Your Survival Guide to the Dreaded Tax Audit
Taxes are challenging and tax season is stressful even for those of us that are fully prepared to file our taxes. I do not know about you, but every time I file my taxes, I have an uneasy feeling about a tax audit. For the record, I do everything I am supposed to when it comes to filing my taxes, but I still have the slightest feeling of dread.
I feel like I always owe money to IRS no matter how hard I try to get my taxes to break even. It never seems to work out for me. I know there are red flags that cause the IRS to look twice at a tax return. If you can avoid these items in your taxes and follow the rules, you should never have to face an audit.
What Are Taxes?
Before you can fully understand when you face a tax audit, you have to have a good understanding of personal income tax. First, you should understand that taxes are charges enforced by the government on individuals and businesses. Taxes can be charged on top of money you spend on activities, privilege and income.
Taxes are used by the government for various items such as defense, schools, highways, and roads. You are required by law to pay taxes. If you do not pay your taxes, you can be fined or jailed. You want to make sure you are always paying your taxes.
Income tax is a tax that is charged to you based on the money you earn. Your total income puts you in a certain tax bracket. That tax bracket dictates the percentage of tax that you pay. Those who make the most money are subject to the highest taxes. Your employer withholds money from each paycheck to pay your federal taxes.
What is a Tax Return?
You must file a tax return so the IRS can determine if you have paid the right amount of taxes throughout the year. If you have not paid enough taxes throughout the year, you will owe money when you file your taxes.
If you have paid too much in taxes throughout the year, you will get a tax refund. If you are one of the lucky few that manage to figure out what you owe, then you will break even and not owe IRS anything, nor will you receive a tax refund.
If you feel like filing taxes is not in your wheelhouse and you might mess it up, there are many tax preparation services available to you. You can also download one of the various software products that will walk you through filing your taxes step by step.
What Is an Audit?
A tax audit is when IRS wants to look more closely at the tax return you filed. They want to ensure that the income and deductions you reported are correct. Usually, there is something in your tax return that attracts the attention of the IRS and causes an audit. I will discuss some of the items that cause a huge red flag for the IRS a little later in this article.
An audit comes in one of three forms. It can be a mail audit, an office audit, or a field audit.
Mail Audit
It is the easiest of all the audits and you do not have to meet in person with the auditor. Usually, in this case, the IRS wants more documentation to prove what you have reported on your tax return. For example, if you claim a certain amount in contributions to charity, then the IRS may want proof of what you donated. As long as you can provide proof, the IRS usually ends the audit there.
Office Audit
This is when you have to appear in person at an IRS office. In this case, you will have to answer questions from an auditor. You may also have to bring specific proof to your interview. You are notified of what you should bring to the audit via a notice. You can bring a lawyer or accountant with you to the meeting.
Field Audit
Lastly, a field office is when the auditor comes to your home or business. This type of audit usually covers just about every part of your tax return. This is an in-depth interview and you should expect to answer a lot of questions.
Now, let’s start with the advice on how to avoid tax audit:
Too Much Or Too Little Income
One of the best ways to avoid a tax audit is to make sure you report all of your income properly. When you work for an employer, they withhold taxes from each paycheck. You determine how much they withhold, so you could end up withholding too little.
Stick to the W2
Your employer sends you a W2 in the beginning of the next calendar year. This document shows how much you earned from that employer and what they withheld. They also send a copy of that W2 to IRS, so you should not report this number incorrectly. If you do not put the correct information in your tax return, you will get a bill for the earnings you did not report.
Special Attention on the High-Earners
IRS tends to focus more attention on the highest earners. They know that if they catch someone making millions of dollars making a mistake or withholding information, the mistake is worth more money than someone earning much lower. If you make a substantial amount of money, make sure that all of the information you are reporting is correct. IRS will be looking much more closely at your tax return.
Special Attention on the Ones Who Report $0 Gross Income
The attention of the IRS is focused on those who are high-earners, but they also focus their attention on those who report no or little earnings. If you are a high school or college student, it is likely that you have limited earnings. That is ok. However, if you are employed and reporting a gross income of $0, the IRS is going to pay a little more attention to your tax return.
Just be sure that whatever you are reporting on your tax return is accurate and legitimate and you have the proof to back it.
Improper Deductions
A tax deduction is a way that you can reduce the amount of taxable income that you have. It may also lower the tax bracket in which you reside. There is a list of acceptable items that can be used as a tax deduction. There are a number of ways that misusing deductions can set you up for a tax audit.
Don’t Duplicate Your Expenses
The first step you should take is to make sure that you are not duplicating your expenses. This can happen when you deduct the same amount for employee expenses and business expenses. These are two different types of expenses and placed in different places on the tax return and it is easy to duplicate this expense in these two places. However, they are two different items and you should not use the same expenses in those two places.
This tends to happen more to those who prepare their own taxes. When you have a professional file your taxes, this is not a mistake they often make.
