A tax audit occurs when the IRS (or the local tax authority) flagged your tax return for a closer scrutiny. This is done to determine if your income, expenses, deductions, and credits are reported accurately. When you are audited, you will receive an official notification from the tax agency with information and instruction on what you need to do. Most audits could be resolved by sending additional supporting document, and/or amended tax return, to the . More serious cases typically involve a visit to the local tax office for an interview, or in some instances, a tax official will visit your place of business.
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Here are some common red flags the could trigger an audit. If you can avoid falling into one of these categories, it can help reduce your chance of getting audited.
Because people making more than $100,000 a year account for more than 60% of the taxes paid in this country, the IRS is very interested in looking for tax evaders in this category. As a result, if you make six figures, you are automatically increase your chance of getting flagged for a tax audit. Of course, the risk of being audited is no reason to avoid making more money; you just need to be careful about your documentation so that you are properly prepared in the event of a tax audit.
Itemized deductions can be quite helpful in lowering your taxable income and saving you some money. However, it is important not to go overboard. The average total deductions vary according to income, for example, the average total of itemized deductions is right around $20,000 for those making between $30,000 and $50,000 in gross income each year, around $24,600 for those making between $50,000 and $100,000, and around $36,500 for those making between $100k and $200k. If your itemized deductions exceed these amounts, you might be flagged. Keep records of your deductions, including receipts for charitable donations.
You can take home office deductions when you telecommute or have a home business. However, it is important to be careful about the sorts of expenses you count, since anything you use for something other than business won’t be allowed. Home office deductions, especially if they are large and numerous, may raise red flags, although just taking them no longer marks you out, since technology has given rise to millions of home businesses and telecommuters.
I’m guilty of this. For years, before I began going to an accountant, I filled out my tax return by hand. I even added in business expenses for what was then a sole proprietorship. Apparently, I should feel very lucky that I wasn’t audited. Tax returns filled out by hand raise red flags about accuracy, and can cause legibility problems. You don’t have to go to the accountant to avoid a handwritten return, though. The IRS has forms you can fill out online, and you can use software that fills out your tax return.
When I first switched to an Limited Liability Company (LLC), my accountant had all sorts of trouble with this. Some of my clients didn’t get the memo that I had a new tax identification number. As a result, all of the income on 1099 forms that showed my Social Security Number still had to be reported on the Schedule C, rather than with the income under my Employer Identification Number.
The IRS matches up what others report on your income with how much your report, so you want to double check to make sure that everything is in the right place. This goes for your spouse’s income (if necessary), income from hobbies and other types of income. And, if you know that you will be receiving a corrected W-2 or a 1099, wait until that comes in before completing your return.
Making sure that your tax return is filled out properly is your responsibility, as is making sure you have all of the proper documentation to back up your claims. While there is no full-proof way to avoid a tax audit, you can significantly reduce your chances of being red-flagged if you are careful about how your tax return is completed, from reporting your income to claiming investment losses.