During the past decade, the IRS has gotten more business-like about the taxpayers they select to audit. Like all smart businesses, the IRS wants to turn a profit these days. Currently, tax returns are selected for audit based on the chance that the IRS will find enough errors or missing income to generate additional taxes – and perhaps penalty and interest.
How can you avoid being caught in the IRS net?
When you file your tax return this year, here are some things you can do to make yourself less of an audit target:
1) Review all the dependents and taxpayers on your tax return. Make sure that names and Social Security numbers match. Verify dates of birth – they are important for a variety of tax credits. Most importantly, do not claim dependents that someone else is legitimately claiming on their tax return. IRS will initiate a correspondence audit – and when you lose, it may cost you more than just this year’s taxes, penalty and interest. You may lose the right to future tax credits related to those dependents.
2) Make sure you report all the income that the IRS knows about. The IRS computer will be matching all the W-2s, 1099s and K-1s with your Social Security number on them. If you moved or don’t believe you have them all, contact your employers or clients to get copies of the ones they sent to your old address. Or, have your enrolled agent put your tax return on extension. They can request copies from the IRS after tax season.
3) Be sure to report the rest of your income. A major purpose of IRS audits is to find unreported income. When you receive a substantial part of your earnings in cash, or without paperwork, that doesn’t mean you’re off the hook. The IRS computers look at certain aspects of your lifestyle and will tag you for audit if your visible income is much too low to match your ZIP code or family size.
4) When you claim mortgage interest deductions for loans that have not issued to you a Form 1098, be sure to fill in all the information related to the private lender – name, address and taxpayer ID number. The IRS computer automatically cross-references this information and sends notices disallowing the mortgage interest when there is no match.
5) Be sure to fill in the information about your (and your spouse’s) occupation with a description that’s specific to your main income source. Believe it or not, when filled in correctly, that helps the IRS computer eliminate you from audit.
6) When there is something unusual about your tax situation that needs additional explanation – explain. You can do this by filing a paper tax return and including a statement or attachments to clarify your unusual circumstances. Not only can a good explanation help you avoid an audit this year, it can limit your audit exposure to three years instead of six.