Even for people who are completely honest and straightforward with their tax returns, the thought of an IRS audit is a nightmare. The process of gathering all the relevant records, and dealing with all the questions you are subjected to, can be quite onerous. In addition, if you have made a mistake, even if it was completely unintentional, the results can be unpleasant.
What can you do to avoid being audited, or at least minimize the likelihood? Continue reading to learn more.
Will You Get Audited?
It is helpful to understand how the IRS decides who to audit. They rely on computer programs, which calculate two scores for each taxpayer, called the Discriminant Index Function (DIF) and Unreported Income Discriminant Index Function (UI-DIF). The higher your scores, the greater the probability that your return will be audited.
Yet, the exact procedure for calculating these scores is kept top secret, for the rather obvious reason that the IRS doesn’t want people to be able to figure out tricks they can use to avoid being audited. Even so, it is possible to work out a few general principles that are likely to be of assistance.
It also helps to check out this guide for deducting expenses.
The most obvious factor is that the higher your overall income, the higher the chances of an audit – but there isn’t really any way of using that fact, other than failing to report income, which is just about the most dangerous thing you can do. Here are a few suggestions that do work.
Be Careful with Deductions
There is a natural temptation to deduct as much as you can, because each deduction reduces the amount of tax you have to pay. Nonetheless, deductions are probably one of the most important components of the DIF.
Make sure all your deductions are strictly in accordance with the rules. If a given deduction doesn’t yield a significant amount of money, consider leaving it out. Some advisors say that a high level of charitable deductions is a red flag, but that may or may not be true.
Many people, for example, follow the practice of “tithing,” which means donating 10 percent of income to a religious institution. It doesn’t seem likely that the IRS would set up its programs in a way where tithing would provoke an audit.
Use a Professional Tax Preparer
The tax code is exceptionally bewildering. Even the simplest forms such as the 1040-EZ can be challenging to fill out, and for the more complex forms that come into play when you have multiple sources of income and lots of deductions, it can be endlessly confusing.
Even if you use a 1040-EZ it is a good idea to use one of the free online preparation services. To illustrate, if you have business income, a professional preparer is likely to be more than worth the money, by helping you avoid mistakes that increase the chances of an audit.
Check All Your Information Carefully
It is important that your social security number, address, and all the other items of information in your return be correctly written. If there are errors, the best that can happen is that you will have to fix them later. The worst that can happen is that your DIF score will increase and with it your chances of being audited.
Don’t Report as Self-Employed
As mentioned earlier, no one knows for sure what goes into the DIF score, but various people have noticed that workers who report as self-employed seem to be about 10 times more likely to be audited than corporations that report a similar income.
If you are self-employed and would like to avoid an audit, it might be worth the effort of incorporating. Of course, this costs a certain amount of time and money, but there are also other potential benefits beyond those relating to taxes. It’s worth your consideration.
Don’t Move Money Around Unnecessarily
The government gets reports from banks about transactions between accounts. If you frequently move money from one place to another, it may give rise to a suspicion that you are trying to use sleight-of-hand to conceal something nefarious. So, don’t move your money too often unless you have a valid reason.
Paradoxically, perhaps the best strategy for avoiding an audit is to assume that you are going to be audited, and do everything in a way that you think will survive the audit. If you get yourself into a state where an audit won’t hurt you, it will probably also be a state in which the IRS’s tools are less likely to flag your filing.