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by Barbara Weltman

Friday, April 15, 2011

provided by

Worried about extra scrutiny from the Internal Revenue Service?

While you can never completely "audit-proof" your business's income tax return, you cantake actions that will greatly reduce your chances of being flagged.

Here are 10 ways to avoid a tax audit:

1. Choose your tax return preparer with care. Today, according to the recent NationalTaxpayer Advocate report, 60% of individuals and even a greater percentage ofbusinesses use paid preparers to do their income tax returns. Yet, preparers now facemore intense IRS review. If the IRS believes a preparer is claiming unwarranteddeductions or taking other fraudulent steps on clients' returns, then the preparer's clientsare at risk for audit.

The IRS has eight tips for choosing a tax

preparer. Key among them is to check thepreparer's history to see if there has been anydisciplinary action. For example, if you use anenrolled agent, check with the IRS' office ofProfessional Responsibility at [email protected] (include the preparer's name and address).

2. Report all of your income. The IRS usesinformation returns, such as W-2s and 1099s, tocross-check income reporting. Under itsdocument-matching program, the IRS' computerscompare information on the forms with the incomereported by taxpayers on their returns. If theinformation doesn't match, this leads to an automatic audit. But don't panic; it's merely acorrespondence asking about the discrepancy. It can be easily cleared up by submittingan explanation by mail if you think you are correct, or paying the tax owed if the omissionwas your oversight and the IRS is correct.

Sole proprietors, freelancers and independent contractors who use the cash method ofaccounting may be vulnerable to year-end payment problems. For instance, a soleproprietor that performed work for a client may have received a payment in early January-- but the client might have mailed (and recorded) the payment in December. The clientwill include the payment on Form 1099-MISC for 2010, but it isn't taxable until 2011.What to do: Include the payment as it is reported on the 2010 return, but then subtractthe payment and attach an explanation with the return. Then include the payment on the2011 return, even though no 1099 will be issued for this year.

[More from WSJ.com: IRS Announces Tax Refund 'App' For iPhone]

3. Provide complete information. All questions should be answered and all requiredinformation should be included on the forms and schedules necessary for your return.That means if you're a sole proprietor, include your business code number, accountingmethod, and, where applicable, inventory valuation method on Schedule C. If informationis missing, it could trigger a more extensive look at the return.

Also add information where necessary to explain entries or omissions that are not easilyunderstood -- such as in the prior example, when income received in January is reportedon a prior year 1099.

4. Avoid claiming deductions that are audit red flags. This advice is easy to give, but

unfortunately, the IRS does not say which deductions are likely to provoke a closer look.There are no official audit red flags. While many warn that claiming a home officededuction can prompt an audit, there's no proof of this. If you meet the qualifications forclaiming a home-office deduction, there's no good reason not to take the write-off. Checkyour eligibility in IRS Publication 587, Business Use of Your Home.

A number of years ago, the Government Accountability Office (formerly the GeneralAccounting Office) compiled statistics on deductions claimed by sole proprietors to showthe types of deductions relative to the amount of their revenue. Some tax professionalsbelieve that taking more than the "average" can raise an IRS eyebrow, but again, there isno concrete support for this view. A business that is entitled to deductions, even if theyare high relative to the amount of their income, should claim them -- but be prepared toprove entitlement if the return is questioned.

[More from WSJ.com: Tax Refunds Move to Debit Cards]

5. Don't file certain forms or schedules. Some optional forms and schedules virtuallyguarantee an audit. For example, if you turn a hobby into a sideline and show a businessloan, the IRS may question whether some of your deductions are legitimate. If thathappens, you might file a Form 5213, which keeps the IRS from auditing you for the first

five years of the business. If you can show that you're profitable in at least three of theyears, then the business isn't a hobby and the losses in the other years aren'tquestioned. The problem: Filing the form virtually guarantees an examination at the endof five years.

10 Ways to Avoid a Tax Audit

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4/17/2011http://finance.yahoo.com/taxes/article/111960/avoid-tax-audit-wsj?mod=taxes-advice_ ...



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Better way: If you have loss years, be prepared to prove that you are operating theactivity with a profit motive.

6. Pay attention to details. Math errors or incorrect entries of Social Security numbersor tax identification numbers can easily trigger an inquiry into your return. Math errors canbe greatly reduced by electronic filing rather than filing paper returns. In the past, the IRShad said that errors are less than 1% on returns that are filed electronically, comparedwith about 20% on returns submitted via paper. If an e-filed return has a math error, itwon't be accepted; instead it is sent back for correction and refiling.

But information on electronically filed returns is only as good as the information yousubmit. Reporting $2,000 in income when it should have been $20,000 is your mistake

and one that likely won't be noticed as a math error by a computer.7. Mind your personal entries. If there are entries related to the personal side of yourreturn, this can ultimately lead to scrutiny of your return activities. The IRS selects returnsfor audit in some cases based on a Discriminant Function System or DIF score, which isbased on IRS experience with taxpayers claiming certain deductions or credits within setincome levels. For example, if you claim charitable contributions that are higher than theaverage deductions for your income level, this could lead to a personal audit; thepersonal audit may be expanded to include your business activities.

[More from WSJ.com: How Uncertainty Cripples Us]

8. Change your business status. IRS Statistics show that you are 10 times as likely tobe audited as a Schedule C filer than if you incorporate your business and elect Scorporation status. While it costs a bit of money to incorporate, the move affords yougreater personal liability protection and reduces your chances of being audited. Indeciding whether to change your business status, include both tax and non-tax factors.

Note: Forming a limited liability company for one owner will not give you any auditprotection, because the owner still files a Schedule C.

