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February 18, 2013

15 Tips to Avoid an Audit

There’s no reason to pay more tax than is legally required, but there’s also no reason to make yourself a target for an Internal Revenue Service audit or to get your return flagged by the IRS’ computers, which match billions of documents each year. So consider what situations might make you more likely to invite government scrutiny at tax time.

Be super wealthy
This may seem like a “duh” moment, but the IRS finally is increasing the percentage of really rich people it audits, on the reasonable theory there’s a lot more potential to uncover big dollars owed. Generally, the IRS audits only 1 percent of all tax payers, but that percentage rises to 5 percent if you make more than $100,000 annually. The IRS even has special “wealth squads” looking at all their holdings.

Hide offshore accounts
It’s not illegal for U.S. taxpayers to have accounts in Switzerland or Hong Kong or some Caribbean island. It’s only illegal not to declare them or their income. Ask the ex-clients (some now convicts) of Swiss banking giant UBS. If you do have an offshore account, make sure to alert your CPA of this as the penalties can be substantial.

Be a tax protestor
Let’s be blunt. The IRS simply does not like it when you claim you owe no taxes because the income tax is illegal or only applies to weird income categories that don’t apply to you. Such wacky theories landed actor Wesley Snipes in jail.

Claim huge charitable contributions
Rules require complete before-you-file documentation of your gifts to nonprofits. The IRS’ use of correspondence audits, in which it demands you mail in the documents backing various deductions, makes claims of substantial contributions a tempting target. The general rule of thumb is that any charitable contribution total above $5000 will garner IRS attention without the proper documentation.

Omit some reported income
IRS computers are very good at matching all the little pieces of paper you get reporting your income with what you put on your 1040. These papers include employer W-2s and independent contractor, brokerage and bank 1099s. Best practices suggest keeping track of all your documentation using an accordion file

Take a big home-based business loss every year
The IRS presumes that a Schedule C business losing money three years out of five is not necessarily all that legitimate. You might have to produce evidence of a profit motive. Those cases can often be difficult for the taxpayer to prove, so if you do see that your home-based business is not profitable over a 5-year span, it’s best to cut your losses.

Claim a loss on a hobby
By definition, a hobby is not pursued for profit. But that doesn’t stop some taxpayers from trying to write off expenses for their dog showing, comic book trading or other “businesses.” If you are wondering whether your hobby can claim a loss, determine if it is a profit producing hobby/business, and just to be sure, run it by your CPA.

Use a sleazy tax preparer
The IRS’ efforts to regulate all paid tax preparers were just shot down by a federal judge. But that doesn’t stop its ongoing campaign to ferret out and shut down the sleazy ones. When the feds get onto a tax pro playing fast and loose, his or her clients become easy target. Just be aware of how aggressive your tax preparer is, and NO preparer should ever tie their fee into what your return is.

Write off big unreimbursed employee business expenses
They’re only deductible beyond 2% of adjusted gross income. The IRS may use a by-mail audit to ask for back-up paperwork, thinking you are trying to write off ordinary work clothes, commuting costs and other not-allowed items.

Take deductions in round numbers
The world is an uneven place. So if you file a tax return taking deductions ending in lots of zeros, the IRS might think you don’t have the required paper backup. You risk an audit by mail. Our advice: if you’re not sure of the final number, make a best guess, but just don’t make it round.

Make math errors
IRS computers are programmed to check your math. Returns with errors can invite scrutiny that might trigger more IRS requests for back-up information.

Brag a lot
Laws require the IRS to pay minimum rewards for tips in cases that result in big collections. The neighbor overhearing your expansive claims may become a government informant.
Anger an ex-business partner, employee or spouse, and they might blow the whistle on you as well. And it’s possible they won’t do it just for the informant’s bounty.

Make careless mistakes
These can include not signing a return, leaving off your Social Security number or miswriting it. All are red flags. If you have a tax preparer, make sure to double check the cover letter they send just to be safe.

Fail to file on time or at all
The IRS has a special program that will generate a substitute return using W-2 and 1099 paperwork. Don’t expect it to allow your deductions.

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