The chances of being the target of an IRS audit are actually fairly low. During 2016, about 0.7% of taxpayers got notices — which was the lowest rate since 2003. A big part of this is that there have been significant cutbacks at the IRS over the years.
But of course, such statistics are meaningless if you happen to get selected for an audit.
Keep in mind that higher income people have a higher percentage as well as those who operate their own businesses. And with the recent enactment of the tax reform law, there is likely to be more spending on the IRS and an increase in audits.
So then, what can you do to reduce the odds of an IRS audit?
Here are 5 tax tips to help:
Tax Tips to Avoid an IRS Audit #1: File Your Return
At the heart of the U.S. tax system is voluntary compliance. You are expected to file of a return as well as the accurately report your income. Thus, if you fail to do so, the IRS can take draconian actions. The agency may also be more prone to launch an audit.
In terms of the consequences of the non-filing of a return, they are certainly hefty. It comes to 5% of the unpaid tax bill per month, for a maximum of 25%. The IRS also can bring criminal sanctions, which could include a fine of up to $25,000 and a jail term of one year for each year you fail to file.
Tax Tips to Avoid an IRS Audit #2: Accuracy
Because of the huge volume of tax returns filed every year, the IRS relies heavily on computers. And this means looking for inconsistencies, such as with tax statements like W-2’s and 1099’s. If there is not a match, then you are guaranteed to get a letter from the IRS.
What if you did not receive a statement? According to the IRS, it does not matter. You still have to report the income.
The bottom line? Make sure you double check your tax return and go over your financial statements to ensure you are reporting everything accurately.
Tax Tips to Avoid an IRS Audit #3: E-File Your Return
E-filing your return will significantly reduce the chances of errors. What’s more, by using software from companies like H & R Block Inc (NYSE:HRB) and Intuit Inc. (NASDAQ:INTU), you will get diagnostics that point out red flags. You will get the same benefits from using a paid tax preparer, who will also have access to sophisticated software.
Oh, and another benefit of e-filing: You’ll get your refund much faster.
Tax Tips to Avoid an IRS Audit #4: Round Numbers
A big tip-off for the IRS is when a return has round numbers. It’s an indication that you do not have receipts or other documentation to back-up your deductions.
For the most part, if you cannot prove a deduction, then don’t take it. It’s really that simple.
Tax Tips to Avoid an IRS Audit #5: Hobby Or Business?
Running a small business can be challenging. During the first couple years, you may sustain losses — which is normal.
But when it comes to the IRS, the agency wants to make sure that your business is really not just a hobby. The rule of thumb is that there must be a profit for three out of the past five years. If not, all the deductions may be limited to the revenues generated, which could mean having to pay a sizable tax bill.
So if you are in a situation where you may not meet the rule, then its is a good idea to seek the help of a tax professional.
And one more note: There may be instances when you have substantial deductions — say from medical bills or a casualty loss — that will could get the attention of the IRS.
Yes, this may result in an audit.
But this does not mean you should avoid taking the deduction. The fact is that there are no fool-proof ways to completely avoid an audit. Rather, the key is that you need to have a legitimate reason for the deduction and have the necessary documents to prove it.
Tom Taulli is an Enrolled Agent and also operates PathwayTax.com, which is a tax advisory and preperation firm. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.