Each year, well over a million taxpayers will typically be selected by the IRS for audit. No one wants to get that dreaded notice in the mail, so let’s look at ten tips that could help you avoid ending up on their annual tax audit list.
1. Know When to File
This may be counter-intuitive, but most tax experts recommend filing an extension and filing on that deadline in October rather than on the normal deadline in April. The reason for this is that the IRS generally selects returns to audit after the majority of them come in, which is earlier in the year. By the time October rolls around, they may have already selected everyone they will audit for that tax year or have very few return audits left to select.
2. Make Sure Your Numbers Match
The most important thing to check is to ensure that the numbers on any forms submitted by your employer or clients line up with those which you submit to the IRS. For instance, if you received 3 1099 forms totaling $18,200 in a year, but you only submit two of them totaling $15,500, you could be flagged by the IRS because they already know about the other income thanks to the corresponding copy of the third 1099 they received from your client. When they see the discrepancy, you could be audited. Of course, in a real business, these numbers might be much larger, but the principle is the same. Check and double-check those numbers!
3. Don’t Leave Blank Spaces
Be sure to fill in absolutely every relevant space on your tax forms, as sometimes just leaving room for assumptions can get you into trouble. You don’t want it to look like you are hiding anything.
4. Avoid Amendments
If you submitted your return months ago, and then submit an amended return with different numbers on it, it may get the attention of the IRS. Even if those numbers are valid, they may be inspected more closely than they otherwise would have been, which gives the IRS another chance to find something they want to audit.
5. Avoid Reporting Repeated or Frequent Yearly Loss
Many people claim excessive deductions for personal ventures with low profits. What can happen in this case is that you might end up reporting more deductions than net income and end up with a net loss. This is ok once in a while, but if you are reporting a loss every year, the IRS may audit your return and decide to declare your business to be a hobby. If this happens, you could lose all your itemized deductions and owe a lot more in taxes. In general, you should avoid reporting a loss for more than two out of five years.
6. Separate Personal and Business Funds
You can help minimize your risk of audit if you use separate bank accounts for your business and personal finances. This way your business expenses will all be sorted for you and easy to categorize correctly. Having things separate can also help prevent you from accidentally deducting a personal expense as a business expense or vice versa. Plus, if you ever get audited, it will be much easier to obtain all the relevant records for the IRS quickly if they are all separate already.
7. Be Diligent About Home Office Deductions
If your home office qualifies for a deduction because you use it for work, feel free to claim the appropriate deduction on your tax return. However, there have been a lot of instances in the past of people claiming home office deductions when they did not, in fact, have a space that qualified for it. A qualified home office is generally considered a dedicated space for conducting business. This space should be a separate room, not merely a desk in another room such as a living room or study. One major thing that could red flag your home office expense deduction is if you claim too much in maintenance or utility costs relative to what is expected. You can also get in trouble if the IRS finds out that you are claiming a home office expense but also rent dedicated office space somewhere outside the home.
8. Watch the Ratio of Independent Contractors to Employees.
If you are running a business and claim too many independent contractors relative to the number of employees you have, you could potentially get red flagged for trying to evade payroll taxes. This practice has become very common in recent years, so there are a lot of businesses out there for the IRS to potentially audit. You just want to make sure yours doesn’t end up on the list, so be sure to read through the IRS guidelines on who qualifies as an independent contractor and who needs to be considered an employee. If in doubt, you can consult a small business tax lawyer or accountant to see what to do in your specific situation.
9. Pay Estimated Quarterly Taxes
If you are running a small business and don’t make a habit of paying your estimated quarterly taxes, you could potentially be flagged if you owe more than $500 at the end of the year. Failing to make these payments could potentially cause you to incur penalties as well.
10. Consider Incorporating
If you currently file your business taxes independently as an individual, consider forming an LLC or other small corporation for your business. By doing this, you could potentially reduce your risk of an audit while simultaneously becoming eligible for many more business expense deductions. It’s a win-win.
As long as you maintain accurate records and are honest on your tax returns, you generally don’t need to be live in fear of being audited. If it happens, you’ll be prepared. With these tips, you may be able to reduce your chances of being audited in the first place.