In 2007, 1.38 million taxpayers got the dreaded audit notice from the Internal Revenue Service (IRS). That was 90,000 more taxpayer audits than in the previous year.
How can you avoid being one of those people this year? Here are 10 ways to avoid a tax audit:
1. Understand the selection process.
Although the process may seem rather random, actually, to flag potential audits, the IRS uses the Discriminate Income Function (DIF), a computer program that compares your deductions with those of others in your income bracket.
Don't let this scare you into not taking all the deductions you're entitled to—just be sure to have documentation to back them up.
Remember, though, that some taxpayers really are selected through the "luck" of the draw, so you can't completely protect yourself from being audited, but you can lower your odds by following the rest of the tips below.
2. Know if you're a likely target.
Note that if you are in a cash business (waitress, bartender, hairdresser) or if you're a doctor, lawyer, or accountant (who normally keep their own books), you are already more likely to be audited.
You'll need to be extra meticulous with deductions in particular, so document everything and stay away from miscellaneous deductions.
3. Incorporate if you're self-employed.
Filing a Schedule C as a self-employed taxpayer also raises the chance for an audit. If you are self-employed, you might consider incorporating or forming a limited liability company (LLC); corporations and LLCs are audited less frequently than other small businesses. Incorporating or forming an LLC also allows for more deductions.
Overall, small businesses are some of the IRS's favorite audit targets, so be prepared by keeping excellent records. You might also consider hiring someone to prepare your return.
4. Include explanations.
If you think your return has a good chance of raising an audit flag, you should include extra forms, worksheets, receipts, etc. Use them to explain inconsistencies from previous years' returns in areas such as your name, your dependents, deduction amounts, and income.
For example, if your charitable deduction is significantly higher than in previous years, include an explanation as to why—even copies of canceled checks. The DIF system may still flag you, but a human IRS agent can look at all your additional forms and hopefully decide that your deductions are well-documented and not deserving of an audit.
5. Know what is often questioned.
Some of the most common flags for an IRS audit are bad debt expenses, casualty losses, home office deductions, medical expenses, and business travel, meal, and entertainment expenses.
The importance of having proper documentation for these deductions cannot be overstated.
6. Avoid filing amendments to your return.
Flying below the radar is your goal here, and filing an amended return won't accomplish that. With the filing of an amended return, your original return may also come under scrutiny, so do your best to file correctly the first time.
7. Know when to file.
Most tax advisors say the later you file, the less likely your chances of an audit. Some go one step further and say you should even file for extensions as most returns are already selected for auditing in a given tax year by the latest extension deadline of October 15th.
Remember, though, that if you owe taxes, you are still expected to pay by April 15th or face penalties. Even if you're not sure of the amount you'll owe or if you don't have the money to pay, send along a check for a small amount, even $10, with your promptly-filed return to show good faith on your part and lower future tax penalties.
On the other hand, if you're expecting a hefty refund and don't anticipate any audit problems, file as soon as possible so you can get your money quickly.
8. Check your math.
Even if you're a mathematician, use a calculator and double-check everything. Be especially careful that your numbers match those on forms submitted to the IRS by employers as the computer simply matches them up and looks for discrepancies.
Also pay special attention to deductions that have adjusted gross income limitations such as the medical expenses deduction; you probably won't be audited for a simple mathematical error, but you don't want to alert the IRS that you've carelessly prepared your return.
9. Be exact and be neat.
Use exact numbers instead of rounding them off, and write neatly so you don't cause excess stress for IRS agents reviewing your forms. Also be sure that your state tax returns match your federal ones.
10. Leave nothing blank.
It's often said that the devil is in the details, and for the IRS, the reason for an audit may simply be an empty space. Answer every question and fill in every line, even if it's simply with a dash or zero. Don't leave room for the IRS to assume anything.
No matter how many precautions you take, there's no way to guarantee you won't be selected for an audit. Use the tips above to lessen your chances, but also be sure to maintain thorough, organized records in case you're chosen. If you have nothing to hide and the documentation to prove it, you don't have anything to worry about—if you're chosen, the audit will be a breeze.
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