I often get referrals of people who have not filed their tax returns in several years or who have received letters from the IRS that they are being audited.
More Americans than ever may be subject to unwanted attention from the IRS this season as the IRS is under severe pressure from Congress. Last year the IRS struggled with budget cuts. Congress is very unhappy about the lack of funds used for customer service, which last year was at an all-time low, and tax collection.
Being meticulous with your tax return may seem obvious, but many people aren’t careful enough. And with the IRS seeking to collect every penny it can this year, you could end up paying for even the smallest mistakes.
Unfortunately, the IRS doesn’t reveal its highly confidential secret formula for selecting returns for an audit. Here are some tips to substantially decrease your chance of being selected:
- Self-employed? Be ready to prove it.
- Do you have overseas bank accounts? You better disclose them.
- Selling stocks? Make sure your cost basis is correct.
- Making a donation? Be sure to get a receipt.
- Are you a high earner? Better seek professional help.
Self-employed? Prove it’s legit.
With a record-high jobless rate, many Americans have turned to self-employment, making the IRS increasingly skeptical of the legitimacy of home-based businesses.
More people are trying to turn hobbies into businesses in order to bring in a little extra money, but this won’t fool the IRS. In order to prove that your business is legit, you need to keep consistent and accurate records of income and expenses, maintain a separate bank account for the business, register the business with the proper authorities and make sure you have a good tax accountant.
An activity is considered a for-profit business if the gross income for any three of the most recent five years exceeds the deductions taken for the activity. If the IRS determines that a business is not engaged in for-profit, you will only be allowed to deduct an amount that does not exceed your gross income.
High expenses of self-employed individuals will also provoke suspicion from the auditor, who will look closely at travel, entertainment and automobile expenses relative to an individual’s income.
Overseas bank accounts? ‘Fess up.
As the government continues to crack down on offshore bank accounts, deposits abroad are likely to catch an auditor’s eye this year.
The IRS will spend most of its resources going after people with the largest deposits, but all taxpayers with foreign accounts should take precaution and comply with the rules in order to avoid huge penalties.
Make sure you indicate on your tax return if you have one, and make sure you include any interest income from that bank account on your return. You must also report foreign bank deposits that exceed $10,000 at any point during the year on Form 90-22.1.
Selling stocks? Careful with your cost basis.
Remember those stocks your grandmother gave you a long time ago? If you sell them, you will need to track down the original purchase price, no matter how far back the transaction was. Reporting an unreasonable stock value on your return can easily trigger lots of problems from the IRS.
Knowing the date a stock was purchased is crucial since it determines the cost basis–the cost of the original purchase including commissions and adjustments like stock splits–and ultimately tells the IRS how much profit you made when you sold it.
Think twice before guessing the original value. It’s important to determine the actual purchase price, whether it means verifying with your broker, hiring an accountant or calling up a relative that might also have received stocks as a gift.
Making a donation? Get a receipt.
Declaring unusually large charitable donations as deductions on your tax return is another danger zone–especially if the amount donated is high relative to your income.
The IRS seems to be stepping up its investigations of both cash and non-cash donations this year.
However, determining the value of non-cash items such as artwork, cars, clothing and furniture can be difficult. For smaller items, you’ll need to assess the value yourself, usually based on resale value at the time of donation. For most items valued over $500, the IRS will require a qualified appraisal.
Make sure you have the receipt when taking a charitable deduction, and for any donation of more than $250, be sure to get a letter from that charitable organization.
High earner? Hire a pro.
Because high earners have more income and more deductions on their returns, such as businesses, second homes, stock transactions and charitable contributions, the chances of miscalculation or inflation are much greater. The more money a person makes, the more valuable those errors become to the IRS. Your chances of being audited increase as your income increases.
Wealthy taxpayers should triple-check everything and be mindful of careless omissions and inaccurate numbers, especially when reporting items that the IRS receives copies of as well, such as dividends. Hiring an accountant can be a smart move. The more complicated a tax return, the more cost-effective hiring professional help becomes.
Adopted from an article by Blake Ellis, staff reporter CNNMoney.com 2/16/10