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The Tax Man Cometh: How to Avoid an Audit 101Use these 5 tips to help avoid audit this tax season and protect yourself in the future.
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Don't worry if you get audited, it may be a relatively painless endeavor.
“ There are actually five types of audits, the least serious of which are conducted by mail, (usually) resolved easily, and do not require you to meet face-to-face with an IRS agent.”
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When you’re married, there are some things about filing your income taxes that might make you smile; for instance, the possibility of saving hundreds or even thousands of dollars by filing jointly instead of separately. But no matter who you are or what benefits you expect to enjoy as a married taxpayer, there’s at least one thing that may strike fear into your heart: an audit. Even if an audit doesn’t end up being painful (to your joint bank account, that is), it’s a stressful hassle that no couple wants to deal with.
The good news is there are a lot of things couples can do to minimize their chances of being audited. If you and your spouse take a little time to learn what often sparks audits and take some wise precautions when preparing your returns, you should be able to face April 15—and beyond—with peace of mind.
Here are five things you should know about tax audits:
Work with a trusted financial advisor. The average American family pays more than one-third of its income in federal, state, and local income taxes—and even more in property taxes, excise taxes, sales taxes, and other hidden taxes, such as taxes on cigarettes, liquor, and certain luxuries. For such a substantial expense, isn’t it worth making sure that you and your spouse "get it right" the first time?
The fact is, tax laws are incredibly complicated and it’s very difficult for the average American to understand the virtually infinite ins and outs of the often arcane U.S. Tax Code. A professional tax advisor can not only help you and your spouse make sure that nothing the IRS wants slips through the cracks, he or she can also make sure that you benefit from tax strategies and don’t overpay!
Know what triggers audits. Certain items can trigger an audit: a sudden increase in income; returns missing a signature; itemized deductions that are exceedingly high, or higher than previous years or the average of others in the same tax bracket. Working in an occupation that lends itself to cash income (such as being a server or a hairdresser) or being self-employed also makes it more likely that the IRS will check up on you, as does preparing your own returns (especially if they’re complicated!).
Anytime the IRS suspects that you and/or your spouse may not be paying your full share of taxes, you can expect it to verify that all is as it should be. Even entering round, "too-perfect" numbers on your returns can arouse suspicion.
Keep meticulous records. If the government does audit your taxes, the IRS will be looking to see that all income received was properly reported and that any and all deductions were legitimate. As a result, it is imperative that you and your spouse keep complete and accurate records.
It’s especially important to keep records and receipts for areas in which people tend to, shall we say, overstate the truth. These include business travel expenses, charitable deductions, and expenses for your home office, if you or your spouse has one. No matter what you’re reporting, before you send your returns in double-check to make sure all of the numbers add up!
While it may be a bit late to put into practice this year, make it a goal to keep tax records on a year-round basis from now on (if you don’t already). Throwing relevant documents into a drawer or shoebox and then hastily assembling them just for your annual tax appointment can lead to problems. Without complete, careful records, you can lose valuable deductions by forgetting to include them on your tax return, or you may have unsubstantiated items disallowed if you are audited.
Save old returns and records. Generally, returns can be audited for up to three years after filing; however, the IRS may audit for up to six years if it discovers substantial unreported income. The three- and six-year limits start with the filing of a tax return; if no return is filed, the time limit never starts to run. In other words, if you and your spouse have failed to file a return, you can be audited and taxed at any time.
