Sunday, 25 March 2012

How to know if an IRS audit is round the corner?

With ever improving improved detection systems and computerized checks, the IRS can more easily identify red flags that trigger audits.
Contact typically starts with a letter requesting more information and can lead to in-person meetings. It is usually triggered by a tax return that contains something unusual, such as an above-average deduction or change in income from previous years. As long as the taxpayer can defend his filings with the proper paperwork and logic, he has nothing to worry about--other than the time it takes to respond.
Here are a few of the signs you need to take note of:
1. Earning a lot less money last year.
The IRS looks out for any major changes in income, which can signify that a taxpayer is under-reporting his earnings. As the IRS tracks historic data, people who suddenly start reporting much less income can be flagged for an audit.
2. High incomes.
According to IRS 2010 enforcement results, your chance of being audited triples once your income crosses $200,000.
3. Over-sized medical expenses.
Medical expenses - You only can deduct these costs to the extent they're greater than 7.5 percent of your adjusted gross income, and it's important to have detailed records.
Any higher-than-average deduction in any category will send out a signal to the IRS that all is not right.
4. You work for yourself. 
It might not seem fair, but being self-employed can raise red flags for the IRS, especially if you claim your home office and other costs as business expenses but don't earn much income. The best advice is to keep careful track of all paperwork so you can defend any deductions and credits you take.
Home offices -  You can only take a home office deduction if you regularly and exclusively use part of your home as your principal place of business. If your office doubles as the kids' playroom, forget about it. For details, see IRS Publication 587.

5. You claim losses from a hobby. 
While writing off business expenses can be legitimate, it's illegal to pretend a hobby is a business and then write off the related expenses. For example, if you enjoy woodworking, you might practice the craft on the weekends for fun. Doing so does not enable you to write off the cost of wood and tools. (If you were selling those creations online, that would be a different story.) The difference between a small business and a hobby is that a business "must be entered into and conducted with the reasonable expectation of making a profit."
6. Deducing home office (or car) expenses. 
While plenty of people can legitimately claim home office expenses on their taxes, some people do so incorrectly. Merely checking email from home after work, for example, does not justify a home office deduction. In order to qualify, the home office must be used for work only. Likewise, claiming a car as a business expense can also raise red flags; taxpayers doing this need to keep careful track of how much they use the car for business versus personal use.
7. You included expensive meals and entertainment costs among your deductions.
The IRS often double-checks these types of claims to make sure they are legitimate business expenses, says Perry.
8. You were particularly generous this year. 
The IRS is on the lookout for people who inflate their charitable donations, and the agency takes a close look at taxpayers who say they donated $500 or just under, since anyone who donates more than that amount must file form 8283. (And if you do donate more than $500, be sure to file that form.)
Charitable deductions. - You'll need a canceled check or dated receipt for any cash contributions, and contributions of $250 or more require a written acknowledgement from the charity. If you made a noncash contribution valued at more than $5,000, you'll need an expert appraisal to back up your claim.
9. You maintain an overseas bank account. 
The IRS has added more reporting requirements this year for people with money in foreign accounts. Failing to report one could trigger an audit.
10. Your numbers don't match. 
If numbers on various forms don't match or add up correctly, the IRS is likely to notice and look into any disparities. So treat your taxes like a final exam in algebra and check over all the numbers before submitting.
As long as you know you filed your paperwork properly, you can sit back and enjoy any refunds coming your way.
For more on getting through an IRS audit, refer to our earlier blogpost

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