Tip of the Month for November 2004

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TIP: Play It Safe - Avoiding An Income Tax Audit
There’s nothing you can do to avoid random selection for a tax audit, but there’s plenty you can do to minimize the likelihood that the taxman will select your income tax return for special scrutiny.

Here are a few tips to help you avoid this:
  1. Report all income. This sounds obvious, but a hastily filed return that omits income information will cause the Internal Revenue Service (IRS) to zero in for a much closer review. Remember that the IRS receives reports on all publicly disseminated income data - W-2 forms, interest and/or dividend statements and 1099 forms. With this in mind, get your paperwork in order, and be thorough. Sounds simple? Perhaps not. Complications abound for this year’s filing. New tax laws regarding dividend income and the pending status of the bill to rebate state sales taxes are just two of the new issues facing this year’s filers. Your professional tax advisor can help resolve these issues and other concerns.

  2. Watch your deductions. If you file a Schedule A form and list itemized deductions - business expenses, medical costs, charitable contributions, etc. - remember that personal expenses do not count as write-offs. Unusually high deductions will set off an audit. The IRS won’t quantify what levels tend to lead to an audit, but tax experts believe that claiming 30 percent, or more, of adjusted gross income is risky. Whatever the amount you deduct, keep records of donations and receipts for deductible expenses. Make sure you follow the rules regarding medical costs (claiming only those costs that exceed 7.5 percent of your adjusted gross income).

  3. Keep thorough records. All tax filers should keep good records, but some have more incentive to do so than others. If you file a Schedule C, you are about 3 times as likely to be audited as taxpayers filing a regular return. Those are not good odds. If you are self-employed, or a freelancer, be prepared to back up your numbers with records. For clues as to what the IRS "expects" to see and what might prove to be a "red flag," check out the guidelines that the IRS provides its agents regarding "typical" expenses and earnings for various professions. Your tax advisor can help you locate these.

  4. Check your return carefully and address errors. A mistake is a mistake, and the IRS generally does not mitigate the interest payments and penalties it seeks for "genuine" mistakes. However, there are exceptions. If you can show reasonable cause for the error, the IRS might waive interest and any other penalties. If you have concerns about past errors, consult your professional tax advisor, who can counsel you on amending an earlier return, and can help you avoid future problems.

  5. Smart taxpayers play it safe. They keep good records, disclose all income, and can back up deductions with appropriate documentation. And, if in doubt, remember that a professional tax advisor is your best source for up-to-the moment insight and advice on income tax issues.


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