Many people stress about the possibility of an audit from the Internal Revenue Service. If you follow some common sense principles you should be able to limit the possibility of being called upon by these agents of good will and sympathy (LOL). Although the I.R.S. can audit you for up to three years after you file a return, most occur within eighteen months. My father was audited three years in a row. Often when you’ve been audited, the I.R.S. likes to make a come back the following year. Let’s take a look at some strategies to limit this occurrence. See also Debt Prison related article: Can you go to jail for not paying your taxes?
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Understand that the I.R.S. audits certain groups more than others. For example, if you have just straight income documented on a W-2, with no investments, contributions, or strange deductions, then you aren’t likely to be audited. We’ll call this group number 1. It’s true that the I.R.S. computer system will randomly flag a very small number of people within group number 1 to be audited – even if everything looks legitimate and the tax form is flawless.
Group 2 would be lower income wage earners who receive a percentage of their income in tips, such as a waitress or pizza delivery person. These workers are more carefully scrutinized because of the ease with which one can omit cash earnings from their 1040. The I.R.S. has calculated a range of what these wage earners’ cash tips should be. If the amount you claim in cash tips varies wildly from what is expected, you may have just bought yourself a dinner date with big brother. I recall a story from a co-worker whose friend worked at Pizza Hut where he earned cash tips as a waiter. At the time minimum wage for waiters was just over $2/hour. This particular guy failed to claim any tips on his tax form. His tax return was flagged, he was audited, and he ended up having to pay thousands. And to think this kid was only 19 years old at the time. The I.R.S. isn’t big on auditing the lower class because there’s more money to be made from the rich. But they’ll still shake down enough low wage earners to keep the masses intimidated.
Group number 3 would be the self employed. Many self employed business owners will try and write off household expenses as a business expense. Also, the self employed may fail to report cash transactions and instead simply pocket the money. There are so many ways that a self employed worker can beat the I.R.S., it’s no surprise they fight back.
The wealthy or high income earners are group number 4. In 2007 the I.R.S. audited one in every eleven citizens with income over one million dollars. Compare that to the number of audits performed if your income is $100,000 or less; chances are one in a hundred that you’ll be making coffee for an Internal Revenue Agent. However, as a whole these Agents are auditing about one in every hundred Americans who file a tax return.
Focus on honesty
Whether you think the Federal Income Tax is unconstitutional, unfair, or even immoral, you’ll be less concerned about an audit if you attempt to be honest. This means reporting all of your income accurately. If you’re honest about what you report, then the idea of an audit will seem less worrisome. I knew a person once who received wages in the form of cash. The contractor (who was self employed) could save on paperwork and employment related taxes by paying some employees in cash. Because he was paid in cash this worker had a very small amount of income from a previous job reported on his tax return. What this person failed to realize is that the cash he received should not have been deposited in the bank into his checking account. If audited the first question an I.R.S. agent is going to ask is “Where did this money for the deposits come from?” And if you rat on your boss then the I.R.S. will move over and audit him too. If we try and play by the rules we are less likely to get burned.
Maintain a paper trail
Any deductions that you plan on reporting should be backed up with paper. This would mean receipts, bills, or even charitable donations. Anything that will have an effect on the way you fill out your tax return should be organized by category and filed. If you can’t prove that you deserve a deduction by producing a receipt…..then don’t claim the deduction. During an audit, having all your receipts organized and on hand, will make the I.R.S. agent realize that you are prepared. Remember an audit doesn’t work like court. The burden of proof is not on the State, it’s on you.
My father was audited because he claimed his sister as a dependent. At the time both my fathers’ parents were unemployed and my father, who was in his early twenties, was bringing home the bacon. During the audit it was discovered that he lacked $25.00 in receipts to lawfully claim his sister as a dependent. Therefore my father was audited the next two years as well.
If you are claiming something that could be seen as unusual, send a copy of it with your tax return. For example, if you are claiming $13,000 in medical expenses, make a copy of the bills, attach it to the tax return, and mail them in. This could prevent an audit. Likewise, if you made large charitable donations, attach a copy of the receipt to your return. This can only reduce your chances of an audit.
Use online tax software
Using an online tax service like Turbotax will help reduce your chances of a mistake. For example, this year I filled out a 1040 EZ to get a quick idea of how much tax I owed. Later on I actually filed using the free online edition of Turbotax and discovered I owed much less than I thought. It seems I forgot to subtract the standard deduction from my adjusted gross income when I was quickly filling the form out, causing my tax liability to be higher. Online tax services also allow you to file your tax return with the I.R.S. online for free. Your refund will be deposited into your bank account electronically if you’d like. But most importantly is the fact that Turbotax incorporates a wealth of tax knowledge into their tax software. If there is a problem with your return, the software will likely catch it.
In the comments section below, a reader mentioned using Vulocity to log business mileage. I looked into it and Vulocity is a mileage logger which uses GPS technology to log your mileage for you. From their website it states “Simply plug the device into the car lighter adapter and place it in a cup holder, center console or sun visor and forget about it when you’re driving around for business. Let the power and accuracy of GPS technology do all of the writing for you. The device receives GPS signals and transmits your mileage data wirelessly over the cellular network to you. Access all of your records online, any time.” It costs $249 and that doesn’t cover the $14.95 to $19.95 monthly fee for the logger and tracking service. Since I despise wasting money I would do some research before buying. If possible, try and find someone who has already purchased it and ask their opinion.
Filing late
This is a concept I’ve been reading a lot about lately. There’s a consensus among some tax professionals that filing at the last possible moment (April 15th), or even filing an extension, will reduce your chances of an audit. They claim that by April the majority of audit victims have already been selected. I’ve read other sources that say the opposite, that filing an extension could actually trigger an audit. If you’re planning on filing at the last possible minute don’t wait till April 15th to file using an online service like Turbotax. The internet traffic can be so impressive that in overwhelms the servers that host the website. Why don’t we play it safe and shoot for April 13th? Sounds good to me too.
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