Denver Taxpayer Ways to Avoid an Audit

Congratulations! You have been selected to attend an IRS audit! Although there are a number of “lucky” people selected completely at random by the IRS computer, the majority of returns chosen for review drew attention for specific reasons. So how did this happen and how can you prevent it from happening again? Check your arithmetic. Few audits are generated by mathematical mistakes alone, but too many of these kinds of errors indicate a sloppy return, and that may lead to a full audit.

How do you get picked? An IRS computer program compares your deductions to others in your income bracket and weighs the differences. This formula, called the DIF Score, is used to select returns with the highest probability of generating additional audit revenue. The DIF formula incorporates not only income and deductions, but also your profession, where you live and the size of your family, among other things. For example, a family of five living in the Hamptons on an income of $30,000 would be very unlikely. The IRS will want to know how you do it (wouldn’t we all). A household with a $50,000 salary would rarely have $10,000 in charitable contributions. But if you did, by all means claim it; just be prepared to prove it.

Arrange your finances so they don’t stand out. There are two situations which are likely to invite close scrutinization by the IRS. The self-employed have more opportunity to either “hide” their income or “create” deductions by converting personal expenses into business expenses. Be prepared to substantiate your expenditures as deductible expenses. The IRS also has specific audit programs aimed at specific professions and occupations for those who receive their income in cash. People working in the gaming industry, waiters and bartenders are prime audit targets; the more cash you receive and the higher your income potential, the more likely the IRS is to find additional tax dollars by reviewing your return.

Substantiate. In the audit itself, the IRS will focus on those items where taxpayers have historically failed to keep the required substantiation. Traditionally, auto, travel, meals and entertainment have been the areas most audited. Know the rules for deducting these expenses and keep accurate records. Don’t come to your audit with a shoe box full of scraps of paper and receipts. The more organized and thorough your documentation is, the easier it is for the IRS agent to conclude that you have full substantiation and owe no additional taxes.

Know when to file. It is a good idea to have your return prepared early. If you have a big refund and are unconcerned with audit issues, file early and get your money back. If you have taxes due, and no penalty for underpayment, don’t file until April 15th. Paying a federal tax bill before it is due amounts to an interest-free loan to the government. However, if you are concerned about a potential audit, never file until the last minute. It won’t hurt and can only decrease your chances of being selected.

Plan your taxes to preempt an audit. It is highly recommended that you use pre-audit strategies. If you have a large medical deduction for a year that you feel would increase your chances of being audited, attach copies of your medical bills to your return. Or if you made an unusually large charitable contribution, attach a copy of the check or receipts to your return. The IRS computer will still kick out your return, but when a real person looks at it, the reviewer will recognize that you know the rules.

You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.