February, 2005 Tax Tip
Itís Filing Season Ė Reduce Audit Exposure on Your Return
While a tax professional can never guarantee that a return will be audit proof, there are steps that can be taken to minimize exposure that might otherwise exist on your return.† I have maintained that proper tax return preparation is an art that I feel I have mastered over many years by preparing several thousand tax returns†
Instead of doing random audits as in the past, today the IRS relies on computer programs to find tax returns with problems that suggest they may be productive audit material.† With limited resources it makes sense that the IRS will target higher-income and self-employed individuals.
While the IRS doesnít share its audit-potential secrets, tax professionals have identified some patterns based on identifying the profiles of taxpayers who tend to get audited more often.
Some tips to keep in mind:
Use a professional.† A tax return prepared by a professional will, in all likelihood, be less apt to contain errors. However, there has been much recent publicity relating to unscrupulous preparers that have inflated refund claims by taking non-existent deductions and using other devious schemes.† These preparers are high on the IRSí target list.† Therefore, your tax professional should be reputable.
File electronically.† Most tax return preparers now offer electronic filing of returns.† Your chance of getting an error notice from the IRS or state taxing authority is significantly reduced because E-Filing has less than a 1% error rate.
Report all income.†† Be sure to keep all tax reporting documents provided to you† during January and, in some cases, later (e.g. K-1 schedules from partnerships, S corporations, trusts, and estates).† This should prevent you from overlooking little-used bank or brokerage accounts.
As you are no doubt aware, banks and other companies tell the IRS how much they paid you and the IRS computers will likely flag you if the figures on your return don't match the information they have received.† If it's a small amount, you may just get a notice telling you of the adjustment.† But larger amounts could make the IRS think you are careless and may have more adjustments for it to uncover.
Your business must be viable.† Tax deductions for business expenses or losses related to a part-time activity that rarely, if ever, makes money continue to proliferate.† Sooner or later the IRS is going to wonder whether you really are engaged in an activity for profit.† If you continuously show losses on your tax return business schedule, you no doubt will get audited at some point .† Recent statistics show that the IRS audited six times as many taxpayers who filed Schedule C showing a small or negative business income as it did with total returns.
Watch deductions.†† Itís important to take any deduction youíre entitled to.† But many practitioners believe that if you claim a large amount of deductions compared with you income, you could become a target for an audit.† The IRS uses a data base that compares the itemized deductions (medical, taxes, interest, contributions, and miscellaneous itemized deductions) taken at various levels of income to establish norms.† If youíre claiming amounts way above the norms, the IRS might take a closer look at your return.
Listen to the IRS.†† While the IRS doesnít disclose how it selects taxpayers for audit, you can get some idea by paying attention to the issues it says it is concerned about.† For example, charitable deductions for cars received such scrutiny that the law on figuring the deduction for donated vehicles was changed.† While the new law doesnít take effect until the 2005 tax year, expect the IRS to zoom in on how you value any donations made under the old rules, too.
Similarly, home office deductions and automobile deductions, among other areas, have been known to raise eyebrows at the IRS because many taxpayers either abuse the rules or simply make mistakes.† By all means you should take these deductions if you are entitled to them; however, it is highly recommended that you document your files to support your position.
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