Tax Audit Triggers To Avoid

OK, so the mere thought of an Internal Revenue Service (IRS) tax audit sends a chill down your spine. But is there a way to avoid certain triggers that might cause an audit? Absoutely!

The IRS identifies returns warranting a closer look by using a computer program called DIF, which stands for “discriminate index function.” This program compares a taxpayer’s deductions with others in the same income bracket. Here is how it works;

The DIF looks at every tax return and gives the return a computer-generated score. This score indicates the likelihood that you have questionable items on the return. Example:  If the IRS has statistical data that shows the average person in your income tax bracket claims $500 in charitable donations on a return and you claim $5,000, the DIF will give you a score that will be looked at by IRS personnel. The more your return deviates from what is considered normal, the higher your score and of course the more likely you will be audited.

Common Tax Audit Triggers

Unreported Income

Unreported income is one area in which you can take steps to avoid an audit. Just report all of your income. The IRS computers are able to match the taxable income reported on your return with the information it receives from employers and from 1099 forms that were issued by banks and brokerage firms to you. For example, if you failed to report interest earned on your bank savings account, the IRS will catch it when it matches the bank's interest payment records 1099 against your tax return. To help ensure you don’t miss reporting any taxable income, compare the reported income on your 1040 with all income from your W2’s and all 1099 forms.

Business Expenses and the Home Business Deduction

Being a business should not be a trigger but it is, especially if you’re a sole proprietor and you file a Schedule C. That’s true in part because the IRS has determined that self-employed taxpayers have more opportunities for hiding income. Being self-employed also allows for the converting of personal expenses into business expenses. The pen and paper you bought for the kids can be treated as a business deduction when in fact it is not.

Your return may be flagged if you claim large deductions for your business travel or entertainment, if you take a home office deduction, or if you show a large overall loss. The best defense is to retain all receipts for business meal and entertainment expenditures of $75 or more. For expenses less than $75, you MUST keep a detailed log noting everything about that expense, including the who, what, where, when and why! That home office is a tricky one so you might want to consult with a CPA to determine your eligibility before claiming the deduction.

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