Have you ever been audited? If so, it's not a fun process. My wife was audited the year after we were married (for a tax year prior to our marriage). For all the stress of the event, it went very well -- and she actually got MORE MONEY BACK. I bet that doesn't happen very often.
For those of you wanting to avoid an audit (isn't that just about everyone?), here's some advice from the National Tax Advice Day web site on eight ways to avoid an audit:
1. Cross your t's and dot your i's - The easiest way to avoid an audit is to ensure your return is accurate. The best way to do that - have it prepared by a certified tax professional who knows your situation. Now this may seem like common sense - a few mathematical errors alone won't get you into trouble - but several mistakes can imply that your return is a sloppy one and in need of a second look.
2. How you generate income does matter - There are also certain professions that attract more scrutiny. For example, those who are self-employed or receive large amounts of cash (like servers and taxi drivers, for instance) are always at risk for an audit as opposed to those who receive a steady salary. Since the IRS already believes that most under-reporting occurs among the self-employed they are on the lookout for red flags, such as taking home office deductions. It's important to weigh the risks. You can talk to your tax professional about the best option for you.
3. Alimony is not free and clear - Not reporting taxable alimony payments received can cause big trouble. The IRS now matches deductions for alimony from one spouse with the alimony income reported by the other.
4. Be accountable for automobile logs - One of the most commonly audited items are automobile logs for self-employed persons or employed individuals using their cars for business purposes. The key to protecting yourself here is to keep detailed records of your mileage on a daily basis, if possible. Try to keep a log that charts the beginning and ending odometer readings, location and reason for the trip. Your tax professional can then help you determine how much of those miles qualify for business use.
5. Limit itemized deductions - Large amounts of itemized deductions can make you a likely target for an audit. Even though you should claim every deduction you're entitled to by law, making tax deductions that exceed the averages for your income can put you at risk. For example, many people make large charitable donations in relation to their incomes. If you fall into this category, keep track of the date of the donation, the receiving organization and the amount of the contribution. Try to pay with a check whenever possible so you have a record, and make sure you obtain a receipt from the charity for donations exceeding $250. If audited, you should be prepared to also offer the IRS the original value of the items donated (non-monetary) and their fair market value. In general, the larger the donation, the more paperwork the IRS requires.
6. High DIF can hurt you - When you file your return with the IRS, they use a proprietary formula to calculate your Discriminate Information Function (DIF) score. Returns with the highest DIF scores are the most likely to be selected by the IRS because they pose the best chance for the IRS to collect additional taxes, interest and penalties. The best way to avoid a high DIF: Make sure to report all taxable income - from interest earned on your bank accounts to interest earned on investments.
7. Avoid offshore credit cards - An estimated one million Americans have offshore credit cards. And the IRS is taking notice. People put money in an offshore account to avoid paying taxes on the interest. It may seem like a good idea, but it's really only a great way to volunteer for an audit.
8. Take care when selling stocks or bonds - The IRS receives a 1099 form noting the sale price of your stocks or bonds. So it's best to claim capital gains in full and back out your purchase price on another section of your return. For example, if you buy stock for $2,000 and sell it for $5,000, you may think it makes sense to claim only $3,000 in capital gains. However, this will throw up a red flag. Instead, claim the full $5,000 and back out the $2,000 purchase price somewhere else on your return. A tax professional can help you complete your return accurately to avoid any mistakes.
The issues I deal with most are #5 and #8. These are just two more reasons I have an accountant handle my taxes.