IRS red flags: How to avoid a tax audit | Families
Jeff Reeves, Special for USA TODAY
There's a general conception that the Internal Revenue Services is too understaffed at tax time to go after anyone but high rollers and blatant cheats.
Don't believe it.
While it's true that the IRS only audits a small percentage of returns, government officials are getting smarter about which taxpayers are the likeliest to be overstating deductions or underreporting income.
It starts with a high-tech analysis of all U.S. tax returns, calculating average deductions and calling out filings outside the norm.
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"The IRS gets literally mountains of tax returns," says Andrew Porter, a certified public accountant and partner with California firm Comyns, Smith, McCleary & Deaver LLP. Officials "feed the tax returns into a piece of software and call out the juiciest ones. It's a first cut that allows them to focus their examination attention on things that are most likely to yield additional tax for the government."
So how can you avoid being part of that first cut?
According to tax experts, here are a few things that will make you stand out in the eyes of IRS auditors and their high-tech screening tools:
Typos and omissions
Computers don't make adding errors. Humans, however, do.
One of the most easily prevented errors is simply not properly copying over the numbers on your tax forms. Any difference between what your employer reported you earned in their filings and what you personally reported earned will raise a red flag, even if it's an honest mistake.
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Even if you have your taxes professionally prepared, Porter said, "you don't want to just blindly sign and drop it in the mail. You have to look at it and know that your W-2 amount actually shows up correctly."
An unprofitable home business
Stan Veliotis, associate professor at the Fordham University Schools of Business, said that the Schedule C tax forms for self-employed Americans have been improved recently to help filers. However, while the forms have gotten easier to manage that doesn't mean anything goes.
"If you have someone reporting $100,000 in revenue but $99,000 in expense, what kind of business person would have such an expense-to-revenue ratio?'" Veliotis said.
$250,000 or more in income
An unfortunate reality of IRS audits is that they are "a profit making venture for the government," says Porter. That means the tax man doesn't have time to waste on folks who won't yield a big payday.
High earners may not have done anything wrong, but simply being a bigger target is enough to draw attention because of the potential in lost tax revenue.
The flip side is that a person with insignificant income could sometimes be flagged by the IRS – particularly if they are associated with other people or businesses that are known tax avoiders.
Some of those reporting low income are actually hiding how they make their money, Veliotis said. That means the IRS can win a big payday by proving how much real income exists – and more importantly, the unpaid taxes (and penalties) on that income.
Big charitable contributions
If a taxpayer claims a massive charitable contribution on their 2013 returns, there's a good chance that will raise a red flag with the IRS. Charitable deductions are frequently reported without proper documentation or occasionally made fraudulently.
"That doesn't make (a big donation) illegitimate," Porter said, "but you more likely than not will stand out and be audited. It's all about documentation."
Don't be intimidated
It is hard to know for sure exactly what will spark an IRS audit given the sheer volume of tax filings, the secretive nature of how the IRS flags returns and the complexity of the ever-changing tax code.
But the experts agree that no matter what the auditors may think, you have every right to claim the deductions that are entitled to you and should never leave money on the table.
"Not wanting to take a legitimate deduction is just stupid," Porter said. "And audit is not something to be afraid of if you have all the right documentation."
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor's Guide to Finding Great Stocks.