The Tax Man Cometh

10 Feb

Sure, it’s early February, but before you know it April 15th will be closing-in fast.

Whether you decide to get an early start on things, or wait until the last minute – here’s some sage (and abridged) advice on taking steps to greatly reduce your chances of being flagged, and potentially audited [from The Wall Street Journal]:

1. Choose your preparer with care

+ Tax return preparers face more intense IRS review
+ Refer to the IRS’ eight tips for choosing a tax preparer

2. Report all of your income

+ This includes W-2s and 1099s, which the IRS cross-checks
+ If the information doesn’t match, this leads to an automatic audit

3. Provide complete information

+ All questions should be answered and all required information should be included
+ If information is missing, it could trigger a more extensive look at the return

4. Avoid claiming deductions that are audit red flags

+ The IRS does not say which deductions are likely to provoke a closer look; there are no official audit red flags
+ If you meet the qualifications for claiming a home-office deduction, there’s no good reason not to take the write-off; check your eligibility in IRS Publication 587, Business Use of Your Home
+ A business entitled to deductions, even if they are high relative to the amount of their income, should claim them—and be prepared to prove entitlement if the return is questioned

5. Don’t file certain forms or schedules

+ Some optional forms and schedules virtually guarantee an audit
+ If you have loss years, be prepared to prove that you are operating the activity with a profit motive

6. Pay attention to details

+ Math errors or incorrect entries of Social Security numbers or tax identification numbers can easily trigger an inquiry into your return
+ File electronically; errors are less than 1% on returns that are filed electronically, compared with about 20% on returns submitted via paper

7. Mind your personal entries

+ This can ultimately lead to scrutiny of your return activities
+ The IRS selects returns for audit in some cases based on a Discriminant Function System or DIF score, which is based on IRS experience with taxpayers claiming certain deductions or credits within set income levels

8. Change your business status

+ IRS Statistics show that you are 10 times as likely to be audited as a Schedule C filer than if you incorporate your business and elect S corporation status
+ While it’s slightly more costly to incorporate, it gives you greater personal liability protection and reduces your chances of being audited
+ In deciding whether to change your business status, include both tax and non-tax factors

Note: Forming a limited liability company for one owner will not give you any audit protection, because the owner still files a Schedule C.

9. Watch your state tax return

+ The IRS has information-sharing agreements with the states
+ State level audits that owe additional taxes because of omitting income or for other reasons, are shared with the IRS
+ The IRS may then contact you asking for additional tax payments or to audit your return in more depth

10. Plan for an audit, just in case

+ Because the IRS conducts random audits from time to time any return could be selected for review at any time.
+ Compile good books and records for your business activities
+ Retain required receipts and other documentation
+ Use separate bank accounts and credit cards for your business and personal activities
+ Retain the records and receipts for your tax return for a minimum of three years (the period in which the IRS usually has to audit a return)

[Barbara Weltman via The Wall Street Journal | Small Business]

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