Should you be thinking about a tax audit? With the staggering federal deficit the government is looking for any means possible to collect money, including more fees and taxes.

The federal government believes that one of the quickest ways to do this is to close the tax gap. This is the difference between what Americans pay in taxes and what the government thinks we should have paid. The current tax gap is estimated at $450 billion. It is clear there is a large incentive for the IRS to go after individuals and businesses they believe are not complying with the tax laws.

So are you at risk of being audited by the IRS? In 2011 there were 184,596,616 tax returns filed with the IRS. There were 1,724,728 returns examined during that period equaling .9% of the total returns. With the initial odds of getting audited less than 1% it appears that for most taxpayers the risk is relatively low.

However, there are other factors that can increase your chances of showing up on the IRS audit radar. Some of those include:

– Sole-proprietor/single-owner businesses
– Substantial business meal and entertainment deductions
– Unreported income, in the form of investment returns or contract work
– Excessively high incomes compared to the previous year
– Large deductions relative to income
– Excessive home office deductions
– Losses from a hobby rather than a business venture
– Offshore credit cards
– Low incomes, but significant business deductions
– Non-cash charitable deductions
– Several dependents
– Math errors

These and other factors go into the many processes the IRS uses for selecting tax returns for audit. Those processes include but are not limited to:

– Statistical analysis using DIF score system – where returns are compared to a statistical model of similar returns based on prior returns filed with the IRS. Returns that contain deductions that exceed the norms are flagged for audit consideration.

– IRS matching programs – computer matching of entries on a tax return to the corresponding information the IRS receives on forms W-2, 1099, 1098, K-1, etc. If the information does not match a computer generated letter is sent to the taxpayer for evidence supporting their return or payment of the additional taxes.

– IRS special projects on various occupations or professions – the IRS routinely picks certain industries or professions and conducts IRS audits on a large percentage or tax returns that fit the IRS project criteria. The IRS calls this type of IRS audit the market segment specialization program (MSSP).

– Informant tips, Random audits, tax returns with prior IRS audit history.
What can you do to put the odds in your favor of avoiding hearing from the IRS? The best way is to take some precautionary steps to minimize your chances of having to go through this stressful, time-consuming, and potentially expensive experience.

Report all taxable income. Don’t leave anything out, including amounts on your W-2, interest income, capital gains, and alimony payments. The IRS will calculate your Discriminate Information Function (DIF) score; the higher your score, the more likely you’ve submitted inaccurate information. Recently, the IRS has been calculating an Underreported Income Discriminate Information Function (UI DIF) score, looking for inconsistent information, such as a high mortgage but little taxable income. The higher your scores, the more likely you’ll get flagged for an audit.

Catch your errors. It pays to double-check, even triple-check all your figures and calculations. The IRS closely scrutinizes taxpayers who make simple math mistakes or who enter inaccurate figures. If you discover an error after you submit your return, it’s better to fix it fast rather than hope they don’t catch it. Most of the time a fast fix incurs no penalties.

Get, and stay, organized. Save receipts and keep good notes, particularly if you’re itemizing. Having that paper trail is your best defense if you’re picked for an audit. Keeping back-up receipts throughout the year means you won’t be searching through the house on April 14 or waiting for credit card companies to send duplicate statements.

Know the pitfalls of certain jobs. People in certain professions; self-employed, waiters and cab drivers or those who work from home are more likely to be audited. If you attached a self-employment schedule (Schedule C), you’re three times more likely to be audited. Save receipts and keep good records.

Don’t underestimate tax payments. Make timely, accurate payments to avoid scrutiny and penalties.

Use an established tax professional. They can ensure you have all the required information and that it meets the current requirements. Also, the IRS keeps track of preparers and the clients of those with good track records are less likely to be scrutinized.

The bottom line is that the odds are you will not be selected for an IRS audit, but if your income, investments or business practices put you into one of the potential problem areas your chances increase significantly. Visit a tax professional and seek guidance or have them assist you with your record keeping. Being prepared is the best defense when the IRS comes calling.

Richard Simms Founder

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