As you thumb through the mail one day, an unassuming letter catches your eye. Return address: The IRS. You nervously tear open the envelope and your worst fears are confirmed: The IRS has chosen your return for a correspondence audit.
How do you beat an IRS audit?
Create an audit-proof return
Obviously, the best way to beat an IRS audit is to avoid one in the first place. A few smart moves when you prepare your return can save you a boatload of trouble later.
Of all returns audited, IRS computers select about 75 percent using mathematical formulas that predict which returns have the highest probability for unpaid taxes. If the IRS flags your return, it goes to an IRS "classifier" who checks for reasons why your return doesn't conform with averages.
Ensure that your company won't face an IRS audit this year with our all-time best-selling tax guide: Audit-Proof Your Small Business
Here are 5 tips to help prevent your return from waving red flags:
1. Make sure your reported income seems sufficient to support the deductions and exemptions you're claiming. Simply put, you must have enough money coming in to cover the amount going out. If you don't appear to pass this test, it could be an indicator of unreported taxable income.
2. Watch out for large refunds that raise eyebrows. Taxpayers typically don't prepay a lot more taxes than they owe. So, be prepared to back up your claims if you're in line for an unusually large refund.
3. Don't round off deductions to the nearest hundred or thousand. Round numbers make it appear that you're "guesstimating" the figures. Provide the actual figures from your records.
There are 15 triggers that signal trouble to the IRS. Find all of them...
4. Itemize deductions on Schedule A, if you're self-employed. Small business owners who report a high income, show a small profit and take the standard deduction—instead of itemizing—on their personal return are practically waving a red flag in front of the IRS. The suspicion is that you're burying personal expenses in the purported business write-offs listed on Schedule C.
5. Beware of other red flags that could raise eyebrows at the IRS, including large travel and entertainment (T&E) expense deductions, any amount of underreported income, unusually high itemized deductions, losses from a sideline business and early retirement plan distributions.
Key point: Never pass up a bona fide tax deduction or credit just because you fear it may ring audit bells at the IRS. Just make sure you have the records to prove it.
Does filing an amended return draw extra IRS attention? The tax experts are split on this issue. But it's not worth filing an amended return if you will gain an insignificant amount of money. If you legitimately missed a big-ticket deduction, go ahead and file an amended return as long as you have the proof.
Audit-Proof Your Small Business will give you pointers on:
- Knowing the best (and worst) places in the country for an IRS audit
- Conducting your own IRS audit using the IRS auditors’ official playbook
- Aligning your deductions with industry averages
- Knowing which records to save, and for how long
- Using an IRS private letter ruling to protect your interests – without paying the IRS a $500 fee
- Stopping an audit in its tracks with a Taxpayer Assistance Order. An experienced advocate can request one and the IRS will pay for it.
- Avoiding paying an extra 20% on what you owe (the secret’s in ditching the negligence penalty)
- Improving your position if you get notice of an audit. It helps to respond faster than the IRS requests.
- Taking advantage of the pressure auditors are under to end meetings and close cases quickly
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