Don’t make yourself a target for an IRS audit

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(CBS News) – The IRS may be performing few audits of individual tax returns, but that doesn’t mean it has given up the practice altogether.

First of all, the IRS conducts most audits through “correspondence.” This is when the agency sends you a Notice of Tax Due, a letter indicating the changes it proposes to your tax return and specifying an additional amount of tax due. These are usually nothing to worry about, and if you have the supporting information requested, responding to these is straightforward.

Then there’s the field audit, which is something no one wants to go through. Anyone with a pulse will feel a sense of panic when they get a letter from the IRS requesting to show up at your house or place of business for an audit.

Even though the chance of being selected for a field audit is statistically very small, if you’re among the not-so-lucky few, it’s a big hassle. You’ll spend a great deal of time just preparing for an examination, with the stress and aggravation taking its toll. The IRS will assume you’re guilty until you can prove otherwise, so you’ll need to be careful how you answer the agent’s questions and be prepared with documentation for every deduction on your return.

If you want to lower your chances of being selected for an audit, you need to know what can trigger it. Here are a few flags that can draw additional attention to your tax return:

  • Large amounts of self-employment income and deductions: Self-employed individuals report income and related-business deductions on Schedule C, and the IRS know taxpayers filing Schedule C are more likely to underreport their income and overstate their deductions. If your net income is over $100,000, or your deductions are unusually large in relation to your gross income, this could increase your chances of being audited.
  • Married taxpayers filing separately: Spouses who file separate tax returns should carefully determine who is claiming which deductions. Make sure you’re splitting the deductions that are paid jointly and not each claiming the same amount, which would result in double-counting. But it’s perfectly fine for one spouse to claim 100 percent of a deduction if the other spouse doesn’t also claim the same deduction.
  • Large charitable donations: If you make a large amount of cash donations, make sure you have receipts to back them up. High charitable donation deductions in relation to income (more than 10 percent) can be an audit trigger.
  • Reporting incorrect mortgage interest paid from Form 1098: Banks report the interest you pay on home loans to the IRS. So the amount you report as a deduction must agree with the figures sent to the IRS. And if you also pay mortgage interest on a second home, special rules limit the interest you can deduct on total home loan indebtedness.
  • Not paying the full tax due without explanation: If you don’t have the money to pay the taxes you owe with your return, don’t just send in a lesser amount without an explanation. This will trigger an IRS notice, and it could also result in the IRS requesting a more invasive review of your return. Instead, file Form 9465 Installment Agreement Request with your return. You’ll still have to pay interest and possibly a late payment penalty for any taxes not paid by April 18. However, the IRS will work out a payment plan for up to 60 months for the balance that you owe.

The best audit defense is to keep clear and organized records of all deductions and seek the advice of a tax pro if you’re not clear as to whether a deduction is legitimate. Good tax pros will prepare work papers and supporting tax documents and organize receipts in an indexed order. They’ll also ask lots of questions, to tease out the details of your financial situation to help you take every legal tax deduction or favorable tax position available to you.

Since tax audits typically happen two to three years after you’ve filed the return, having a well-organized file of your receipts, papers and tax forms will be very helpful if you do get that letter from the IRS.

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