There's nothing like the word "audit" to make taxpayers quiver. If you're looking to stay off the IRS audit list this tax season, here are a few important rules to follow.
1. Report every penny you earn
That $20 in interest you received from your bank? The IRS wants a piece of it. The same goes for dividend income, capital gains, and side earnings from your freelance gigs. Any time you earn money, you're required to report it on your tax return -- even if you were paid in cash. Hiding earnings is a good way to not only get audited, but get in trouble with the law.
2. Dispute incorrect 1099 forms
Much of the time, the side income you receive will be documented on a 1099 form. Your bank, for example, will issue a 1099 summarizing your interest income for the year, while each company you do business with will give you a 1099 provided you earn at least $600. (And yes, you're still required to report your income, even if you earn less and there's no form to show for.)
Sometimes, however, companies or entities that issue 1099s make mistakes, but if your records don't match what a form is stating, you can't just enter what you believe to be the correct amount on your tax return and call it a day. For every 1099 you receive, the IRS also gets a copy, and if it detects a mismatch in reported income that works out in your favor, it will likely choose to investigate. If you spot a discrepancy on a 1099, your best bet is to reach out to the issuer and attempt to get it corrected immediately. If you can't, then go ahead and list the amount your records show, but include an explanation on your tax return so the IRS doesn't think you're trying to pull a fast one.
3. Avoid guessing at deductions
The IRS offers a number of deductions that can significantly lower your tax bill. But if you don't have impeccable records supporting those deductions, you're opening the door to trouble. That's why it's critical to track your spending throughout the year as it relates to deductions you're planning to claim. For example, if you're self-employed, you can deduct business expenses, but you'll need good records that prove you made them. The same holds true if you're planning to claim a medical expense deduction.
If, come tax season, you don't have all the information on hand that you need, do some digging before claiming those deductions. Comb through your bank and credit card statements. Reach out to medical providers who might have a record of your spending. Do whatever it takes to arrive at the most accurate figures possible, and be extra certain to steer clear of nice, round numbers. If the IRS sees that you managed to rack up precisely $10,000 in medical expenses, for example, it might get suspicious.
4. Be careful with certain deductions
Some tax deductions lend themselves to abuse more easily than others, and these are the ones you really need to be careful about. One deduction that the IRS tends to examine more closely is the home office deduction. You can take a home office deduction if you're self-employed, have a dedicated space in your home used solely for work purposes, and that space constitutes your principal place of business. But if you bend the rules or attempt to inflate your deduction (either by exaggerating your office's square footage or the expenses you write off against it), the IRS might take a closer look.
Similarly, claiming deductions for things like business meals, travel, and even charity can get you into trouble if your numbers just seem off. If you're a graphic designer, for example, and you deduct a whole bunch of meals, flights, and hotel rooms, the IRS might question whether all that travel and entertainment is really legitimate (whereas these write-offs make much more sense for someone in sales). Similarly, if you earn $50,000 a year and claim $10,000 in deductions, the IRS might get suspicious, since most people aren't able to donate 20% of their income.
5. File an electronic return
Not only will filing electronically typically get you your refund faster, but it will also reduce your chances of making a critical error on your tax return. The IRS reports that the error rate for electronically filed returns is less than 1%, whereas 21% of paper returns contain mistakes. Though the IRS is equipped to distinguish honest math blunders from outright fraud, it will also have no choice but to reject or audit your tax return if the numbers just don't seem to add up. Filing electronically can help you stay off the audit list, and if you earn less than $64,000 a year, you get the option to file online for free.
Nobody wants to get audited, but even if you are picked, there's a good chance you'll be able to settle the matter by mail. More than 75% of tax audits are conducted as correspondence audits, so the likelihood of an in-person meeting with a scary IRS agent is considerably lower than you'd think. Besides, you never know when a tax audit might work out in your favor. In 2015, the IRS gave out over $1 billion in refunds to taxpayers it decided to audit, so if you do make the list, you might actually get some cash out of it.