10 Tips to Avoid an IRS Audit

The IRS chooses some tax returns at random so there is no way to completely avoid being audited, however, by following some basic tips you may be able to avoid raising certain red flags. Statistically there are certain items on a return that may cause the IRS to take a closer look at the return, which in turn may increase the chance you will be audited.

1Double check for math errors: Making mathematical errors is one way to trigger an audit. Double check all addition and subtraction for errors and check to be sure that there are not any transposed numbers. Making math errors is a quick way to draw unwanted attention to a return. While one math error likely will not trigger an audit, several errors indicate a carelessly prepared return and will raise a red flag.

2Follow the directions on the forms, fill out all required spaces, and make sure your entries are legible: When filling out your return it is better to put in a zero or a dash mark than to leave any blank spaces. Do not forget to sign your return. Every year people forget, which brings unwanted attention to their return. If the person processing your return cannot read your writing you are inviting extra scrutiny. If possible, prepare your return on a computer. If that is not possible, enlist the aid of someone with more legible hand writing.

3Be careful if you claim the home office deduction: The IRS has found that some taxpayers that claim the home office deduction tend to inflate their deductions or do not actually qualify for the deduction. In order to qualify for the home office deduction the area in your home used for business must be used “exclusively and regularly for your trade or business.” This means that the space cannot be used for any other purpose. If you qualify for the home office deduction you should claim it. Be prepared, however, to prove that you are entitled to the deduction.

4Filing False or Misleading Forms: When the IRS finds a tax preparer that has a tendency to distort numbers they may be more likely to audit all of his clients. When choosing a tax preparer check their credentials and ask for references. The IRS provides 8 tips to follow when choosing a tax preparer. Many taxpayers do not need to hire a tax preparer. The IRS offers free tax help to taxpayers making less than $50,000.

You should also keep in mind that it may not be a good idea to hire a tax attorney to prepare your return if you are also going to use that attorney to settle any tax liability you may have because when a tax attorney prepares a return, they lose attorney-client privilege where that return is concerned. For most people this is not a problem, for others it could be a big problem, so it is best not to take the chance.

5Incorporate: The U.S. Government Accountability Office has found that a large number of sole proprietors declared losses that were a result of noncompliance. The IRS believes that the self employed have more opportunities to under report their income or to take questionable business deductions than a wage earner. Corporations are not audited as frequently as taxpayers that file a Schedule C and may even be eligible for more deductions.

6Explain any significant changes in income: If you have had a sudden drop in income, it may be a good idea to explain why. This is particularly true if you have retired at an early age, become disabled, or lost your high paying job and are reporting income from a much lower paying job. You might still get flagged by the IRS computers but when an IRS agent looks at the return your explanation may help to avoid an audit.

7Meet filing deadlines: You want to make sure that you look like the average taxpayer. File and pay your taxes on time. This includes your quarterly tax payments. For small business owners this also includes their employee tax payments, 1099's and W-2's. Filing or paying late makes you look disorganized, which may invite additional scrutiny. If you file for an extension make sure you file your taxes by the October 15th deadline, and remember you still need to pay your taxes in full by April 15th.

While you do not want to file late, you also do not want to file early. Filing early gives the IRS additional time to scrutinize your return. In cases where you are due a refund and are not worried about being audited, you should file as early as possible.

8Report all income and make sure all income and deductions match what the IRS is receiving from third parties: Report all income, no matter how small the amount. Some taxpayers mistakenly believe that they do not have to report income under $600. This is not true. If you are audited the IRS will ask to see all of your bank statements and you need to be prepared to explain every deposit and have the documentation to back up your figures. The IRS compares what they receive from third parties to what you report on your return. The Failure to report $7 received in interest from a bank will raise a red flag when the bank reports the interest to the IRS. This may result in the IRS taking a closer look at your return.

9Do not be too rich or too poor and live within your means: Taxpayers making more than $200,000 are more likely to be audited. That is because taxpayers that make more money tend to take more itemized deductions, including the charitable deduction, or are small businesses filing a schedule C. This tends to attract the attention of the IRS.

The IRS also has paid particular attention to returns that include the Earned Income Tax Credit. The IRS has found that the error rate when claiming this credit is much higher than with other credits. Taxpayers frequently get the math wrong or enter incorrect social security numbers for their dependents. It is also a credit that is often claimed fraudulently. The IRS estimates that between 23%-28% of Earned Income Credits paid out are erroneous payments. Returns claiming this credit are audited at a higher rate than returns that do not claim the credit. If you are entitled to the credit you should take it. Just make sure you read the instructions carefully to ensure you qualify for the credit and check your math and social security numbers before filing your return.

Not living within your means can also attract the attention of the IRS. If you are reporting an income of $30,000 and mortgage interest deductions of $20,000 that is going to raise a big red flag. The IRS also utilizes a database that estimates what you need to make in order to survive, based on where you live and your number of dependents. If your numbers differ too drastically from the IRS statistics, it will invite scrutiny.

10Explain any high deductions: If you have any unusually high deductions on your tax return, make sure to explain them. Deductions in excess of 30% of your income may raise a red flag. If you moved or sold your home and chose to donate a lot of your furniture and belongings, you should either donate them over several years, or include an explanation as to why your charitable deductions are higher than normal and provide documentation. Another deduction that gets a lot of scrutiny is the medical deduction. If you had very high medical bills, provide an explanation and documentation. If the computer flags your return, when someone at the IRS reviews your return, they will see the provided explanation and documentation and it may satisfy them that your deductions are legitimate and you may be able to avoid an audit.