In part one Wednesday, Martin addressed. He discussed some new tax breaks, as well as others he says you shouldn't miss.
In part two, he tells how to stay off the IRS audit list, and in part three, he'll offer advice on putting your tax refund to work for you.
Just about everyone who's ever filled out a tax return has thought about what would happen if the Internal Revenue Service called them in to talk about it.
Here, financial adviser Ray Martin tell us how to avoid a tax audit.
Reducing the Chance of an IRS Audit
The IRS Office Audit, in which every receipt and line item on your tax return is scrutinized, actually only makes up a small portion of audits.
Instead, the IRS uses several computerized scoring and checking programs to select returns for audit.
First, the IRS runs some tax returns through a computer selection process called Discriminant Function System. This process basically assigns a number value to certain items on a tax return. If the total score of all the values exceeds a minimum score set by the IRS, the computer will single out the return for an audit. The return will be assigned to an IRS agent who will check it and determine if the return is worth conducting an audit on.
This scoring process is a closely guarded IRS secret. What is known is that some of the items that raise the audit score include income not subject to withholding tax, large deductions when reported income is low, an unusually large number of dependent deductions, and discrepancies such as a change of address without reporting a change of home-related deductions.
The majority of tax returns audited are through Correspondence Audits, which are the result of computer scanning of returns for errors and compliance with reporting requirements. When errors are found, a computer-generated letter is sent to the taxpayer. It includes an explanation of the problem, the proposed correction and tax, and how and when to respond. If you want to reduce your chances of this type of audit, then you need to know what can lead to one..
Audit Triggers to Avoid
Incorrect Data: The most common factor prompting the IRS to flag individual returns is incorrect reporting of Social Security Numbers of filers and dependants. Incorrect tax return reporting of income and taxes paid from forms W-2 and 1099 also are a surefire way to set off IRS computers.
Filing Late: Not filing returns on time or not filing for a particular year will catch up to you. Instead, file a form a Form 4868, Application for Automatic Extension for Time to File U.S. Individual Income Tax Returns. This must be filed no later than April 17. While this gives you an automatic four-month extension, until August 17, to file your return, it does not give you an extension to pay any taxes due. Filing an extension does not make your return more likely to be selected for audit.
Paying Too Little: If you do not have the money to pay the taxes due, don't just send in a lesser amount without an explanation. This will trigger an IRS notice and it could also lead to a more invasive IRS review of your return. Instead, file Form 9465, Installment Agreement Request with your return. You'll still have to pay interest and possibly a late payment penalty for any taxes not paid by April 17. However, the IRS will work out a payment plan for up to 60 months at a lower interest rate for the balance that you owe.
Math Errors: These are also high on the list of audit triggers. Using a tax professional or a computer program to prepare your return should help you avoid this problem.
Also, certain combinations, such as not reporting some gains on the sale of a home when business-use-of-home deductions were claimed on past returns will trigger an IRS flag. Also, reporting large amounts of self-employment income, typically in excess of $100,000, on Schedule C seems to get the IRS' attention. According to the IRS, often these filers load up on dubious deductions and have fewer records justifying the write-offs they claim.
And be sure to use the mailing labels and envelopes provided to you by the IRS. This will prevent another common tax filing error: sending your tax return to the wrong IRS processing center.