10 Ways to Prevent a Tax Audit

10 Ways to Prevent a Tax Audit

by Louise Banks, January 2006

Tax audits can be very frightening to people for a wide variety of reasons. Both individuals and businesses can receive letters from the Internal Revenue Service (IRS) requesting a meeting to audit tax returns filed over the course of several years. Even though only about 1.5% of all tax returns are audited each year, there are steps you can take to reduce your chances of being audited.

Tip #1: Report all income.

You are required to report in detail all the income you receive from all sources. Whether you are a salaried employee or an independent contractor, the IRS publications clearly define what you must report on your tax return. Tips and any cash payments have to be reported as well.

Tip #2: Have proper documentation.

Each company you work for will send you a 1099 or a W-2 that reports your income from the year before. The numbers on these forms should match the numbers on your tax return. It is always best to have the paperwork that can prove everything you enter on your tax return.

Tip #3: Check for math errors.

Errors in math get you noticed by the IRS. Check the figures on your tax return. Make certain you enter amounts on the correct line of the form. The IRS might assume that if your math is sloppy, there are other errors as well.

Tip #4: Keep records for Schedule C.

If you have a business, that can also send up a red warning flag. Some business owners hide part of their earnings to avoid paying taxes on this income. Creative bookkeeping or having two sets of books is illegal. You must keep excellent financial records of all aspects of your business and ensure that Schedule C is accurate.

Tip #5: Use your home office just for business.

Claiming a home business can also bring you to the attention of the IRS. Make certain that the space or room you use to conduct business is kept separate. Having a dining room that is occasionally used for your home business is not legally a home office. Do not keep personal belongings in a home office or use the space for socializing. If you have business meetings at home, keep a log of your clients or business partners. Make certain that no more than twenty percent of your home is claimed as a home business office.

Tip #6: File a joint tax return.

Filing your tax return separately from your spouse's can put you at risk for a tax audit. This usually occurs if there is a large number of deductions or if there are duplicate deductions on the two returns.

Tip #7: Don't forget to sign or file your tax return.

In the rush to get your tax return filed on time you may fail to sign the 1040. Others prepare the tax return then forget to mail it. These two errors can leave you at risk for an audit.

Tip #8: Check your personal information.

You also want to make sure that your personal information is correct on your tax return. Make sure that your name is spelled correctly and that your address is correct. Your social security number must also be accurate. If this important information is incorrect, the IRS may assume that you are trying to obscure your identity and select you for an audit.

Tip #9: Keep track of large money transfers.

Large money transfers attract attention from the IRS. For example, if you transfer money from an interest-bearing account to a non-interest checking account or savings account, this may appear to be double income. Try to limit the number of large money transfers and keep detailed records of these transactions.

Tip #10: Be careful of deductions.

If your itemized tax deductions appear too high in relation to your income, this could signal an audit. The IRS has guidelines for the average amount of expenses for each income bracket. Take the tax deductions you are entitled to, but be aware that if you exceed the average for your income level this increases your chance of being audited.

Keep these suggestions in mind for the upcoming tax season.