Certain things tend to scare most people – snakes, spiders, public speaking, root canals ... and tax audits. Though audits are rare, several factors boost your odds, including your income level, the types of deductions you claim and your industry. Here are a few tips to lower your audit risk.
KNOW THE SELECTION PROCESS
The IRS scans every return it receives and compares your return to others in your income bracket. Depending on how it deviates from the norm, your tax return is assigned a score. Certain things boost the score and may throw your return into the “deviant” group, prompting an auditor’s review. Ultimately, the tax agencies are looking for returns with the highest probability of additional audit revenue.
MINIMIZE YEAR-TO-YEAR DIFFERENCES
The IRS identifies returns to audit based on comparisons with your previous tax returns. Avoid large swings in income or deductions from one year to another.
BE PROACTIVE WITH EXPLANATIONS
If you think your return is waving a red flag, include extra information to head off an audit. For example, if you have high charitable deductions, attach supporting documentation with your tax return. It might still be flagged for audit, but an agent could decide to pass once your information is reviewed.
AVOID FILING AMENDMENTS
Flying below the radar is the goal and filing an amended return won’t achieve that purpose. When you file an amended return, your original return may also be reviewed. Get it right the first time.
CONSIDER HOW YOU DO BUSINESS
Believe it or not, the way you organize your business impacts your audit risk. Sole proprietorships have a higher probability of audit than corporations and LLCs. Sole proprietorships are a gold mine for audit adjustments due to commonly poor record keeping and make-believe deductions. Sole proprietorships with gross revenues of $100,000 or those that report losses have a higher audit risk. Cash-based businesses are also on the radar.
REPORT ALL INCOME
The IRS receives copies of your 1099s and W-2s, then matches the totals to your tax return. If you don’t report the income, mismatches will automatically generate an IRS notice. Keep in mind if you receive income but a 1099 was not issued, it’s still reportable. How could the IRS possibly know? If your bank accounts do not show income, your cash-based lifestyle may give you away. How would the IRS know about your lifestyle? Know that whistleblowers have a monetary incentive to report you to the IRS.
AVOID EXCESSIVE MEALS AND TRAVEL EXPENSES
The IRS is on the lookout for frequently abused deductions such as meals and travel. Depending on your industry, these expenses should be in line with your profession.
DON’T USE ROUND NUMBERS
The IRS knows that the chances of your deductions being perfectly round numbers is slim to none. This audit flag sends the signal that deductions are estimated or are flat-out fantasy.
CHECK YOUR MATH
It may seem obvious but math errors are one of the top mistakes that draw an IRS response. One advantage of using tax software or a professional preparer is that you don’t have to do the math.
CHOOSE THE RIGHT PREPARER
More than half of taxpayers rely on someone else to prepare their return. Avoid hopping from preparer to preparer, otherwise the IRS assumes you have something to hide. Speaking of unscrupulous ways, the IRS is also on the lookout for dishonest tax preparers. Using the wrong preparer could flag your return for audit.
THE BOTTOM LINE
If the thought of a tax audit is enough to scare you, there are several strategies you can take to minimize your risk and put your mind at ease. ￼
Chris Thornburgh is a CPA and partner at Brown Armstrong Accountancy Corp. Contact her at email@example.com or 661-324-4971. The views expressed are her own.