9. Watch your state tax return. The IRS has information-sharing agreements with thestates. If you are audited at the state level and owe additional taxes because of omittingincome or for other reasons, this information is shared with the IRS. The information maythen prompt the IRS to contact you asking for additional tax payment or to audit yourreturn in more depth.

10. Plan for an audit, just in case. Because the IRS conducts random audits from timeto time (such as a three-year random audit program for S corporations in 2007 and acurrent three-year random audit program for employment tax returns), any return couldbe selected for review at any time. Be prepared:

• Compile good books and records for your business activities.

• Retain required receipts and other documentation.

• Use separate bank accounts and credit cards for your business and personal activities.

Retain the records and receipts for your tax return for a minimum of three years (theperiod in which the IRS usually has to audit a return). However, keep in mind that theperiod becomes six years if 25% or more of income is omitted from the return, and thereis no limit when it comes to fraud.

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0 0Ana 1 minute ago Report Abuse

here is an idea - how about we stop going after ppl who DO pay taxes and

go after those who DON"T!!! 50% of ppl living and working in USA are not

paying taxes AT ALL!!! But IRS does nothing about them, instead it goes

after those who do pay. Even if you have all the paper to prove your

deductions and income it is such a pain in a neck to deal with them

Reply

0 0A Yahoo! User 2 minutes ago Report Abuse

Interesting that Social Security AND medicare is deemed Entitlement. If

that is what it is,,,,,,Then STOP TAKING IT OUT OF MY PAYCHECK!!!. I

think we should all be equal. That means you Mr Senator, Representative,

State and Federal. Take Social Security out of your fat checks, sign up and

pay for the expensive health care yourself that we taxpayers are now

paying for you. AND WHEN YOUR TERM IS DONE, SO IS YOUR

PAYCHECK. I dont get one for the rest of my life when I quit and neither

should you. Try to remember when you were one of us and how hard it is

to make ends meet. Especially now. Stop taking away things from us and

take a cut in your pay and benefits. Pay for your own gas and postage and

travel. How many millions would that put back into our system?

Reply

0 0ALLYN 3 minutes ago Report Abuse

Interesting that people complain that a flat tax would disadvantage the

poor, but then complain that the rich pay at a lower rate than the poor





because of all the loopholes. A flat tax has no loop holes (duhh). Make up

your mindes.

Reply

0 0AlbertW 5 minutes ago Report Abuse

WAKE THE HELL UP USA !!!!

Reply

0 0Dave 6 minutes ago Report Abuse

Number 8 is a very good recommendation. But you will have to set up a

separate set of books, bank accounts and your bookkeeping must be more

careful. Sub S Corporations DO get audited as well especially when people

co-mingle personal and business transactions in the Sub S Corp. Pay

yourself a draw, just like a paycheck. and also, do pay yourself a paycheck

to be sure you add to your Social Security earnings. AND please hire a

professional accountant to help you set it up right........ NOT A LAWYER!

Reply

0 0Ricky 7 minutes ago Report Abuse

@#$% the irs

Reply

0 0IMFEDUP 11 minutes ago Report Abuse

I see those sheep on the right are following the shepard Paul Ryan right

back into the slaughter house. They say they want to ELIMINATE

ENTITLEMENTS. Social Security and Medicare are funds taxpayers pay

into so they are ENTITLED to get that money. The Knee pad wearing

republicans are servicing the large corperations with ENTITLEMENTS

SUCH AS Paying no taxes and a bailout jsut because Bush recruits

Gueitner and Bernacki who are Goldman SAKS GOOD OLD BOYS and

the other wall street firms get rewarded for destructionof the world

economy.

Why are the corperations ENTITLED TO OUR MONEY WHENE EVER

THEY WANT IT? So whene we talk about ENTITLEMENTS open your

eyes and see who is due entitlements and who are not. Kudlow talks about

FREE MARKET CAPITOLISM IS THE PATH TO PROSPERITY. SURE IF

YOU ARE THE SUPER WEALTHY. And the sad thing is BARACK HASBECOME ONE OF THEM!

Replies (1)

0 0Carol 13 minutes ago Report Abuse

they are all crooks in DC the rich get richer and the poor poorer and the fat

cats in DC and IN PA are all the same JUST A BUNCH OF LIARS AND

THEIVES. WHO GET EVERYTHING HANDED TO THEM,THEY GET

COST OF LIVING ,DO NOT PAY FOR HEALTH INSURANCE, BIG

EXPENSE ACCOUNT AND STAFF AFTER STAF THAT GET PAID BIG

BUKS ALSO DID WE SEE THEM TAKING A PAY CUT

NOOOOOOOOO,WE PAY THE TAXES AND TEHY REAP THE

BENEFITS DO YOU THINK THEY CARE IF THEY PAY 4- 5 DOLLARS

FOR GUS HELL NO WE ARE PAYING IT FOR THEM,

Reply

0 0Paul 13 minutes ago Report Abuse

follow the rules to the letter of the law ..........just like Washington LMAO

Reply

0 0Xuan Bee 14 minutes ago Report Abuse

Interesting article ! I'am a sweet, friendly, honest (sometimes too honest),

caring girl in search of "the one".I've been single for over two years and i

wanna find an interracial mate. so i got a username Krystay2011 on

---------BlackWhite'Hub.℃'óM--------it's where to meet black, white,

gorgeous, beautiful for romance and enduring relationships ! i m serious !

------

blow, while the government got fatter and fatter. I had to spend my

retirement money just to make it by, while government employees get a

very generous retirement, not to mention outrageously high benefits. If thisoverreaching, overspending and overtaxing government is not being taken

back by the people, than it will take us all over the cliff with it. Wake up

America!





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