First lesson: Always file your taxes! Second, store your supporting tax return documents for at least three years, or to be on the safe side, six years. These include:
* Records of income received
* Expense items, especially work-related expenses
* Home improvements, sales, and refinances (for homes with profit potential of $250,000 for single filers and $500,000 for married filers or more)
* Investment purchases and sales information
* The documents for inherited property
* Medical expenses
* Charitable contributions (records vary with value of donation)
* Interest and taxes paid
* Records on nondeductible IRA contributions
That said, some records are worth keeping permanently, partly because of long-term needs and partly because they take up very little room. Consider permanently retaining a copy of each year’s tax return. As long as you and your spouse have correct documentation, you won’t need to panic or scramble to re-create returns if an audit does happen. It’s better to be safe than sorry. Remember, there is no statute of limitations if you never file a tax return. Therefore, if you cannot prove that you filed your tax return, you can be audited for that year at any time. I would encourage everyone to keep a permanent electronic copy of their tax returns stored on a flash drive and put it away in a secure place, password protected of course. Even better, have your tax preparer send you a PDF copy of your tax return and don’t even bother with a paper copy. This is not only eco-friendly but it will take up less space and you can store a lifetime of tax returns on a single flash drive.
If you are audited, know the difference between audit types. Not all audits are created equal. If—despite your best efforts—the dreaded a-word is directed at you and your spouse, it doesn’t necessarily mean that you’ll be subjected to a tense, line-by-line review of your return with an IRS agent. There are actually five types of audits, the least serious of which are conducted by mail, (usually) resolved easily, and do not require you to meet face-to-face with an IRS agent. If you are asked to do an office interview, the IRS probably has more serious questions for you. It’s always possible that you might just be one of the "lucky" American households chosen to undergo a random audit each year.
When you receive an audit notice of any type, I suggest contacting your tax advisor. He or she can help you and your spouse determine if the tax audit notice is correct or incorrect—which happens often, believe it or not—and advise you on how to best proceed.
If you and your spouse do fall into any category that puts you at a higher risk to be audited, don’t let anxiety prevent you from taking advantage of any legitimate tax deductions for which you qualify. Remember, the Internal Revenue Service does not require you to pay any more in taxes than the law requires. Don’t overpay Uncle Sam by not taking advantage of what you’re allowed—or even worse because of fear.
John J. Vento is author of Financial Independence (Getting to Point X): An Advisor’s Guide to Comprehensive Wealth Management, www.ventocpa.com). He has been the president of the New York City-based Certified Public Accounting firm John J. Vento, CPA, P.C., and Comprehensive Wealth Management, Ltd., since 1987. Mr. Vento is a Certified Public Accountant, a Certified Financial Planner, and has an MBA in Taxation. John has been ranked among the most successful advisors of a nationwide investment service firm and has held this distinction since 2008.
The good news is there are a lot of things couples can do to minimize their chances of being audited. If you and your spouse take a little time to learn what often sparks audits and take some wise precautions when preparing your returns, you should be able to face April 15—and beyond—with peace of mind.
Here are five things you should know about tax audits:
Work with a trusted financial advisor. The average American family pays more than one-third of its income in federal, state, and local income taxes—and even more in property taxes, excise taxes, sales taxes, and other hidden taxes, such as taxes on cigarettes, liquor, and certain luxuries. For such a substantial expense, isn’t it worth making sure that you and your spouse "get it right" the first time?
The fact is, tax laws are incredibly complicated and it’s very difficult for the average American to understand the virtually infinite ins and outs of the often arcane U.S. Tax Code. A professional tax advisor can not only help you and your spouse make sure that nothing the IRS wants slips through the cracks, he or she can also make sure that you benefit from tax strategies and don’t overpay!
Know what triggers audits. Certain items can trigger an audit: a sudden increase in income; returns missing a signature; itemized deductions that are exceedingly high, or higher than previous years or the average of others in the same tax bracket. Working in an occupation that lends itself to cash income (such as being a server or a hairdresser) or being self-employed also makes it more likely that the IRS will check up on you, as does preparing your own returns (especially if they’re complicated!).
Anytime the IRS suspects that you and/or your spouse may not be paying your full share of taxes, you can expect it to verify that all is as it should be. Even entering round, "too-perfect" numbers on your returns can arouse suspicion.
