It’s tax season. And with that comes the five-letter word that strikes fear into the hearts of taxpayers everywhere: audit.
While the mere idea of an audit is stress-inducing, the percentage of returns audited annually by the IRS is actually quite low, even among high net worth individuals. Though wealthy taxpayers should expect more scrutiny from the IRS due to the diversity of their assets and complexity of their filings, it is a common misconception that wealth alone can make someone a target for an audit.
No matter how wealthy you are, there are some situations and common mistakes that increase your odds of being audited. Keeping the following points in mind can help you steer clear of audits no matter your tax bracket or the complexity of your filings.
- Manually-Prepared Tax Forms
The complexity of the modern tax code and related forms make preparing your tax return by hand a mistake in the making. It’s too easy to skip a deduction or addition simply due to lack of knowledge. And doing all the calculations by hand introduce the chance to make small math error, which could turn into a big problem.
- Spouse and Dependent Misidentification
If you are newly married, be sure to report your name exactly as it appears on your Social Security card. Also, remember that all claimed dependents must be identified by a valid social security number or tax identification number. Fumbling on either of these situations could throw up an audit flag.
The IRS targets unincorporated business filers (Schedule C) for audits because their returns are more complicated and dependent on self-reported income and expenses. If you are self-employed double check all of your math, since careless error may imply that you haven’t been careful with the entire return; keep very good and clear records; get professional help if you’re not using it already.
- Form 1099
There are actually several issues related to Form 1099 that could trigger an audit. First, it’s easy to miss one since you can have any number of payers sending them to you. Additionally, payers have until the end of February to send copies to the IRS, while they must send yours by January 31. If there is an error and the payer sent the incorrect form to the IRS, you need to ensure the box showing it is a corrected form is checked. Do not, however, submit the corrected form, just keep all 1099s with a copy of your tax return.
Failing to report the payer name and income exactly as they appear on the 1099 may suggest to the IRS computers that you have failed to account for all of your income. For similar reasons you should report each item of income separately, rather than combine the amounts reported on different 1099s.
- Questionable Deductions
Claiming a high quantity or large dollar amount of deductions and credits will get the IRS’ attention. Charity and alimony claims spark the greatest interest, but medical expenses can prompt the IRS to more closely examine your return and records too.
- Business Use of Automobile
Understanding how the IRS looks at automobile write offs is key to avoiding extra attention. Reimbursed mileage is never deductible. Neither is the cost of commuting between your home and place of business deductible. There are instances in which mileage can be written off, but to do this you must keep complete, detailed records of your both your business and personal mileage.
- Home Office Deduction
This is another area where understanding the requirements of the law will help to avoid audit red flags. To rightfully claim a home office deduction, the area claimed must be used exclusively as a home office and must function as your principal place of business. If you have another office outside of your home, you probably will not qualify for these deductions.
Recent reports show that only about 1% of filings are actually audited. If you are one of the lucky few selected for an audit, there is no reason to panic, the IRS may just be trying to clear up a discrepancy or wanting more information. To keep a calm mind, stay prepared by keeping careful records and being aware of the things that cause the IRS to look twice.