Eight Ways to Avoid an Audit

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.

FMF recommends: H&R Block.  Do it yourself or have us do it.  It's never been easier.

Comments

[helpmewithtaxes]

"back out your purchase price on another section of your return"
"back out the $2,000 purchase price somewhere else on your return"

Where, for example, would that "other section" or "somewhere else on your return" be?????

I think the schedule where you enter your gains provides space where you can enter your purchase price, and what you enter as capital gain gets taxed at 15%. So how would it be possible to enter more than you have to in this section, and "back out" that amount "somewhere else" on the return?????

Thanks for your help.

[NO THANKS FOR YOUR HELP---]

It seems to me that FMF gets a kick-back from H&R BLOCK to write this story on taxes---Back out the 2K purchase price somewhere else!!! really, what a total misleading statement--all made to confuse the stupit, average tax payer during tax time! Of course this is the thing that most writers seem to do at tax time---but I have never seen a story smell so bad as this one!!!!

[FMF]

You must be new here based on your comments and the fact that you have the facts all wrong. For instance:

1. I did not write this story -- it was from the NTAD site as it says. I publish pieces from various sources all the time and give them credit as such. If you were a regular reader, you'd know that.

2. Yes, that's a link ad at the end. Is there anything wrong with placing an ad in a post? If so, you've got an issue with about 10 billion bloggers.

3. I've stated time and again that I use a CPA to do my taxes (see http://www.freemoneyfinance.com/2006/01/why_i_use_a_cpa.html) and for those with more complicated taxes, I recommend professional help. You may have a different opinion, but does it make this piece wrong.

4. This piece is good advice by itself. It adds value to the readers and the site. Otherwise, I wouldn't have published it.

5. You need to read the entire site before you accuse someone of being dishonest. Did you read the other 200 pieces I've written on taxes? Or how about the almost 4,000 posts overall. Or did you do a search, maks some bogus assumptions based on one piece, and fly off the handle?

6. A little late aren't you -- this piece ran almost 1 1/2 years ago.

7. And just so you know, I give all the proceeds earned on this blog to charity. (see http://www.freemoneyfinance.com/2007/01/2006_charities_.html)

Finally, if you're going to criticize someone without the facts, at least don't be such a coward as to not leave your website/contact information.

[Mike]

Back in 1999, We were audited with similar results. I was working full-time with a part-time wholesale car dealing business. We also had high charitable contributions as we were tithing. In preparation for the audit, we were much more thorough with finding and documenting expenses.

Our CPA refused to allow me to even be there but he did a fantastic job. The result: they owed us money! And they paid it back...with 9% interest.

[Apex]

FMF,

I too am way late on this article, found it from a link on your current tax article.

As the first commenter on here asked, I am quite confused by #8. I don't understand how this would work. As the first commenter said, the schedule D has columns for sale price and cost basis. It seems like reporting 100% gains here and then trying to deduct the cost basis somewhere else is more likely to cause a flag than just following the instructions for the form?

So are you actually familiar enough with this practice to explain it? Do you know if your CPA does this and what it looks like on your return? I am just curious because I do a lot with taxes and understand them probably a lot better than most average people (I just met with a CPA yesterday to consider having him do my taxes as I enter real estate and I brought my return from last year which is quite complicated including itemized deductions, capital gains, installment sales from previous business, etc, all of which I did myself and he said I seemed to have everything under control on it). So this suggestion on #8 was quite an interesting but confusing concept to me.

I do know that the IRS is getting reports of stock sales now and I do worry about how they will treat that with respect to your reported cost basis but I don't know of any other way to report schedule D gains than to just list sale price and cost basis with the net gain on schedule D.

So any insight you could give into how the suggestion on #8 would work would be greatly appreciated.

Thanks.

[FMF]

Apex --

I suggest you go to the NTAD website for details since this is their article/suggestion (or you can ask your tax advisor.)

[Apex]

Ok, I was just curious if you were advocating this because you do it or were just referencing the list in general. Specifically since you said #5 & #8 is what you deal with I thought maybe you were familiar with what they are talking about there. It seems like you are maybe not quite versed on this technique they mention since you don't want to elaborate on it and I understand that. That information is helpful to me because the things you comment on that you actually are informed and versed in are things that seem to make sense.

I actually think what they are saying here in #8 is kind of goofy advice. In fact I suspect is actually wrong and potentially audit triggering.

The website that you referred to in this post is now defunct which adds to my feeling that #8 is probably just bad advice. I would recommend anyone else who finds this post does not attempt to report ("hide") stock cost basis on some other form and deduct them somewhere else on their return. I bet thats a real good way to trigger an audit, not avoid one. Besides the fact if you don't do it right you could report extra gains to be taxed at 15% and extra deductions to be taken against ordinary income which would clearly be incorrect. If anyone has done the worksheet for figuring the tax rate on capital gains then you know that you don't try to figure that stuff out somewhere else and add it in. The forms make a big mess of it and if you don't report everything exactly where they say, its almost surely going to be reported incorrectly.

I think I will consider the issue closed from my standpoint now since it made no sense to me, FMF appears to not be versed in it, and the website that made the claim is defunct.

#8 appears to be just incorrect bad advice.

I do appreciate you responding though FMF on something that was so old. I certainly do not intend my question as a criticism, just trying to understand if there was something tax wise I needed to understand better.

[NothingSpecial]

Somewhere else? Its schedule D you dopes. This is how it is suppose to be done.