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Avoid an Audit

By Alden Wicker of LearnVest Read more about taxes on LearnVest.com

Tax time is annoying enough without the IRS knocking on your door or sending you a stern letter saying they think you’re trying to pull a fast one.But the IRS has audits for a reason—so that everyone pays their fair share.

In order to quickly process millions of tax returns, the IRS has certain things that will automatically trigger an audit. That doesn’t necessarily mean you’ve done something wrong, just that the return you filed has something that might signify you’re trying to defraud the IRS. But if you did everything correctly on your return, you should be able to prove that you are paying all of your taxes. The IRS will then agree with you and leave your return the same, and the audit will be over without any fines or (God forbid) jail time. Phew!Click here to find out more!

The audit can be conducted either by mail or in person, and there are three possible outcomes:
  1. The IRS decides all is well and the return stays the same.

  2. The IRS proposes a change and you agree to it and/or pay more taxes, interest or a penalty (and in rare, severe cases, forfeiture of property and jail time).

  3. The IRS proposes a change, and while you understand it, you don’t agree. In the latter case, you can appeal or enter into a mediation with the IRS.

We’ve listed the top audit triggers for you, how to know if you’re in the wrong and what proof you’ll need to ward off a full-blown audit, fines and frustration:

1. Reporting the Wrong Taxable Income

You can’t lie about your taxable income, because both you and the IRS received your W-9 and 1099 forms, for both full-time and freelancer employees.

Perfectly OK: Making a small math error. The IRS will correct that.

Not OK: Estimating or fudging how much you’ve made, even if you’re a freelancer.

The Proof You Need: Compare the 1099 you receive from the company against your own records. If you think it is wrong, inform the company and ask that they file a correct 1099 with the IRS.

2. The Home Buyer Credit

If you bought a home for the first time after April 8, 2008 and before January 1, 2010, then you could have gotten the first-time home buyer credit. This credit is like an interest-free loan of up to $8,000 from the government. People who claimed the credit in 2008 pay back the loan over 15 years by paying an additional tax, but those who claimed it in 2009 and 2010 (and 2011 for service members) do not have to pay it back.

However, this credit has been used and abused by those trying to defraud the IRS, so they will scrutinize anyone who claims this credit to exclude people who are flipping homes or speculating in real estate. For that reason, they will be checking to see if you stayed in the home for more than 36 months (three years), as required.

Perfectly OK: You bought your first home, and you’ll be living in it for a while.

Not OK:You bought your first home … and then promptly resold it within three years for a profit, or made another home your primary residence. You’ll need to pay back the credit in full when you pay your taxes that year.

The Proof You Need: Keep all records pertaining to the purchase of your home.

3. Huge Donations on a Small Budget

The IRS will raise its eyebrows if you’re giving away large charitable donations when you don’t have much income.

Perfectly OK: You gave a generous donation to your alma mater … and then suddenly lost your job, making your income lower than expected.

Not OK: You’re getting creative with your charitable deductions. (“That 1995 Camry I gave to charity is worth at least $15,000!”)

The Proof You Need: Get your large donation appraised, file form 8283 for any donation over $500, and make sure you keep all charity receipts and follow the IRS’s tips for charitable donations.

4. A Steak Dinner With the Clients

Rules for claiming this are strict, so it’s a smart idea to read up on them before trying to make the government pay for your nights out on the town.

Perfectly OK: Deducting 50% of the cost of a reasonably priced meal where you entertained potential clients for your business.

Not OK: Deducting the cost of a lavish steak dinner with rare champagne as entertainment, and then trying to deduct it again as a travel expense. Or deducting half the cost of a concert ticket you bought from a scalper who charged you $150 more than face value. To see more instances, read this publication from the IRS.

The Proof You Need: Keep all receipts, and record the dates and times, description of the expense, the business purpose and business relationship. More details are here.

5. Using Your Car for Business

Sure, a lot of people use their cars for some part of their business. But if you’re also using it to shuttle kids to lacrosse practice, it just doesn't qualify. This is old hat to the IRS, so don’t think you can outsmart them.

Perfectly OK: The car is used solely for delivering wedding cakes to your clients.

Not OK: Sometimes you drop off deposits at the bank on your way to getting your nails done.

The Proof You Need: Keep a record of your mileage, and calendar entries for every time you use the car for business.

6. Your Home Office

A lot of people think they can stretch the definition of a home office, which is why claiming it could trigger an audit.

Perfectly OK: A study where you keep your computer, phone, bookshelves and other supplies for work, and where you do the majority of your work.

Not OK: A desk with a computer in the corner of your living room or guest bedroom where you work for a few hours a week.

The Proof You Need: If you want to take this deduction, make sure to read IRS Publication 587. It is very detailed, and even includes a semi-fun (well, sort of) flow chart to make sure you’re on the up-and-up.

7. Errors

It seems obvious, but we can’t leave it off the list because it’s one of the top reasons for audits.

Perfectly OK: Small math errors. The IRS will fix these.

Not OK: Claiming the wrong deductions and credits, filing under the wrong status and stating the wrong income.

The Proof You Need: Double and triple check your work before filing and, again, keep meticulous records and proof for deductions and credits.

8. Round Numbers

Did you really spend $125 on this and $75 on that? If every year you have tidy little numbers, it will cue the IRS that you’re making some things up. Or at least keeping terrible records.

Perfectly OK: Rounding to the nearest dollar.

Don’t Perfectly OK: Doing things from memory and rounding to the nearest $25.

The Proof You Need: Have documentation for your deductions and credits, and use the actual numbers on your forms so they match.

9. A Business That Loses Money

It’s not ideal that your business loses money. (That kind of misses the point, right?) If the IRS sees someone who has a full-time business, and reports a loss two years in a row, it will make them look closer.

Perfectly OK: Things didn’t go well with your business this year or last year, and you took a loss. Or your hobby is usually quite profitable and this year didn’t go well.

Not OK: You have an expensive, full-time hobby like owning a vineyard or fixing up antique bicycles and you’re not even trying to make a profit.

The Proof You Need: You can claim a loss for your hobby this year—if it usually makes you a profit. You should have all the proper documentation as if it were a business, and prove that it made a profit for three out of five years.

More on Taxes From LearnVest:

Itemizing could save you thousands. Should you do it?
You might have heard about the dreaded Alternative Minimum Tax. Could you be hit with it?