Not to be the bearer of bad news, but the IRS is intensifying and expanding its tax return audit program.
A total of 1.58 million individual returns were audited in the 2010 fiscal year, nearly 11% more than the year before. (Back in 2000, the number of audits was only 600,000.) In all, just over 1% of all personal returns were audited last year.
And so while your odds of receiving an IRS audit are already about 1 in 100, there are a few ways you can minimize your risk -- and potential headaches -- even further.
Neatness Can Make a Difference
Even with the widespread adoption of computers and tax software to help with returns, there are still a number of people who do their taxes by hand. For those people, remember that neatness counts.
Messy handwriting is a strong invitation for a closer look at your return. If you can't read your own handwriting, there's little chance a time-strapped IRS employee will be able to decipher it. As well, the risks of making an error increase with handwritten returns.
If your penmanship isn't the best, use tax-preparation software to prepare your filing (many versions are free). And even if you have award-winning handwriting, you should still use tax software to prepare your taxes, if only for the added assurance that the program will catch a box you have left empty. You'll also never have to worry about your computer forgetting to carry the one when it's adding up your deductions.
If You're Self-Employed, Keep Detailed Logs
Neatness shouldn't only apply to the physical appearance of your tax filing. You should also strive for neatness and organization in the logs and records you keep if you're self-employed, and do your best to keep your bills and receipts organized. Not only will these precautions save you if you are ever audited, but they will make the first three-and-a-half months of every year much more enjoyable. Imagine a life of calmly going to your well-disciplined filing system when it's time to prepare your taxes. All it takes is a few minutes everyday and a little elbow grease.
One place that keeping a log is most important is if you use your car for business purposes. It may seem tedious to keep a daily log of your mileage and its business purpose, but automobile mileage deductions are one of the most common audit red flags. The best logs track where you went, the reason for the visit, and the odometer reading at the beginning and end of the trip. Armed with information, you and/or your tax professional will be able to make a well-educated assessment of how much driving you can write off as business use.
Be Honest About Your Home Office
Anyone who has ever worked from a home office can attest to the difficulties of drawing the line between work and life, especially when it comes to filing taxes. The key to satisfying both the IRS and your sense of sanity is to be reasonable when writing off expenses.
Technically speaking, if you use your computer for your home business, you should log exactly how much time you use your computer for work. And by exactly, I mean subtracting the eight minutes you spent checking out your friends' latest Facebook pictures. But is that reasonable?
Probably the best thing to do is make an honest estimate of how much time you use your computer for work (maybe you curb personal surfing to 15% of your total online time) and deduct accordingly. Likewise, if your home office takes up 10% of your home's total square footage, deduct that percentage from expenses like electricity or gas. Just think twice about trying to pass off the bill for those new fuzzy slippers you wear at your desk or overestimating your bedroom office as 40% of your home's size. These sorts of claims increase the risk of auditing.
It was a rough year. Not only did you pay out the nose for your kid's broken arm, your wood-beamed house suffered a termite infestation, and you had to rebuild.
If this is you (or something similar), and you deduct these expenses, then your chances of an audit are likely to increase. In this case, there are three words you should know: Log, log, log. If you have high expenses on your tax filing that are out of line with your income, keep a log of what exactly you paid for, especially if you paid in cash. Do your best to explain the reason behind each expense. Receipts and bills (and a well-kept log) will always be your best defense against an audit, but don't be afraid to get creative. For instance, attaching documents such as police reports or news articles about your house fire to your tax return offer evidence of unusual expenses that can nip an audit in the bud.
If You're a High Earner, You're an Auditor's Dream
No matter how hard you try, sometimes you just can't avoid an audit. That's especially the case if you earn a high-flying income.
Try not to feel targeted -- at the IRS, it literally pays to pay closer attention to the big fish. For every $100 "mistake" made by a person in the 10% bracket, the IRS only nets $10 in additional tax. But the same accounting error made by someone in the 35% bracket generates an extra $35. That’s a +250% difference!
It also doesn't help that people making more than $100,000 a year tend to have more than one income source, be it from investment returns or rental properties. Taxpayers doing anything more than submitting their W-2 are bound to face some complex accounting, which opens up all kinds of room for error.
But it doesn't stop at six figures. If you're one of the fortunate taxpayers out there that's bringing in $1 million or more, your odds of being audited are significantly higher; nearly 8% of all people reporting more than $1 million in income were audited last year. Just consider it one of the "perks" to being so fortunate.
Your Occupation Alone Can Lead to an Audit
Avoiding an audit can mean more than shunning certain "liberal" deductions -- it could also mean passing up certain career choices. Since the IRS is constantly on the lookout for taxpayers under-reporting their earnings, their ears instantly perk up when they see filings from the self-employed or those who work in a cash-heavy industry (like taxi-drivers or restaurant servers).
If you fall into this category, be especially careful when filling out sections that may raise a red flag, like making deductions for your home office if you're self-employed or under-reporting tips if you're a server. As with everything else, keeping records is your best ally in fending off the taxman.