Tips to Reduce Your Chances of an IRS Audit

The IRS audits more than 50,000 businesses and 1,250,000 individual taxpayers each year, mainly via correspondence exams. Although no one can guarantee you will never be audited, you can lower your chances of being selected for an audit by following a few straightforward strategies.

Tip 1: Check Your Arithmetic

Double check your calculations for all the numbers on your tax return to ensure they are correct. IRS computers review the income and deductions on returns for accuracy and if yours has several miscalculations your return could be flagged for an audit.

Tip 2: Don't Overstate Your Deductions

Make sure you have supporting documents to prove every deduction on your return. Your deductions are evaluated relative to other taxpayers in your income bracket by IRS computers. This is done to spot taxpayers claiming relatively high deductions, such as $25,000 in charitable contributions by a taxpayer with an adjusted gross income of $75,000.

Tip 3: Don't Mix Business With Pleasure

Self-employed taxpayers are commonly audited by the IRS. If you are self-employed, keep mileage logs for the business use of your vehicle (list the date, location, purpose of your trip, and miles driven) and retain all receipts for meals and entertainment (on the back of the receipt write down the names of the people you entertained, their business relationship to you and the business matters you went over). Also, if you are a claiming a home office deduction, include only the amount of space you are using strictly as your office. The IRS does occasionally visit taxpayers to evaluate the accuracy of the percentage used to claim home office deductions.

Tip 4: Don't Understate Your Earnings

Taxpayers in occupations that receive a substantial portion of their earnings in cash, such as waiters and small shop owners, or service-oriented professionals like lawyers, are also more likely to be scrutinized by the IRS. This is especially true if you are behind in filing and paying your taxes and if the IRS discovered that you failed to report income in the past. Be careful to not understate your earnings because depending on your profession, your clients may be deducting amounts paid to you on their tax returns. For example, the IRS may find out a lawyer understated income because a business deducted professional fees paid to that lawyer on its tax return but the lawyer never reported that income.

Tip 5: Keep All Your Supporting Documents

You may think you are in business but the IRS could have a different opinion if you are not making profits for several years. This is because people will rarely stay in a business that is not financially successful, unless of course they are in it for a hobby. While it is common for new sole-proprietors and startup companies to be unprofitable during the first few years in business, if you are consistently losing money, the IRS may want to evaluate your deductions more closely. You should have no problem proving that you are not in it for a hobby if you always maintain the best possible records to support your expenses.

Tip 6: Know the Difference Between Employees and Independent Contractors

If you run a business, make sure that the people who work for you are properly classified as either employees or independent contractors. Companies with a lot of contractors and few or no employees are more likely to be audited because the IRS will want to verify that these companies are not evading payroll taxes.

Tip 7: Attach Explanation Statements

Answer all questions on your tax return and attach statements to explain items on your return that may look suspicious to the IRS. For example, if you had $100,000 in business income during the tax year and deduct $75,000 for business travel, by attaching an explanation statement to your return you will reduce your chances of a full audit because the IRS will see that you have a basis for the deduction.

Final Notes

Keep in mind that if you are selected for an audit, you will be required to provide the IRS with supporting documents of all business deductions taken, such as travel, meals and entertainment expenses, to prove that they were a necessary cost for your business. The more organized you are, the better your chances of the IRS agent assigned to your case concluding that you do not owe additional taxes.

Keep all your receipts and supporting documentation for at least three years after you file your return because the IRS can audit you anytime during this time frame. However, if the IRS suspects you of fraud there is no time limit for which you can be subjected to an audit.

About the author:

Jovana Jerinic is a Certified Public Accountant that provides accounting and tax services to individuals and small businesses, including tax return preparation, tax planning and IRS audit representation. Please visit Orange County CPA for more information.