First thing’s first: don’t worry. You will probably never face a tax audit, because an audit is actually a rare occurrence. Did you know that each year not even 2% of all tax returns are audited (or “examined”, as the IRS likes to put it)? There are “red flags” that trigger some audits, but a lot of audits are the result of random selection by the IRS. It’s sort of like how airplane passengers get randomly screened in an airport by TSA workers.
Good Record-keeping: The Front Line of Audit Defense
Even if your tax return doesn’t raise any red flags, there is always a small chance that it will be randomly selected by the IRS for examination. Therefore, it is a good idea to keep good tax records. You should hold onto all of your tax-related documents–anything that supports what you report on your tax return–for at least 3 years after you file a return. You might want to keep your records longer, but the IRS generally has only 3 years to audit a tax return, unless suspicion of tax fraud is involved. This 3-year period begins on the day you file your tax return. But if you file early, the period begins on the day of the actual tax deadline.
Records are an essential part of tax planning and preparing for the possibility of audit. Of course, even if you are never the victim of an audit, there are still good reasons to keep your tax records in order. Congress has been known to retroactively introduce a tax break from time to time, and you may need to produce documentation in order to claim it on an amended return. Or you may need to file an amended return to claim a tax credit that you missed when you were preparing your original return. In that case, you have 3 years to file an amended return and get a new refund check. But after 3 years, any unclaimed refund is forfeited.
Here are some examples of tax-related documents you should keep in your records:
- Pay stubs
- Old tax returns
- Tax information forms (W-2′s and 1099′s, etc.)
- Mortgage statements
- Receipts from charities
- Receipts (or statements) from childcare facilities
- Credit card statements
- Canceled checks
- Medical bills
- Vehicle mileage logs
- Self-employment business records
- Gambling journal
If you are worried about becoming a hoarder because of the stacks of paper you have collected, you can always just scan your documents and save the digital files. But remember to back up your computer regularly!
Audit Defense No. 2: File Electronically (efile)
When you file your tax return online, you can drastically reduce your chances of being audited. A lot of red flags are raised by mistakes in calculation or by errors of omission. When you prepare your tax return online, the tax software will check your return for omissions and errors before you efile. According to the IRS itself, efiled returns have only a 1% error rate–compared to a 20% error rate for paper returns!
Potential Audit Red Flags
Certain things reported on an income tax return have been seen to increase the chances of examination by the IRS:
- Itemized deductions (above the average amount for your income level)
- Schedule C self-employment losses
- Large home office deductions
- Large charitable deductions
- Rental losses
- Casualty losses
- Drastic increases in income from the prior year
- Income over $100,000
The Biggest Red Flag for Audits
Unreported income is the one thing that is most likely to lead to an audit. During processing, the IRS will match the figures on your tax return with all of the W-2s, 1099s, and other information that has been reported to them. The IRS is very good at ferreting out unreported income, and they will audit your return, or at least send you a nice letter asking for clarification (a CP-2000 notice). Remember that the IRS has 3 years to audit any return without suspicion of outright tax fraud.
Audit Defense No. 3: Your Right to Appeal
I know it might be hard to believe, but even the IRS can make a mistake from time to time. That is why you have the right to appeal the results of an audit. If you disagree with the IRS “adjustment” (new tax bill) after a flawed audit, you can file an appeal. This kicks into motion the process known as “audit reconsideration”. Audit reconsideration will be a lot easier if you have the documents to substantiate your case. If you ever have to file an appeal, you will find good tax records to be your greatest ally.
Who’s Afraid of the Big Bad Audit?
So, if you ever find an audit notice in your mailbox, don’t panic! With good tax records at your disposal, you can face the challenge head on. Don’t be afraid to present your case and to file an appeal if you need to. Just don’t forget to breathe!
Paul works and writes for efile.com, a company that provides an online platform for tax return preparation and secure efiling. They aspire to be a less expensive and more user-friendly alternative to the big online tax companies, with all of the same capabilities and more benefits.
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