How to avoid an IRS audit of your taxes
There's nothing like the prospect of an audit by the Internal Revenue Service to add even more anxiety to doing your taxes.
First, know that the chance of an IRS audit is low. About 6% of taxpayers in a given year will receive a letter from the IRS regarding a recent tax return. And while it's impossible to fully inoculate yourself — since a portion of audits are truly random — there are steps you can take to minimize getting that dreaded letter from the government.
Keep your records straight
The majority of IRS letters deal with errors or mismatches, such as when you forget to report some income that the government finds out about.
"You're required to report income from whatever source you get it from, unless there's a specific exemption," said Martin Davidoff, national managing partner at accounting firm Prager Metis. "The highest volume of issues I see is failure to report income that gets reported to the IRS."
For instance, someone may have forgotten to report a profitable stock sale. Or they may have picked up a few gigs on TaskRabbit or Craigslist and forgotten about that income by the time tax seasons rolls around.
Ask for a transcript
If you're not sure you know 100% of the income you made, you can check whether your information aligns with the IRS by requesting what's called a wage and income transcript. This reveals the information the IRS has on any type of income you received. You can request it going back 10 years.
"If you have a cell phone in your name, you can get it instantaneously online. Otherwise you can call the IRS and they can read you the info, or have them mail it to you, and you can get it in a week or two," Davidoff said.
Vet your tax preparer
About half of Americans this year will do their returns using a tax professional. Many people imagine that using a pro inoculates you from IRS scrutiny. But if you're not careful, paying someone to do your taxes can actually get you into more trouble than doing it yourself.
"If somebody is saying, 'I can get you the biggest refund compared to so-and-so,' that's not a measure of whether they're qualified or not," said Nina Olson, founder of the Taxpayer Rights Center and the former National Taxpayer Advocate.
"There are… a whole batch of preparers out there, and all they know is that they've got a software program and they plug in information to the software program," Olson said. "They don't know the law."
To be safe, check that your preparer has registered with the IRS and exists in its directory. Also, understand that different levels of certification exist for tax professionals. Some levels may be able to do your taxes but not represent you to the IRS in case of an audit. If that's a concern for you, make sure your preparer is an attorney, enrolled agent or a CPA. Those are the only three types of certifications that can represent you before the IRS.
Double-check advice
Even paid tax pros make mistakes, so if you hear something that sounds suspicious — or like a suspiciously good deal — it's worth checking it with the IRS. The tax collector has an extensive directory of tax tips and questions. You can also call to get your questions answered. While the IRS is known for long phone wait times, especially during tax season, your money is worth getting it right.
Be wary of high writeoffs and round numbers
One common flag for the IRS is when people estimate how much they spent or received, and round the number, instead of reporting the exact amount. While "a certain amount of rounding is acceptable," Accounting Today writes, it's better to round to the nearest 10 or 100, and using the exact number is always your best bet.
High expenses for travel and entertainment on a business return are another such flag. The IRS "knows what the industry average may be," Olson said. "And their formulas look at outliers."
That goes for other business deductions as well. Davidoff recalls a client who came in with "zero income, $63,000 in expenses for a business, and they sold two widgets. You see that, and, of course you're going to get audited," he said.
Now, there are some businesses that could legitimately be in that situation, he added. If that's your case, just make sure you keep records explaining your situation — so you can make your case if the IRS comes calling.
The IRS typically has a three-year time limit to audit your returns. In cases where you've substantially underpaid your taxes, the limit goes up to six years. Tax pros usually recommend you keep tax records for four years, to stay clear of the three-year limit.