How to Avoid a Tax Audit

Posted by Home Morgage | Personal Finance | Monday 25 January 2010 10:18 am

The tax man cometh… Tax season is well underway. I know, I’ve already called my tax professional to set up a time for me to come in and have a little chat about how things are going, taxwise. And, of course, to fill out my tax return. For many, this time of year also means increased worries about the possibility of an audit. While random chance plays its role in tax audits (sometimes there is just no way to avoid some sort of an audit — no matter what you do), there are some red flags that may prompt a closer review of your paperwork.

Photo by blmurch via Flickr

Here are some tips for avoiding a tax audit:

Make less than $100,000 a year

Because people making more than $100,000 a year account for more than 60% of the taxes paid in this country, the IRS is very interested in looking for tax avoiders in this category. As a result, if you make six figures, you are automatically in the running for a tax audit. Of course, the risk of being audited is no reason to avoid making more money; you just need to be careful about your documentation so that you are properly prepared in the event of a tax audit.

Don’t go overboard with itemized deductions

Itemized deductions can be quite helpful in lowering your taxable income and saving you some money. However, it is important not to go overboard. Manny Davis at Back Taxes Help points out that the average total deductions vary according to income. He points out that for those making between $30,000 and $50,000 in gross income each year, the average total of itemized deductions is right around $20,000. For those making between $50,000 and $100,000, the total was around $24,600; and for those making between $100k and $200K, the total amount of deductions is $36,500. If your itemized deductions exceed these amounts, you might be flagged. Keep records of your deductions, including receipts for charitable donations.

Be careful about home office deductions

You can take home office deductions when you telecommute or have a home business. However, it is important to be scrupulous about the sorts of expenses you count, since anything you use for something other than business won’t be allowed. Home office deductions, especially if they are large and numerous, may raise red flags, although just taking them no longer marks you out, since technology has given rise to millions of home businesses and telecommuters.

Don’t fill out your tax return by hand

I’m guilty of this. For years, before I began going to an accountant, I filled out my tax return by hand. I even added in business expenses for what was then a sole proprietorship. Apparently, I should feel very lucky that I wasn’t audited. Tax returns filled out by hand raise red flags about accuracy, and can cause legibility problems. You don’t have to go to the accountant to avoid a handwritten return, though. The IRS has forms you can fill out online, and you can use software that fills out your tax return.

Make sure all income is reported in the proper places

When I first switched to an Limited Liability Company (LLC), my accountant had all sorts of trouble with this. Some of my clients didn’t get the memo that I had a new tax identification number. As a result, all of the income on 1099 forms that showed my Social Security Number still had to be reported on the Schedule C, rather than with the income under my Employer Identification Number.

The IRS matches up what others report on your income with how much your report, so you want to double check to make sure that everything is in the right place. This goes for your spouse’s income (if necessary), income from hobbies and other types of income. And, if you know that you will be receiving a corrected W-2 or a 1099, wait until that comes in before completing your return.

Making sure that your tax return is filled out properly is your responsibility, as is making sure you have all of the proper documentation to back up your claims. While there is no full-proof way to avoid a tax audit, you can significantly reduce your chances of being red-flagged if you are careful about how your tax return is completed, from reporting your income to claiming investment losses.

Tags: Accounting, back taxes, red flags, tax audit, 100k, IRS, gross income, Income Tax, avoid tax audit, random chance