taxpayer can do to lower their probability or propensity of being audited:
1. Check Your Deductions – This means more than making sure your math adds up as a tax return with a few math errors usually doesn’t trigger an audit especially if you used a tax filing program like Turbotax. Don’t take large deductions on medical expenses (only expenses over 7.5% of adjusted gross income are deductible) and inflate charitable donations if untrue because the IRS programs will be comparing your deductions to taxpayers or businesses (if reported for a business) in your income bracket based on your location, family size, and profession. Lastly, make sure all your expenses itemized make sense. For example, don’t claim excessive travel expenses if you work from home.
2. Check Your Income to Expenses Percentage – The IRS is looking for individuals with high expenses and low income which is inconsistent to the averages in your category. Some notable experts such as Amir Aczel will argue that itemized deductions should rarely be more than 35% of adjusted gross income on Schedule A and up to 52% of revenue with a Schedule C (filled out by businesses). If they exceed these numbers, and you are truthful, that is fine, just make sure you have supporting documentation.
3. Report All Income – Report all bank interest, capital gains on stocks, real estate, gambling’s, alimony payments and any other potential income sources (even foreign accounts). Realize that the IRS receives 1099s and those need to match up with what you are reporting as income.
4. Include All Necessary Schedules and Fully Complete Your Tax Return – If you failed to fully complete your tax return or failed to include necessary schedules this may trigger an IRS audit.
5. File A Tax Return – If you didn’t file a tax return it doesn’t mean you can’t be audited. In fact the IRS may file a “Substitute of Return,” on your behalf (which is not good because credits and deductions are kept a a minimum typically) and then audit the return they filed for you.
6. Avoid Rounded Numbers – Rounded numbers are unrealistic, and usually will cause the IRS programs to select your tax return for review. Don’t wing your tax return, the IRS and State taxes are not a joke and should not be underestimated ever.
7. Avoid Running Into The Law – Don’t break the law, because if you are arrested for drug possession/intent to sell, or some other illegal activity this could trigger a review of your tax returns.
8. Avoid Claiming False Dependents – If you are divorced realize that only one parent can claim any child as a dependent. Make sure that your ex-spouse is not claiming your child as a dependent.
Other Causes Outside Your Control That Increase Audit Probabilities
1. Cash-Based Income Professions: If you are in a certain profession, like being a waiter, hair-stylist, tax driver, deli manager, or any profession where income is largely based on cash, your chances of being audited are much greater.
2. Self-Employment – If you are self-employed, you are much more likely to be audited because the IRS knows that many individuals will claim business expenses that should be personal expenses. Don’t try to expense huge business travel expenses, entertainment, or a large home office deduction.
3. If You Make More Than 100k a Year – Statistics and professionals will argue that a person who is making more than $100k a year is much more likely to be audited than someone who is making less.
4. Businesses That Report Small Losses – Businesses that report losses are typically targets for the IRS especially those with small losses because an Audit has a greater potential of producing income if incorrect.
In summary, these are just a few things to consider when trying to reduce your probability of being audited including other factors. Realize that there is no sure fire way to avoid an IRS audit only things you can do to lessen your chances. If you are faced with an IRS tax audit, or need representation fill out the form on the right for a free quote or give us a call today for a free consultation.
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