Special Rules for Charitable Contributions
Another deduction that will get the attention of the IRS is charitable contributions. There are strict rules on the documentation that is required for you to count something as a charitable donation. Make sure you review them and provide all documentation. The typical household with earnings between $100,000 and $200,000 claims deductions around $4,000. If your deductions are over that, IRS is going to pay attention and there may be an audit.
You must remember that the IRS has been around for a long time and they know what an average deduction and expense look like. Anything that seems outside of the ordinary will be a red flag for the IRS.
Inflated Expenses (Rental Property)
When it comes to rental property, expenses get a little tricky.
Hiring a Professional Can Help
Truthfully, if you are new to rental property and filing taxes with them and you want to avoid a tax audit, you should have a professional handle your taxes this year. Ask questions and get all your questions answered so you know what to do in the future. The thing that tends to get rental property owners is knowing what expenses are deductible and which ones need to be capitalized.
Getting this wrong will means a possible audit. The best and easiest thing for you to do is to hire a professional to handle your taxes for you.
There are areas of gray for sure when it comes to these types of deductions. An expense for a repair can be deducted in full. However, an improvement has to be capitalized over a period of 27. 5 years. If you use the rule of a repair, you can deduct in full but if it is any type of renovation, large or small, it should be capitalized. If you are not sure, this is an area where you want to get the help of a professional, at least for your first year filing as a new rental property owner.
Improper Reporting Of Dependents
Another way you may cause a tax audit for yourself is to incorrectly claim dependents. This often happens when there is a divorced couple and both people try to claim the same child as a dependent. The IRS does not like this and they will audit you. You should talk to the other parent of your child or children and confirm which of you is filing which children as dependents.
This also can happen when you have a child that is over the age of 18 but still living at home. If that child is working and decides to file their own tax return, but you have already filed with this same child as a dependent, the IRS does not like it at all. Make sure you know what your child over the age of 18 is doing when it comes to filing taxes. This will also cause IRS to perform an audit. Sometimes when you file as head of the household it causes the IRS to look a little closer at your tax return.
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Business Vehicle Misuse
If you claim a vehicle that you own as used 100 percent as a business vehicle, it may cause you to have a tax audit. It is really rare for someone to use a vehicle only for business. Even when you do have a vehicle that is used for a business, you may still use that vehicle to take your kids to school or stopping at the grocery store for dinner. These are all personal business and if you use your vehicle for any of those personal purposes, then you are not using the vehicle for business only.
Don’t Say that Business Use Is 100%
Be careful when you make this claim. If you make this claim, the IRS is going to pay attention and you may find yourself in an audit. If you are going to claim that you are using your vehicle for business only, you should keep detailed and complete logs of every mile on your vehicle and how it was used for business purposes only. Do yourself a favor and do not say the vehicle is 100 percent for your business.
What Happens If I Am Audited?
You got a notice about a tax audit, so what do you do now? First, stay calm and read the notice carefully to find out exactly what the IRS wants. Most often, this is a mail audit and IRS wants some documentation. Make sure you find out exactly what documents they want, get them together and send them timely.
Do not delay and make sure you get the documents to the IRS by the time they want them. If you miss a deadline, you will have to pay a fine. IRS does not mess around with the deadlines that they give you. When you are in your audit, you should keep your mouth shut as much as possible. This is a time of high anxiety and nervousness and people tend to talk in those situations. Do not be one of those people.
When you ramble in a stressful situation, you are more likely to say something that may dig you a deeper hole. Only answer the questions you are asked and do not say any more than you have to. The auditor is paying attention to the things you are saying, even if they do not seem to be. Remember, the auditor is not your friend. They are there to do a job and follow the law.
Do I Need a Lawyer For an Audit?
You do not need to take a professional CPA with you when you are in the middle of a tax audit, but you can. It may be a good idea for you to do so. A tax professional can represent you in your audit. A professional that is experienced with audits is a good choice to represent you. You can even give your CPA power of attorney so they can appear for you and you may not even have to be in the audit.
A CPA knows the tax rules and laws and knows when you are within the law. They can recognize when the IRS is fishing around to see what you may have reported incorrectly and they can stop the fishing without saying too much.
IRS is known to be intimidating during an audit. Make sure that all your documents and receipts and are organized and in order so that when you need to provide some type of proof you have it available to you.
Conclusion
So, you are concerned you might have to face a tax audit. I have given you a lot of information about all the ways to avoid a tax audit. You should make sure that everything you report, including all expenses and deductions, is correct and accurate. You should also have documentation to back up your allegation, just in case you need it.
If something went wrong during the filing of your taxes and you put an incorrect number somewhere, and you are facing an audit, you need to remain calm. Provide all of the documentation you have to the auditor and correct anything that you believe may have been an error. If you doubt your ability to file your tax return because you have a complicated situation, then you should have a tax professional file your taxes for you.