You may be a regular taxpayer but that doesn’t guarantee you a life without income tax audits related to Income tax and auditing is considered to be an important affair in the US.
According to CNN, in 2007 the Internal Revenue Service or the IRS inspected individual tax returns of almost 1.4 million people which comprises almost 1% of the total individual tax returns filed.
In 2006, the IRS carried out income tax audits of 1.29 million individuals. When the two consecutive years are compared, it is seen that income tax and auditing activities have been increased by the IRS to keep unpaid amounts under check.
People falling under high-income groups often face the brunt of frequent audits. According to the Associated Press, in 2006 almost 6.25% of taxpayers having an income of $1 million or more were audited by the IRS.
An income tax audit is a scrutiny of the tax returns you have filed. The IRS examines the files thoroughly and points out in case of any discrepancies. If any data doesn’t add up, the IRS reaches out for an explanation for the item. Depending upon the examination, it is determined whether the taxpayer owes money or he is clear.
Income tax audits may sound like a strenuous affair but not when you know the know-hows. To start with, the various kinds of income tax audits; how to deal when you are served with an audit notice; what not to do to stay away from matters related to income tax and auditing.
If you want to prepare yourself for an income tax audit, it is important to know the various types of audits. They are:
1. Correspondence Audit
The Correspondence Audits attend to the most usual problems related to tax files. These include missing schedules and forms, mathematical errors, and illegal entries.
In case you are faced with such audits, it is wise to respond to the IRS with all necessary documents or justifications the IRS has asked for. The documents may include statements of a home mortgage, tax returns, statements of brokerage, receipts, records of the retirement account, and pay stubs.
2. Field Audit
Field audits refer to the visit by the IRS to your office or home in order to substantiate the data on your income tax return. Suppose you have mentioned an enormous amount of printer ink on your files, a field examiner may visit your area questioning about its usage.
3. Office Audit
If you receive a notice on the office audit, you have to go to the IRS examiner’s office. Your lawyer or tax preparer needs to provide all essential documents needed to back up your income tax return.
After the examination, a 30-day letter will be provided to you in hand or via mail. This letter contains the examination results, the changes the IRS wants to make on your files based on the final report, a clarification about your right to appeal. It also contains a user-friendly publication titled ‘Your Appeal Rights and How To Prepare a Protest If You Don’t Agree.’
Considering the 30-day time slot, go through and sign the report of the examination only if you find the IRS to be correct. In case of any disagreement, appeal the findings before 30 days. Cases handled by the Appeals officer of the IRS may take a year or more than that.
Post-appeal, the IRS serves another 90-day notice to appeal to the tax court if there is any dispute in the findings of the appeals officer. However, in most cases, audits don’t reach the tax court and are settled beforehand.
It is advisable to scrutinize the findings of your appeal and be sure. The interest stems from the time you have filed your tax returns and not from the auditing date. Thus, if the IRS examines your tax returns from two years back and if there is any discrepancy from your end, you will have to pay a hefty amount which includes unpaid dues, the interest of those two years plus late payment fine.
However, it’s not impossible to stay away from income tax audits. Here’s how:
The IRS uses a software called the Discriminant Inventory Function System. This software looks for inconsistencies in your income tax returns. Based on its research, a score is assigned to each file and that decides whether the IRS will conduct an auditing.
Pay-hikes or self-employment is unavoidable but keeping in mind a few things may help you to avoid income tax audits.
Keeping Good Records
Auditing comes with a limitation of three years from the date of your income tax return filing. Keeping good records helps to keep income tax audits at bay. However, auditing can be carried out on fraud cases at any time and the statute of limitations doesn’t apply in such cases.
Explain and Justify Yourself
Keep a proper explanation ready for all the receipts you have included in your income tax returns. For example, if you include a receipt of a trip to the bowling alley under business expense, ensure you have a justifiable reason behind it.
Spending Money doesn’t Give Way to Deduction
Neither overdo nor estimate your deductions, more so if you are self-employed.
Look Out for Tax Softwares
A tax software is perfect for a minimal amount of income. If you fall under deductions and complex income sources, it’s best to consult with a tax professional.
Scrutinize your tax files if you find a huge gap between your tax liability and that of the country’s.
A Tidy Tax Return File
File a neat income tax return and auditing can be avoided.
Check your Return
Rectify mathematical errors before filing an income tax return.
It’s best to keep yourself in the good books but the chances of being audited are not zero. However, punctual filing of tax returns and clearing off dues on time can help you to stay off the radar of income tax audits.