First and foremost, there is no surefire way to avoid a tax audit. If anyone tells you otherwise, they are probably trying to sell you something, and it’s probably shoddy tax preparation services. Each year the Internal Revenue Service audits — or, as it puts it, examines — approximately 1 percent of all tax returns filed, and the selection criteria are fuzzy at best. The IRS audits people from every income bracket, including those who report no income, for any of a thousand different reasons, including “just ’cause.”
As bad a reputation as audits have, it doesn’t necessarily mean there is something wrong or malicious about the return. “In fact, some examinations result in a refund to the taxpayer or acceptance of the return without change,” comments the IRS in an overview of the process. The picture painted makes the IRS look something like the Transportation Security Administration, auditing tax returns the same way the TSA runs security at airports. If something is obviously wrong, you will probably attract the attention of an auditor. If something is a little wrong, you may be asked to fix it and resubmit. If nothing is wrong, well, there’s still a chance you’ll have a federal agent looking through your stuff.
But even if there’s always a small chance you could get audited, there are still ways to reduce your risk, just like you can hedge against a headache at the airport by making sure you leave your pocket knife at home. Here are a few tips.
1) Be honest
Honesty is a pretty good policy in general, but the last person you want to catch you lying is an IRS agent. Pretty much the best thing you can expect is a financial penalty, but if you press your luck there’s no ruling out criminal penalties.
Lying in this case also means the intentional withholding of information. Not reporting all of your income to the IRS is about as classic a tax offense as you can get. If you fail to report all your income and the IRS catches you, expect to pay back taxes and some penalties at minimum. Remember that the government gets a copy of every 1099 and W-2 you receive, so if you get one, make sure to report it. It’s pretty easy for a computer to catch a discrepancy on the magnitude of “this entire document is missing.”
A common area where otherwise upstanding citizens are sometimes tempted to lie is when they lose money through a hobby, and try to pass off the losses as business losses. Sometimes it can be hard to distinguish between a hobby and a start-up, and sometimes a hobby turns into a business. This ambiguity or the transition from one to the other can encourage fudging. If you’re on the fence, consult a professional.
2) Be careful with deductions
It’s not everyday someone will tell you that donating to charity can be dangerous, but if you’re worried about an audit you need to make sure a little forethought goes into your charitable contributions. The IRS is nothing if not a massive number-crunching machine, and you can be sure that they know what the average charitable contribution is for someone in your income bracket. If you donate way more money than the IRS expects or give away an outsized amount of your income and claim the donations as deductions, you increase the risk of an audit. This is not to say that you shouldn’t donate, it’s just a heads up.
Non-charitable deductions can also raise some red flags. If you’re self-employed, you’re probably familiar with Schedule C — if you work for a tax preparation or the IRS, then you know that self-employed people are sometimes over enthusiastic in their approach to Schedule C. A fairly good rule of thumb is that if you had to spend money to make money, the money you spent may qualify as a deduction. Don’t abuse the rule, though. Taking every client you court out to a five-star restaurant and raking up thousands in business meal deductions is a good way to pique the curiosity of an IRS agent.
As always, make sure to keep good records of everything you plan to deduct. If you do get audited, your deductions can vanish if there is no proof to back them up.
3) File online
Filing your tax return online has a lot of advantages. For one, software can remove a lot of the tedium of paperwork through the magic of digital automation and save you a bunch of time. Americans already dedicate an average of 24 hours per year to tax preparation, which is altogether way too much time.
Another advantage is that the computer is much less likely to make a basic transcription or mathematical error than you are (no offense). Miscellaneous factual errors like this will most likely get picked up by the IRS and raise some red flags. If you’re lucky, and the error is small enough, an endeavoring government employee can fix the issue without even involving you. If not, your sloppy arithmetic may end up causing you a headache down the line.
Most tax software will warn you if there are glaring errors with your return and guide you through a remedy. Because of this and several other benefits of e-filing, the IRS actually recommends it over paper filing.