Preparation Tips for an IRS Audit
How to reduce the possibility of a tax audit
Tax audits are few and far between these days. Most taxpayers are looking at a 1 in 100 shot of going through an IRS examination ( where you actually go through a formal face to face sit down with a human being ) Its much more likely that you’ll get a notice automatically generated by a federal government computer that states you’ve made a mathematical mistake, or that the income declared on your return doesn’t match with the information reported by 3rd parties (W2, 1099s, etc) These notices are much less daunting than a sit down with your local IRS office
Your audit risk increases under certain situations, like reporting your earnings from a home business or rental real estate, itemizing your deductions, or earning over 200 k per year. Also, if you claim the earned income tax credit , approximately 25% of these returns will be examined since so many folks fib in order to get a big government check..
Business deductions
Do you file a Schedule C for your home based business ? Do you claim a large amount of unreimbursed employee deductions on the bottom of schedule A? If so, you’ll need impeccable documentation to prove that your new iPhone, , trip to Vegas, and dinner at Spagos all had a legitimate business purpose. Many folks like to stretch the truth to claim a deduction for personal expenditures. Don’t be the knucklehead who writes off the cost of Directv NFL Sunday Ticket and the Red Zone channel as legitimate business expenses for your fantasy football team, Especially if you netted a cool ten bucks for the year on this activity.. Don’t confuse your hobbies with legitimate business enterprises. In general, the IRS wants a schedule C filer to show a profit for two out of the last 5 years. If you can’t show a profit motive, you may not be allowed to claim your business deductions. Also, when claiming your home office, be sure that the square footage you claim is used exclusively for business. You can’t claim a home office for space used for your adult website research or for that Xbox Call of Duty session. Also, its a good idea to keep up a professional look of this space. Probably not the best idea to keep a running beer tap and arcade games in your work area.
Rental income
Are you a schedule E filer who claims earning and expenses on your rental real estate? Do you subcontract the landlord / rental property duties out to a management company or do you handle management duties by yourself? How you manage the property will determine how much of the loss will be deductible on your tax return. Be sure to provide documentation supporting your level of involvement. Do you know the difference between a repair and an improvement ? A repair will just restore something to its original condition, i.e. – patching a hole in the wall, plugging a leaking toilet, or repainting the bedrooms. . An improvement is something that adds value to your property by extending its life and adapting the property for a new use. such as adding central air conditioning, building a ramp for handicapped access, or installing new wooden plantation shutters, You must depreciate this improvement cost over several years instead of taking 100% of the repair expense in one year. You can get into trouble if the IRS thinks you decided to write off the entire cost of that swimming pool rather than depreciating it over its useful life. If you’re lucky enough to have a vacation home that you rent out and use for family getaways, be sure to document the number of days your family stayed there vs the number of days you rented it out . ( at the fair market value) To take the maximum deduction for your vacation property, your family must not use property for 14 days or 10% of days rented out , whichever is greater. keep track off how many days your family stayed there. If your family used the property for the of 14 days or 10% percent of days rented out at fair market value, whichever is greater.
If you own rental property, take care completing Schedule E for supplemental income and loss. How much you can deduct for expenses and losses depends on how actively involved you are in managing your property and how well you can prove it. Other tips to prevent a tax audit: Know when to depreciate. Repairs and new equipment that extend a property’s life or add to its value aren’t considered maintenance. Depreciate them over a number of years rather than taking full deduction in a single year. If you own a vacation home that you rent out and use as a family retreat, be sure to distinguish between personal use days and days your rented it out. You won’t be allowed any deduction for rental property expenses if your family uses property for more than 14 days or 10 percent of days rented out to guests at fair market rental rate. ( whichever is greater) It would be wise to maintain a travel log with receipts and visa card statements so you’re covered during an audit.
Donations to Charity
If you gave $250 or more of cash to an organization or $500 or more of non-cash goods ( home goods, furniture, clothing) save all your receipts with the date and amount clearly identified. If you report a large amount of charitable giving,in proportion to your income, like a $ 25,000 gift- when you report $ 50,000 on your return, don’t be shocked if the auditor doesn’t buy your story. Bear in mind that donations exceeding $500 require an additional IRS form and donations over $5,000 must be accompanied by a written appraisal.
Keep records and tax returns forever
I’ve witnessed too many incidents where the IRS or state have sent letters informing taxpayers that their tax return was never filed or that they have no record of having received it. That’s why I advise keeping your tax returns and supporting records indefinitely. Scanning and storing digital copies of original records and returns makes this task easy. Also, don’t forget to save canceled check for payment made and refunds you received.