One out of 100 personal income tax returns are chosen for audit by the IRS every year. Although there is nothing a taxpayer can do to guarantee that their return is not chosen by the IRS for audit, there are certain strategies that can be used to reduce the likelihood of audit selection.
Sometimes the IRS computer selects a return based on the size of certain deductions or items of income. Other times a return might be selected simply because of the type of income or deductions shown. And other times a return will be selected because of errors and discrepancies.
Discrepancies in the income reported on a return and what payers have reported to the IRS on forms W-2 and 1099 can increase the changes of audit selection. If W-2 or 1099 errors are found, the taxpayer should request that the issuer make the correction and issue corrected forms.
Taxpayers filing married filing separately are more likely to be audited than those filing jointly. The IRS has found that returns filed separately often are not consistent and sometimes double report deductions.
A return that contains sizeable items that often make taxpayers liable for the alternative minimum tax (AMT). Among them are: deductions for state and local income tax; deductions for state and local property tax, exercise of incentive stock options (ISOP) and large capital gains.
If a taxpayer works in a business where substantial cash payments are made, the IRS is more likely to select the return for audit. Examples include doctors, lawyers, store owners and waiters. Audit is especially likely if this type of taxpayer reports over $160,000 in gross receipts on Schedule C.
The IRS examines certain types of businesses more than other. Businesses subject to closer scrutiny include: air charters, art dealers; bed and breakfasts, entertainment concerns; gas stations; liquor stores, mortuaries, pawn shops, restaurants and bars, taxi services and used car dealers.
Deductions or business expenses that seem large in proportion to reported income may trigger an audit. The exact ratio is not disclosed by the IRS.
If the return is signed by a tax preparer that is on the IRS's list of "problem preparers" also increases the likelihood of audit selection. "Problem preparers" are those who have repeatedly violated the law.
Complex business or investment transactions without clear explanation may trigger an audit. Attach a separate statement, if needed, to explain an item on the return.
Filing a Schedule F, particularly with sizable salary income, also increases the chance of an audit, as does claiming the earned income credit.
If you have reported all of your income and have not fraudulently completed your return, the IRS has three years from the time you file you return to conduct an audit. If you have understated your gross income by more than 25%, the IRS has six years from the date of filing to assess additional tax. If you file a fraudulent return, there is no statute of limitations. The return can be audited at any time.
The best defense against an audit is to keep good records and to review those records for completeness and organization.
Maxwell Shmerler & Co., CPAs
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