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There Are Some Not-So-Smart Ways to Attract an Audit, or Other Unwanted Scrutiny, From the Tax Enforcers
With increased computer power and more money for staff from the Obama administration, the IRS is gearing up to intensify its audits of individual taxpayers. High income alone is far from the only factor triggering an audit: Last year only 6.4% of the nation's 440,000 highest-income filers were audited.
That means there are steps you can take -- or in some cases, not take -- to minimize the chance of getting audited. Many of the precautions revolve around the wisdom of that old Japanese proverb, "The raised nail gets hammered down." The less attention you can draw, the less likely you are to get audited.
A lot of this is very simple stuff. For instance, make sure that all the Forms 1099 you've gotten for dividend, interest and other investment receipts are reflected somewhere on your tax return, usually on Schedule B. IRS computers have gotten better at matching the copy of the 1099 sent to the agency with your return, and noting any omissions on your return. The result of a mismatch might be a CP-2000 letter from the IRS giving you 30 days to explain the discrepancy, or even the start of an IRS audit.
If you're claiming big deductions for gifts to charity, be sure you meet congressionally ordered paperwork requirements. Those include having a receipt or paper proof for each donation, no matter how small, and written acknowledgment from each charity for every donation of $250 or more. In the case of these larger donations a canceled check won't do -- you must have the charity's letter in hand before you file the return. The IRS is now asking for such paperwork in "correspondence audits" and then denying otherwise valid deductions because of missing or untimely paperwork.
Hobby losses are another favored IRS target. Last year the IRS issued to its agents a manual about how to look for hobby losses, in which taxpayers improperly underwrite their fun and games activity -- say, butterfly collecting or bowling -- by labeling them as businesses and claiming a loss on a Schedule C for self-employment. Any Schedule C listing a loss is audit bait, especially if it looks like you were having a good time.
There's nothing wrong with doing your own return, especially with the help of a computer program like Intuit's (NYSE: INTU - News) TurboTax or H&R Block's (NYSE: HRB - News) At Home, so long as you have the patience to do it. But if you use a tax preparer, find one who is reputable.
The IRS, which is finally moving to regulate the field, has all but admitted it keeps a list of preparers it considers dodgy, but won't tell you who those bad apples are. So be wary of tax pros who base their fees on a specified cut of the refund, claim they can get you bigger refunds than others, or suggest you write off that butterfly collection or claim a credit you're probably not entitled to.
This also may seem like a no-brainer, but do not claim you owe no taxes because the tax system is voluntary, or receipt of Federal Reserve notes isn't income, or you have a Fifth Amendment right against filing self-incriminating tax returns. The IRS considers these frivolous arguments worthy of penalties, which the courts have supported. Ask actor Wesley Snipes, now appealing his three-year sentence for willfully failing to file tax returns.
At the same time, don't shoot off your big mouth about how you put one over the IRS, even if you did. The IRS is now authorized to pay big bucks to people who rat you out. You don't want to end up a convicted tax felon like Orange County billionaire Igor Olenicoff.
Here are some ways to attract unwanted attention from the IRS:
Leave Out 1099 Income
One thing IRS computers have gotten a lot better at doing is matching the various varieties of Form 1099s issued for dividends, interest and the like with what's shown on your term. A mismatch, even a small one, can trigger a letter from the IRS and maybe further scrutiny. Make sure you account for all the 1099s you received.
Deduct Your Butterfly Collection
The IRS keeps a sharp lookout for hobby losses, efforts by taxpayers to subsidize their recreational activity by calling it a business and claiming a loss on Schedule C. The agency just issued a manual to its agents on what to look for.
Claim Big Charitable Gifts
New rules require you have a written statement listing the amount of each claimed contribution, and that you have it at the time you file your return. It's pretty easy for the IRS to start an audit by mail asking for the proof--then disallowing your charity, even if you get proper paperwork, for your being late.
Use Round Numbers on Schedule A Deductions
To the IRS, $2,979.68 looks a lot more real than $3,000.00. This is especially true on the Schedule A deduction form, where the agency gets relatively little paper verification from elsewhere. Entries ending in a bunch of zeros are not your friend.
Don't Sign Your Return
Your John Hancock--a clicked box if electronic, an actual signature if on hard copy--subjects your return to the laws of perjury, and its absence, even if inadvertent, is always noted by the IRS. At a minimum the agency will reject the return for processing and might claim it wasn't filed on time, and therefore is subject to penalties.