It’s bad enough to burn precious personal time filling out a federal tax return, but worse still to worry about inviting an audit.
It’s like Russian roulette — there’s no telling what will happen. Taxpayer A claims a home office without a hitch, Taxpayer B does the same and gets a letter demanding details.
Still, there are ways to minimize the odds of a showdown with the IRS.
“The only way to reduce risk of an audit is to file a legitimate return and have the proper documentation to back it up,” says David Gannaway, a former IRS agent who is a principal at PKF O’Connor Davies, a national accountancy and advisory firm. “Pushing the envelope, or trying to see what you can get away with, can have consequences.”
The good news is that there aren’t many tax law changes for the 2015 return. If you’ve been doing your return the same way each year and have been audit-free, and if your income and deductions haven’t changed very much, you’re likely to be OK.
Also, the IRS budget has become tighter in recent years, so the agency is auditing only those returns that really do raise red flags. Typically, that’s less than 1 percent of individual returns, with only a small fraction of those involving face-to-face meetings with auditors, experts say.
The process usually starts with an IRS letter asking about one or more items in the return. But once the door is open, the agency is free to explore anything it wants, not just those first questions. So the taxpayer is wise to avoid drawing the government’s attention in the first place.
Dumb mistakes. Be sure your Social Security number is correct, and that the numbers you put in the return match what the IRS will see on forms submitted by others, such as financial services firms you do business with. That includes profits and loses on investments you sold and so forth.
And be sure to double-check your arithmetic, says Carol-Jean Higgins, director of tax management services at Summit Financial Corp. in Burlington, Massachusetts.
“Failure to include information on your return which has been reported by others is a problem, but does not necessarily mean there will be an audit,” she said. “W-2s and 1099s will be compared to the returns and, if there is a discrepancy, they will likely point it out and suggest that you change your figures or provide an explanation.”
Honest mistakes. The more elaborate the return, the greater the odds of making an unintentional error, which can involve something as simple as putting a deductible expense in the wrong place. It’s easy to stumble over investment and business losses carried over from previous years, or to put the mortgage interest deduction for a second home in the wrong place if the home is rented out.
Big income. The more you make, the bigger the chances of an audit. That’s partly because your return may be on the complex side, with greater potential for mistakes or fudging.
“Because of budget and restructuring, it’s more important for the IRS to focus on high net worth individuals and businesses with more opportunity to cheat, which will net a bigger return (from the audit),” Gannaway says.
Charitable donations. Taxpayers used to simply estimate the value of items given to charity, an honor system that encouraged tall tales. Now you need a receipt from the recipient organization. If you give the old minivan to a cancer charity, the outfit will send you a statement of the exact amount realized when the car was sold.
Clinging to old habits. A significant change in life — a marriage, divorce, baby, retirement or purchase or sale of a house — can make a big difference in the items you deal with on your return. Even if you’re a savvy taxpayer who avoids the dumb mistakes listed above, you might need extra time to get on top of new issues.
Health care. There are two easy ways to go wrong here. The first involves the Affordable Care Act, or Obamacare. Starting with the 2014 return, taxpayers had to confirm they have health insurance or were exempt, or face a penalty, which for 2015 was raised to 2 percent of income, or $325 per household member up to $925 per household.
“Obviously, not paying this penalty is going to raise red flags, which could ultimately lead to an audit,” says David Hryck, a partner at Reed Smith, a New York law firm.
The second issue concerns medical deductions, which are hard to get right, says Joe Rehm, an enrolled agent at Tax Defense Network, a nationwide company that helps clients resolve tax debts.
“In the unfortunate event that you had major medical bills last year, you’re under 65 years of age, and your total medical expenses exceeded 10 percent of your adjusted gross income, you can begin deducting what you spent,” he says. “However, the probability that all of these conditions were met is statistically low, which is well-known to the IRS.”
Business expenses. Lots of taxpayers have tried to save a buck by attributing personal expenses to a business. A car used for business is deductible, a car driven to the grocery store is not. Unfortunately, all this sleight of hand has drawn the spotlight to this area. Claiming the guest bedroom is a home office is a classic case.
“Remember, the room must be used only for business purposes,” Rehm says. “This means you can’t so much as store personal items there.”
Also, deducting expenses is likely to draw attention if the business racks up losses year after year, experts say.
Even the most honest taxpayer can get something wrong, resulting in a letter from the IRS asking for more information. Professional advice on handling an IRS inquiry is so obvious it shouldn’t need mention, except that so many taxpayers do the wrong thing anyway. Respond by the deadline, even if only to say that you’re gathering the information.
“Do not ignore the audit, as it will not go away,” says Pam Blair, and enrolled agent with Compass Financial Management in San Mateo, California. “If no response is received, the IRS will disallow all deductions under audit and issue a tax assessment, with limited recourse.”
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How to Avoid an IRS Audit originally appeared on usnews.com
