The thought of being audited by the IRS sends shivers down your spine, doesn’t it?
While this process can be intimidating, many are comforted to know that only 1.4 million people are audited each year, which is less than 1 percent of taxpayers. That said, many people might receive an automatically generated IRS notice. This works generally the same as an audit, where the taxpayer is likely going to be required to send in supporting documents to account for underreported income or face penalties.
So how can you avoid being contacted by the IRS? Well, in some cases, you can’t. But here are a few ways you can reduce your chances!
Top red flags for an IRS audit
- Excessive write-offs compared with earnings
- Unreported income
- Refundable credits like the earned income tax credit
- Home office and auto deductions
- Rounded numbers
1) Be sure to report ALL income. That may sound obvious, but don’t look at a document and say, “that is a small amount” or, “my expenses associated with that 1099 offset that income anyway, why bother reporting it”. The IRS uses software to look at the income reported by employers and employees and match the payor to the payee. If something doesn’t look right, you could be notified.
2) Burden of proof. While you should absolutely report all your business expenses, just be prepared to back them up with receipts. You have a burden of proof. The IRS will use the deductions you’ve reported and compare them with deductions from others in the same industry. If yours are an excessive amount, be prepared to be flagged. Again, this doesn’t mean you shouldn’t take those deductions, just be ready to back them up.
3) Don’t use round numbers. Nothing says “I don’t keep great records, so I’ll estimate this expense” like a round number. Keep great records and have receipts to back up your expenses (have we mentioned that yet?) and be exact in what you report, down to the very dollar.
4) Sole proprietors, be extra diligent. The IRS pays more attention to sole proprietors than most other entities. It is easy to start a business and claim losses to help offset income. And it is easy to lie about that as well. Simply forming an LLC for your small business can help reduce the likelihood that you will be audited.
At the end of the day, no matter how many precautions you take, sometimes avoiding an audit is simply not possible. While most audits are because the IRS flags something in the return which raises questions, truly some of the returns the IRS selects for an audit are completely random.
If you receive an audit notice, stay calm! Simply gather the proof and documents you’ve so diligently kept throughout the year (you have been diligent, right?), and present your case! If there is a clerical or mathematical error caught by the IRS, relax, you aren’t going to jail over it. You’ll simply be asked to pay what you owe (with penalties in most cases).
We hope this helps put your mind (somewhat) at ease. Happy filing!