February 4, 2015
Things to consider when preparing your return to reduce your risk of audit
Audit Red Flags
Some deductions are red flags to the IRS. If you honestly report your deductions and keep supporting documentation you may avoid severe penalties and fines should you encounter an IRS audit. Consider the list below when filing your return.
1. Keep documentation for deductions. Document every deduction and keep that proof for at least three years from your filing date.
2. Use a professional tax preparer or software program that allows you to attach all the paperwork necessary to back up any unusual deductions you choose to claim. Be sure the software you utilize has the capability to include disclosure statements to include explanations for unusual circumstances.
3. Consider incorporating your business (LLC perhaps) rather than using Schedule C and Form 8829. There is a 3% risk for audit. If you incorporate the risk falls to .3% (IRS 2013 Data Book)
a. When and How to Deduct the Home Office. There is debate in Public Accounting about taking a Home Office Deduction. Some experts see it as a red flag to the Internal Revenue Service because it can easily be abused by small business owners. Others confer the deduction is valuable and should be included.
1. Do Not claim a larger home office than you actually have.
2. Do claim if the area is regularly and exclusively dedicated to business use.
a. Take pictures of the area and equipment to retain with your tax records.
4. Do not round off your or estimate deductions. Use exact figures from supporting documents. The norm is 2% of income. In particular, if your charitable contributions exceed 2 percent, collect letters or receipts from charities for both monetary and in-kind donations — especially those over $250. Up to 50% of your reported gross income is allowed by the IRS Code. Deductions exceeding 50 percent of reported gross income are at risk of audit. In any event keep all documentation.
5. Report all your income. If audited and additional money is discovered you may be charged with a felony, tax evasion that can be punishable by five years imprisonment and a $250,000 fine.
6. Keep business and personal accounts separate. Track and document transfers which may be perceived as income.
7. Document every deduction and keep that proof for at least three years from your filing date.
8. Remember your Social Security number, address and signature. If you repeatedly forget these important items your behavior may be viewed as deliberate and may be associated with fraud.
9. Business Expenses. Document names and purpose of meetings associated with receipts. This will give credence to a restaurant receipt to represent dinner with a potential client.
10. Be sure documents match with figures on your tax form. For example, the income you report corresponds with figures in W-2s, 1099s, etc.
11. A high DIF score: Discriminant Inventory Function System is an IRS computer program to assign a score to each individual return. An illustration is, DIF compares your deductions and income with others in the same profession or ZIP code. The further your amounts are outside the averages, the higher your DIF and increase the chance of audit. Make sure your reported income supports your living expenses and other deductions. Keeping your business income and deductions well within the averages for your type of business will reduce your chance of being audited. If they are beyond the ranges have documentation for support.
12. High income: Income under $200,000 a year has a 1 percent of audit. According to 2012 audit information audit risk increases to 2.5 percent for income ranging $200,000 – $1,000,000. Audit risk increases to over 10.8 percent for income exceeding $1 million. (IRS 2013 Data Book)
13. If you are chosen for audit, never schedule the audit to take place in your home or at your business. Most IRS agents are reasonable. However, once an agent is at your site, their tax questions may be unrelated to the tax return that is under scrutiny. Ask for the audit to held at your CPA’s office and ask your Tax Professional to handle the IRS on your behalf. A trained CPA that prepared your return can fully answer any IRS concerns.
Any tax advice expressed in this communication (including any attachments) is not intended to be used, and cannot be used, for the purpose of avoiding penalties imposed on the taxpayer by any governmental taxing authority or agency. In addition, if any such tax advice is made available to any person or party other than the party to whom the advice was originally directed, then such advice, under IRS Circular 230, is to be considered as being delivered to support the promotion or marketing (by a person other than Wilke & Associates LLP) of the transaction or matter discussed or referenced. Thus, each taxpayer should seek specific tax advice based on the taxpayer's particular circumstances from an independent tax advisor.