Tax Time Tips: 6 Ways to Minimize Your Odds of an Audit
The following column from Phoebe Venable, CapWealth Advisors President & COO, appeared in The Tennessean on February 24, 2017.
While tax audits are rare, nobody wants the distinction of experiencing one. Unfortunately, they’re not completely avoidable for any of us. That’s because, among other considerations, the IRS also uses random selection and computer screening — meaning some returns are picked for audit based purely on a statistical formula! But understanding how the IRS selects returns for audit might help you minimize your odds of being chosen.
If your return is selected for an audit, the IRS will notify you by traditional mail. Not by phone, not by email, not by text. Nor will they ever call you to demand payment — if you receive such a call, it’s a scam. The IRS is old-school and advises taxpayers of audits and owed taxes in writing only.
How far back can the IRS go with an audit?
The majority of audits conducted by the IRS are of returns filed within the last two years. The IRS states that they want to audit tax returns as soon as possible after they are filed. If the IRS finds substantial errors, they can go back six years or more, so it’s a good idea to hang on to your returns for the last seven years along with all your documentation.
The IRS will compare your return against “norms” for similar returns. If your return is significantly different from the statistical norms for your area, level of income, household size and other factors, your odds of an audit go up. If you are entitled to a deduction, you should claim it. But be sure to have documentation in case the IRS inquires.
6 ways to minimize your odds of an audit
- Check and double-check your return. Electronic filing will greatly reduce simple mathematical errors on your return because the computer software will add and subtract correctly. Be careful if you are completing your return by hand and be sure to check the math.
- Make sure you include everything. The IRS receives a copy of every Form W-2 and Form 1099 that you receive. If your return doesn’t match their records, you are almost guaranteed to receive a computer-generated audit letter.
- If you are a sole proprietor who files Schedule C detailing the expenses and profits of your business, reporting a net loss for three years or more in a row is likely to result in the IRS questioning the legitimacy of your business.
- Don’t include political contributions as charitable contributions. You may have an eloquent argument for how you’re helping society with donations to your favorite politicians, but the IRS isn’t listening. Political donations are not tax-deductible and the IRS’s computers will catch this, thereby increasing your chance of an audit.
- Make sure you qualify for the deductions you are claiming. Unusual or unrealistic deductions will increase your odds of being selected for an audit. Giving away 40 percent of your income to charity is highly unusual, so be sure you have proper documentation.
- Use a reputable tax preparer. The IRS automatically flags returns prepared by tax preparers who’ve been criminally charged with tax fraud. If your preparer is on the list, you are more likely to be selected for an audit. Additionally, a good tax preparer will provide advice on how to minimize your total tax liability and what you can do differently in future years to lower your tax burden. The money you spend on a tax professional is likely to save you money.
Being selected for an IRS audit doesn’t mean you’ve done something wrong. It simply means the IRS has questions about your return. Fear of an audit shouldn’t keep you from noting legitimate expenses and deductions. Just be sure to keep accurate records and proper documentation. If you aren’t sure what is a legitimate expense or deduction, I suggest you talk to a reputable, professional tax preparer.
Phoebe Venable, chartered financial analyst, is president and COO of CapWealth Advisors, LLC. Her column on women, families and building wealth appears every other Saturday in The Tennessean.