Tax season is here and the IRS (and tax professionals as well) are already bogged down as they work to make their way through the ever-growing stack of filings. There are many things to consider as you file your taxes this year, including a slew of new tax laws and provisions. While most filers are concerned about how much they will get back or owe in taxes, they tend to pass over the fact that they may get audited, because they believe there is nothing they can do to avoid it. This is a misnomer however, and in this article we are going to discuss some methods you or your tax professional can employ to avoid being audited by the IRS.
The IRS audits 1% of tax returns each year. While there is no magic ball that tells us exactly how tax auditors decide which filings are audit-worthy, we do know that there are some red flags that can help trigger further investigation. Ultimately, at the end of the day, if your taxes are filed properly – and if you rely upon a tax professional such as a CPA they should be – you have nothing to worry about. Still, tax audits can be a lengthy process with a lot of hassle involved, so it is best to avoid them if possible.
One factor the IRS seems to look at closely is income level. While the normal tax audit rate for a filer is 1%, people earning an income of $200,000 or more have a 3.26% higher chance of being audited. If you make over $1 million, your chances increase to one-in-nine.
Obviously you don’t want to make less money each year, but you should be aware that your income does play a factor in the likelihood of a tax audit occurring.
Large Charitable Donations
Charitable donations are great – giving back to your community is a wonderful thing and should be applauded. Giving back too much – or at least claiming too large of a charitable deduction – however, can get your rewarded with a red flag.
The IRS tracks how much the average filer donates per income level, and if you greatly exceed this limit, or if your donation amount is overly proportional to your charitable contributions, it can cause you to be scrutinized more.
Another thing to consider with donations is valuable property. If you donate any noncash items valued over $500, be sure to get an appraisal for donations of valuable property and file Form 8283. Doing otherwise raises your risks of being flagged.
Business Travels and Meals
Self-employed individuals have the ability to make deductions for business meals, traveling expenses, and even entertainment – so long as it is in the pursuit of acquiring or retaining business. That doesn’t mean you have cart-Blanche to write off every dinner or airplane ticket, or take your clients to $500 meals every visit. The bigger your Schedule C deductions are, the bigger your chances of being audited.
Make sure you keep detailed notes about your expenses, including who you had dinner with and what type of business discussion you had. And, as always, keep your receipts well-organized. You will need all of this information in the event of an audit.
Home Office Deductions
Home office deductions are great if you qualify for them, as they can earn you a deduction of $5 per square foot of legitimate space (up to $1500). However, the space you deduct must be used solely as an office or space of business. You cannot deduct your living room or a guest bedroom – unless you have converted it to an office and use the space as such.
Claiming the home office deduction might get you looked at a little more closely, however, we still urge you to claim it if it applies to your situation.
Failing to Report Income
Another big no-no is failing to report any and all taxable income. The IRS receives copies of the same 1099s and W2s that you get, and if the numbers do not add up to what you claim, it will earn you a red flag. Always be sure to report all taxable income properly.
Finally, taking deductions that are excessive or out of proportion to your income or higher than what the standard filer in your income bracket takes always sends up a signal for closer inspection. If you have legitimate claims to a deduction, you should definitely take it – just be aware that it may earn you an audit. So long as you can justify the deduction and have records and receipts for it, however, it is your right to claim it.
At the end of the day, if you file your taxes properly and all of your information is correct, tax audits are nothing more than a hassle. However, not everyone is a tax expert and you cannot be expected to keep up with every new tax law that hits the books. So why take the chance? We encourage you to hire a tax professional such as a CPA or Certified Public Accountant to not only file your taxes, but to be there in the event of an audit to help get you through the process.
Also, hiring a CPA to handle your taxes can be the start of a beautiful relationship. CPAs, unlike traditional tax preparers, are there for you year-round, and can help with other matters such as estate planning, business consulting, accounting, bookkeeping, and so much more.
Best of luck to you during this tax season!