Keep meticulous records. If the government does audit your taxes, the IRS will be looking to see that all income received was properly reported and that any and all deductions were legitimate. As a result, it is imperative that you and your spouse keep complete and accurate records.
It’s especially important to keep records and receipts for areas in which people tend to, shall we say, overstate the truth. These include business travel expenses, charitable deductions, and expenses for your home office, if you or your spouse has one. No matter what you’re reporting, before you send your returns in double-check to make sure all of the numbers add up!
While it may be a bit late to put into practice this year, make it a goal to keep tax records on a year-round basis from now on (if you don’t already). Throwing relevant documents into a drawer or shoebox and then hastily assembling them just for your annual tax appointment can lead to problems. Without complete, careful records, you can lose valuable deductions by forgetting to include them on your tax return, or you may have unsubstantiated items disallowed if you are audited.
Save old returns and records. Generally, returns can be audited for up to three years after filing; however, the IRS may audit for up to six years if it discovers substantial unreported income. The three- and six-year limits start with the filing of a tax return; if no return is filed, the time limit never starts to run. In other words, if you and your spouse have failed to file a return, you can be audited and taxed at any time.
First lesson: Always file your taxes! Second, store your supporting tax return documents for at least three years, or to be on the safe side, six years. These include:
* Records of income received
* Expense items, especially work-related expenses
* Home improvements, sales, and refinances (for homes with profit potential of $250,000 for single filers and $500,000 for married filers or more)
* Investment purchases and sales information
* The documents for inherited property
* Medical expenses
* Charitable contributions (records vary with value of donation)
* Interest and taxes paid
* Records on nondeductible IRA contributions
That said, some records are worth keeping permanently, partly because of long-term needs and partly because they take up very little room. Consider permanently retaining a copy of each year’s tax return. As long as you and your spouse have correct documentation, you won’t need to panic or scramble to re-create returns if an audit does happen. It’s better to be safe than sorry. Remember, there is no statute of limitations if you never file a tax return. Therefore, if you cannot prove that you filed your tax return, you can be audited for that year at any time. I would encourage everyone to keep a permanent electronic copy of their tax returns stored on a flash drive and put it away in a secure place, password protected of course. Even better, have your tax preparer send you a PDF copy of your tax return and don’t even bother with a paper copy. This is not only eco-friendly but it will take up less space and you can store a lifetime of tax returns on a single flash drive.
If you are audited, know the difference between audit types. Not all audits are created equal. If—despite your best efforts—the dreaded a-word is directed at you and your spouse, it doesn’t necessarily mean that you’ll be subjected to a tense, line-by-line review of your return with an IRS agent. There are actually five types of audits, the least serious of which are conducted by mail, (usually) resolved easily, and do not require you to meet face-to-face with an IRS agent. If you are asked to do an office interview, the IRS probably has more serious questions for you. It’s always possible that you might just be one of the "lucky" American households chosen to undergo a random audit each year.
When you receive an audit notice of any type, I suggest contacting your tax advisor. He or she can help you and your spouse determine if the tax audit notice is correct or incorrect—which happens often, believe it or not—and advise you on how to best proceed.
If you and your spouse do fall into any category that puts you at a higher risk to be audited, don’t let anxiety prevent you from taking advantage of any legitimate tax deductions for which you qualify. Remember, the Internal Revenue Service does not require you to pay any more in taxes than the law requires. Don’t overpay Uncle Sam by not taking advantage of what you’re allowed—or even worse because of fear.
John J. Vento is author of Financial Independence (Getting to Point X): An Advisor’s Guide to Comprehensive Wealth Management, www.ventocpa.com). He has been the president of the New York City-based Certified Public Accounting firm John J. Vento, CPA, P.C., and Comprehensive Wealth Management, Ltd., since 1987. Mr. Vento is a Certified Public Accountant, a Certified Financial Planner, and has an MBA in Taxation. John has been ranked among the most successful advisors of a nationwide investment service firm and has held this distinction since 2008.
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