Tax audits can be terrifying. We all dread the very thought of filing our taxes so the nightmare that our records could be further investigated sends many of us into orbit. As April looms near, it is important to remember that about 1 to 2 percent of all tax returns are audited each year. So how do you avoid becoming one of the statistics? Although there is no surefire bet, here is a short list of red flags to avoid.
Yes, yes, you are probably thinking: "but...I entertain business clients all the time!" Even as a sole proprietor, you should be aware that itemized deductions on a Schedule C are more likely to garner scrutiny from the IRS. The IRS is particularly wary of small business owners and the self-employed. The biggest concern is "creative bookkeeping." The best practice is to make certain that you are able to justify each and every deduction that you make.
Above Average Deductions
The IRS has guidelines for the basic amount of expenditures for each salary tax bracket. If your particular itemized deductions appear too high in relation to that figure, i.e. your salary, the tax auditor just may come knockin'. Now, don't be alarmed, if you have deductions that you are entitled to, take them. Simply remember, if those deductions greatly exceed the average amount, you could be flagged.
Home Office Deductions
Many small businesses start in the home. However, the home office deduction can only be taken if you use the room exclusively for business purposes. In other words, if your dinning room table has been doubling as a desk, the room is not being used solely for your business. On the flip side, if you keep your personal belongings outside of that room, it is eligible as an office. Yet even if you are eligible for the home office deduction, only a certain percentage of your total home expenses can be claimed as a business expense.
Giving, Giving, and More Giving
Charitable contributions are a great way to give back to the community. Many people devote most or all of their charitable giving to one particular non-profit that they support. However, extremely large or excessive contributions often elicit an IRS flag. The government's concern is that taxpayers exaggerate their contributions for the tax benefit. To make sure your gift doesn't come back to bite you, simply keep a record of your donation.
Six Figure Salaries
You thought you hit the jackpot when you started making six figures. Well you did...but your rockin' new big-digit salary just came under the radar of the IRS.
It only makes sense that as you begin to collect more and more, so does the IRS. So, it makes even more sense that they would watch high level returns more vigilantly. The bottom line is that there is more at stake for those IRS auditors—a mistake on a big income return could translate into many more dollars for the IRS than an error on a small income return.
One Final Note
Proofread. Whether you forgot to sign your name or you made a miscalculation, you always want to make sure that your information is absolutely accurate when you send in those forms. Although it isn't always a red flag, errors may appear as an attempt to obscure information.
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