31 May What triggers an IRS audit?
By Atty. Crispin Caday Lozano
In preparing your 2015 income tax returns, we are giving some suggestions that will help your avoid an IRS audit. Your IRS tax return can be flagged randomly in an IRS study of the behavior of similar taxpayers, such as those in the same profession. But more often, audits result from:
· Document mismatches: This includes the income you report not jibing with figures in W-2s, 1099s and other statements.
· A high DIF score: A top-secret IRS computer program, the Discriminant Inventory Function System, assigns a score to each individual return. For instance, DIF compares your auto deductions with others in the same profession, your income in relation to others in your ZIP code. The further your amounts are outside the averages, the higher your DIF and chance of audit.
· High income: If you make under $200,000 a year, your chances of an audit are about 1 percent. But based on 2012 audits, the risk approaches 4 percent among people making $200,000 to $1 million and is over 12 percent for those earning more than $1 million.
The following are suggestions to lessen the chance of your tax return to be audited by the IRS:
1. Document every deduction.
You want to be able to document every deduction and keep that proof for at least three years from your filing date. Certain ZIP codes, like those in higher-income neighborhoods, have a higher audit rate. Self-employed workers also tend to get a red flag, especially when they claim a business operating loss “of any size,” Also on the IRS’s radar: those whose overall deductions approach 50 percent of their reported gross income.
2. Avoid round numbers
A tax return with lots of round numbers — $1,200 in travel expenses or $1,500 in charitable contributions — suggests that you’re just estimating those claims, “and the IRS loves to go after people who don’t keep good records. You don’t need to include cents, but use the closest accurate dollar amounts, such as $1,260 or $1,525.
3. Explain on paper what you can’t with e-filing
Do-it-yourself tax preparation software makes for easier and more accurate tax return preparation. But you can get into trouble if you file electronically with software that has no capability to include disclosure statements. You should include such explanations whenever there’s something unusual in your return.
In many cases, a type-written note will suffice to explain such red-flag issues as losses for a small business, a high mortgage-interest deduction or a home office deduction for a regular W-2 employee. In other cases, you’ll be able to attach signed documents related to charitable contributions or dependents.
4. Double-check your math
It’s no surprise that sloppy arithmetic on a paper return can flag an audit.
5. Verity and complete each line item
Don’t forget the easy stuff — your Social Security number, address and signature. It’s a myth that if you fail to sign your return, you will automatically be audited. The IRS will simply send it back for your signature. But if you repeatedly forget to sign and the IRS believes this is a deliberate pattern, you could face fraud penalties, and unwanted attention on your future returns.
6. Don’t claim undocumented donations
The IRS knows that many taxpayers are extraordinarily generous, at least in the charitable contributions they declare. Claims of giving, say, 10 percent of income may trigger attention, as the norm is about 2 percent. So if you’re a self-described philanthropist, be prepared to back up claims with written proof. As you give, collect letters or receipts from charities, both for monetary and in-kind donations — especially those over $250.
For a big item such as a donated car, you used to be able to deduct fair market value, no matter what the charity did with the car. Now you can claim that amount only if the charity uses the car. If it’s sold at auction, you can only deduct the usually much lower price that the car actually commanded. Your receipt should specify what happened to the car, and, if it was sold, for how much. And you should have detailed paperwork on any car donation worth $500 or more.
7. Keep records of description of some receipts
If audited, you might need to demonstrate that a restaurant receipt actually represents dinner with a potential client, not a night on the town with your spouse. Receipts don’t talk, so jot down notes as you go along
and keep records
8. Consider an LLC or incorporating
The self-employed who file a Schedule C rather than a corporate return are reportedly 10 times more likely to be audited. “One way to lower that risk is to have an entity, such as an LLC [limited liability company], or any other kind where you can file with a different tax ID number.
9. Be ready to explain your bank transfers
If your return is flagged, the auditor will run a total of all the deposits in your bank accounts. If you move a lot of money between different accounts, it could appear as though you have three or four times more money than you really do. Be prepared to document these transfers carefully to show that a deposit doesn’t necessarily equal new income. Not having such proof causes more trouble in audits.
Note: This is not a legal advice.