Tax time brings with it numerous ups and downs.
For many, doing their taxes is time consuming, can bring about numerous hours of headaches and receipt hunting, and is a constant reminder, frankly, of how taxing taxes can be in the first place. Yet for many of those who will gripe about their taxes this year, a majority of them will wind up getting money back. As we've looked at previously, more than 80% of those who file their taxes are owed a refund when all is said and done.
While I've certainly pointed out how giving a free loan to the U.S. government is one of the most common tax mistakes, there's perhaps an even greater tax misconception that's lurking out there that I come across on a nearly daily basis through various online financial news sources and from simply talking with financial-savvy friends. This misconception is a myth in every sense of the word, but I see it pop up, without fail, around this time of year.
The greatest tax misconception of them all
The greatest tax misconception of all is the notion that you can audit-proof your tax return.
It doesn't matter whether you're a blue-collar or white-collar worker, or if you own an island or rent a studio apartment -- you have at least some chance of being audited by the Internal Revenue Service. This doesn't mean there aren't income brackets that have a higher propensity to attract audits than others, but there is no such thing as audit-proofing your tax return. Period!
In 2012, according to data released by the IRS (link opens a lengthy PDF file) last year, the tax agency processed a whopping 237.3 million tax returns, including individual income tax returns that made up the bulk of filings, as well as individual estimated income taxes, S and C corporations, estate and trust income taxes, employment taxes, gift taxes, and many more. These returns generated $2.54 trillion in tax revenue, but based on IRS audits it should have generated $38.7 billion more in additional tax revenue -- and this was with an audit rate of just 1.03%!
There is truth in the idea that higher income levels do yield a higher rate of audits, and this thought process does make sense from an IRS standpoint in that it's more worthwhile to go after upper-income earners, since their errors could result in considerably more tax revenue collected.
However, another myth you can dispel is that lower-income tax filers aren't at risk of an audit. According to IRS data, 2.67% of individual tax filers claiming no adjusted-gross income in 2012 were audited, while 1.05% of people claiming earnings of less than $25,000 were audited -- both higher than the national average. In other words, this is more conclusive evidence that there is no such thing as an audit-proof tax return.
Relax! You can reduce your risk of an audit
But there is good news! While you can't audit-proof your return, you can certainly take a few key steps to reduce the likelihood of being audited.
Nothing is more crucial to reducing your chance of an audit than being honest on your tax return. Being honest is likely to result in tax figures that don't raise the eyebrows of auditors (such as an overwhelming amount of deductions relative to your claimed income, or understating your investment or business income), and it will also make your life easier were you to be audited.
One particular deduction that the IRS tends to keep its eyes on it's the Earned Income Tax Credit, which is a refund doled out to lower-income working citizens. In an average year, the IRS will divvy out $55 billion in EITC refunds, but somewhere in the neighborhood of $11 billion of those loans are considered to be fraudulent, at least according to research conducted by Sen. Tom Coburn (R-Okla.) in his annual Wastebook report. While this number is extraordinarily high, and Sen. Coburn would insinuate that the IRS is doing little to reduce EITC fraud, taxpayers would be wise to double-check whether they qualify for this refund.
Home office deductions are another big sticking point for those of you who are considered to be self-employed. Small-business owners have far more flexibility when it comes to fudging their deductions and failing to report business income than individual tax filers because their pay stubs aren't reported to the government on a weekly, bi-weekly, or monthly basis. Therefore, those who are self-employed should be smart about what sort of deductions they're claiming and should ensure they have the documentation to back up those deductions.
Finally, an easy way to reduce your chance of an audit is to e-file and use tax-prepping software. The error rate of filing your taxes on paper versus e-filing is approximately 40 times higher. In addition, tax preparation software has been designed by tax professionals to cover all your bases and will automatically check your returns for accuracy, as well as audit risk. Plus, there's virtually no chance of an incomplete or illegible form if you e-file as opposed to filling out your tax return by hand.
This is probably the smartest thing you can do to reduce your taxes this year!
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Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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