By
Alexander Carl on August 12, 2010
Say “IRS audit”, and you'll make sword-swallowers and Mt. Everest climbers cringe. Having your personal life numerically reviewed by a stranger, is, well... it's the root canal of the financial world.
But like a root canal, you can prevent it. The most essential measure is to
be honest about your taxes. Duh.
However, honesty alone is not enough to prevent a letter from the IRS. (Plus, everyone seems to know someone who fudges their return and gets away with it).
If you're contacted for an audit, it could be because of
errors,
random selection,
mismatch with employer records, or because
a financial relative (such as business partner or investor)
is being audited.
Overall, not many taxpayers are audited— only 6% of those making more than $1 million are audited, and lower income brackets are audited much less.
Yet certain factors make an audit more likely:
The more complex your return, the more likely an audit. The bigger the haystack, the easier it is to hide a needle. The IRS suspects more errors (and cheating) with a plethora of deductions and income sources than with a few.
If you file a
Schedule C (Profit or Loss from Business, Sole Proprietor), the IRS immediately becomes interested. Mostly filed by self-employed workers and small business owners, Schedule C has many opportunities to claim imaginary expenses as deductions.
In general— the less documentation a deduction entails, the more the IRS will sit up and notice when you claim it.
Other red flags are
inconsistencies, especially from year to year. If you report $287,992 in income in 2009, and $17,604 in 2010, you'll trigger all sorts of tax alarms, even if the difference is legit.
This includes assets and liabilities. If you own a $4 million home on $38,500 a year, or put three kids through private college on the same income, the IRS will want to know how you do it.
Round numbers are also alarming. If you've ever filled out a tax form, you know that numbers like “400.00” for statements and calculations are virtually nonexistent. Don't “estimate”.
Audits happen, but thoroughness in record-keeping and reporting keep them away.
See also:
How to Get Help with an Audit