How do I avoid an audit?

There are many different reasons that you can be audited, but more times than not you will receive that dreadful letter in the mail from the IRS because there was a mistake on your tax return. There’s nothing you can do to prevent yourself from being randomly selected, however there are a number of precautions you can take to reduce the likelihood of being audited.

Make sure your information is correct

The most common reason people are audited is for inconsistent information on their tax return. If you file your return with one income on your return but your W-2 says otherwise, you will most likely be audited.

It is important to double check everything you write on your return. Make sure all of your math is correct, nothing is omitted, and everything is signed. Make sure you sign your return! Many people are guilty of this simple mistake that gives the IRS reason to take a closer look at your return.

Always double check your math. Math errors raise eyebrows, so be certain that your calculations are correct.

It is crucial that the income you claim matches the income reported on documents such as the W-2, 1099, and 1098. Underreporting income is a serious matter that can get you in a lot of trouble. Mistakes happen, just make sure this mistake doesn’t!

To verify that your information is correct, wait until you have all the necessary documents before filing your tax return. Gathering bank statements, income reports, and other financial documents make filing your return a whole lot easier. You’ll have a reference to work from to ensure your information is correct and it will be hard to forget any income with your financial records right in front of you.

Although the IRS has human auditors, most returns are examined by computers that analyze your tax return and search for errors and inconsistencies. It is crucial to double check everything you write on your return. If there is an error, the computer will catch it.

Maintain your records

Keeping financial records for both business and personal expenses can help you prevent an audit. Maintaining accurate books and records assures that your return will be accurate, preventing suspicion from the IRS. In the event that you are audited, keeping meticulous records can also be used as substantiation for any questions the IRS has. Financial records you should track include:

  • At least three years worth of tax returns
  • Checkbook stubs
  • Receipts from all purchases throughout the year
  • Property and taxable investment costs
  • Bills
  • Records of deductible items
  • Receipts and appraisals for any charitable contributions
  • Records of work-related expenses.

Small Businesses

Small business owners and self-employed individuals are some of the most at-risk for audits because they have the most opportunity to under-report income. If you’re a small business owner, it’s crucial that you don’t try to “push the envelope” and see how much income you can get away without reporting. If you really want to avoid the nightmare of an audit, it’s best just to be honest.

Businesses that deal primarily in cash are under more scrutiny from the IRS. Restaurants, bars, salons, taxi services, and other cash/tip based businesses are very likely to be audited because it is much easier to under report income when dealing in only cash. That being said, it is important to be consistent in your accounting method. Switching back and forth between cash and accrual accounting is a red flag to the IRS and will most likely trigger an audit.

One thing that the IRS loves to nail small business owners for is writing off personal expenses as business expenses. While ordering new business cards justifies a business expense, a vacation to Disney World does not. Be smart about what you write off as a business expense, because the IRS will come knocking if you decide that your personal expenses can be deducted. An easy way to keep your business and personal expenses separate is by having a separate account and card for each. It’s recommended to keep a journal of everything you purchase for your business and your reasoning why. Both these methods reduce the likelihood of the IRS auditing your business and will help you in the event of an audit.

Deductions

A simple way to avoid an audit is to make sure your deductions are in check. If you claim an usually high deduction given your income, the IRS will be suspicious. It’s important to know what constitutes a deduction. Gas money for your daily commute to the office does not justify a deduction, whereas a special trip to meet with a client in the next state over would.

Again, do not write off personal expenses as business expenses. If you work from a home office, don’t try to write off the new dishwasher as a business-related deduction.

A general rule of thumb is if you have to spend money on something to help you make money, it can count as a deduction. Don’t get carried away, though. The IRS won’t appreciate it, and you’ll pay for it regardless in the end.

Report your income accurately

Are you currently a small business owner who also does some consulting on the side? If so, be sure to accurately report all of the money you are bringing in across your different income streams.

