8 Ways To Avoid An IRS Tax Audit
The key to surviving an IRS or State audit is the reporting of ALL income and the proper substantiation of deductions. It is every taxpayers right to take ALL deductions you are entitled to; however, a deduction without proper substantiation will not survive an audit.
Below are eight ways to help you survive an IRS or State audit:
1: Failing to Report All Taxable Income
This is one of the top audit triggers, failure to report all income.
Solution: If you do not know what should be on your return, get a copy of your IRS Wage & Income transcript. This will help you identify potentially missed items of income.
2: Taking Higher-than-Average Deductions
Taking EVERY deduction is each taxpayers right; however, deductions that are in excess of the norm could get you audited. Especially if they are high in relationship to your income. For example, if you made $47,000 in 2014 and contributed $23,500 to several charitable organizations, you would want to keep very detailed records because you have a high probability of being audited.
Solution: You would want to keep very detailed records because you have a high probability of being audited.
3: Business Losses for Self-Employed or Sole Proprietor Taxpayers
Business losses in the initial couple years of a business are common. If you are still claiming losses in your third year or later, you have significantly increased your chance of being audited.
Solution: In the initial year of the business, develop a business plan that details the projections of the business, in particular, in which year it is projected to be profitable. Include your basis for these projections, especially if the projections are based on a similar businesses or your own prior business. Continually revise your projects based on the progress of your business. This will help to document your profit motive, even if your business losses should exceed the first three years.
4: Be careful with those Self-Employment Deductions
Being in business for yourself provides some significant opportunities for deductions. The IRS knows a fair amount of self-employed individuals may be taking deductions that are not related to their business or are exaggerated.
Solution: Keep excellent records and avoid mixing personal expenses and business deductions. At some point in your business life cycle you may want to look at other business structures.
5: Business Use of Home Deduction
While the business use of home is not the audit red flag it used to be, you certainly want to understand the requirement and make sure you have great substantiations for the deductions.
Solution: Your home office must be exclusively used. Read IRS Publication 587 to ensure you qualify for the home office deduction, according to the IRS.
6: Comparison to others in your industry or profession
The IRS does a pretty good job of keeping statistical information of income based upon industry and profession. If you are significantly outside the norm, you have increased your chance of being audited.
Solution: Have an understanding of how your income compares to that of your industry or profession. If it differs significantly, you should be prepared to answer why yours is either higher or lower than others in your industry or profession.
7: Your income is $200k or higher
It is a fact of life, the more money you make the more likely you are going to being audited by the IRS. The IRS knows people make more mistakes as the volume of their returns increases. The IRS also knows they get a higher payoff when auditing these types of returns.
Solution: Ensure that you report all income and have the substantiation for your deductions. As your income increases, it makes sense to upgrade the experience of your tax professional.
8: If you are in an industry or profession were people get paid in cash
Anytime you are in an industry or profession that gets paid in cash, you are more likely to be audited. In these types of audits, the IRS tends to also look at the lifestyle of the audited. They are verifying that the lifestyle matches the income that is being reported.
Solution: Make sure you are reporting ALL of your income. In an audit the IRS agents tend to ask specific questions that will tell them when someone is hiding their true cash income.
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