As tempting as it may seem, never exclude a portion of your income from your tax return. When you do this on accident, it’s called negligence and can have minor but unfavorable penalties in the form of fines plus interest. When you do this on purpose, it’s called tax fraud and there will be harsh consequences such as a $250,000 fine and up to 5 years in prison.

The IRS compares your reported income to information collected from banks and employers to look for any discrepancies. Always make sure that what you report is accurate. Any error, whether by mistake or intention, can have you face fines that should’ve easily been avoided.

Dependents

If you or your spouse can claim dependents, make sure the dependents are only claimed on one tax return. This is a common mistake that can trigger an audit.

File your return electronically

The IRS says that the chances of you making a mistake on your return are dramatically reduced if you file it electronically. The IRS reports that the rate of errors on paper returns is 21%. The error rate for electronically filed returns, however, is only 0.5%. If you’re still filing on paper, it is highly recommended that you make the switch over. Less chances of an error means less chances of an audit.
The most effective thing you can do to avoid an audit is be honest. Lying on your return will never work out for you. As long as you file your tax return accurately, honestly, and on time, you don’t have much to worry about. Should you find yourself under audit regardless, contact the Law Offices of Jef Henninger, Esq., for professional assistance. You don’t have to face the IRS alone, we’re here to assure the best possible outcome for our clients.

Why am I being audited?

You’ve received a letter from the IRS notifying you that your tax return from last year is undergoing an audit and the first question that comes to mind is, “Why me?” Unless you’re intentionally committing a tax crime such as tax evasion or under-reporting your income, you probably won’t know beforehand why you were chosen to be audited. After your tax return has been reviewed by the IRS, there are a variety of different reason the return will be audited.

Auditor Examination

When a return is reviewed individually by an auditor, they may either accept it as filed or pass it on to an examining group if anything on the return raises suspicion. If the manager of the examining group also does not accept the return as filed, the return is given to an auditor for one final examination. At this point either the return will be accepted or the taxpayer will be audited.

Computer Analysis

The majority of audits are chosen by computers that conduct a statistical analysis of tax returns to determine the likelihood of the information on the return to be correct. The IRS uses a couple different computer systems such as the:

  • Discriminant Function System (DIF): This system analyzes a tax return and gives it a score, called the DIF score, based on how accurate it appears to be. The higher the DIF score, the more likely the return is to be audited. The IRS does not disclose the specifics on how this system works, but it is believed that many factors are considered with deductions and exemptions being of most importance.
  • Unreported Income Discriminant Function (UIDIF): This program determines the likelihood for a return to have unreported income based on an expense to income ratio. If the program finds that an individual or firm is spending significantly more money than it makes, unreported income is probably occurring, triggering an audit.
  • Information Returns Processing System (IRP): The third program the IRS uses information gained from third parties that are required to report taxpayer income to the IRS such as employers and banks. If the income listed on your tax return is inconsistent with the data given by the employer, you are likely to be audited.

Related Audits

If the IRS audits a tax return involving transactions with other taxpayers or businesses and that return had questionable items, it is likely that individuals and businesses associated with the suspicious return will be audited.

Random Selection

While this method is not used very often, the IRS does use computer screening and random selection to determine which returns will be audited.

High Income

Your income can determine the likelihood of the IRS auditing you. The more income you make, the more likely you will be audited. IRS statistics state that over half the audits conducted are for taxpayers making over $1 million per year. In fact, even if you make $100,000 per year your chances for being audited are much higher than average. High-income taxpayers claim more deductions and contribute more to charity, leaving more room for error on a return and more reason for the IRS to take a closer look.

Document Matching

The IRS will audit a tax return if the information provided on the return does not match other records. For example, if the income listed on a tax return does not match the income listed on a Form W-2, the return will be audited.
Whether you’ve been audited for inconsistent records, missing documents, or even randomly selected, you shouldn’t try to handle an audit all on your own. The Law Offices of Jef Henninger, Esq. provide professional representation during audits, taking the burden off your shoulders and ensuring the audit settles in your favor.